Direct Tax Alert - Rule notified for computing written down value and the resultant capital gains on goodwill
12 July 2021
With a view to overturn Supreme Court’s Ruling in case of SMIFS Securities Limited1 and thereby deny depreciation on goodwill, the Finance Act, 2021 (FA 2021) brought about various amendments in the Income-tax Act, 1961 (IT Act). The rationale for this amendment (as mentioned in the Memorandum of Finance Bill, 2021) being that the goodwill, in general, is not a depreciable asset and in fact depending upon how the business runs; goodwill may see appreciation or in the alternative no depreciation to its value. Therefore, there may not be a justification of depreciation on goodwill in the manner there is a need to provide for depreciation in case of other intangible assets or plant & machinery. With goodwill no longer entitled for depreciation, the Written Down Value (WDV) of Intangible asset would be impacted and that the taxpayer would need to recompute the WDV of its asset. To address this, one of the amendment provided that a Rule will be prescribed for computing short term capital gains (STCG) and WDV of such goodwill on which depreciation has already been obtained by the taxpayer.
Recently, the Central Board of Direct Taxes (CBDT) has issued a notification2 inserting new Rule 8AC in the Income tax-Rules, 1962. This new Rule 8AC of Income-tax Rules, 1962 (IT Rules) provides computation methodology for STCG and WDV of block of assets, where goodwill is a part of such block and depreciation has been obtained in fiscal years (FY) prior to FY 2020-21. We, at BDO in India, have analysed and summarised the said notification and provided our comments on its impact hereunder:
Goodwill of the business or profession is the only asset in the Block:
Where the goodwill of the business or profession is the only asset in block of intangible asset on which depreciation is claimed up to 31 March 2020, then WDV of such block of intangible asset will be determined in accordance with section 43(6)(c)(ii)3 of the IT Act.
Goodwill of the business or profession is one of the asset in the Block:
Where block of intangible asset comprises goodwill as also various other intangible assets then the WDV of intangible block of asset as on 1 April 2020 needs to be reduced by standalone WDV of goodwill computed as difference between the actual cost of goodwill and depreciation allowable on such goodwill up to 31 March 2020.
Gains arising on account of discontinuance of depreciation on Goodwill:
- Where the standalone WDV of goodwill is higher than aggregate of opening WDV of entire intangible block of asset and actual cost of any intangible asset acquired in FY 2020-21 then the excess shall be deemed to be capital gain of FY 2020-21 arising from the transfer of short term capital asset.
- It is clarified that there will not be any capital gains or loss where the goodwill was the only asset forming part of intangible block of asset as on 31 March 2020 and such block of asset ceases to exist due to reduction of WDV of goodwill.
- Given that goodwill would cease to be part of block of intangible assets from FY 2020-21 and no depreciation would be allowable, the capital gains or loss on transfer of such goodwill shall be determined in the manner as if the goodwill is non-depreciable capital asset. For such cases, the cost of acquisition shall be the tax WDV as on 31 March 2020.
The above methodology for computing WDV and capital gains was awaited by the taxpayer after the amendment brought by the FA 2021. The same shall assist the taxpayers in computation for calculating the WDV of block of assets and STCG of the block of assets, where depreciation on goodwill has been obtained in both situations i.e. where the block of intangible assets comprising goodwill alone and where the block of intangible assets comprised goodwill along with other intangible assets.
1CIT vs. SMIFS Securities Ltd (2012) 348 ITR 302
2Notification No. 77/2021/F. No. 370142/23/2021-TPL, dated 7 July 2021
3As per section 43(6)(c)(ii) of the IT Act, WDV in respect of block of asset is defined to mean the WDV of the block of assets in the immediately preceding previous year as reduced by the depreciation actually allowed in respect of that block of assets in relation to the said preceding fiscal year and as further adjusted by,
(A) the increase or the reduction (not being increase on account of acquisition of goodwill of a business or profession) for purchase of asset or sale of asset;
(B) the reduction by an amount which is equal to the actual cost of the goodwill falling within that block as decreased by the amount of depreciation that would have been allowable to the taxpayer for such goodwill for any assessment year commencing on or after the 1st day of April, 1988 as if the goodwill was the only asset in the relevant block of assets,