India’s New Rule for Computation of Short-Term Capital Gains to Increase Tax Liability for Businesses
India’s main tax body, CBDT, announced new rule 8AC for businesses that obtained depreciation on goodwill in FY20-21. The excess of such depreciation will be considered a short-term capital gain and invite tax liability. This rule is most likely to impact start-ups and companies in the pharmaceutical sector and life sciences sector who have opted for merger and acquisitions in the past five years.
On July 7, 2021, the Central Bureau of Direct Taxes (CBDT) notified new rule 8AC for computation of short-term capital gains (STCG) and written-down value (WDV) under Section 50 of the Income Tax Act, 1961.
The new rule lays out the computation methods of STCG and WDV applicable for those companies which have obtained depreciation on goodwill in the assessment year beginning on April 1,2020 since depreciation can no longer be deducted on goodwill, as provided by the Finance Act 2021. This provision is retrospectively in effect from April 2020.
Experts believe that start-ups preparing for initial public offering (IPO), and companies in the pharmaceutical sector and life sciences sector who have opted for mergers and acquisitions (M&A) in the past five years will most likely be impacted by the new rule. This is mainly because companies in these sectors, especially unicorns, fetch substantial value for their intangible components.
Exclusion of goodwill from the purview of intangible assets will lead to a reduction in their overall valuation, and increase their tax liabilities.
Rule 8AC: What are the implications for businesses ?
This rule enforces the amended Section 50 of the Income Tax Act, which provides a method for computation of STCG and WDV in cases where goodwill of a business or profession formed part of a block of asset for the assessment year beginning on April 1, 2020, and depreciation has been obtained by the assessee under the Act.
If the value of net goodwill removed from the block is in excess of the opening WDV value as on April 1, 2020, such excess will now taxable as STCG. But in cases where goodwill was the only asset in the block, there will be no impact as per Section 55(2(a)) of the Income Tax Act.
Companies will now be required to calculate the tax on these short-term capital gains and pay it before filing the income tax return (ITR) for financial year 2021 (FY21). It is to be noted that the deadline for filing the returns has been extended for businesses, from October 31, 2021 to November 30, 2021, due to the pandemic. To know more about latest deadlines and tax rules, refer to our article here: Tax Deadlines and New Income Tax Rules in India in 2021
How to determine the Written Down Value (WDV) relevant for assessment year 2021 ?
The WDV relevant to the assessment year (AY) 2021-22 shall be determined in the following manner:
- Determine the opening WDV of a block of assets as on April 1, 2020.
- Add the actual cost of the asset (other than goodwill) acquired during the previous year.
- Deduct the amount payable with respect to any asset that is sold, destroyed, discarded, or demolished during the previous year. The scrap value, if any, must also be deducted.
- Deduct the WDV of the assets, transferred under ‘slump sale’ falling under that block. (Slump sale means the transfer of one or more undertaking, for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales)
- Deduct the actual cost of goodwill after reducing depreciation allowed, falling within the block.
Rule 8AC provides that if the actual cost of goodwill after reducing depreciation (amount calculated at point 5) exceeds the aggregate of opening WDV (point 1) and the actual cost of asset acquired during the year (point 2), such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets.
Why is the new rule introduced ?
The Finance Act, 2021 amended various provisions of the Income Tax Act to prohibit the deduction for depreciation on goodwill, with effect from April 2020, as goodwill will no longer be considered an intangible asset.
Section 2(11) of Income Tax Act, which defines the term “block of assets” was amended to exclude goodwill of a business or profession from the purview of “block of asset”.
Section 32(1(ii)) of Income Tax Act was amended to remove goodwill of a business or profession from the definition of tangible assets to make them ineligible for depreciation.
Section 50 of the Income Tax Act was amended to provide a method for computation of STCG and WDV, as may be prescribed by the concerned authority. Therefore, CBDT invoked its powers under this section to notify the new rule.
While making the amendments in the Finance Act 2021, it was observed that usually, goodwill is not a depreciable asset, and depending upon the business profitability and operations, goodwill may also experience appreciation or may remain unchanged.
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