Tax Alert: Tribunal grants depreciation on goodwill arising on Amalgamation

Background

Where capital asset is used in the business, depreciation is claimed under section 32 of the Income-tax Act, 1961 (IT Act). Earlier depreciation used to be allowed only on tangible assets but since 1998, depreciation is allowed on intangible assets also viz. know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature. Although the word ‘Goodwill’ is not specifically stated in the list of various intangible assets, it is considered to be in nature of intangible asset eligible for depreciation. However, the allowability of depreciation on goodwill under section 32 of the IT Act has been subject matter of debate with the Revenue Authorities.

This section also contains the methodology for claiming depreciation under various situations. One such situation provides that in case of succession, amalgamation or merger and demerger, the depreciation should not exceed the depreciation allowable had such activity (i.e. succession, amalgamation or merger and demerger) not taken place. As such, allowability of depreciation on goodwill (in the hands of resultant entity) created due to any of such events was subject matter of controversy.

The Supreme Court in the case of Smifs Securities^[1] put such controversy at rest and held that excess of consideration paid over net assets acquired upon amalgamation constituted goodwill eligible for depreciation under the IT Act. While the said ruling has been consistently followed by various courts, in the case of United Breweries Ltd.^[2], the Bangalore Bench of Income-tax Appellate Tribunal (Bangalore Tribunal) held that the difference between the fair value of assets and the total consideration paid under amalgamation cannot be shown as goodwill by the amalgamated company and no depreciation is allowable on the same. It distinguished the ruling in the case of Smifs Securities Ltd. by holding that the Supreme Court dealt only with the issue of whether ‘goodwill’ is an intangible asset or not and that the said ruling would not override provisions of section 32 of the IT Act.

Recently, Hyderabad Bench of Income-tax Appellate Tribunal (Hyderabad Tribunal)^[3], along with other grounds of appeal, had an occasion to delve on the above issue. We, at BDO in India, have summarized the ruling of the Hyderabad Tribunal in so far as it relates to above mentioned issue and provided our comments on the impact of this decision.         

Facts of the case

Taxpayer, a pharma Company, acquired shares of a company viz. Agila Specialities Ltd. (ASPL) along with its subsidiary Onco Therapies Ltd. (OTL) through Share Purchase Agreement. Soon after acquisition, both ASPL and OTL were amalgamated with the taxpayer. In terms of the amalgamation scheme, the excess of investment made over the aggregate value of the net assets acquired and liabilities assumed, was treated as goodwill by the Taxpayer and accordingly depreciation was claimed. The tax officer observed that the goodwill was not existent in the books of ASPL and OTL and was introduced only under the scheme of amalgamation. The tax officer contended that the allowance of depreciation to the successor / amalgamated company in the year of amalgamation would be on the WDV of assets in the books of the amalgamated company and not on the cost as recorded in the books of the amalgamating company. The Tax Officer also contended that under section 2(47) of the IT Act, transfer of capital assets by subsidiary to parent is not recognized as transfer and hence not subject to capital gains tax. As such, claiming goodwill would be a case of making profit out of oneself. While the taxpayer relied on Smifs Securities Ltd^[4]  the tax officer placed reliance on the ruling in the case of United Breweries Ltd.

The matter (including other grounds) came up before the Tribunal.

Tribunal ruling

The Hyderabad Tribunal observed that in terms of Accounting Standard 14, amalgamation by purchase, the consideration paid in excess of net value of assets and liabilities of amalgamating company is to be treated as goodwill. The Hyderabad Tribunal also observed that the goodwill on which depreciation is claimed by the taxpayer is not solely the self-generated goodwill since the Taxpayer acquired shares of ASPL and OTL from an unrelated entity. Hence, relying on the Apex court ruling in case of Smifs Securities Ltd, the Hyderabad Tribunal held that the depreciation on goodwill is permissible. The Hyderabad Tribunal also distinguished the ruling in the case of United Breweries Ltd. on facts.

Apart from the issue of depreciation on goodwill, the Hyderabad Tribunal also had an occasion to consider whether the fine / fee paid towards violation of foreign jurisdiction’s laws would attract disallowance under section 37(1) of the IT Act. The Hyderabad Tribunal held that the laws are specific to each of the countries according to their rules and regulations and an offence in one country may not be so in another country. Hence, it is only the payment made for contravention of laws in force in India shall be disallowed.

BDO Comments

The eligibility of depreciation on goodwill arising out of restructuring has been subject to considerable judicial scrutiny. Recently, there were news reports that the Indian Revenue Authorities are challenging the tax payer’s claim for depreciation on goodwill arising out of restructuring. In the backdrop of such reports, this Ruling will strengthen Taxpayer’s contention that depreciation should not be denied in such cases.