The Supreme Court of India has very recently on 22.08.2012 in the case of CIT Vs Smifs Securities Ltd.,1 declared that goodwill would fall under the expression “any other business or commercial right of a similar nature” under clause (b) of Explanation 3 of section 32(i) of the income Tax Act, 1961. The apex court further stated that the principle of ejusdem generis would strictly apply while interpreting the said expression which finds place in Explanation 3(b). Consequently, “Goodwill” is an asset under Explanation 3(b) to s. 32(1) & eligible for depreciation.

The Supreme Court held this ruling while deciding the vital issue of the above said case – “ Whether goodwill is an asset within the meaning of Section 32 of the Income Tax Act, 1961, and whether depreciation on `goodwill’ is allowable under the said Section?”

Brief facts of the case

The taxpayercompany, Smifs Securities Limited had entered into a Scheme of Amalgamation with YSN Shares & Securities Private Limited (Transferor company), pursuant to which the assets and liabilities of the Transferor company were transferred to Smifs Securities Limited. The Scheme was duly approved by the High Courts of Bombay and Calcutta.

In this amalgamation process of the companies, goodwill had arisen in the books of Smifs Securities Limited due to the excess consideration paid to the Transferor company, over and above the book value of the assets taken over.

The taxpayer claimed depreciation on goodwill under section 32(1)(ii)[1] of the Income-tax Act, 1961 considering the same to be an intangible asset. The depreciation on goodwill was not allowed by the Revenue Authorities. On appeal, both the Commissioner of Income-tax [CIT(A)] and the Income-tax Appellate Tribunal (Tribunal) decided the issue in favour of the taxpayer company i.e. Smifs Securities Limited and allowed depreciation on goodwill. When the matter went for further appeal, the High Court held that no question of law arose in the appeal and dismissed the same. Aggrieved with this order the “Revenue” further appealed to Hon’ble Supreme court.

A Discussion on the issue and Analysis of the judgement

Generally intangible assets are such types of assets which emanates some very remarkable values and importance for an Organisation or Company but they are not in the nature of tangible assets. ‘Goodwill’ is also an intangible and vital part of such intangible assets. Although, Income Tax Act, 1961 does not provide definition of the ‘Goodwill’, yet it is referred precisely under Section 55(2(a) of the said Act, wherein it is reorganized as a ‘Capital Asset’ which is used for computation of Capital Gains.

Therefore when the ‘Goodwill’ is purchased while the incident of mergers and acquisitions, then the cost of Acquisition is treated to be the ‘Amount of Purchase price’ and Goodwill is embedded in it. On the other hand if this Goodwill is not purchased or being transferred from other organization or company then it is a self generated Goodwill and in that case the cost is computed to be ‘Nil’.

It is not like all the intangible asset which are eligible for depreciation. whether an intangible asset is entitled to get Depreciation or not, can be decided on finding the real nature of intangible asset in regard to rights obtained by Acquiring company. It is also pertinent to note that for the purpose of deciding the real nature of transaction, merely the various types of nomenclatures which are generally provided as ‘Entries’ in Books of Accounts is an irrelevant factor.

Goodwill consists of several components and depreciation is granted for those intangible assets only which can be recorded as Goodwill by the efforts of Taxpayer, if the taxpayer can establish the same.

Like various other issues, allowability of tax depreciation on Goodwill was also surrounded by contrary rulings . The Hon’ble Supreme Court has expressed its view through this above said judgement that Depreciation can definitely be claimed on Goodwill and it also possess the statutory assistance on applying the principle of ejusdem generis with the concerned proviso.

Uncertainty and litigation on eligibility of depreciation on intangible assets embedded within goodwill was expected to continue before this judgement of the Supreme Court, due to lack of clarity on the subject and contrary views held by the judicial authorities. This decision of the Hon’ble Supreme Court is not very detailed and the apex Court has applied the principle of the “ejusdem generis” to hold that goodwill would be in the nature of an intangible asset eligible for depreciation under section 32 of the Act. For the purpose of the ready reference of the concerned provision it reads as –

Explanation 3.-- For the purposes of this Subsection, the expressions `assets’ and `block of assets’ shall mean--

(a) tangible assets, being buildings, machinery, plant or furniture

(b) intangible assets, being know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.

The Supreme Court emphatically stated that goodwill is in the nature of ‘any other business or commercial rights of similar nature’ and the principle of ejusdem generis would strictly apply while interpreting the said expression which finds place in Explanation 3(b).

Furthermore on a careful reading of the Supreme Court’s decision and the law under the Direct Taxes Code (DTC), (15th Schedule) it definitely suggests, on the basis of golden interpretation rule that – Depreciation is allowable on Goodwill under the DTC also although the same is not clearly and specifically mentioned in the DTC.

All Such contradictions and the disputes will most probably be diluted after this landmark judgement of the Hon’ble Supreme Court and simultaneously benefit the branded companies  also, in cases of mergers and acquisitions. This ruling may be successful in putting a conclusive end to all such concerned disputes and issues.