As per an amendment carried out by the Finance Act, 2021, from 1st April, 2020 (F.Y. 2020-21), goodwill (including existing goodwill) of a business or profession will not be considered as a depreciable asset and depreciation on the same would not be allowed as a tax deduction. Whilst depreciation of goodwill is no longer tax-deductible, the tax goodwill balance is tax-deductible when the underlying business is sold on a slump sale basis – except where goodwill has not been acquired by purchase from previous owner. This article deals with the accounting for the deferred tax liability (DTL) on account of abolition of goodwill depreciation for tax purposes consequent to the Finance Act amendment.
ISSUE
An entity acquired a business on a slump sale basis and recorded goodwill in its stand-alone accounting books maintained under Ind AS, which was hitherto deductible for tax purposes. On 1st April, 2020 the carrying amount of goodwill in the balance sheet was INR 1,000 and the tax written down value (tax base) for tax purposes was INR 750. Consequently, a DTL was recorded on INR 250 (INR 1,000 carrying amount-INR 750 tax base) by applying the applicable tax rate on INR 250. From 1st April, 2020, with the amendment coming into effect, the amount of INR 750 is no longer tax-deductible (other than in a slump sale). Whether an additional DTL is required to be created on the difference of INR 750, i.e., carrying amount (INR 1,000) minus tax base (zero) minus already existing DTL on temporary difference (INR 250) in the preparation of Ind AS financial statements for the year ended 31st March, 2021)?
RESPONSE
To address the above question, the following paragraphs in Ind AS 12 Income Taxes are relevant:
Paragraph 15
A deferred tax liability shall be recognised for all taxable temporary differences, except to the extent that the deferred tax liability arises from:
a. the initial recognition of goodwill; or
b. the initial recognition of an asset or liability in a transaction which:
i. is not a business combination; and
ii. at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).
Paragraph 51
The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities.
Paragraph 51A
In some jurisdictions, the manner in which an entity recovers (settles) the carrying amount of an asset (liability) may affect either or both of:
a. the tax rate applicable when the entity recovers (settles) the carrying amount of the asset (liability); and
b. the tax base of the asset (liability).
In such cases, an entity measures deferred tax liabilities and deferred tax assets using the tax rate and the tax base that are consistent with the expected manner of recovery or settlement.
Paragraph 60
The carrying amount of deferred tax assets and liabilities may change even though there is no change in the amount of the related temporary differences. This can result, for example, from:
(a) a change in tax rates or tax laws;
(b) a reassessment of the recoverability of deferred tax assets; or
(c) a change in the expected manner of recovery of an asset.
The resulting deferred tax is recognised in profit or loss, except to the extent that it relates to items previously recognised outside profit or loss (see paragraph 63).
ANALYSIS & CONCLUSION
Temporary differences may arise as a result of changes in tax legislation in a variety of ways, for example, when an allowance for depreciation of specified assets is amended or withdrawn [Ind AS 12.60]. The initial recognition exception in [Ind AS 12.15] does not apply in respect of temporary differences that arise as a result of changes in tax legislation. It can only be applied when an asset or a liability is first recognised. Any change in the basis on which an item is treated for tax purposes alters the tax base of the item concerned. For example, if the Government decides that an item of intangible assets that was previously tax-deductible is no longer eligible for tax deductions, the tax base of the intangible assets is reduced to zero. Accordingly, under Ind AS 12 any change in tax base normally results in an immediate adjustment of any associated deferred tax asset or liability and the recognition of a corresponding amount of deferred tax income or expense. In our example, DTL would be created on the additional temporary difference of INR 750, caused by the change in tax law, and which did not arise on initial recognition.
The measurement of deferred tax assets or liabilities reflects management’s intention regarding the manner of recovery of an asset or settlement of a liability. [Ind AS 12.51, 51A]. Some companies may argue that the goodwill continues to be tax deductible if the acquired business were to be sold on a slump sale basis in the future. Consequently, they argue that no additional temporary difference is created as a result of not allowing the amortisation of goodwill for tax deduction. In other words, in our example, they argue, the tax-deductible goodwill (the tax base) continues to be stated at INR 750 because the business along with the underlying goodwill could be sold in the future and tax deduction availed. As a result, there is no additional temporary difference, and therefore no additional DTL is required to be created. This position is not acceptable because where the entity expects to recover the goodwill’s carrying amount through use a temporary difference arises in use. If, however, a number of years after acquiring the business the entity changes its intended method of recovering the goodwill from use to sale, the tax base of the goodwill reverts to its balance tax deductible amount (i.e., INR 750 in our example).
The goodwill’s carrying amount needs to be tested for impairment annually and whenever there is an indication that it might be impaired. Any impairment loss is recognised immediately in profit or loss. Some companies may argue that there might not appear to be an expectation of imminent recovery through use if goodwill impairment is not expected in the foreseeable future. In other words, they argue that goodwill is a non-consumable asset, like land. Such an argument is too presumptuous and does not fit well with the principles in Ind AS 12, particularly paragraph 15 which requires DTL to be recognised on all taxable temporary differences, subject to the initial recognition exception.
Under Ind AS, goodwill is not amortised for accounting purposes but that does not mean that goodwill arising in a business combination is not consumed. It may not be apparent that goodwill is consumed because new goodwill replaces the old goodwill that is consumed. If goodwill is amortised for tax purposes, but no impairment is recognised for accounting purposes, any temporary differences arising between the (amortised) tax base and the carrying amount will have arisen after the goodwill’s initial recognition; so, they should be recognised.
The expected manner of recovery should be considered more closely. When a business is acquired, impairment of the goodwill might not be expected imminently; but it would also be unusual for a sale to be expected imminently. So, it might be expected that the asset will be sold a long way in the future; in that case, recovery through use over a long period (that is, before the asset is sold) should be the expected manner of recovery. If however, the plan is to sell the business (along with the underlying goodwill) in the near term, the expected manner of recovery would be sale. If this was indeed the case, and can be clearly demonstrated, DTL should not be created as a result of change in the tax law. This is because the tax base, INR 750 in our example, continues to remain at INR 750 as this amount would be tax-deductible as cost of acquisition of the underlying business, in the sale transaction which is expected to occur in the near term.
During 2009 and 2010 the IASB received representations from various entities and bodies that it was often difficult and subjective to determine the manner of recovery of certain categories of assets for the purposes of IAS 12. This was particularly the case for investment properties accounted for at fair value under IAS 40 which are often traded opportunistically, without a specific business plan, but yield rental income until disposed of. In many jurisdictions rental income is taxed at the standard rate, while gains on asset sales are tax-free or taxed at a significantly lower rate. The principal difficulty was that the then extant guidance (SIC 21 – Income Taxes – Recovery of Revalued Non-Depreciable Assets) effectively required entities to determine what the residual amount of the asset would be if it were depreciated under IAS 16 rather than accounted for at fair value, which many regarded as resulting in nonsensical tax effect accounting. To deal with these concerns, in December, 2010 the IASB amended IAS 12 so as to give more specific guidance on determining the expected manner of recovery for non-depreciable assets measured using the revaluation model in IAS 16 and for investment properties measured using the fair value model in IAS 40. An indefinite-life intangible asset (that is not amortised because its useful economic life cannot be reliably determined) is not the same as a non-depreciable asset to which this amendment would apply. Similar considerations apply to goodwill.
