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Sale of Goodwill and its taxability:

Goodwill, the name in itself gives us an idea that it is a reputation that was built through business over a period of time. Goodwill includes trademarks, copyrights, licences, patents, brands, etc.  Why should goodwill be a topic of debate and why is it always complex to account for goodwill?  Why should goodwill even be accounted for in the books...? These are some of the basic questions which we will see further. There are physical assets for a company such as Fixed assets, Cash, etc which are tangible and can be identified and seen. However, this alone will not add value to the company's products and services. There is something else which makes a company stand out from others. We will look at the concept of goodwill with a simple example.

Let's take two companies in a Technology Industry where goodwill plays a very major role in the sale of their products and services. There is Apple Inc and Lenovo group limited. Both these companies sell products such as mobile phones, laptops, etc. but we all know which product comes out with a “grand entrance” and gets a head start in the market. Unlike many people's idea, this is not something which is achieved by just running a company over a period of time. Sustaining for a longer period alone in the market will not add value or increase the goodwill of a company. In fact, Apple during its initial years had a rough start in the global market to compete with already big companies such as IBM and Sun Microsystem. But later it went to have a strong foothold in mobile markets in the early 2000s. We can see how much people like Apple's iPhone and how much they adore in holding the product in their hands. So, in our example, if you look at the accounting of Apple and Lenovo, Apple comparatively will have huge goodwill since the brand had literally reached all the major countries in the world. So, how much a name Apple cost? People hadn't heard about a company called Pixar as much as Apple, which is a subsidiary of Apple. We can look at this scenario keeping the brand popularity in mind and see how much a brand could make a difference when it comes to Pixar's product. Pixar is a production house for making animation movies. Since Apple has a huge reputation, the same reputation could be used to sell Pixar's product in the market. It makes a huge difference to their end product and this will give you an idea of how much Apple's Goodwill could cost.

How are Goodwill�s accounted?

There arises the need for accounting and valuation of Goodwill at its correct cost. However, there is no standard formula or methods for determining the correct value of goodwill. Companies are free to account the value of goodwill provided they have a proper basis for its valuation.

Let's look at this from a tax angle: 

We all know goodwill is an intangible asset and there is wide confusion whether goodwill will be an asset for the purpose of the Income Tax Act. The above confusion was put to rest in a case of Commissioner Of Income-Tax vs. Jaswantlal Dayabhai on 15 April 1978, where goodwill will be considered as Capital Asset and the resulting gain or loss will be charged u/s 45 as Capital Gains.

What is the Cost of Acquisition in case of Goodwill?

i) If goodwill was purchased, Cost of acquisition of goodwill is the purchase cost.

ii) If goodwill was acquired from a previous owner, the cost to the previous owner will be considered as Cost of acquisition

iii) If goodwill was self-generated, there arises a question how to determine it's the cost of acquisition.

We might refer a case law CIT Vs B.C. Srinivasa Sheety where the Hon'ble Supreme Court had given a verdict, where the cost of goodwill cannot be determined, then, in that case, there will not be any Capital Gains tax.

However, after the above verdict, the department made an amendment in sec 55 to give further clarification on what will be the cost of acquisition in case the goodwill if not, purchased goodwill. Sec 55 read as follows:

"in any other case [not being a case falling under sub-clauses (i) to (iv) of sub-section (1) of section 49], shall be taken to be nil"

The amendment made it very clear that if the cost of goodwill cannot be determined then it will be taken as nil for the purpose of computation of Capital Gains.

Confusion among Goodwill of business and goodwill of a profession?

However, there exists a confusion that BC Srinivasa Sheety case still applies in the case of the goodwill of a profession and goodwill of business will be governed by sec 55. The impact of this interpretation is that the cost of self-generated goodwill in case of business will be taken as Nil since the same has been included in the definition in sec 55 as amendments after the courts' verdict in BC Srinivasa Sheety case and Capital gains will be computed accordingly. Whereas, transfer of goodwill of a profession will remain out of the tax ambit due to the operation of BS Srinivasa Shetty case until a recent amendment in the AY 2017-18.

The recent amendment in the AY 2017-18 included self-generated goodwill of a profession also to form part of sec 55(2)(a) and makes its Cost of Acquisition Nil.

Why profession is covered under BC Srinivasa Sheety case and not business?

A profession such as doctors, lawyers, technicians, etc. earns goodwill based on their individual capacity and moreover, this individual reputation is so inherent in most of the individual. So, this reputation almost present in most of the individual cases. It could be a good reputation for some individual or bad for some other. Hence, a view could be taken that this self-generated Goodwill of a profession will not by nature be considered as a capital asset to be charged to Capital Gain tax because of its exclusivity of one Individual's talent, knowledge, and skills. It is difficult to determine the cost of a lawyer running a sole proprietorship who had gained a reputation in the market. If the same was sold it cannot be said that the person who bought his sole proprietorship will run as efficiently as the previous lawyer. But this difficulty should not be a hindrance in charging the transfer of above the goodwill to capital gain tax.

From AY 2017-18 since the profession was also included as a part of sec 55(2)(a), we can conclude that BC Srinivasa Sheety case no longer applies to Transfer of self-generated Goodwill of a profession. Hence, Cost of acquisition will be nil and Capital gains will be charged to tax just like the transfer of goodwill of a business.

Why BC Srinivasa Sheety case should not be used as a safeguard in case of self-generated goodwill?

Goodwill can be called as self-generated when no cost was involved in generating goodwill. Unlike in the case of trademarks, license, copyrights, patents, etc. So, why goodwill, when it was self-generated in case of a profession, will be covered under BC Srinivasa Sheety case…? The reason could be, it is difficult to determine the cost in case of self-generated Goodwill of a profession for the above case. However, this difficulty was cleared by making an amendment in sec 55(2)(a) by introducing a Cost of self-generated goodwill as "Nil". Hence, BC Srinivasa Sheety case no longer will apply to self-generated goodwill of a profession.

Conclusion:

Hence, transfer of self-generated goodwill of a profession which is also a Capital Asset by nature, the cost of such self-generated goodwill will be taken as Nil and resulting Capital Gains should be charged to tax accordingly.

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