M&A costs to go up after Budget 2021 axes tax depreciation on goodwill

The merger and acquisitions (M&A) transactions are set to become costlier after the Budget announced on Monday proposed that goodwill (including existing goodwill) will not be eligible for tax depreciation.
 

The amendments on goodwill are retrospective as depreciation on any past goodwill, partly claimed in the past, would not be available going forward. Therefore, while the amendment is prospective, it would adversely impact any goodwill created before March 31, 2021, say tax experts. The amendment is retrospective from April 1, 1998 and will also impact internal corporate restructuring where goodwill was claimed. ‘’This may lead to more litigation,” said a top tax expert.
 

Several M&A transactions signed in the past, including Hindustan Unilever’s acquisition of Horlicks in December 2018 from GlaxoSmithKline PLC, had claimed high goodwill as depreciation and will now be impacted by this amendment as, tax experts said, goodwill claims are still pending of the previous years.  Unilever had expected around 1.3 billion euros of the goodwill to be deductible for tax purposes from the Horlicks deal.
 

"Depreciation is allowable on intangible assets, and there are judicial precedents to the effect that depreciation is allowed on goodwill, arising as result of an acquisition and/ or merger. The amendment seeks to nullify this position, and will impact the economics of M&A, especially in relation to those transactions where intangibles are the predominant chunk of the acquisition price; the ability of the seller to negotiate with the buyer to share the benefit of the tax break will be impacted," said Ketan Dalal, managing partner of tax advisory firm, Katalyst.
 

The amendment is to be effective from FY 20-21 itself and also applies also to earlier acquisitions, and the consequent goodwill related to such earlier transactions. "'In that sense, the amendment is retroactive, and one wishes that this is reconsidered and existing positions are grandfathered," he said.

Tax experts said the proposed amendments would effectively nullify the judgment of the Supreme Court and various other subsequent judgments. Consequently, the sound principles of commercial prudence which evolved in the past, and especially over the last 9 years, in relation to depreciation on goodwill, specifically in cases of acquisition of business between third parties, and the valuation of which is at arms’ length, would be overruled by this amendment.
 

The axiom of “intended consequences” would squarely apply here since the benefit of tax break available to the acquirer on account of depreciation on goodwill would now not be available and therefore, result in lower negotiating power to the seller while valuing the business.
 

“The goodwill acquired will not be allowed as depreciation on acquisitions thus affecting big ticket merger transactions which will have to factor in this additional tax burden,’’ said Mahindra Chhajed, partner of Chhajed & Doshi and a noted tax expert. Amrish Shah, Partner, Deloitte India said, “Well one could say that goodwill has lost its charm. Non-availability of tax depreciation on goodwill may be a tough bargain between sellers and buyers (due to higher tax outflows) and could potentially impact the business value.“
 

According to Katalyst, the extant provisions of Section 32 of the Income Tax Act provide for depreciation on tangible as well as intangible assets used for business or profession. Intangible assets include know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature. However, goodwill of a business or profession, was not specifically included in the definition of intangible assets.
 

After long litigation on the issue of whether goodwill, arising from acquisition of a business either through slump sale or amalgamation or demerger or any other mode, should be considered as an intangible asset and eligible for depreciation or not, the Supreme Court had held that goodwill of a business or profession is a depreciable asset under section 32 of the ITA.

But the Budget has now proposed to amend the Section 2(11) of the ITA which defines block of assets and section 32 of the ITA to categorically provide that goodwill should neither be included in “block of asset” nor should it be considered as an asset for the purposes of section 32 of the ITA.
 

The proposed amendment only excludes “goodwill” from the definition of “block of assets” and not any other intangible assets.

Zero goodwill
 

• Pending goodwill claims to get impacted

• M&A, internal restructuring included in amendment

• May lead to more litigation

• Amendment retrospective since 1998

What does the budget propose?
 

Goodwill (including existing goodwill) to be non eligible for tax depreciation

• Where goodwill forms part of an asset block on which tax depreciation has been claimed, the asset block’s written down value and the short term capital gains on goodwill will be determined in a manner to be prescribed

• Acquisition cost of acquired goodwill will be the purchase price (as reduced by obtained tax depreciation); it will be nil for other cases

• The amendment is proposed to be effective from FY20–21