Depreciation on goodwill from amalgamation allowed; statutory exclusion of goodwill applies only prospectively, assessment adjusted in assessee's favor

ITAT AHMEDABAD - AT allowed the assessee's appeal for AY 2012-13, holding that depreciation on goodwill recognized on amalgamation cannot be denied retrospectively. The Tribunal found the law settled by the SC and subsequent HC/tribunal decisions that goodwill may not be depreciable in many cases, but statutory amendments excluding goodwill from intangible assets operate prospectively from AY 2021-22. On that basis, the AO/CIT(A)'s disallowance was set aside and the assessment adjusted in favor of the assessee.

---

---

ISSUES PRESENTED AND CONSIDERED

1. Whether depreciation under Section 32(1)(ii) of the Income-tax Act is allowable in respect of goodwill recognized in the books of the transferee company pursuant to a court-sanctioned scheme of amalgamation effected prior to assessment year 2021-22.

2. Whether goodwill arising on amalgamation can be treated as a colourable creation to evade tax such that the Assessing Officer may invoke the proviso to Section 32(1) (now the sixth proviso) and disallow depreciation claimed by the transferee.

3. Whether statutory explanations to Section 43 (including Explanation 3(b) to Section 32(1), Explanation (7) to Section 43(1) and Explanation (2) to Section 43(6)) preclude allowance of depreciation on goodwill arising on amalgamation for the relevant pre-amendment years.

4. (Raised but not substantively adjudicated) Validity of initiation of penalty proceedings under Sections 274 read with 271(1)(c) in respect of the claimed depreciation.

ISSUE-WISE DETAILED ANALYSIS

Issue 1 - Allowability of depreciation on goodwill arising on amalgamation (legal framework)

Legal framework: Section 32(1)(ii) allowed depreciation on "Goodwill of a Business or Profession" prior to Finance Act 2021 amendments. Explanation 3(b) to Section 32(1) and related provisions in Section 43 came to focus in judicial debate; subsequent Finance Act 2021 expressly excluded goodwill from block of intangible assets and amended related provisions prospectively from AY 2021-22.

Precedent treatment: The Court relied upon the Supreme Court decision in Smifs Securities Ltd. and subsequent High Court and Tribunal decisions which interpreted Explanation 3(b) as permitting goodwill to be treated as an intangible asset for depreciation purposes in appropriate factual circumstances. The Tribunal decisions cited (including the jurisdictional decisions) that followed Smifs were treated as binding on the facts.

Interpretation and reasoning: The Court observed that for the amalgamation under consideration (effective date 1-4-2015 and court-sanctioned scheme), the excess of consideration paid by the transferee over the net assets of the transferor was recognized as goodwill in the transferee's books in compliance with AS-14 and the sanctioned scheme. Applying the principle in Smifs Securities Ltd., the Court accepted that goodwill recognized on amalgamation constitutes an intangible asset on which depreciation could be claimed for years prior to the prospective amendments of 2021, provided the cost recognized in the transferee's books reflects actual cost incurred and is not demonstrably artificial or inflated contrary to other statutory provisions.

Ratio vs. Obiter: The holding that depreciation on goodwill recognized on amalgamation (pre-2021 amendment) is allowable, following the Supreme Court authority, constitutes the ratio of the decision.

Conclusion: Depreciation on the goodwill recognized upon court-sanctioned amalgamation for the relevant assessment year is allowable; the appeal was allowed on this ground.

Issue 2 - Allegation of colourable device and invocation of proviso to Section 32(1)

Legal framework: The proviso (now sixth proviso) to Section 32(1) limits depreciation where assets acquired under certain transactions (including amalgamation) are subject to restrictions aimed at preventing enhancement of depreciation beyond what would have been allowable to the transferor; Explanation(s) to Section 43 provide guidance when goodwill forms part of the block of assets of the transferor.

Precedent treatment: The Court cited Tribunal and High Court decisions (including United Breweries and Nirma Ltd. analyses) that applied Smifs and held that, while goodwill is an intangible asset, the Assessing Officer may test whether the cost has been enhanced improperly and, where appropriate, limit depreciation to what would have been allowable to the amalgamating company in view of the proviso.

Interpretation and reasoning: The Court found that the AO and the lower authority's conclusion that the amalgamation was a colourable device was not supported by reasons in the record and was premised on assumptions and presumptions. There was acceptance of the sanctioned accounting treatment (purchase method under AS-14) and reliance on an independent valuer for determining net assets and consideration. In absence of evidential foundation for the charge of colourable evasion or of goodwill forming part of transferor's taxable block with zero written down value, the proviso could not be applied to deny depreciation.

Ratio vs. Obiter: The determination that assertions of colourable device must be reasoned and supported by evidence (and that mere suspicion is insufficient) functions as part of the operative reasoning (ratio) in allowing depreciation in this case; ancillary discussion about the proviso's proper operation as a limitation mechanism is explanatory but necessary to the decision.

Conclusion: Invocation of the proviso (now sixth proviso) to deny depreciation was unwarranted on the record; no colourable device was established and depreciation could not be disallowed on that basis.

Issue 3 - Application of Section 43 explanations and effect of later amendments (prospectivity)

Legal framework: Explanations to Section 43 and related amendments by Finance Act 2021 expressly clarified that goodwill shall not form part of the block of intangible assets for future years and adjusted treatment of written down value and cost of acquisition in amalgamation/gift scenarios. The Memorandum to the Finance Bill 2021 explained policy reasons for excluding goodwill prospectively.

Precedent treatment: Courts and Tribunals have applied pre-2021 law to permit depreciation where authoritative precedents (Smifs and follow-on decisions) so held. Post-2021 statutory changes were acknowledged to be prospective from AY 2021-22 and not to affect pre-amendment years.

Interpretation and reasoning: The Court emphasized that the Finance Act 2021 amendments apply prospectively and therefore do not alter the legal position for assessment years prior to their commencement. The statutory amendments and legislative intent were noted for context, but they do not affect the claim for AY 2016-17. Where goodwill was not shown to have formed part of the transferor's taxable block with nil WDV, the explanatory provisions invoked by the AO did not operate to deny depreciation for the pre-amendment year.

Ratio vs. Obiter: The observation that 2021 amendments are prospective and thus inapplicable to the year in issue is a necessary legal conclusion (ratio) for disposal; broader comments on legislative policy are explanatory (obiter) but relevant.

Conclusion: Explanations in Section 43 and the 2021 amendments do not preclude allowance of depreciation on goodwill for the pre-amendment assessment year under consideration; the statutory changes are prospective and distinguishable.

Issue 4 - Penalty proceedings under Sections 274/271(1)(c)

Legal framework & reasoning: Penalty initiation was pleaded as a ground of appeal. The Court's order does not contain substantive adjudication or detailed discussion on the validity or merits of penalty proceedings in the available text; disposition relates solely to the allowance of depreciation on goodwill.

Ratio vs. Obiter: The absence of adjudication on penalty renders any reference to it either not decided or procedural; no ratio on penalty is established by the present order.

Conclusion: Penalty ground was raised but not determined in the decision as recorded; the operative order addresses and allows the depreciation claim only.

Cross-references

* Issue 1 and Issue 3 are interlinked: the conclusion on allowability of depreciation (Issue 1) is premised on the application of pre-2021 law and authorities (Issue 3).

* Issue 2 intersects with Issues 1 and 3 because the proviso and explanatory provisions are the statutory mechanisms by which an Assessing Officer may limit depreciation arising on amalgamation; the Court required evidential foundation before such restrictions could be invoked.

---