Depreciation on block of assets as per Income-tax Act is not dependent on treatment in books of account – judgment in case of Aramark about goodwill – not properly presented and decided- needs rectification, reconsideration and appeal

[CA DEV KUMAR KOTHARI]

Case under study:

ARAMARK INDIA PVT. LTD. (NOW KNOWN AS ARAVON SERVICES PVT.LTD.) VERSUS DCIT-9 (1) (2) MUMBAI 2019 (8) TMI 1410 - ITAT MUMBAI

Relevant provisions:

Section 2(11) – block of asset, S.32 - depreciation, S. 43(1) (actual cost, S. 43(6) Written down value,S.50 special provisions relating to STCG on depreciable assets,  of the Income Tax Act, 1961 and Rule 5 and Appendix I to the Income Tax Rules,1962 and also

Forms of Income tax Returns in which depreciation debited in accounts is added in income and depreciation allowable, is ascertained and allowed through specific Schedule.

Commissioner of Income-Tax, Bangalore Versus B. C. Srinivasa Setty (and Other Appeals) 1981 (2) TMI 1 - SUPREME COURT Other Citation: [1981] 128 ITR 294 (SC) – referred for detailed discussion about nature of goodwill. Dated - 19 February 1981

Depreciation as per accounts:

Depreciation as per accounts is the amount debited in the P & L account as per method and rates adopted for preparation of financial statements. This can vary from person to person and even in case of the same person from year to year. One can change method and rates for providing depreciation. One can also revalue assets by increasing valuation or reduction valuation. For example, in case of Companies SLM method or WDV method can be applied. Rates can are to be taken as prescribed under the Companies Act, from time to time. A company can also adopt different rates for technical and economic reasons.

In case of companies, in balance sheet gross book value (cost or revalued amount) and depreciation provided till date and net value are to be shown which can be reflected in different styles. The amount of depreciation for the accounting period is debited in P & L account.

Depreciation on block of assets for allowance under IT Act:

In the ITR  in Part A- BS  in details of balance sheet also in application of funds fixed assets are shown as gross block, depreciation, net block ad Capital WIP. In case an assesse has not provided any  depreciation in accounts, the gross value and net value remain same.

In part P & L depreciation and amortization as per P & L account are disclosed.

 In case of business and profession in Schedule BP amount debited in P & L account for depreciation is added back. Depreciation allowable is worked out by filling details in schedule DPM for plant and machinery  which includes for different block of assets for

1. Block of asset,

 2.Rate,

3. WDV b/f,

 4. Additions for 180 days or more for assets acquired and

 5. reduction for assets sold or damaged , lost etc. under description or heading             

            “Consideration or other realization during the previous year out of 3 or 4” 

6. Amount on  which depreciation at full rate is to be  allowed (3 + 4-5).

In respect of additions of assets for less than 180 days also information is separately provided under columns  1 and 2 as follows:

7. Addition for a period of less than 180 days in the previous year

8. “Consideration or other realization during the previous year out of 7.

9.  Amount on  which depreciation at half  rate is to be  allowed (7-8)

(Note: for depreciation on other assets Schedule DPA is also on similar lines).

Therefore we find that depreciation allowable under IT Act is computed differently and at different rates for various assets. Even if  in any case, suppose depreciation in accounts is provided as per IT Act, the form of ITR required to add the amount of depreciation debited in P & L account and to claim depreciation through the Depreciation Schedule- DPM and / or  DPA as may be applicable

 If data in Depreciation Schedules DPM and DPA are not entered, depreciation will not be allowed.

 For computation of depreciation and also capital gains in case of transfer of depreciable assets special provisions, as referred to in references are to be followed.

Therefore it is clear that  generally for  depreciation  different methods and rates are followed in accounts, particularly in case of companies and others who have significant investments in assets used in business or profession. Only in case of small organizations of individuals, HUF, firms etc. we find practice of following method of accounting for depreciation as per IT Act. However, in those cases also differences as per accounts and depreciation as per IT Act arises when an incentive deduction is allowable, or when any asset is sold. 

Therefore, in course of filing of ROI and assessment there is complete delinking of blocks of assets and amount of depreciation as per accounts and as per Income tax Act.

Reduction from WDV:

Reduction from WDV  is only for  “Consideration or other realization during the previous year out of  WDV b/f and additions for more than 179 days  or out of additions for less than 180 days, as discussed earlier. These can be for any sale or insurance claim etc. Unless there is realization, there will not be reduction.

A write off in accounts does not require reduction from block in Scheduled DPM and DPA.

Impairment and improvement:

In case of impairment, of any asset, a provision can be made and if impairment is recouped by improvement in conditions,  it can also be written back. For example, suppose a machine for specific purpose or product or process is not found suitable at some time due to no use for any reason (e.g. no demand for specific product), can be impaired and later on when  the product is again in demand and machine is used, the impairment can be written back.

Impairment and improvement of goodwill:

Goodwill is an asset which is not stagnant in nature. In any business or profession goodwill may improve or impair from time to time due to several factors relating to business, products, local conditions, economy of country and international conditions.

Only profitability is not a factor though on profitability considerations goodwill fluctuates.

 A good advertisement or good news about a company or its products can improve its goodwill whereas a bad news can impair goodwill. An improvement as well as impairment may be of short to medium duration or long duration. In some situations an impairment can, for time being can  be assumed or  perceived as of permanent nature, on change in situations that can also be reversible and impairment can be recouped.

In case of B.C.Sriniwas Setty (supra.)  we find detailed discussion and references on nature of goodwill:

Quote (with highlights added by author):

Goodwill denotes the benefit arising from connection and reputation. The original definition by Lord Eldon in Cruttwell v. Lye [1810] 17 Ves 335 that goodwill was nothing more than " the probability that the old customers would resort to the old places" was expanded by Wood V.C. in Churton v. Douglas [1859] John 174 to encompass every positive advantage " that has been acquired by the old firm in carrying on its, business, whether connected with the premises in which the business was previously carried on or with the name of the old firm, or with any other matter carrying with it the benefit of the business." In Trego v. Hunt [1896] AC 7 (HL) Lord Herschell described goodwill as a connection which tended to become permanent because of habit or otherwise. The benefit to the business varies with the nature of the business and also from one business to another. No business commenced for the first time possesses goodwill from the start. It is generated as the business is carried on and may be augmented with the passage of time. Lawson in his Introduction to the Law of the Property describes it as property of a highly peculiar kind. In CIT v. Chunilal Prabhudas & Co. [1970] 76 ITR 566 = 1969 (9) TMI 17 - CALCUTTA HIGH COURT  the Calcutta High Court reviewed the different approaches to the concept (pp. 577, 578):

 " It has been horticulturally and botanically viewed as 'a seed sprouting' or an 'a corn growing into the mighty oak of goodwill'. It has been geographically described by locality. It has been historically explained as growing and crystallising traditions in the business. It has been described in terms of a magnet as the 'attracting force'. In terms of comparative dynamics, goodwill has been described as the 'differential return of profit'. Philosophically it has been held to be intangible. Though immaterial, it is materially valued. Physically and psychologically, it is 'habit' and sociologically it is a 'custom'. Biologically, it has been described by Lord Macnaghten in Trego v. Hunt [1896] AC 7 (HL) as the 'sap and life' of the business. Architecturally, it has been described as the 'cement' binding together the business and its assets as a whole and going and developing concern."

A variety of elements goes into its making, and its composition varies in different trades and in different businesses in the same trade, and while one element may preponderate in one business, another may dominate in another business. And yet, because of its intangible nature, it remains insubstantial in form and nebulous in character. Those features prompted Lord Macnaghten to remark in IRC v. Muller & Co.'s Margarine Ltd. [1901] AC 217 (HL), that although goodwill was easy to describe, it was none the less difficult to define. In a progressing business goodwill tends to show progressive increase. And in a failing business it may begin to wane. Its value may fluctuate from one moment to another depending on changes in the reputation of the business. It is affected by everything relating to the business, the personality and business rectitude of the owners, the nature and character of the business, its name and reputation, its location, its impact on the contemporary market, the prevailing socioeconomic ecology, introduction to old customers and agreed absence of competition. There can be no account in value of the factors producing it. It is also impossible to predicate the moment of its birth. It comes silently into the world, unheralded and unproclaimed and its impact may not be visibly felt for an undefined period. Imperceptible at birth it exists enwrapped in a concept, growing or fluctuating with the numerous imponderables pouring into, and affecting, the business. Undoubtedly, it is an asset of the business, but is it an asset contemplated by s. 45 ?

Unquote:

The judgment is of 1981 and many judgements referred are very old. With development of information technology and globalization of business meaning and importance of goodwill its improvement and impairment are widely fluctuating. For example, we find that even some statements of government authorities can very badly impair goodwill of companies, and on some occasion’s results into improvement of goodwill. In case of listed companies, improvement and impairment of goodwill is more visible by changes in market capitalization.

For example an adverse statement, notice or order issued by SEBI can immediately impair goodwill of a company and promoters and group. We find several cases of such statements affecting goodwill of not only company but also its promoters and associates. An enquiry, a notice by a regulatory authority, affecting business can impair goodwill. When company clarify and removes doubts, some part of impairment may be recouped very soon but still people have some doubts so full recoupment in goodwill may take long time.

For example in case of pharmaceutical companies any news about enquiry by regulatory authorities of India and abroad and clearance of the same affect goodwill of companies from time to time and quite frequently. For example, during  4-5 years  we can study about  various  listed companies in pharmaceutical sector.

A report or notice by Income Tax Department about survey, search, enquiry and demand etc. on any company or its promoters, management and even associates can badly impair goodwill of company.

A news of additional income tax demand can adversely affect goodwill and a news of substantial refund can improve goodwill. For example we can recall news about demands and refunds in case of MTNL affecting its market capitalization.

Therefore, government authorities must be very careful and premature announcements should not be made.  For example, an enquiry, survey or search is a routine and many times it is based on wrong information, bias and prejudices. Levy of some penalty on banks is found in news many times, though ultimately such penalty may not stand and be deleted. Penalty be SEBI is also a common news though many of such penalties are not upheld, ultimately.

 However, unfortunately authorities of government of India are insensible and they have no hesitation in making adverse comments on business it is very common now-a-days. Author recall long ago, may be more than 25 years ago a news was published about some alleged default for TDS by Reliance group. The alleged default was for a very small sum but it appeared in newspapers.

  Authorities should not make a public comment for the same. Even companies should not be required to publicly disclose the same when it is premature.

Case of Aramark (supra.)

After discussion of provisions and procedure relating to depreciation claim a discussion on judgment is made below:

On reading of the reported case author find that unfortunately all provisions related with depreciation, including procedure and forms for  have not been properly considered by the Tribunal.

Important difference between depreciation as per accounts and as per IT Act have not been considered. It is wrongly assumed that if a value of any asset is not shown in account that means that the assesse is not owner and has not used the asset. WDV as per accounts has been considered to be WDV for depreciation allowance also.

Very fluid nature of assets in form of goodwill consisting of various elements of goodwill were not pointed out and have been ignored. The honorable Tribunal, as a final fact authority, is expected to find out the same and to do justice.

Weaknesses in case:

As per author, the case has not been prepared and represented for the following reasons:

1. Entire value of goodwill was written off in accounts- this was a mistake of accountants and management. As discussed above in a going concern goodwill is a fluctuating assets. And impairment can be recouped.  What was reason for such impairment is not clear. Even for any business lost, contract lost, or product failure, cancellation of franchisees etc. it cannot be said that entire goodwill is lost or its entire value is eroded. Goodwill has many  components like trade names, brands, licenses, permits, business rights,  place of business, business  contacts, old standing in business, future prospects, etc. Though company has suffered huge loss, but it does not mean that company has lost its future prospects. Goodwill of promoters, people in control, associates etc are also component of goodwill.
2. Writing off of 100% of goodwill and showing goodwill at zero value in block of assets was a big mistake and that has been (though wrongly) a reason for adverse inferences by all concerned authorities and  unfortunately and unexpectedly by  honorable Tribunal also.
3. In the judgment, there is no discussion from annual report or any business reports, any negotiations etc. and any submissions made at any stage  about (a) why there was 100% write off (b) continuing use of goodwill (c ) nature of impairment and possibility of recoupment of impairment (d) continuing business with the same trade names, brands, corporate names, same address, same premises, same licenses, same registrations, including the  same PAN and TAN  etc. which are still held and are part of goodwill. Therefore, full write off was a wrong decisions. In practice, we find that sometimes auditors, without understanding business, insists for such actions and representative of company being unable to explain and convince auditors  just surrender before auditors and do as insisted by auditors. This is one of unfortunate  aspect and a ground reality of accounting and auditing profession.  Even if auditors had insisted for write off, management should have taken a reasoned decision and could have partially written off goodwill, if at all it was required.
4. Another aspect that write off for impairment is nothing but a part of depreciation as per accounts, which is added in computation of income  and amount allowable as per DPA is to be allowed seems not pressed.
5. There may be more weaknesses which are not feasible to find out on reading of judgment.

Discussion on order of Tribunal (with highlights added in reproduced portions:

In this case the assesse contested on the following grounds of appeal:-

1. The Commissioner of Income Tax (Appeals)- (CIT (A)) erred in upholding the disallowance of depreciation on Goodwill amounting to ₹ 3,03,70,514/-made by the Deputy Commissioner of Income Tax- 9( 1)(2),Mumbai (hereinafter known as Assessing Officer (AO))

1.2 The CIT (A) should have allowed depreciation on Goodwill amounting to ₹ 3.03,70,514/- as the same is allowable U/s 32(1) when the intangible assets were acquired and paid in past years and Honorable ITAT Mumbai has allowed depreciation on Goodwill in the assessment year 2009-10 .

1.3 The AO has erred in disallowing depreciation on Goodwill only on the pretext that the asset is impaired in the books of accounts as per Accounting Standards issued by Institute of Chartered Accountants of India and the Petitioner Company has not sold the asset but continues to enjoy the Goodwill.

To Quote from paragraph 6 and 7 of the order of Tribunal( order part)

The provision of section 32 of the I.T.Act, 1961 provides for grant of deprecation. Section 2 (11) defines, the term of block of assets, which includes intangible assets being know-how, patent, copy rights, trade marks, licences, franchise or any other business or commercial right similar nature. In order to claim depreciation, the assessee should fulfill three conditions, as per which, the assessee should be owner of the asset, the asset should be used for the purpose of business and the block of assets should exist to claim deprecation. In this case, the assesse has impaired, the value of goodwill recorded in the books of accounts and the excess value as determined, in accordance with accounting standard issue by the ICAI has been written off in AY 2011-12.

Further, it was noticed from the assessment order that the assessee has shown “Nil’ value for goodwill as on 31/03/2012 in its books of accounts. Thus, as per books of accounts, the goodwill ceased to exist. Accordingly, the assessee has not claimed any deprecation in the books of account on value of goodwill. Further, deprecation is calculated on written down value of the block of assets. If, the written down value of asset is reduced to zero or, the block of asset is empty or ceased to exist on the last date of the previous year, then no depreciation is allowable, even though the written down value of the asset is not reduced to zero. In this case, there is no doubts of whatever with regard to exists of assets in the books of accounts for the relevant financial year. As claimed by the assessee itself, it has fully written off goodwill in the books of accounts on the asset ceased to exist in the books of accounts and the last date of the previous year. Therefore we are of the considered view that once, a particular asset is ceased to exist in the books of account and also, the assessee is not getting any enduring benefit from such assets, then the question of depreciation on such non existing asset does not arise

                       “….. . As we have already stated earlier, there is no dispute with regard to allowability of deprecation on goodwill, but when you compare the facts of the current year, the question of allowability of deprecation has to be examined, in the light of provision of section 32(1), where it mandates the block of assets should exists to claim depreciation. Since, goodwill is not treated as an asset in its books of accounts and also, the assessee is not getting any enduring benefit out of such goodwill, the question of allowing depreciation on such non existing asset does not arise. The Ld.AO as well the Ld.CIT(A), after considering relevant facts has rightly disallowed depreciation claimed on non-existing asset being goodwill. We do not find any error in the order of the Ld.CIT(A). Hence we are inclined to uphold order of the Ld.CIT(A) and dismissed appeal filed by the assessee.

7. In the result, appeal filed by the assesee is dismissed.

 

Observations of author:

From ground no. 1.2 we find that the goodwill was acquired and paid in earlier years. From ground  no. 1.3 we find that the assesse had claimed that goodwill has not been sold and assesse continues to enjoy the goodwill. That means that assesse hold goodwill,  is still owner of goodwill and is using it and continue to enjoy the goodwill. Therefore, in view of author, on correct application of provisions and procedures as referred earlier, there cannot be any deduction from WDV b/f for the block of assets of intangible assets and depreciation should be allowed on WDV b/f.

The value of block of assets as per books of account was reduced for impairment and not for exhaustion of assets in form of goodwill which is composed of so many intangible assets all of which cannot be vanished just because full amount has been impaired and written off in books of account. We can also compare case of any asset in block being obsolete and written off in accounts, but in that case also depreciation on block of assets will continue as per provisions.

As per author, with great respect , the honorable Tribunal has not at all considered these two important aspects and finding recorded are wrong and perverse in as much as that the Tribunal has held that three conditions of ownership, existence of block of assets and use are not satisfied.

Just like the AO and the CIT(A), honorable Tribunal was also unduly influenced by the fact that assesse had written off entire value in its accounts as impairment and confirmed conclusion that three conditions are not met. Tribunal has in fact not considered and examined facts contended in grounds in so far it states the fact that  the Petitioner Company has not sold the asset but continues to enjoy the Goodwill.

Without an independent examination of these facts by the Tribunal, there have occurred mistake (which may be apparent from records) , and perversity in the order of honorable Tribunal.

Course of action for assesse:

In this case the assesse need to examine material available in assessment records, also appeal records including paper book and submissions and documents  filed before Tribunal to clearly find out and establish:

1. Material and evidences on record not considered by honorable Tribunal about continuing ownership and use of goodwill. This can be found in annual report, tax audit report,
2. Wrong consideration of facts and legal position and wrong conclusions contrary to facts as borne out from records.
3. Wrong application of law.
4. Non consideration of nature of goodwill particularly in view of judgment in case of B.C.Sriniwas Setty (supra.)

On the basis of findings from records, assesse can make an application u/s 254(2) for rectification of mistake apparent from records in the order of Tribunal  and should can   prefer an appeal before High Court on substantial questions of facts and law including mistake, and perversity in the order on facts and law both thus there will be pure questions of law and mixed question of law and fact.

ARAMARK INDIA PVT. LTD. (NOW KNOWN AS ARAVON SERVICES PVT.LTD.) VERSUS DCIT-9 (1) (2) MUMBAI 2019 (8) TMI 1410 - ITAT MUMBAI