DEPRECIATION ON GOODWILL ARISING DUE TO AMALGAMATION

ISSUE FOR CONSIDERATION
Depreciation is allowable u/s 32(1) on buildings, machinery, plant or furniture, being tangible assets, and also on knowhow, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets, acquired on or after 1st April, 1998. The Supreme Court in the case of CIT vs. Smifs Securities Ltd. 348 ITR 302 has held for assessment year 2003-04 that the goodwill acquired on amalgamation (being excess of consideration paid over the value of net assets acquired) by the amalgamated company would fall under the expression ‘any other business or commercial right of a similar nature’ and qualify to be treated as an intangible asset eligible for depreciation while computing business income. This was decided by the Supreme Court on the basis of the undisputed factual finding as recorded by the lower authorities that such a difference constituted goodwill and that the assessee in the process of amalgamation had acquired a capital right in the form of goodwill because of which the market worth of the assessee had increased.

The sixth proviso to section 32(1)(ii) provides that the aggregate depreciation allowable to the transferor and transferee, in any previous year, in the case of succession or amalgamation or demerger shall not exceed the deduction allowable at prescribed rates, as if such succession or amalgamation or demerger has not taken place and the deduction on account of depreciation shall be apportioned between the transferor and the transferee in the ratio of number of days for which the assets were used by them.

While the Supreme Court has held that the goodwill arising on account of amalgamation falls within the scope of the ‘intangible assets’ and it is entitled for depreciation u/s 32(1), an issue has arisen subsequently as to whether the depreciation on such goodwill can be denied to the amalgamated company by applying the sixth proviso to section 32(1)(ii) on the ground that no such goodwill was held by the amalgamating company. While the Bangalore bench of the Tribunal has held that the amalgamated company was not eligible for depreciation on goodwill due to the restriction placed in the said sixth proviso, the Hyderabad bench of the Tribunal has taken a contrary view, holding that the depreciation was available on such goodwill to an amalgamated company in spite of the restriction of the sixth proviso.

THE UNITED BREWERIES LTD. CASE
The issue first came up for consideration before the Bangalore bench of the Tribunal in the case of United Breweries Ltd. vs. Addl. CIT, TS-553-ITAT-2016 (Bang.). In this case, during the previous year relevant to A.Y. 2007-08, the assessee’s wholly-owned subsidiary, Karnataka Breweries & Distillery Ltd. (KBDL), got amalgamated with the assessee as per the order of the High Court. The shares of the said company were acquired by the assessee in the preceding year for a consideration of Rs. 180.52 crores. The goodwill amounting to Rs. 62.30 crores was shown as arising on account of the amalgamation, being the excess of purchase consideration over fair value of tangible assets and other net current assets received from the amalgamating company. Accordingly, depreciation of Rs. 15.57 crores was claimed by the assessee.

The AO, in the first place, disputed the method of valuing the assets and disallowed the depreciation on the goodwill on the ground that there was no goodwill if proper valuation was assigned to the tangible asset and land. Apart from that, the AO relied upon the sixth proviso (then fifth proviso) to section 32(1) (ii). He noted that the goodwill on which depreciation was being claimed by the assessee arose only on amalgamation and the amalgamating company had no goodwill on which depreciation was allowed to it. Under such circumstances, there would not be any deduction of depreciation on goodwill in the hands of the amalgamated company. Prior to the amalgamation, KBDL could not have claimed any depreciation on such goodwill that came into existence only on amalgamation as it did not own any such goodwill nor was it eligible for depreciation on such goodwill.

The CIT(A), while concurring with the decision of the AO, observed that the value of the goodwill recorded in the books of KBDL was only Rs. 7.45 crores while it had been shown by the assessee at Rs. 62.30 crores. The CIT(A) also questioned the valuation of goodwill in view of the fact that KBDL had not earned sufficient profits in the past to justify the goodwill on the basis of average of profits. The CIT(A) also concurred with the view of the AO that the assessee was not entitled to depreciation in view of the sixth (then fifth) proviso to section 32(1)(ii).

Before the Tribunal, the assessee submitted that the issue of depreciation on goodwill was covered by the judgment of the Supreme Court in the case of Smifs Securities Ltd. (Supra). Insofar as the valuation was concerned, it was contended that when the assessee had produced the valuation report valuing the tangible asset, then without giving the correct value by the AO, the rejection of the valuation report was not justified. Without giving any counter valuation, the claim of depreciation could not have been rejected only by doubting the valuation of the assessee. Insofar as the sixth proviso to section 32(1)(ii) was concerned, it was submitted that it did not apply when the assets were introduced in the books of the assessee at the balancing figure, being the excess consideration over the value of the tangible assets. It was further contended that in none of the cases decided by the Supreme Court as well as the High Courts the Revenue had ever raised the objection of rejecting the claim of depreciation by applying the fifth (now sixth) proviso to section 32(1) of the Act. Therefore, the Revenue could not have raised the objection in the assessee’s case only when it was not raised in the other cases before the courts in the past.

The Revenue, apart from resting its case on the valuation as well as the said proviso to section 32(1)(ii), also relied upon Explanation 3 to section 43(1) and submitted that the AO had the power to examine the valuation of the assets acquired by the assessee if these assets were already in use for business purpose. If the AO was satisfied that the main purpose of transfer of such assets was the reduction of the liability to income tax, then the actual cost of the asset to the assessee was to be such an amount as the AO determined. Therefore, it was claimed that the AO had rightly determined the valuation of the goodwill at NIL. The Tribunal rejected the contention of the assessee that the AO could not have disturbed the valuation of the goodwill in cases where it represented a differential amount between the consideration paid for acquisition of shares and the FMV of the tangible assets. It held that if such claim of goodwill and depreciation was allowed, then it would render the provisions of Explanation 3 to section 43(1) redundant; in every case of transfer, succession or amalgamation, the party would claim excessive depreciation by assigning arbitrary value to the goodwill. However, the Tribunal held that the AO was at fault in choosing to examine the valuation of goodwill alone; the AO ought to have examined the valuation of all the assets taken over by the assessee under the amalgamation and thereby should have determined the actual cost of all the assets to the assessee for the purpose of claim of depreciation.

The Tribunal further held that by virtue of the said proviso to section 32(1)(ii), the depreciation in the hands of the assessee was allowable only to the extent that was otherwise allowable if such succession or amalgamation had not taken place. Therefore, the assessee, being amalgamated company, could not claim or be allowed depreciation on the assets acquired in the scheme of amalgamation of an amount more than the depreciation which was allowable to the amalgamating company. Insofar as the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra) was concerned, the Tribunal observed that the said ruling of the Supreme Court was only on the point whether the goodwill fell in the category of intangible assets and the said judgment would not override the provisions of the said proviso to section 32(1)(ii), which restricted the claim of depreciation in the cases specified thereunder. Accordingly, the issue of allowability of depreciation on goodwill was decided against the assessee.

THE MYLAN LABORATORIES LTD. CASE
The issue again arose recently, in the case of Mylan Laboratories Ltd. vs. DCIT TS-691-ITAT-2019 (Hyd.). In this case, during the previous year relevant to A.Y. 2014-15, the assessee had acquired Agila Specialities Ltd. (ASPL) along with its wholly-owned subsidiary, Onco Therapies Ltd. (OTL), vide a share purchase agreement on 5th December, 2013 immediately followed by the merger of both the companies with the assessee under the scheme effective from 6th December, 2013. The assessee, by applying the principles of ‘purchase method of accounting’, considered the difference between the amount of investment (Rs. 4,386 crores) and the fair value / tax WDV value of net assets which was negative (being Rs. -106 crores) as goodwill arising on amalgamation. This goodwill of Rs. 4,492 crores was grouped under the Intangible Assets block as goodwill, and depreciation at half of the eligible rate of 25% was claimed by the assessee, since the assets were put to use for less than 180 days.

The AO disallowed the depreciation on goodwill by relying upon the decision of the Bangalore bench of the Tribunal in the case of United Breweries Ltd. (Supra). The CIT(A) confirmed the order of the AO.

Before the Tribunal, apart from relying upon the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra) and several other decisions of the High Court holding the goodwill as eligible for depreciation, the assessee also submitted that the sixth proviso to section 32(1)(ii) was only a mechanism of allocation of depreciation otherwise allowable on the WDV of assets owned by the amalgamating company, whereby such depreciation got allocated between the amalgamating and the amalgamated company in the year of amalgamation, and had no applicability for any new asset arising on account of the amalgamation in the hands of the amalgamated company. It was contended on behalf of the assessee that the sixth proviso was introduced to curb the practice of claiming depreciation on the same assets by both the predecessor company and the successor company in the case of a merger or succession, as was evident from the Memorandum explaining the provisions of the Finance Bill, 1996. Therefore, the said proviso should not be made applicable to the goodwill arising by virtue of the amalgamation.

The assessee also submitted that a similar issue was raised before the Hon’ble Kolkata High Court in the appeal by the Revenue in the case of Smifs Securities Ltd. ITA No. 116 of 2010 for the year, i.e., A.Y. 2001-02, and the said question was not pressed by the Department, by conceding that it was covered by the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra). It was submitted that the Revenue had not filed any appeal before the Supreme Court against the decision in the said case and once the Revenue had chosen not to challenge a particular decision, it was bound by the said decision. In this regard, reliance was placed on the decision of the Supreme Court in the case of Narendra Doshi, 254 ITR 606 [SC].

The Revenue, on the other hand, supported the orders of the lower authorities and submitted that the net assets acquired were valued at Rs. -106.8 crores after reducing the liabilities. Thus, when the net asset value was negative, there could not have been any goodwill. It was also pleaded that the amalgamation of whollyowned subsidiary would not lead to transfer of assets u/s 2(47) and therefore, claiming of goodwill as arising out of a transaction not regarded as transfer would be a case of making profit out of oneself. Additionally, it was also claimed that the valuation of the enterprise for purchase of shares could not be equated to the valuation for amalgamation.

On the basis of the arguments raised by both the sides, the Hyderabad bench of the Tribunal ruled in favour of the assessee, holding that the deduction of depreciation on goodwill could not be denied. The reliance placed by the Revenue on the sixth proviso to section 32(1)(ii) did not find favour with the Tribunal. The Tribunal referred to the accounting principles as laid down in AS-14 and observed that, in case of amalgamation in the nature of purchase, the consideration paid in excess of the net value of assets and liabilities of the amalgamating company was to be treated as goodwill. Such goodwill was held to be eligible for depreciation u/s 32(1) by relying upon the decision of the Supreme Court in the case of Smifs Securities Ltd. (Supra).

 

The issue under consideration moves in a narrow compass. Depreciation is allowable in computing the total income by virtue of section 32 on compliance with the conditions of the said provision. One of the conditions is that the asset in question should be acquired and owned by the assessee claiming the depreciation. On satisfaction of the conditions prescribed, the depreciation can be denied only with an express provision for denial of the claim. The provisos to section 32 have the effect of restricting the amount of depreciation, or of sharing it, or denying it in the stated circumstances. We do not find that any of the provisos, including the sixth proviso, denies the claim of depreciation in cases of an amalgamation. In the circumstances for a valid claim of depreciation, the amalgamated company should satisfy the compliance of the main conditions, namely, acquisition and ownership, besides use. Once they are satisfied, the claim could be denied only by an express provision and not by a roundabout or convoluted reading of the sixth proviso that has been inserted much later in the day to ensure that in the year of transfer both the transferor and the transferee do not claim the ‘full’ depreciation; it is introduced to ensure the sharing of the amount of depreciation in the year of transfer, nothing less, nothing more.

In the absence of the sixth proviso, it was not possible to deny the claim of depreciation in full by both the transferor  and the transferee, a position that had been confirmed by the courts. Reference can be made to CIT vs. Fluid Controls Mfg. Co. 286 ITR 86 (Guj.), Sita Ram Saluja vs. ITO 1 ITD 754 (Chd.).

The sixth proviso does not deal with the case of an asset that comes into existence and / or is acquired for the first time in the course of amalgamation. It also does not deal with an asset on which one of the parties could not have claimed the deduction for depreciation. Goodwill of the kind being discussed here is one such asset on which it was never possible for the amalgamating company to have claimed depreciation, and therefore it is fruitless to apply the sixth proviso to such a situation or claim.

The enabling provision therefore is the main provision of section 32(1), and once the terms therein stand satisfied, the claim cannot be denied or even be reduced without an express provision to do so. In our considered opinion, there is nothing in the sixth proviso to facilitate the denial of the claim altogether. In the absence of the disabling provision, it is not fair on the part of the Revenue to frustrate the claim otherwise held to be lawful by the Apex Court.

The sixth proviso can have an application, in cases of amalgamation, only where some asset which was owned by the amalgamating company is acquired by the amalgamated company in the course of the amalgamation and the acquiring company is seeking to claim depreciation thereon.

There is no dispute as to whether the goodwill arising on the amalgamation falls within the ambit of business or commercial rights, being intangible assets eligible for depreciation. The only dispute is about the applicability of the sixth proviso to section 32(1)(iia) and invocation thereof by the Revenue so as to deny the benefit of depreciation on such goodwill to the amalgamated company. The sixth proviso to section 32(1)(ii) reads as under:

The aforesaid proviso was originally inserted as the fourth proviso by the Finance (No. 2) Act, 1996. The rationale behind insertion of this proviso can be gathered from the Circular No. 762 dated 18th February, 1998, the relevant extract from which is reproduced below:

From the Circular as well as the language of the proviso it becomes clear that the restriction placed is applicable only when it is otherwise possible to claim depreciation on the same asset by both the companies, i.e., the amalgamating company as well as the amalgamated company. In order to trigger the sixth proviso, there has to be an asset, tangible or intangible, on which both the companies could have claimed the depreciation u/s 32(1) in the year of amalgamation. This proviso should not be made applicable to any such asset on which only one of the two companies could have claimed the depreciation otherwise. The goodwill being an offshoot of the amalgamation, the question of claiming depreciation thereon by the amalgamating company does not arise at all.

There can be a case where the amalgamated company is disentitled to claim depreciation on the assets acquired through the amalgamation, even without applying the sixth proviso to section 32(1)(ii). For instance, where the assets acquired through the amalgamation are recognised as inventories of the amalgamated company, though they were depreciable assets of the amalgamating company or where the corresponding income generated from such assets falls outside the scope of business income of the amalgamated company and, therefore, depreciation on such assets cannot be allowed to it on such assets u/s 32(1). In such cases, the question is whether the aggregate depreciation can be determined ignoring the amalgamation and the portion of it can be claimed in the hands of the amalgamated company on the basis of number of days for which the assets were used by it merely by relying upon the sixth proviso to section 32(1)(ii)? The answer obviously is no. This leads us to the conclusion that the sixth proviso to section 32(1)(ii) applies only in a situation where both the companies are eligible to claim the depreciation on the same assets for the year of amalgamation and not otherwise.

Further, this proviso has a limited applicability only to the year in which the succession or amalgamation takes place and it does not apply to the subsequent years. There is no probability of claiming depreciation by two entities in the subsequent years on the same assets exceeding the depreciation otherwise allowable, for the obvious reason that the predecessor or the amalgamating company will cease to own the asset or exist by virtue of the succession or the amalgamation as the case may be. Therefore, if a view is taken that the depreciation on goodwill arising on account of the amalgamation cannot be allowed only because of the sixth proviso to section 32(1)(ii), then it will result into denial of depreciation only for the year of amalgamation and not for subsequent years. It would be quite illogical to consider the amalgamated company as ineligible for depreciation on such goodwill only for the first year and, then, allow it to claim the depreciation from the second year onward.

The better view therefore is the one propounded by the Hyderabad bench of the Tribunal in the case of Mylan Laboratories Ltd. (Supra) that the depreciation should be granted to the amalgamated company on the goodwill recognised by it, being the excess of consideration over the appropriate values of net assets acquired, starting from the year of amalgamation itself.