30 June 2010
WHETHER DEPRECIATION CAN BE CLAIMED ON ëGOODWILLí ACQUIRED ON PAYMENT OF COST? This issue came up for consideration of the ITAT ‘H’ Bench, Mumbai in the case of R.G. Keswani v. ACIT (2009) 116 ITD 133 (Mum). The assessee, in the case before the Tribunal purchased a running business from M/s R.G. Keswani & Engrep (R for short). At the time of acquiring the business, the assessee had paid certain amount in respect of trade name, goodwill and for all other business and commercial rights and claimed depreciation on said amount. The Assessing Officer rejected the assessee’s claim holding that goodwill could not be treated as intangible asset and, therefore, not depreciable. On appeal, the Commissioner (Appeals) held that goodwill by itself was not in the nature of business or commercial right. He, therefore, concluded that the provisions relating to depreciation on capital assets as well as the provision relating to the computation of capital gains did not contemplate providing of depreciation on goodwill. The ITAT agreed with the view of the AO and the CIT(A). Grounds given by the ITAT for rejecting the claim of depreciation. Briefly these could be summarized as under: (a) The law has specified items of intangible asset eligible for depreciation in the following categories - (i) Know-how (ii) Patents (iii) Copyrights (iv) Trademarks (v) Licences (vi) Franchises (vii) Any other business of commercial rights of a similar nature Thus other assets have not been made entitled to depreciation. (b) Goodwill does not fall under any of the categories (i) to (vi) specified in the provision. The only remaining category is the residual one ‘any other business or commercial Although the Finance Act 1998 provided for grant of depreciation on intangible assets subject to the satisfaction of certain conditions, the ITAT had recently held that goodwill is not entitled to depreciation. The correctness of this decision is examined in this article. * Former Chairman, Central Board of Direct Taxes and Special Secretary, Ministry of Finance. Articles rights of similar nature’. Hence it is to be seen if the goodwill can be said to fall under the residuary category. (c) To be eligible for consideration under the residuary category, Goodwill must be of the same nature as know-how, patents, copyrights, trademarks, licences and franchises. A business or commercial right not similar in nature to these six items cannot be treated as intangible asset for the grant of depreciation. This is because any other business or commercial rights of similar nature provided as a residual category is found in the company of expression like knowhow, patents, copyrights, trade marks, licences, franchises and, therefore, in view of the principle of ejusdem generis, the above expression ‘any other business or commercial rights’ has to be read in the company of the preceding words. Ejusdem generis rule is the rule of generic words following more specific one. The rule is that when general words follow specific words of same nature, the general words must be confined to the things of the same kind as those specified. This rule of interpretation makes an attempt to reconcile incompatibility between the specific and general words. The first category of words like know-how, patents, copyrights, etc., form a distinct genesis or category inasmuch as all those items are specific and elucidated rights of business or commercial nature. In such circumstances, the expression ‘any other business or commercial rights of similar nature’ also must be in the same genesis or category with specific and elucidated identity of commercial or business nature. Therefore, in the light of the statutory provisions contained in section 32(1)(ii), the goodwill acquired by the assessee does not come under the expression of any other business or commercial rights of the nature similar to know-how, patents, copyrights, etc. (d) In the case before the ITAT, though the expression “all business and commercial rights” has been used in acquiring the business ‘R’, but this expression has been considered to be “too generic an expression which did not find similarity with specific expression like know-how, patents etc.. Therefore, such a general expression of business and commercial rights could not be equated with the expression of ‘any other business of commercial rights of similar nature’ occurring in section 32(1)(ii). The Tribunal has accordingly held that the claim of the assessee was not tenable either in facts or in law. Therefore, the lower authorities had rightly held that the acquisition cost of goodwill was not entitled for depreciation. APPRAISAL OF THE TRIBUNALíS DECISION The term ‘ Goodwill’ has not been defined in the Income-tax Act though in section 55(2)(a) it has been recognized that it is a ‘capital asset’ (for the purposes of sections 48 & 49 of the Act) and its cost of acquisition is to be taken as the ‘amount of purchase price’ when it is purchased from a previous owner and in any other case (not being a case falling under sub-clauses (i) to (iv) of subsection( 1) of section 49) as ‘nil’. In other words, the cost of acquisition of a self generated ‘goodwill’ is to be taken as ‘Nil’. Thus in fact that goodwill is a ‘capital asset’ is recognized under the Act. It has also been so recognized judicially vide CIT v. G.D. Naidu (1987) 165 ITR 63 (Mad). What is goodwill In Eric L. Kohler’s ‘A Dictionary for Accountants’ the term ‘Goodwill’ has been defined thus : The current value of expected future income in excess of a normal return on the investment in net tangible assets not as a recorded or reported amount unless paid for. The excess of the price paid for a business as a whole over its book value, or over the computed or agreed value of all tangible net assets purchased. Normally, purchased goodwill is the only type appearing on books of account and in financial statements. Judicial definition of the term goodwill Lord Eldon in Cruitwill v. Lye (1810) 17 Ves 335 (referred in CIT v. B.S. Srinivasa Setty (1981) 128 ITR 294) has defined goodwill saying that it is nothing more than “the probability that the old customers would resort to the old places”. This was expanded by Wood V.C. in Churton v. Douglas, (1859) John 174, to encompass every positive advantage “that has been acquired by the old firm in carrying on its business, whether connected with the premises in which the business was previously carried on or with the name of the old firm, or with any other matter carrying with it the benefit of the business”. The Trego v. Hunt (1896) AC 7 (HL), Lord Herschell described goodwill as a connection which tended to become permanent because of habit or otherwise. An exhaustive and illustrative definition of ‘goodwill’ has been given by the Calcutta High Court in CIT v. Chunnilal Prabhudas & Co. (1970) 76 ITR 566 : “It has been horticulturally and botanically viewed as ‘a seed sprouting’ or an ‘acorn growing into the mighty oak of goodwill’. It has been geographically described by locality. It has been historically explained as growing and crystallizing traditions in the business. It has been described in terms of a magnet as the ‘attracting force’. In terms of comparative dynamics, goodwill has been described as the ‘differential return of profit’. Philosophically it has been held to be intangible. Though immaterial, it is materially valued. Physically and psychologically, it is a ‘habit’ and sociologically it is a ‘custom’. Biologically, it has been described by Lord Macnaghten in Trego v. Hunt, (1986) AC 7 (HL), as the ‘sap and life’ of the business. Architecturally, it has been described as the ‘cement’, binding together the business and its assets as a whole and a going and development concern. There are few other definitions of the term in Accountancy and law books, but it does not seem necessary to mention all these as even after that, it would be difficult to arrive at a generally accepted definition. This has been recognized by Goodwill as an Intangible asset is Eligible for Depreciation? Articles Articles Lord Macnaghten in IRC v. Muller & Co’s Margarine Ltd. (1901) AC 217 (HL) where he has said that “although goodwill was easy to describe it was nonetheless difficult to define”. However the foregoing definitions bring out an important aspect concerning goodwill namely that it is exclusive to the person or business who acquires it or generate it and cannot be infringed upon by others. WHETHER GOODWILL COULD BE CONSIDERED AT PAR WITH INTELLECTUAL PROPERTY RIGHTS? The expression ‘intellectual property’ connotes a string of rights available for the protection and exploitation of technology such as designs, secrets which could be in the form of (i) industrial property such as patents rights in technological inventions, trade marks, designs etc. or and (ii) copyrights covering musical, artistic, literary, photographic works etc.. Intellectual property rights (IPRs) are increasingly becoming a vital asset of the business. The purpose of the Trade & Merchandise Marks Act, 1958, Patents Act, 1970, the Copyright Act, 1957, Designs Act, 1911 etc. is to protect the interest, rights and duties created in regard to proprietors of the registered trademarks, copyrights, patents, designs etc. to serve a public purpose and prevent them against unfair competition which consists in acquiring for oneself by means of false or misleading devises, the benefit of reputation already achieved by the owners. The law of ‘passing off’ is a law designed to prevent unfair/dishonest trading and appropriation of someone else’s goodwill. In Scotch Whisky Association and Another v. Pravara Shakari Shakhar Karkhana Ltd. AIR 1992 Bom 294, the Bombay HC has observed that although the classic form of tort is one trader representing his goods as those of someone else, the basis of liability is wider; it is the injury of the plaintiff’s goodwill, ‘the benefit and advantage of good name, reputation and connection of a business’ . Hence exclusivity which has been secured for the owners of trademarks, copyrights, designs etc. through specific legislations is available for infringement of goodwill rights under the general civil and criminal laws of the country and in this sense the goodwill can certainly be said to be covered under the expression ‘business or commercial right similar in nature to the above’ as used in section 32(2)(ii) of the IT Act (Supra). The commercial value of goodwill becomes difficult to evaluate in the same manner as commercial value of IPRs. Hence it cannot be said that goodwill is not of the same nature as IPRs. Rather, its coverage is more wide and comprehensive. ëEJUSDEM GENERISí RULE SUPPORTS THE FOREGOING INTERPRETATION CONCERNING ëGOODWILLí The foregoing discussion shows that ‘ejusdem generis’ rule supports the view expressed hereinbefore. The true scope of the rule of ejusdem generis is that words of general nature following specific and particular words should be construed as limited to things which are of the same nature as those specified. If a broad based genus could consistently be discovered, there is no warrant to cut down general words to dwarf size. If giant, it cannot be, dwarf it need not be (See UP State Electricity Board v. Hari Shankar Jain AIR 1979 SC 65). To invoke the application of this rule there must be distinct genus or category. This is not the situation in case of goodwill and IPRs and the residuary words can certainly be said to cover ‘goodwill’ as well. In the context of ‘ejusdem generis’ a reference may be made to the Calcutta High Court’s decision in the case of Smt. Sipra Dey v. Ajit Kumar Dey AIR 1988 Cal 28. In this decision, the HC has held that a word, like a man is very often known by the company it keeps and hence it is to be understood in the context and collocation it is used. This rule of interpretation is known as ‘ noscitur a sociis’ which is much wider than the rule of ‘ejusdem generis’ and the later rule is only an illustration or application of the former. From this view also, the word ‘goodwill’ can be said to be of the same genus or nature as the six words mentioned in section 32(2)(ii) of the Act and hence entitled for depreciation. CONCLUDING COMMENTS The view of the Tribunal expressed in the decision discussed above that goodwill is not an intangible asset and hence not entitled for depreciation, does not seem to be correct and hence needs to be reviewed. Goodwill as an Intangible asset is Eligible for Depreciation?
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