The tax department is scrutinising several deals where companies have merged their businesses through share swaps, because it suspects them to have artificially created or inflated goodwill and claimed tax benefits on depreciation.
Tax authorities have disallowed depreciation on the goodwill claimed by companies after mergers on several instances, people in the know said.
Under accounting rules, goodwill is an intangible asset and depreciates after a merger or acquisition. It is typically written off within a few years after a transaction, leading to a lower tax outgo for the merged entity. As per current tax laws, companies can claim up to 25% depreciation on goodwill every year. When a company takes depreciation on an asset.
A tax expert said there was a Supreme Court order favouring the claim of depreciation on goodwill.
“Tax depreciation on goodwill ought to be allowable to the amalgamated company, following the decision of the Supreme Court in the case of Smifs Securities,” said Himanshu Parekh, partner and head of corporate and international tax, KPMG India.
Many companies record goodwill when there is a share swap and then depreciate it at least for the next seven years — though as per current regulations, goodwill can be depreciated as per the weighted average method indefinitely.
Goodwill is not defined under the Income Tax Act, experts said. To qualify for depreciation, the excess consideration paid for acquiring know-how, patents, copyrights, trademarks, licences, franchises or any commercial right is grouped under goodwill. The tax department has alleged that “fictitious assets” were created by companies before mergers merely to evade tax.
According to tax experts, the tax department could initiate action under the General Anti-Avoidance Rule against some companies. Some said whether goodwill was a depreciable asset or not should depend on the merit of the case.
“There has to be business drivers whenever there is a merger through share swaps and commercial substance has to be visible, like if two auto companies are being merged for business synergies. But in other cases where the tax department suspects that goodwill was artificially created only as a tax planning, GAAR could be applicable,” tax advisory firm Transaction Square’s founder Girish Vanvari said.
Some companies that had restructured their assets had been issued notices over goodwill by the tax department earlier. The tax department claimed that goodwill was conjured from thin air just before the restructuring merely to claim depreciation and reduce tax outgo. This, claims the taxman, should be disallowed.
Many are questioning the spate of notices by the taxman when companies have to take permission from the revenue authorities before any restructuring, or mergers and acquisition activity. Every merger and restructuring plan must be approved by the National Company Law Tribunal and each time the income tax department is asked if it has any objection, said people in the know. In most cases the tax department doesn’t respond, they claimed.
Source: Economic Times