Union Budget of 2021 amends the Income Tax Act of 1961 (“Act”) to prohibit depreciation on an organization’s goodwill. The Income Tax Act prohibits depreciation on self-generated goodwill. From 01st February 2021, devaluation on utilizing goodwill of an ownership interest will be not being permissible. Goodwill is specifically immune from the ‘Intangible Assets’ group. Furthermore, on the sale of Goodwill, a scaling down for such payments made for procuring Goodwill would then be legally permissible. Moreover, let us learn in detail whether depreciation on acquired goodwill is allowable.
What is Goodwill?
Goodwill is an intangible asset associated with the acquisition of one organization with the funds of another. Specifically, goodwill is part of the acquisition rate sum up while purchasing an organization. It is an organizational brand name, a stable customer base, world-class consumer relationships, world-class employee relationships, and rates in the age of ownership are etc one get along with goodwill as a gracious benefit.
While valuing the business and negotiating the consideration, the parties not only take into account the market value of the tangible and intangible assets already recorded in the books of the seller, but also that of the goodwill associated with the said business. Thus, any premium paid by the buyer to seller over and above the recorded net worth of the business, i.e. value of all other assets minus liabilities, is often recorded as goodwill in the books of the buyer.
Block of assets – Whether depreciation on acquired goodwill allowable?
Section 2(11) of the Income Tax Act 1961, describe the block of assets that fall under various classes .It consist of two types of goods i.e. Tangible and Intangible goods.
- Tangible goods are mainly physical assets that one can touch.
- Intangible goods which are not in physical form like pre –paid expenses.
- However, Goodwill is not included in any of the above mention assets. So, depreciation on goodwill is not allowed as the government has amendment to the rules in Finance Act, 2021.
Whether Depreciation on acquired goodwill allowable?
Introduction clearly states that the Budget 2021 mentions that goodwill is not permissible for depreciation. As the Finance Ministry made amendment in the rules and regulations and allowed depreciation only in sale of goodwill.
As the section 32 of Income Tax Act, 1961 states that depreciation is permissible on both the tangible and intangible goods but whereas goodwill is not a considered as any asset after the amendment in the Finance Act, 2021. Further it is not clearly mention in the criteria of an intangible asset, courts have look on it as an intangible asset that fits underneath the expression “any other business or commercial rights.”
Legal Gist
The jury trial did not acknowledge if goodwill could be devalued. Therefore led to other disagreements, which are often provoked because of inconsistent judgments from various Indian trial courts.
Eventually, on August 22, 2012, the apex Court upheld that the goodwill emerging from a corporate group. Falls within the interpretation of “any other business or commercial rights of a similar nature” and is therefore an intangible asset focus to depreciation under Explanation 3(b) of section 32(1) of the ITA.
Ruling by the apex court provided clarity, particularly in the references to acquisitions and/or restructuring transaction. Furthermore, where investee persons might depreciate goodwill across time, lowering their taxable income and tax burden.
Amendments in Finance Act 2021
To address the issue, Finance Act, 2021 made changes to resolve the same:
- The written down value of a block of assets may not be increased by the cost to acquire the goodwill of a profession.
- The WDV of a block of assets is to be devaluing by WDV of the goodwill falling within the block.
- Where a taxpayer has claimed devaluation of goodwill. The written down value of that block of assets is to be reduced by the WDV of the goodwill, with any excess following the one treated as gain over short span.
- The cost of acquisition goodwill is the actual price reimburse. Meanwhile, where goodwill initiates from the process of restructuring of the one etc., i.e. the price given by the owner. The cost of acquisition will be zero in other cases.
Some relevant issue
- Sudden changes in rule may lead to outflow of taxes for major tax payers
- Individual assets looses their relevance in the block system and create difficulty to detect the actual good will in this system
- Suddenly denying of claim to the taxpayers by the tax authorities may create hustle.
- Further, if you try to sell a business for which goodwill is set down which results in enactment of capital good tax.
- Further, as of March 31, 2021, it stipulates WDV in goodwill is taken in care as an acquisition cost. Meanwhile, it is necessary for taxpayer to evaluate if such WDV can be arranged.
FAQs
Q: Are There Any Changes in Tax Laws Affecting Goodwill Depreciation?
Tax laws can change, and governments may introduce new regulations or amend existing ones. It’s crucial to stay informed about any changes in tax laws that may affect the treatment of goodwill.
Q: Is Goodwill Depreciable for Tax Purposes?
In many jurisdictions, goodwill is not considered a depreciable asset for tax purposes. Instead, it is typically subject to impairment testing.
Q: How is Goodwill Treated in Financial Statements?
In financial statements, goodwill is initially recognized as an asset. However, accounting standards generally require companies to assess the value of goodwill for impairment regularly. If impairment is identified, the company must adjust the carrying amount of goodwill on its financial statements.
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