Taxation of Intangible assets acquired through business restructuring.

1.    Background   

1.1        When a company aims to acquire another company's business through amalgamation or demerger, assets or liabilities may be acquired at fair value or book value, contingent upon the application of Indian Accounting Standards (Ind AS) or accounting standards. During business acquisition, intangible assets can be acquired or recognized in three ways:   

a) Acquisition of intangible assets.

b) Recognition of other intangible assets not previously recorded in the transferor                                             company's books.

c) Recognition of goodwill, representing the residual amount after recognizing previously     unrecorded intangibles.

1.2        Other intangible assets existing in the acquirer's books can be acquired at fair value through acquisition. Unrecognized intangible assets in the transferor company's books can be recognized upon meeting asset recognition criteria during business acquisition, as per Ind AS 103 (Business Combinations). Goodwill, recognized as the excess consideration over the fair market value of acquired assets, is not amortized but tested for impairment annually.

1.3        Intangible assets acquired in business combinations are amortized according to their economic useful life. The tax treatment of other intangible assets recognized in the acquirer's books, not present in the transferor company's books, is crucial for strategic decisions in business restructuring via amalgamation/demerger. This article explores the income tax implications of acquiring intangible assets through business combinations.

 

2.    Treatment of Goodwill Under Income Tax Act, 1961. 

 

2.1                   The goodwill is not specifically defined under the act, but Supreme Court in their various decisions like Khushal Khemgar Shah v. Khorshed Dadiba Boatwalla, CIT v. B C Srinivasa Setty & CIT v SMIFS Securities Ltd held that  goodwill included under the definition of intangible assets & hence eligible of depreciation.       

 

2.2                    With effect from April 1, 2021, depreciation on goodwill is not allowed, but depreciation is allowed in case of other intangible assets which are acquired from business combinations.  

 

2.3                    The big question is how are other intangible assets treated for tax purposes if they weren't listed in the transferor company's records? Will the acquirer be allowed to depreciate them, and what will be their cost according to section 43(1) & (6)?

 

2.4                    To answer this, we look at a key court case, Smif's Securities, which decided on the depreciation of goodwill in mergers or demergers. It was ruled that the 6th proviso to section 32, concerning the allocation of depreciation for assets used by both parties, doesn't apply to goodwill. Similarly, this ruling suggests that the 6th proviso won't apply to other intangible assets either. In simple terms, this means the acquirer can claim depreciation on other intangible assets recognized in their books. 

 

2.5                   Further the applicability of the section 43(1) and 43(6) for the cost of assets in the hands of the acquirer i.e., what would be the cost in the hands of acquirer as the same was not there in the books of the transferor company. As per Hyd ITAT S&P case judgement section 43(1) & (6) will be applicable for the existing assets. Goodwill and other intangible assets will be recognised on the acquisition of business. Accordingly, the depreciation will be allowed on the new intangible assets created.

 

3.     Conclusion

Income tax is vital in making strategic business decisions, especially in restructuring. During business acquisitions, the acquirer can recognize intangible assets not listed by the transferor company. Goodwill can be formed from excess payment over the net fair market value of acquired assets after recognizing other intangible assets. Depreciation on goodwill won't be allowed from April 1, 2021. However, acquirers can recognize other intangible assets not listed by the transferor and claim depreciation on them. Until March 31, 2021, depreciation on goodwill is allowable, and according to court rulings, certain provisions don't apply to it. Similarly, depreciation on new intangible assets recognized by the acquirer, not listed by the transferor, is allowed, following relevant provisions. Starting April 1, 2021, depreciation on goodwill isn't allowed, prompting companies to restructure to create new intangible assets eligible for depreciation.