How is goodwill treated for tax purposes

July 28 Recording of goodwill in the books of accounts pursuant to acquisition or reorganisation of business and claim of depreciation on it has been a long-debated issue under the Indian Income Tax Law.

While many of the rulings were in favour of claim of depreciation, there were still differences of opinion among the courts on certain issues. While the taxpayers were all geared up to battle it out before the highest courts, the tax department has brought in certain amendments in the budget to put an end to such claims altogether.

Though goodwill is not a term defined in the Indian tax laws, common dictionaries describe it as the established reputation of a business regarded as a quantifiable asset. Lord Macnagthen described it as the benefit or advantage of the good name, reputation and connection of a business.

He also noted that goodwill has no independent existence and it must be attached to the business. Therefore, whenever a business is acquired, the buyer also by default acquires the goodwill associated with such business.

Usually, goodwill which is self-generated over a period of time is not recorded as an asset in the books of accounts of the seller. However, while valuing the business and negotiating the consideration, the parties not only take into account the market value of the tangible and intangible assets already recorded in the books of the seller, but also that of the goodwill associated with the said business.

Thus, any premium paid by the buyer to seller over and above the recorded net worth of the business, i. Indian Income Tax Law provides for depreciation on various tangible and intangible assets, which are owned and used by the taxpayer for the purposes of business see section 32 of the Indian Income Tax Act, Earlier, the scope of intangible assets was wide enough to cover any know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.

Also, the manner in which the other assets and liabilities of the business were valued had a direct bearing on the quantum of goodwill and was often disputed by the tax department.

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Prior to , for accounting purposes a portion of goodwill was required to be amortized, or written off, by a business on their income statement every year. Beginning in , the value of goodwill on the balance sheet need not be written down unless it is determined that there has been an impairment in the value of the goodwill.

For tax purposes, goodwill is considered eligible capital property , and can be written off in a manner similar to capital cost allowance. All Rights Reserved. See Reproduction of information from TaxTips.