Merger and acquisition transactions will be getting impacted with proposed announcement in Budget 2021 with no more benefits on tax savings on depreciation on goodwill acquired.
The Budget proposal states that goodwill (and also existing goodwill) will not be eligible for tax depreciation.
In the financial statement, goodwill is disclosed as the amount a company pays —either as stock or cash — over the net worth of the entity that is acquired. After the acquisition or merger, the goodwill is treated as an ‘intangible asset’. The acquiring company obtains a tax benefit as goodwill could be depreciated over a period of time. Thus reducing the taxable income and tax liability.
Allowance of Depreciation on goodwill under the Income tax Act has been the subject matter of long-drawn litigation in India. Taxpayers claims, even if successfully on most occasions, that goodwill is an intangible asset on which depreciation is allowable under provision of Indian Income tax Act.
In many Judgements including in the case of Smiff Securities Limited [(2012) 348 ITR 302 (SC)], the Courts have allowed the claim of depreciation on goodwill. However, the tax department never appeared to appreciate the favourable rulings and regularly challenged the claim of depreciation on goodwill.
Union Budget 2021 proposes certain amendments to the provisions of the Act. The object was to address the conflict surrounding the claim of depreciation on goodwill. The Proposed amendments includes:
- Goodwill of a business or profession is not considered as a depreciable assets. No depreciation allowed even in respect of purchased goodwill.
- Block of assets shall not include Goodwill for purchase of depreciation.
- If goodwill is forming part of the block of assets as on assessment year beginning on 1st April 2020 and depreciation has been claimed, written down value and short-term capital gain to be computed in a manner to be prescribed.
- Cost of acquisition for goodwill acquired under certain modes of acquisition shall be the purchase price of the previous owner.
If goodwill is purchased, such purchase price would be the cost of acquisition. However, depreciation claimed prior to assessment year 2021-22 shall be reduced from the purchase price of the goodwill.
These amendments are applicable from assessment year 2021-21 but having retrospective impact as depreciation on any goodwill, partly claimed previously, would not be available in future. The amendment is retrospective from April 1, 1998 and may have tax impact on several business restructuring as well as merger and acquisition transaction.
Several big-ticket M&A transactions for example Hindustan Unilever’s acquisition of Horlicks in Dec 2018 from GlaxoSmithKline, had claimed high goodwill as depreciation and will now be impacted by this amendment as no further depreciation shall be allowed.
The proposed amendments in recent Indian Budget closed on one of the most prominent issues which have remained subject matter of litigation for more than a decade. Although the Union Budget 2021 has completely addressed the policy requirements to drive economic growth, the proposals are among the few amendments to the Act which may increase cost of M&A or business acquisition transaction in India from tax prospective.