Alert- Adjustment required in F.Y. 2020-21 if depreciation on goodwill claimed in F.Y. 2019-20

Income Tax Act, 1961 (Act) provides depreciation on ‘block of asset’ which is defined u/s 2(11) as to mean “a group of assets falling within a class of assets comprising, tangible assets, being buildings, machinery, plant or furniture and intangible assets, being know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, in respect of which the same percentage of depreciation is prescribed”.

Although directly Goodwill was not included in the above definition, till F.Y. 2019-20 depreciation on Goodwill was claimed by every assessee on the basis of the judgement of Supreme Court in the case of Smiff Securities Limited [(2012)348 ITR 302 (SC) pronouncing goodwill to be part of the block of asset.

Practical difficulties noticed in claiming depreciation on goodwill

1. Depreciation in case of self-generated goodwill vs. acquired goodwill

When any goodwill is self-generated, cost of acquisition as per the Act was said to be NIL and therefore no depreciation could be claimed in such cases. Similarly, as per the law of the Act, in case of amalgamation also, the cost of acquisition for depreciable assets has been said to be same as in the hand of old amalgamated company and hence again no depreciation on goodwill could be claimed even by amalgamating company being the cost of acquisition to be taken as NIL.

However, in case of acquired goodwill depreciation could be claimed on its purchase value.

The above created an unbalanced scenario in both cases.

2. Practically Goodwill does not depreciate

Depending upon how the business runs; goodwill may see appreciation or alternatively, no depreciation to its value. Therefore, claiming depreciation on Goodwill is not feasible practically.

In the light of the above issue amendment was proposed in Budget 2021 and made effective by the Act No. 13 of 2021, w.e.f. 1-4-2021, under the relevant section to remove Goodwill specifically from the block of asset and therefore no depreciation can be claimed on Goodwill from F.Y. 2020-21 even in case of purchased Goodwill. Now purchase price shall only be cost of acquisition of goodwill for calculating capital gain.

Insertion of Rule 8AC vide Notification No. 77/2021 dated 07-07-2021, summarized as follows:

1. Rectification adjustment required in F.Y. 2020-21

If any goodwill is purchased before F.Y. 2020-21 and depreciation on it was claimed in F.Y. 2019-20 then Actual cost of purchase of goodwill – total depreciation calculated assuming goodwill to be only block of asset, shall be reduced from relevant block of asset.

2. Deemed Capital Gain in F.Y.2020-21

If the amount of adjustment amount calculated above i.e. (Actual cost of purchase of goodwill – total depreciation calculated assuming goodwill to be only block of asset) exceeds (the opening WDV of relevant block of asset in F.Y. 2020-21 + Cost of intangibles other than goodwill acquired in F.Y. 2020-21), the excess shall be deemed as Short Term Capital Gain (STCG) for F.Y. 2020-21.

If the block of asset ceases to exist in F.Y. 2020-21 due to the goodwill being only asset and no further acquisition in F.Y 2020-21, no such capital gain or loss shall occur.

Reference link for Notification 77/2021 dated 07-07-2021- https://www.incometaxindia.gov.in/communications/notification/notification_77_2021.pdf

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