There is a special place of goodwill in the midst of business and taxes. In contrast to the tangible assets such as buildings, machinery, or vehicles, goodwill is the intangible worth of a company – its brand name, customer loyalty and position on the market. One of the recurring controversies in the tax and legal circles is whether goodwill should be considered as an asset which can be depreciated in order to claim deductions as provided in the income tax law. The new decisions and the legislative acts have resolved this problem: goodwill is not a depreciating property.
This blog outlines the concept of goodwill as an intangible asset, its treatment under taxation laws, and the judicial and legislative perspectives, providing a comprehensive understanding for business owners, accountants, and legal professionals.
What is Goodwill?
Goodwill is that non-financial advantage that a business has over and above the worth of its physical and financial assets. It is usually created by:
- Good customer relationships.
- Brand recognition
- Skilled workforce
- Good business location.
- Long-term contracts
Goodwill generally occurs when a firm buys another business at a price that is greater than the fair value of the net assets of the company. This overbuying cost is the cost of goodwill.
Legal Recognition of Goodwill
Legally, goodwill is treated as a capital asset under the Income Tax Act, 1961. It is movable, marketable and can even be inherited. Its nature, however, is different from other intangible assets like patents, copyrights, or even trademarks that can be singly identifiable and isolated and valued.
In a number of cases, the Supreme Court of India has considered goodwill as a type of property. However, the depreciation of goodwill has always been a disputable issue.
Depreciation under Income Tax Law
The depreciation is under section 32 of the Income Tax Act, 1961, on tangible property (such as a machine, building, plant or furniture) and some intangible property (such as know-how, patents, copyrights, trademarks, licenses or franchises). Depreciation is a tax-deductible expense that decreases the taxable income.
The question is whether goodwill was classified as an intangible asset which was subject to depreciation.
Ruling of the Supreme Court in the case of Smifs Securities.
In the landmark case CIT vs. The Supreme Court held that goodwill is considered an intangible asset that depreciates under Section 32 as decided by Smifs Securities Ltd. (2012). The rationale was that goodwill is intangible, but it assists in the continuation of the business, and therefore, it is included in any other business or commercial rights of a similar kind.
This ruling had a profound effect because firms started reporting depreciation on goodwill that came as a result of acquisitions and mergers.
Amendment to the legislation – Goodwill not to be depreciated
In response to the increasing assertions, the Finance Act, 2021, modified the Income Tax Act and made clear that the goodwill of a business or profession would not be depreciated.
The major points about the amendment:
- Section 32 was modified to make it not a part of the definition of intangible assets.
- The depreciation that had already been claimed on goodwill could not be reversed, but no further depreciation could be claimed.
- To businesses that had bought goodwill, the cost of acquisition would be recalculated to create fair tax treatment in the case of sale or transfer.
So the law is very straightforward now: goodwill is not a depreciating asset according to the Indian tax law.
Tax Consequences of the Amendment
There are a number of implications related to excluding goodwill in depreciation:
- Higher Taxable Profits
Companies could no longer use goodwill to claim depreciation as a way of reducing the taxable income. This increases the tax liability in later years.
- Impact on Mergers and Acquisitions
The failure to accumulate depreciation impacts negatively on the tax break to purchasers in case of acquisitions where goodwill comprises a considerable portion of the purchase price. This can have an impact on the valuation of deals and negotiation tactics.
- Capital Gains Calculation
In the transfer of business, the purchase price (before any depreciation has been previously claimed) will be taken as the cost of acquisition of goodwill. This influences the calculation of capital gains, particularly where the goodwill in question is self-created as compared to acquired.
Goodwill Accounting Treatment
From an accounting perspective:
- Goodwill is included in the balance sheet in intangible assets.
- The amortisation and depreciation are not done in accordance with the Indian Accounting Standards (Ind AS).
- Rather, it is impaired on an annual basis. In case the goodwill loses value, then the impairment loss is charged in the profit and loss account.
Difference Between Goodwill and Other Intangible Assets
Although goodwill is omitted, other intangible assets such as patents, trademarks and licenses still have the benefits of depreciation. The difference is that these assets can be identified and transferred. Goodwill is non-identifiable and residual in nature; therefore, it is handled differently.
Practical Example
Company A buys Company B at a price of Rs. 100 crores. Company B has a net asset worth of Rs. 80 crores. The surplus of Rs. 20 crores is considered as goodwill.
- Previously, Company A used to deduct Rs . 20 crores of goodwill through depreciation and the taxable income was reduced.
- This benefit is not available in the Post Finance Act, 2021. The Rs . 20 crores is not subject to depreciation to pay tax, but this amount is treated as goodwill in the books.
Conclusion
The argument whether goodwill is a depreciating asset is no longer an issue of debate through the amendment of the law. Whereas previous judicial statements permitted depreciation of goodwill, the Finance Act, 2021 made it clear that goodwill is not subject to depreciation as found in Section 32 of Income Tax Act.
Tax-wise, this makes the work of companies that have engaged in acquisitions heavier since they lose the deductions on depreciation. Legal and accounting-wise, goodwill has remained to be counted as a capital asset, which, however, is to be impaired, not depreciated.
Goodwill, in a sense, is good but non-depreciating, which strengthens the fact that reputation and brand power will be good, but they cannot be charged against taxable profits.
