Creation, Depreciation and Taxability of Goodwill

As of now many people are confused regarding the concept of goodwill. Even some professionals have inquisitive question about the creation and taxability of goodwill. Goodwill is seen as an intangible asset on the balance sheet because it is not a physical asset like buildings or equipment. Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and any patents or proprietary technology. In this article we will highlight some general points about goodwill. Creation of Goodwill Goodwill is created by doing good business. For vendors, clients and other stakeholders, they want you to provide good quality/relevant products and services, be fair and reasonable in actions and deliver on promises. It’s important to recognize that goodwill is earned — bestowed upon a company by the people who use, make, deliver, and enjoy the company’s products and services. Goodwill is one of those soft assets that translate into an improved reputation and brand, improved loyalty with customers and improved hiring and retention of employees — and perhaps the bottom line. Clients with goodwill are given the benefit of the doubt by stakeholders. A client that handles a crisis well — ensuring that stakeholders have what they need to tackle the crisis — can emerge the other side with even better levels of goodwill. In the accounting sense, Goodwill can be thought of as a “premium” for buying a business. When one company buys another, the amount it pays is called the purchase price. Accountants take the purchase price and subtract it by a company’s book. The difference is called Goodwill. For decades, when a company bought another company, it could use one of two accounting methods: ‘Pooling of Interest’ or ‘Purchase’. When the pooling of interest method is used, the balance of the two businesses is combined and no goodwill is created. When the purchase method is used, the acquiring company will put the premium they paid for the other company on their balance sheet under the “Goodwill” category. Impairment of Goodwill Over time goodwill also loses its value.  Impaired goodwill is that which has become or is considered to be of lower value than at the time of purchase. From an accounting perspective, when the carrying value of the goodwill exceeds the fair value, then it is considered to be impaired. Negative publicity about a firm can create goodwill impairment, as can the reduction of brand-name recognition.   Depreciation on Goodwill According to a judgment of Supreme Court it was held that Explanation 3b to section 32(1) of the Act, states that the expression ‘asset’ shall mean an intangible asset being, know how, patents, copyrights or any other business or commercial right of similar nature. A reading of the words ‘any other business or commercial rights or similar nature in clause (b) of that goodwill would fall under the expression ‘any other business or commercial right of a similar nature. Accordingly “goodwill” is an asset under explanation 3(b) to section 32(1) of the Act and depreciation on ‘goodwill’ is allowable under section 32 of the Act.   Taxability of Goodwill In relation to a capital asset as goodwill of business or manufacturing right or right to carry on business or tenancy right etc. 1)      Where it is purchased by the assessee from a previous owner, the amount of purchase price 2)      Where it is acquired in any of the modes as laid u/s 49(1), the cost to the previous owner and 3)      In any other case, the amount shall be nil. Self-Generated Goodwill will have nil cost. The full value which has been paid for goodwill will be treated as full value of consideration and ultimately it will be charged to capital gain. Thanks for reading for this article. Please feel free to write to us, We want to hear it all!Suggestions? Complaints? Feedback? Requests?  at [info@taxmantra.com] or call us at +91 88208208 11. We would be more than happy to assist you.