Depreciation allowed on goodwill and tangible assets from Business Transfer Agreement under section 32(1)

The ITAT Hyderabad ruled in favor of the assessee regarding depreciation claims on goodwill and tangible assets acquired through a Business Transfer Agreement. The tribunal rejected the revenue's contention that the transaction was a colourable device, noting that capital gains were accepted in the seller's hands without adjustment. The tribunal held that once the department accepted the seller's capital gains, the transaction's legitimacy cannot be questioned in the purchaser's hands. Depreciation on goodwill was allowed, and the matter of tangible asset depreciation was remanded to the AO for verification and proportionate allowance under section 32(1)'s 6th proviso.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Appellate Tribunal (AT) are:

• Whether the depreciation claim under section 32 of the Income Tax Act, 1961 ('the Act') on goodwill arising from the acquisition of the IT services division of Allegis India by the assessee is allowable, given the circumstances of the transaction and the valuation methodology adopted;
• Whether the depreciation on other tangible assets acquired as part of the business transfer can be allowed when the Assessing Officer (AO) contended that such assets were not put to use during the relevant financial year;
• Whether the Business Transfer Agreement (BTA) executed shortly before the financial year-end and the associated transaction constitute a colourable device designed solely for tax avoidance;
• Application and interpretation of the 6th proviso to section 32(1) of the Act concerning depreciation apportionment between predecessor and successor in a business transfer;
• Entitlement to interest on refund under section 244A of the Act.

2. ISSUE-WISE DETAILED ANALYSIS

Depreciation on Goodwill and Alleged Colourable Device

Relevant legal framework and precedents: Section 32 of the Act permits depreciation on tangible and intangible assets, including goodwill, subject to conditions. The Finance Act, 2021, introduced amendments effective 01/04/2021 disallowing depreciation on goodwill; however, the assessment year in question (2017-18) predates this amendment. The Tribunal relied on precedents including the Hon'ble High Court of Delhi decision in Triune Projects Private Limited and the Bangalore Tribunal decision in I&B Seeds Pvt. Limited, which establish that acceptance of capital gains by the transferor precludes doubting the genuineness of the transaction in the hands of the purchaser.

Court's interpretation and reasoning: The AO and CIT(A) doubted the genuineness of the BTA, characterizing it as a colourable device primarily to create goodwill and claim depreciation, noting the timing of the transaction shortly before the financial year-end and the lack of market data supporting the goodwill valuation. They also observed that employees' consent was received post-transfer, and the capital gains tax paid by the seller was marginal compared to the depreciation claimed.

The Tribunal rejected these observations, emphasizing that the business acquisition was part of a global reorganization within the Allegis Group aimed at operational rationalization and efficiency, a common corporate practice. The Tribunal highlighted the significant post-acquisition business growth: an 87% increase in revenue and 39% increase in profit before tax, which contradicted the CIT(A)'s assertion of no fruitful outcome. The Tribunal also noted the capital gains tax paid by the seller (Rs. 67,41,196/-) exceeded the tax impact of depreciation claimed (Rs. 55,76,696/-), undermining the argument that the transaction was merely a tax avoidance device.

Key evidence and findings: The audited financial statements of the seller, management-certified valuation of goodwill, and the profit and loss statements showing substantial revenue and profit growth post-acquisition were critical. The acceptance of capital gains by the tax authorities in the seller's hands was also a decisive factor.

Application of law to facts: The Tribunal applied the principles from judicial precedents to conclude that acceptance of capital gains in the hands of the seller validates the transaction's genuineness in the purchaser's hands. The Tribunal also noted that the Finance Act, 2021 amendment disallowing depreciation on goodwill was not applicable to the assessment year under consideration.

Treatment of competing arguments: The Tribunal acknowledged the AO and CIT(A)'s concerns but found them unsubstantiated by evidence. The assessee's arguments regarding legitimate business purpose, commercial rationale, and post-acquisition performance were accepted over the suspicion of tax avoidance.

Conclusions: The Tribunal held that the depreciation claim on goodwill is legitimate and directed the AO to allow it.

Depreciation on Other Tangible Assets and Usage Requirement

Relevant legal framework and precedents: Section 32(1) of the Act allows depreciation on tangible assets, with the 6th proviso stipulating that in case of succession, the aggregate depreciation claimed by predecessor and successor shall not exceed the prescribed rates as if succession had not occurred, apportioned in proportion to days of usage. The law does not require actual usage or usage for a minimum number of days for claiming depreciation; rather, the asset must be "ready to use."

Court's interpretation and reasoning: The AO and CIT(A) disallowed depreciation on tangible assets on the ground that assets were not put to use during the year. The Tribunal disagreed, holding that acquisition on a going concern basis implies assets were ready for use. The Tribunal further noted that depreciation was allowed to the seller in respect of these assets, and therefore, the assessee's claim cannot be negated on the basis of non-usage.

Key evidence and findings: The BTA executed on 27/03/2017 with closing at 31/03/2017 11:59 p.m., audited financials, and prior acceptance of depreciation in the hands of the seller.

Application of law to facts: The Tribunal emphasized compliance with the 6th proviso, requiring apportionment of depreciation between predecessor and successor based on days of usage. Since no record was available to determine the exact apportionment, the matter was remanded to the AO for verification and appropriate allowance.

Treatment of competing arguments: The Tribunal acknowledged the AO's reliance on timing and usage but prioritized the statutory provision and the going concern nature of the transfer. The assessee's contention that usage is not a prerequisite for claiming depreciation under the block of assets concept was accepted.

Conclusions: The Tribunal set aside the disallowance of depreciation on tangible assets and remanded the issue for verification and allowance in accordance with the 6th proviso to section 32(1).

Interest on Refund under Section 244A

Relevant legal framework: Section 244A of the Act provides for payment of interest on refunds due to the assessee.

Court's interpretation and reasoning: The Tribunal directed the AO to verify and grant interest on refund as per the statutory provisions.

Conclusions: The Tribunal allowed the claim for interest on refund.

3. SIGNIFICANT HOLDINGS

"Viewing from any angle, the circumstances cited by the authorities to hold that the BTA is a colourable device created only to reduce the tax, does not hold water."

"It is legitimate for the assessee to go for acquisition of IT services division of Allegis India and there is no material to make it a colourable device in the shape of any undue advantage derived by the assessee."

"When once we accept the BTA, it goes without saying that the assessee acquired the IT services division of Allegis India on a going concern basis."

"The assessee is entitled to claim such depreciation only in proportion to the number of days for which the asset held by it."

Core principles established include:

• Acceptance of capital gains by the transferor precludes doubting the genuineness of the transaction in the hands of the purchaser;
• Depreciation on goodwill is allowable for assessment years prior to the Finance Act, 2021 amendment disallowing such claim;
• Business reorganizations and intra-group transfers undertaken for operational efficiency are legitimate and not inherently suspect as colourable devices;
• Depreciation on tangible assets acquired on a going concern basis is allowable without requirement of actual usage, subject to apportionment under the 6th proviso to section 32(1);
• Entitlement to interest on refund under section 244A is to be granted upon verification.

Final determinations:

• Depreciation on goodwill of Rs. 33,46,509/- is allowable;
• Depreciation on other tangible assets of Rs. 43,85,945/- is allowable subject to apportionment and verification by the AO;
• The BTA and associated transactions are not colourable devices;
• Interest on refund is to be granted as per section 244A.

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