AN ANALYSIS ON BUSINESS RESTRUCTURING-DEPRECIATION ON GOODWILL
RESTRUCTURING of existing businesses, mergers and acquisitions has become a regular feature of India Inc. Businesses now a days do not simply run with the help of tangible assets in the nature of land, building, plant, machinery, equipments etc., but derives value from ownership of various intangibles, like, brand name, skills of employees, technology, contracts, know-how etc. It is at times the latter category of assets owned by the business houses, which provides higher value to the business in the event of restructuring than the former category.
In such an eventuality, substantial portion of consideration paid on acquisition of business is attributable towards acquisition of such intangibles vis-à-vis tangible assets belonging to that business.
The amount paid on acquisition of business is a capital expenditure and is not an allowable business deduction. The deduction is, however, available for capital expenditure resulting in acquisition of assets on deferred basis by way of depreciation.
Section 32 of the Income-tax Act, 1961(‘the Act’) provides for business deduction by way of depreciation on tangible and intangible assets acquired by an assessee and reads as under:
- In respect of depreciationof–
- buildings, machinery, plant or furniture, being tangible assets;
- know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April 1998, owned, wholly or partly, by the assessee and used for the purposes of the business or profession, the following deductions shall be allowed–…”
Clause (i) of the aforesaid section enumerates extensive category of tangible assets eligible for depreciation under that section. Clause (ii), however, provides that depreciation is admissible on knowhow, patents, copyrights, trade-marks, licenses, franchises or any other business or commercial right of similar nature, being intangible assets acquired on or after1.4.1998.
Clause (ii) of section 32, which provides fors depreciation on intangible asset as been a subject matter of debate and varying interpretations, which causes hardship to an assessee making payment towards intangible assets on acquisition/restructuring of businesses.
In this article, the author seeks to analyze the aforesaid provisions of clause (ii) of section 32 of the Act and address whether the same provides restrictive list of intangible assets eligible for depreciation in comparison to extensive list of tangible assets.
Section 32(1)(ii) of the Act provides for depreciation on knowhow, patents, copyrights, trademarks, licenses and franchises. The aforesaid category of assets is succeeded by residual category, viz., ‘business or commercial rights of similar nature’. The issue that arises for consideration is whether intangible assets/rights, which are not in the nature of former six specified assets is eligible for depreciation under section 32 of the Act within the terms of residual category.
In the author’s view, use of the words ‘of similar nature’ in the residual category as well as by applying principle of interpretation of ejusdem generis, it is clear that intangible asset/right must be in the nature of six category of assets preceding the residual category to qualify for depreciation under section 32 of theAct.
But what is the nature of these six assets- whether they are same or different?
In order to answer the aforesaid question, it would be pertinent to understand the meaning of aforesaid six specific intangible assets referred to in section 32(1)(ii) of theAct:
- any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of a mine, oil-well or other sources of mineral deposits (including searching for discovery or testing of deposits for the winning of access thereto). (Explanation 4 to section 32 of theAct)
- A grant of right to exclude others from making, using or selling one’s invention. (Black’s Law Dictionary (Sixth Edition), page no.1125)
a mark capable of being represented graphically and which is capable of distinguishing the goods or services of one person from those of others and may include shape of goods, their packaging and combination of colours (Section 2(1)(zb) of the Trade Marks Act,1999)
- An intangible, incorporeal right granted by statute to the author or the originator of certain literary or artistic productions, whereby he is invested, for a specified period, with the sole and exclusive privilege of multiplying copies of the same and publishing and selling them. (Black’s Law Dictionary (Sixth Edition), page no.336)
(i) permission to act; (ii) a right or permission granted in accordance with law by a competent authority to engage in some business or occupation, to do some act, or to engage in some transaction which, but for such license, would be unlawful; (iii) formal permission from local authorities, and (iv) a document embodying such permission or evidencing the license granted. (Webster’s Third New International Dictionary, 1996edn. Vol II, p1304)
“Franchise” means right to market a particular product or service, granted by the company that owns the brand name relating to the product or service. (K.G. Aiyer’s Judicial Dictionary, 13th ed.,2001)
On perusal of the meaning of the aforesaid six categories of intangible assets it would be noted that aforesaid intangible assets are not of the same kind and are distinct from one another. The nature of assets, viz., know-how, patents, copyrights, in the author’s view, is different from the nature of trade- mark, licenses and franchises. The former category of assets are in the nature of intellectual property rights. The assets, viz.,trade-mark and franchise are, in the author’s view, relatable to brand-name of an assessee as opposed to intellectual property rights. Similarly, the nature of asset in the form of license is clearly distinct from the aforesaid category ofassets.
In the author’s view, as a result of distinct nature of each specified asset, restrictive meaning cannot be provided to each asset and genus of all the aforesaid six assets should be seen to test whether an asset qualify for depreciation under section 32(1)(ii) of the Act within the residual category of ‘business or commercial rights’. The fact that after the specified intangible assets, the words ‘business or commercial rights of similar nature’ has been additionally used, clearly demonstrates that theLegislature did not intend to provide for depreciation only in respect of specified intangible assets but also to other categories of intangible assets, which was neither feasible nor possible to exhaustively enumerate. In the author’s view, the specified categories fall in the genus of intangible assets that form part of the tool of trade of an assessee facilitating smooth carrying on of thebusiness.
For instance, ‘know-how’ relating to manufacturing would assist in carrying on manufacturing activities. Similarly, license granted to carry on manufacturing activity in a particular area / industry assists an assessee to carry on manufacturingactivity
in that area / industry. Non-existence of both the aforesaid assets will be an impediment in carrying on of the manufacturing activitiessmoothly.
In light of the aforesaid discussion, intangible asset/right of the genus which facilitates carrying on smooth business on acquisition and non-acquisition of same provides impediment to carrying of such business shall be eligible for depreciation under section 32(1)(ii) of the Act under the category of ‘business or commercial right of similarnature’.
The aforesaid view also finds support from the following decisions of various benches of Tribunal discussed in shorthereunder:
- Guruji Entertainment Network Ltd. v. ACIT: In that case the assessee was engaged in the business of production and telecasting of television serials. The assessee acquired business of a sole proprietorship firm viz. Guruji Film, which was also engaged in the business of production of TV serials, documentary ad-films, The assessee attributed consideration paid towards acquisition of business in two parts, viz., (i) goodwill and (ii) tangible assets. The assessee claimed depreciation on the amount recorded as goodwill in the books of account on the ground that same represented intangible assets of the transferor firm, viz., copyright, licenses, telecast rights of episodes of various T.V. serials, ad-films etc. It was contended by the assessee that consideration was paid towards acquisition of aforesaid intangible rights, which was simply nomenclatured as goodwill in the books of account, and were in substance in the nature of ‘business and commercial rights’ eligible for depreciation under section 32(1)(ii) of the Act. The assessing officer disallowed depreciation on the ground that depreciation under the said section was not admissible on intangible assets in the nature ofgoodwill.
On appeal, the Tribunal held that the assessee was entitled to depreciation on intangible assets in the nature of copyrights, telecast rights, commercial rights, etc. as the same are necessary for smooth carrying of acquired business and are eligible for depreciation under section 32(1)(ii) of the Act within the category of ‘business or commercial right of similarnature’.
- Skyline Caterers (P) Ltd. v. ITO:(2007-TIOL-517-ITAT-MUM)In that case the assessee was engaged in the business of providing catering, housekeeping and allied services. During the relevant previous year, the assessee took over catering business of proprietorship firm viz., Skyline Caterers. The aforesaid business included catering contract with Hindustan Lever Ltd. (HLL), which was also acquired by the assessee on acquisition. The amount of consideration attributable towards intangible right in the nature of contract with HLL was reflected as goodwill in the books of assessee on which depreciation was claimed under section 32 (1)(ii) of the Act on the ground that same represented commercial right. The assessing officer disallowed depreciation on the ground that same was not admissible on intangible assets in the nature of goodwill.
On appeal, the Tribunal held that the right obtained by the assessee under the contract with HLL was in the nature of commercial right and was an important tool to
carryon the business of catering. The amount of consideration allocated towards such right, even though represented in the books under the head ‘goodwill’, was in substance in the nature of ‘business or commercial rights’ prescribed in section 32(1)(ii) of the Act and was entitled to depreciation under that section.
- It has been held likewise in the recent decision of Delhi bench of Tribunal in the case of Hindustan Coca Cola Beverages (P) Ltd.: ITA No.1884/D/2006.
It would be pertinent to point out that a contrary interpretation of provisions of
Section 32(1)(ii) of the Act has been recently adopted by the Mumbai High Court in the case of CIT v. Techno Shares and Stocks Ltd.: ITA No. 971/2006 & 218/2007.
In that case the issue for consideration before the Mumbai High Court was whether stock-exchange membership card, being an intangible asset, is eligible for depreciation under section 32(1)(ii) of the Act. It was contended that stock-exchange membership card falls within the meaning of either ‘license’ or ‘business or commercial right of similar nature’ and is eligible for depreciation under the aforesaid section.
The Mumbai High Court, however, while rejecting the contention of the assessee held that assets in the nature of know-how, trade-marks, franchises, copyrights are in the nature of intellectual property rights and the asset in the form of license must be in the nature of intellectual property rights only to fall within the provisions of section 32(1) (ii) of the Act. Similarly, it was held that asset in the nature of intellectual property right only would fall within the residuary category of ‘business or commercial rights’ for the purposes of depreciation under section 32. It was held that since stock-exchange membership card was not in the nature of intellectual property rights, same was not eligible for depreciation.
In the author’s view, though a contrary interpretation of provisions of section 32(1)(ii) has been provided by the Mumbai High Court, however, meaning of the words ‘trade- mark’ and ‘franchises’ have not been correctly appreciated before restricting the scope of six specified intangible assets to intellectual property rights only. The trade- marks and franchises, as discussed supra, are assets relatable to brand name as opposed to intellectual property rights simpliciter and, therefore, restricting the scope of intangible assets to intellectual property rights in order to qualify for depreciation is contrary to the provisions of section 32 and other stated decisions.
Another fallout of the aforesaid controversy is whether depreciation is admissible on acquisition of ‘goodwill’. In the author’s view, whatever interpretation may the given to provisions of section 32(1)(ii) of the Act, viz., whether genus of six specified intangible assets is in the nature intellectual property rights or tool of trade of business, ‘goodwill’ will be eligible for depreciation under thatsection.
Goodwill of a business, which in the author’s view is synonymous with the brand name of that business, is in the nature of intellectual property right just like patent, copyrights, trade-mark and is also an important tool of trade of business. The only distinction between goodwill and aforesaid specified assets is that they are protected under specific statues like, Trade-Marks Act, Patents Act, Copyright Act etc., unlike goodwill, which is not protected under any specific statute. However, goodwill is defendable under the general law and, therefore, in the author’s view, falls within the nature of trademark, patent, trade-mark, etc… The goodwill of a business is also an important tool of trade of business. Any destruction to the goodwill of a business may cause prejudice to the smooth functioning of the business and on that ground falls within the genus of specified intangible assets and consequentially, in the author’s view, qualifies for depreciation under section 32(1)(ii) of the Act.
The Mumbai bench of Tribunal in the recent decision of Kotak Forex Brokerage Limited v. ACIT: ITA No. 2692/Mum/.2007 has also held that depreciation is admissible ongoodwill.
In that case, assessee acquired foreign exchange business for a consideration comprising payment towards goodwill of that business, being use of the name of seller. The assessee claimed depreciation on the amount paid towards goodwill under section 32(1)(ii) of the Act. The aforesaid claim of depreciation was disallowed by the assessing officer on the ground that ‘goodwill’ is not specified under section 32(1)(ii) of the Act.
On appeal, the Tribunal held that ‘goodwill’ or ‘reputation of name of the business’ is a kin to assets in the nature of know-how, patents, copyrights, trademarks, etc., as all these assets, like goodwill, come into existence by experience and reputation and would qualify for depreciation within the residuary category of ‘business or commercial right’ under section 32(1)(ii) of the Act. The relevant observations of the Mumbai Tribunal are as under:
Business or commercial rights are rights obtained for effectively carrying on the business or commerce. Commerce is a wider term, which encompasses business in its fold. Therefore, any right which is obtained for carrying on the business effectively and profitably, has to fall within the meaning of intangible asset. The definition further provides that the business or commercial rights should be of similar nature as know-how, patents, copy rights, trademarks, licenses, franchises etc. all these are the assets which are not manufactured or produced overnight but are brought into existence by experience and reputation. They assume importance in the commercial world as they represent a particular benefit or advantage or reputation built over a period of time and customers associate with such assets. Similarly, goodwill is nothing but positive reputation built by a person/company/business-house over a period of time. Thus, goodwill is a ‘business or commercial right of similar nature.’ As seen from the agreement of sale between Shri Uday S. Kotak and the assessee company formerly known as Komaz Financial Services Ltd., we find that the name ‘Kotak’ has tremendous importance as the assessee company was to be benefitedby
the usage of the said name and it has gone as far as amending its name by including Kotak in its name. Therefore, it is of commercial value for which the assessee has paid the amount of Rs.1.88 crores as goodwill.
- Once it is held that the goodwill is also an intangible asset of the similar nature referred to in clause [ii] of section 32 of the Act, the depreciation is consequently allowable on the same.……..”
The aforesaid decision, therefore, supports that goodwill is a kin to six specified assets and shall be eligible for depreciation under section 32(1)(ii) of theAct.
The provisions of section 32(1)(ii) of the Act at present are subject to varying interpretation by the assessee as well as the tax authorities, which is causing substantial litigation on the issue before higher judicial forums. The aforesaid debate also causes impediment to business restructuring. It is desirable that legislature comes out with clear provisions in order to remove ambiguity and avoid hardship to assessee’s by virtue of enormous litigation on the point.
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