DEPRECIATION ON GOODWILL

[Mr. M. GOVINDARAJAN]

Goodwill is a long-term asset that generate value for a company over a number of years. Therefore, Goodwill is not a current account.  Because they have no physical form, both patents and goodwill are intangible assets—as opposed to tangible assets such as land, buildings and equipment. These include a company's proprietary technology (computer software, etc.), copyrights, patents, licensing agreements, and website domain names. Goodwill represents that can give the acquiring company a competitive advantage.

Section 32 of the Income Tax Act, 1961, which provides for allowance of depreciation, deals with both tangible and intangible assets. In respect of intangible assets, the section provides an inclusive definition of intangibles that are covered for the purpose of depreciation. The section covers Intangible assets, being know-how, patents copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature. On perusal it would be noted that goodwill is not explicitly covered in the aforesaid definition of intangibles and therefore there was a controversy which was put to rest by the  Supreme Court in the case of COMMISSIONER OF INCOME TAX, KOLKATA VERSUS SMIFS SECURITIES LTD. - 2012 (8) TMI 713 - SUPREME COURT wherein it was held that goodwill arising at the time of merger is an intangible asset and is entitled to be depreciated under section 32 of the Act.

In ACIT-4 (2) (1) , MUMBAI VERSUS KEVA FRAGRANCES PVT. LTD. - 2024 (5) TMI 295 - ITAT MUMBAI, the assessee is engaged in the business of manufacturing of perfumes, fragrances and flavors.  The assessee filed its return of income on 29.11.2017 declaring a total loss of Rs. 5,99,74,572/- which was later revised by the assessee declaring a loss of Rs.6,43,52,776/-.  The said return was selected for scrutiny by the Department.  Notices were issued to the assessee and served upon the assessee. 

The assessee company is a private limited company of Keva Group of companies.  S. H Kelkar and Company Limited is the 100% holding company of the assessee.  During the assessment year 2016-17, another 100% subsidiary of S. H. Kelkar and Company Limited., i.e. Keva Fragrances Private Limited, amalgamated with the assessee, earlier known a. K. V. Arochem Private Limited.  The said amalgamation was sanctioned by the Bombay High Court with effect from 01.05.2015.  The name of the assessee was changed from K. V. Arochem Private Limited to Keva Fragrances Private Limited after amalgamation.  The value of the amalgamating entity was arrived at Rs. 381.72 cr using the Discounted Cash Flow Method.   The assessee issued 6,21,029 fully paid-up equity shares of Rs. 100/- each at a premium of Rs. 6,046.50/- to. S. H. Kelkar and Company Limited i.e. the 100% shareholder of the amalgamating company.  The difference of total consideration and value of assets over liabilities of the amalgamating company of Rs. 236.28 cr was accounted as “Goodwill” on amalgamation in the books of the assessee. The assessee claimed depreciation @ 25% on the “Goodwill” amounting to Rs. 47.26 cr, during the year under consideration.

The Assessing Officer observed the following-

• The assessee is an amalgamated company, a loss-making company, carrying forward losses and unabsorbed depreciation.
• The amalgamating company is a profit-making company.
• The scheme of amalgamation has resulted in a large sum of depreciation on “Goodwill” resulting in losses for the amalgamated company.
• The assessee has followed the purchase method for accounting the amalgamation instead of “pooling of interests” method despite the nature of amalgamation being in the nature of the merger as per the conditions prescribed by AS-14. 

Therefore, the Assessing Officer, vide their order dated 29.12.2019, held the following-

• the only impact of the entire exercise of amalgamation is to set off the huge losses and unabsorbed depreciation that the assessee has carried forward till the relevant financial year;
• the market value as determined by the Discounted Cash Flow Method is not the right method for determining the value of the amalgamating company; 
• even in the scenario of the DCF Method representing the market value, it would be incorrect to consider the difference between the market value and the identifiable net assets value as “Goodwill”;
• the generation of “Goodwill” and the claim of depreciation is not genuine but only a means to reduce the tax liability. 

In view of the above the Assessing Officer disallowed the depreciation claimed on “Goodwill” on account of amalgamation on the basis that the existence of “Goodwill” itself is in question and cannot be justified, since the entire exercise of amalgamation amongst the group companies is for the purpose of evasion of tax.

Being aggrieved against the order of Assessing Officer, the assessee filed an appeal before the Commissioner of Income Tax (Appeals). Before the Appellate Authority the assessee contended that for the assessment year 2016-17, the Tribunal has allowed the claim of depreciation on “Goodwill” arising out of aforesaid amalgamation. On the said basis the Commissioner of Income Tax (Appeals) allowed the appeal filed by the assessee on 02.08.2023 and 03.08.2023 for the assessment years 2017-18 and 2018 – 19.

Against the said orders the Department filed appeal before the Income Tax Appellate Tribunal. The Department put forth the following arguments before the Income Tax Appellate Tribunal-

• The Commissioner of Income Tax Officer (Appeals), National Faceless Appeal Centre is erred in deleting the disallowance of depreciation claimed on 'Goodwill' of Rs. 47,26,00,000/- as per valuation done by Discounted Cash Flow method as against Net Asset Value method adopted by the Assessing Officer ignoring the provisions of Section 55(2)(a)(ii) which mandates that cost of acquisition of capital assets being goodwill shall be taken at NIL as the same was not purchased from the previous owner.
• The Commissioner of Income Tax Officer failed to appreciate that the existence of “Goodwill” itself in question and cannot be justified.
• The Commissioner of Income Tax Officer failed to appreciate that as per Proviso 6 to Section 32, the amalgamated company cannot claim depreciation higher than what was actually allowed in the amalgamating company.
• The Commissioner of Income Tax Officer failed to appreciate the fact that the decision of Supreme Court in the case of Smifs Securities Ltd wherein the goodwill was created due to extra consideration paid towards the Goodwill is not applicable in this case.
• The Commissioner of Income Tax Officer failed to appreciate the fact that the amalgamated company KVAPL has since changed its name to Keva Fragrances Pvt Ltd, which is actually the original name of the amalgamating company and also the intention of amalgamation was not to merge the companies as a matter of business arrangement or commercial expediency but to evade taxes.

The Income Tax Appellate Tribunal observed that the only issue on appeal is against the deletion of disallowance of depreciation claimed on the “Goodwill” by the assessee by the Commissioner of Income Tax (Appeals).

The Income Tax Appellate Tribunal followed the decision of its co-ordinate Bench rendered in assessee’s own case in the preceding assessment year.  Accordingly, the Income Tax Appellate Tribunal held that the assessee is entitled to claim the depreciation in the year under consideration on “Goodwill”, which is arising on account of the aforesaid amalgamation.  The Income Tax Appellate Tribunal found no infirmity in the impugned order passed by the Commissioner of Income Tax (Appeals) and the upheld the same.