Goodwill can beget “Bad will”!!!!

Have you ever imagined a situation where a well thought-out agreement, prepared and vetted by eminent lawyers can make you squirm before theTtax man?

Unfortunately, there have been such instances in the past and there could be similar ones in future as well.

Although even the Supreme Court of India had set at rest the controversy some time back, even now the Income Tax Authorities take a myopic view and hold that Goodwill is not eligible for write off like other assets.

A case in point is CYBER INDIA ONLINE LIMITED vs. ASSISTANT COMMISSIONER OF INCOME TAX decided by the Income Tax Appellate Tribunal, Delhi on 27th November, 2013.

Understanding the law would prove beneficial for those who have done mergers or acquisitions or planning any of these routes for business expansion.

For the accounting year 2004-05,Cyber India had filed its return of income showing a book profit of      

 Rs. 29,85,574/- and tax payable thereon of Rs. 2,23,918.

On 28.2.2006, after reckoning the Tax deducted at source, refund of Rs.3,64,011/- was made to Cyber India.

Thereafter on 18.11.2008 the Assessing Officer reopened and completed the assessment wherein he disallowed   

Cyber India’s claim for depreciation of Rs. 16, 99,020/- on the cost of acquisition of goodwill of the business which it purchased. Additional tax was also demanded

Cyber India appealed to the Commissioner Appeals which was decided against them.

The Income Tax Appellate Tribunal negatived the order of the Commissioner and allowed the claim of Cyber India.

While delivering the judgement, the Tribunal referred to earlier instances of allowing depreciation on Goodwill and cited the decision of the Supreme Court of India dated 22.8.2012 in the case of C.I.T., Kolkata vs. Smifs Securities Ltd.

What’s the issue?

While acquiring an ongoing business, normally a value for Goodwill is agreed upon. This is paid over and above the value of the tangible assets.

In computing Income on which tax is payable, the tax laws provide for writing off the value of the fixed assets over the useful life of the assets-.this is called Depreciation.

Since goodwill is an intangible asset, the tax laws were amended by the Parliament   to include intangible assets also eligible for this write off.

The Income Tax authorities however took a narrow view of the provisions of the tax law and went on a literal interpretation.

By doing so, they disallowed Depreciation on the intangible asset which is Goodwill.

What one should note and take care of

The Income Tax authorities are always trying to maximise revenue and would resort to that interpretation which would serve their purpose. To defeat this intention and to be within the law, one has to take care in wording the agreement by which mergers and acquisitions are made.

One manner in which the designs of Income Tax authorities can be defeated is by referring to the clause in the Income Tax law itself in the acquisition agreement.

In many instances, although the business is taken over as a slump sale including all rights, there would be breakup value of all assets like building, equipment and other tangible items.

The difference between the value of tangible items and the total value for which business is acquired, is normally reported as Goodwill in the Balance Sheet of the new concern.

Here it would prove beneficial if the clause regarding value and its break up cites the relevant section of the Income Tax act to say that what is meant by Goodwill is as per the definition in the relevant clause of the Income Tax law.

Such clarity in the agreement can help to avoid the expenditure and stress associated with the filing of appeals and cross appeals against the decision of the authorities imposing huge Tax and penalties.

So, the next time you decide to acquire any   business along with Goodwill, take care not to draw the bad will or ill will of the Taxman.

You need to spend your valuable time pursuing your core competence in your business and not in chasing the Taxman and Consultants and Lawyers!!!!!