Suppose that Alpha Limited, a manufacturer, merges into Beta Limited under a court or tribunal sanctioned scheme. Alpha’s plant and machinery stand in its own books at a written down value of Rs. 40 crore, but the valuers engaged for the scheme report that the same plant is worth Rs. 150 crore. Beta issues its shares to Alpha’s shareholders, records the plant at Rs. 150 crore, and in its first return after the merger claims depreciation on that figure. The Assessing Officer allows depreciation on Rs. 40 crore. Who is right? The Act has answered this question, and answered it the same way, since 1967. Under Explanation 7 to section 43(1), the amalgamated company inherits the transferor’s tax cost; it does not acquire a new and larger one merely because a scheme has intervened. This article explains where that rule comes from, which provisions carry it, what it does and does not reach, and how it has been restated in the Income-tax Act, 2025, in force from 1 April 2026.

Actual Cost and Written Down Value: The Basis of Depreciation on Amalgamation

Depreciation under section 32 of the Income-tax Act, 1961 is not computed on what an asset is worth but on a statutory figure. In the year an asset enters the books that figure is the “actual cost” defined in section 43(1); thereafter it is the “written down value” of the block of assets defined in section 43(6). A “block of assets” is simply a bundle of assets of the same class carrying the same rate of depreciation, depreciated collectively rather than asset by asset since 1 April 1988. Control those two figures and you control the deduction. That is precisely what the legislature did.

Explanation 7 to Section 43(1): Carry-Forward of Actual Cost on Amalgamation

Before 1967 an amalgamation was, for tax purposes, an ordinary transfer. If the transferor received more for its plant than the plant’s written down value, section 41(2) as it then stood taxed the excess, up to the depreciation it had already enjoyed, as business income. That charge was a real deterrent to mergers, and the Finance (No. 2) Act, 1967 removed it. The same statute introduced the definition of “amalgamation” (then section 2(1A), renumbered section 2(1B) with effect from 1 April 1989), the capital gains exemption in section 47(vi), and the cost carry-over for shareholders in sections 49(1)(iii)(e) and 49(2).

The relief was not free. The Memorandum to the Finance (No. 2) Bill, 1967, and CBDT Circular No. 5-P dated 9 October 1967 both explain the quid pro quo in terms: because no profit would be computed under section 41(2) in the amalgamating company’s hands, the actual cost and the written down value of the assets transferred “will be taken, in the assessment of the amalgamated company, to be the same as in the case of the amalgamating company”, and the depreciation already granted to the transferor would count against the aggregate. The transferor escapes the balancing charge; in exchange, the transferee gets no fresh depreciation base. The two limbs of that bargain are Explanation 7 to section 43(1) – “the actual cost of the transferred capital asset to the amalgamated company shall be taken to be the same as it would have been if the amalgamating company had continued to hold the capital asset for the purposes of its own business” – and what was then Explanation 2A to section 43(6), now Explanation 2 to section 43(6)(c) after the block regime was introduced by the Taxation Laws (Amendment and Miscellaneous Provisions) Act, 1986 with effect from 1 April 1988.

The design is deliberately fictional. Explanation 7 does not ask what Beta paid; it asks a counterfactual – what would the cost have been had Alpha never merged at all? The scheme, the share swap and the valuation report are, for this purpose, invisible.

Depreciation in the Year of Amalgamation: The Sixth Proviso to Section 32(1)

The 1967 provisions fix the base. They say nothing about the year of the merger itself, when two assessees have each held the same assets for part of the year. That gap was closed nearly thirty years later. The Finance (No. 2) Act, 1996, with effect from 1 April 1997, inserted a proviso to section 32(1) providing that the aggregate depreciation allowable to the predecessor and the successor, or to the amalgamating and the amalgamated company, or to the demerged and the resulting company, “shall not exceed in any previous year the deduction calculated at the prescribed rates as if the succession or the amalgamation or the demerger… had not taken place”, and that it shall be apportioned between them “in the ratio of the number of days for which the assets were used by them”.

A word of caution on nomenclature, because it trips up citations. That provision was the fourth proviso when inserted, the fifth from 1 April 1999, and the sixth only since 1 April 2016; it was substituted in its present, demerger-inclusive form by the Finance Act, 1999. Most reported decisions therefore call the identical rule the fifth proviso, and the Act itself uses no ordinal at all.

Two consequences follow. The first is arithmetical: a merger cannot manufacture a second year’s depreciation out of a single year. The second is temporal. In Padmini Products (P.) Ltd. v. Deputy CIT (Karnataka High Court, ITA No. 154 of 2014, decided 5 October 2020), a firm’s business was succeeded to by a company and the revenue sought to use the proviso to deny depreciation in later years as well. The Court held that the proviso “in any case will apply only in the year of succession and not in subsequent years”, and separately that Explanation 3 to section 43(1) cannot be invoked without a recorded satisfaction and the prior approval the section requires. The reasoning is difficult to fault on the language, though readers should check the status of the special leave petitions said to have been filed against that judgment before treating it as settled.

An Asymmetry worth Noticing: Amalgamation and Demerger are not Drafted Alike

When the Finance Act, 1999 extended the scheme to demergers with effect from 1 April 2000, it drafted Explanation 7A to section 43(1) in almost the same words as Explanation 7 and then added something Explanation 7 has never had: “Provided that such actual cost shall not exceed the written down value of such capital asset in the hands of the demerged company.” The same Act inserted Explanations 2A and 2B to section 43(6) for the block side. For amalgamations there is no equivalent express ceiling in section 43(1) itself; the ceiling arises indirectly, from the counterfactual in Explanation 7 read with Explanation 2 to section 43(6). For most assets that produces the same answer. The gap matters only for an asset that had no cost, and therefore no written down value, in the transferor’s hands at all – which is exactly where the litigation has settled.

Where the Argument Actually Happens: Goodwill Arising on Amalgamation

Take the merger consideration and subtract the fair value of the net assets taken over. Where the consideration is larger, accounting under the purchase method requires the difference to be carried as goodwill. Until the Finance Act, 2021, goodwill was capable of being a depreciable intangible: in CIT v. Smifs Securities Ltd. [2012] 348 ITR 302 (SC), decided on 22 August 2012, the Supreme Court held that “goodwill” is an asset within Explanation 3(b) to section 32(1). The question that then divided the tribunals was whether Explanation 7 reduces the cost of that goodwill to nil.

The revenue’s argument is faithful to the text. Explanation 7 requires the transferee’s cost to be measured as though the transferor had continued to hold the asset. If goodwill did not appear in the amalgamating company’s balance sheet, then on that counterfactual its cost is nil, and depreciation on a self-created figure is depreciation on nothing. That, in substance, is what the Bangalore Tribunal accepted in United Breweries Ltd. v. ACIT [2016] 76 taxmann.com 103, ITA No. 722/Bang/2014, disallowing goodwill of about Rs. 62 crore recorded on absorbing a wholly owned subsidiary, and holding that Smifs, which decided only that goodwill is an intangible asset, did not answer the separate question of quantification.

The assessee’s answer is equally textual. Explanation 7 operates on “any capital asset… transferred by the amalgamating company”. Goodwill of the kind recorded in a merger is not transferred; it comes into existence for the first time on the merger, as the residue of a valuation exercise, and it frequently reflects synergies belonging to the combined enterprise rather than anything the transferor held. On that view Explanation 7 has no subject matter to operate on, and a deeming fiction cannot be stretched beyond the case it names. Support is drawn from CIT v. B.C. Srinivasa Setty [1981] 128 ITR 294 (SC), where the Supreme Court held that self-generated goodwill has no ascertainable cost, and from the observation that where Parliament wanted a nil cost for goodwill it said so expressly, in section 55(2)(a), and said nothing of the kind in section 43.

High Court authority is thin, and narrower than it is often made to sound. In Pr. CIT v. Zydus Wellness Ltd. [2017] 87 taxmann.com 82, the Gujarat High Court dismissed the revenue’s appeal against depreciation on goodwill arising on amalgamation. But the ratio has two limbs – a procedural holding that a claim made by revised computation is not shut out for want of a revised return, and a merits holding expressly conditioned on the record, that there was “no material referred to by the Assessing Officer to hold that the claim of depreciation was fictitious”. Read fairly, Zydus tells the revenue what it must do, not that it can never succeed.

The recent tribunal trend runs the other way, and it runs on facts rather than on Explanation 7. In Invesco (India) (P.) Ltd. v. DCIT [2025] 176 taxmann.com 784 (Hyderabad), and again in Aptara Technologies (P.) Ltd. v. DCIT [2026] 183 taxmann.com 571 (Pune), decided on 17 February 2026, tribunals disallowed goodwill recorded on the absorption of a fellow or wholly owned subsidiary. Aptara is instructive on method: the Assessing Officer had invoked Explanation 7, but the Tribunal decided the appeal without adjudicating that provision at all, holding on the facts that an intra-group rearrangement under common control, involving no payment beyond an issue of shares and followed by discontinuance of the transferor’s business, produced “merely a colourable transaction” and no intangible asset. Where the goodwill is genuine, paid for and supported by valuation, the Explanation 7 question remains open.

Explanation 3 to Section 43(1): Re-Determination of Actual Cost

Behind all of this stands a much older provision. Explanation 3 to section 43(1) permits the Assessing Officer, where assets were previously used by another person and he is satisfied that the main purpose of the transfer was the reduction of tax by claiming depreciation on an enhanced cost, to determine the actual cost himself. Two conditions are express and are frequently the assessee’s best point: the satisfaction must be recorded, and the determination requires the previous approval of the Joint Commissioner. The underlying principle predates the Explanation. In Guzdar Kajora Coal Mines Ltd. v. CIT [1972] 85 ITR 599, the Supreme Court held that where “a fictitious price has been put on the asset or there is fraud or collusion”, the authorities may refuse the price stated in the deed and ascertain the real cost, and on the facts carved goodwill out of a composite consideration. Explanation 3 is a scalpel with procedural safeguards, not a general licence to substitute the revenue’s valuation for the assessee’s.

Finance Act, 2021: The goodwill Question closes Prospectively

With effect from 1 April 2021, the Finance Act, 2021 (Act 13 of 2021) removed goodwill of a business or profession from the depreciable class altogether, by amending the definition of “block of assets” in section 2(11), clause (ii) of section 32(1) and Explanation 3 to section 32, the written down value machinery in sub-item (B) of item (ii) of sub-clause (c) of section 43(6), section 50 and section 55(2)(a). Rule 8AC of the Income-tax Rules, 1962, inserted by the Income-tax (19th Amendment) Rules, 2021 (Notification No. 77/2021 dated 7 July 2021), prescribes how goodwill already inside a block is stripped out and what short-term capital gain, if any, results. The tribunals have treated the change as prospective, so the Explanation 7 debate survives for earlier years – and for assets other than goodwill it survives outright.

The Position Period by Period

Explanation 7 to Section 43(1): Its Restatement under the Income-tax Act, 2025

The 2025 Act restates this scheme without changing it. Depreciation now sits in section 33, and the apportionment rule in section 33(5), which caps the aggregate deduction at what would have been allowable “as if the succession, amalgamation or demerger had not taken place” and allows it “on pro rata basis based on number of days for which assets were used”. “Actual cost” is computed under section 39, and the Explanations to the old section 43(1) have been recast as a Table in section 39(4): serial 1 carries the amalgamation rule in the same words as Explanation 7, serial 2 the demerger rule with its written down value cap now written inline, and serial 6 the holding and subsidiary rule. The Assessing Officer’s re-determination power, with the Joint Commissioner’s approval, appears in section 39(5) and (6). Written down value is section 41, with the amalgamation carry-over at section 41(2)(c) and the demerger provisions at sections 41(3) and (4).

Two drafting points are worth noting. Because the Explanations now sit in a Table, the demerger cap is visible immediately alongside the amalgamation entry that still does not carry one. And section 33(5) attaches both the cap and the pro rata allocation to the year of the reorganisation on the face of the provision, which is the point the Karnataka High Court had to reach by construction in Padmini Products. One further recent statute is often misdescribed: the Finance Act, 2025 did rationalise amalgamation provisions, but only by capping carried forward losses at the balance of the original eight years. It did not touch actual cost, written down value or the step-up cap.

What is Settled, and What is Not

Settled: an amalgamated company steps into the transferor’s tax cost and written down value; a valuation done for a scheme does not create a depreciation base; the year of merger yields one year’s depreciation, split by days; and the revenue may go behind a stated price, but only on a recorded satisfaction and with the approval the statute requires. Open, at least for years before 1 April 2021: whether Explanation 7 reaches an intangible that came into existence on the merger rather than being transferred through it. The recent decisions have avoided answering that by resolving the cases on genuineness instead – a sensible judicial economy, but one that leaves a real question of construction undecided.

Frequently Asked Questions

Sources & Citations

• Income-tax Act, 1961: section 32(1) and the sixth proviso thereto (the fifth proviso before 1 April 2016; inserted as the fourth proviso by the Finance (No. 2) Act, 1996, w.e.f. 1 April 1997; substituted by the Finance Act, 1999, w.e.f. 1 April 2000); Explanation 3 to section 32(1).
• Income-tax Act, 1961: section 43(1), Explanation 3 (approval of the Joint Commissioner substituted by the Finance (No. 2) Act, 1998, w.e.f. 1 October 1998), Explanation 6 (Finance Act, 1965, w.e.f. 1 April 1965), Explanation 7 (Finance (No. 2) Act, 1967, w.e.f. 1 April 1967) and Explanation 7A (Finance Act, 1999, w.e.f. 1 April 2000).
• Income-tax Act, 1961: section 43(6)(c), Explanation 2 (substituted by the Taxation Laws (Amendment and Miscellaneous Provisions) Act, 1986, w.e.f. 1 April 1988; the predecessor Explanation 2A was inserted by the Finance (No. 2) Act, 1967, w.e.f. 1 April 1967), Explanations 2A and 2B (Finance Act, 1999, w.e.f. 1 April 2000).
• Income-tax Act, 1961: sections 2(1B), 47(vi), 47(vii), 49(1)(iii)(e), 49(2) and 41(2) as it stood before 1 April 1967.
• Memorandum to the Finance (No. 2) Bill, 1967, para 36, and CBDT Circular No. 5-P dated 9 October 1967 (both as extracted in the record in Aptara Technologies (P.) Ltd. v. DCIT, cited below).
• Finance Act, 2021 (Act 13 of 2021), w.e.f. 1 April 2021: sections 2(11), 2(42C), 32(1)(ii) and Explanation 3 to section 32, sub-item (B) of item (ii) of sub-clause (c) of section 43(6), section 50 and section 55(2)(a). Rule 8AC, Income-tax Rules, 1962, inserted by the Income-tax (19th Amendment) Rules, 2021, Notification No. 77/2021 dated 7 July 2021. The Explanation to section 50 was inserted by the Finance Act, 2022 with retrospective effect from 1 April 2021.
• Income-tax Act, 2025 (in force 1 April 2026): sections 33 and 33(5); section 39, including section 39(4) Table (serials 1, 2 and 6) and sections 39(5) and (6); section 41, including sections 41(2)(c), 41(3) and 41(4).
• Finance Act, 2025: section 72A(6B) and the amendment to section 72AA (carry-forward of losses on business reorganisation) – noted here only to distinguish it.
• CIT v. Smifs Securities Ltd. [2012] 348 ITR 302 (SC), Civil Appeal No. 5961 of 2012, decided 22 August 2012.
• CIT v. B.C. Srinivasa Setty [1981] 128 ITR 294 (SC), decided 18 February 1981.
• Guzdar Kajora Coal Mines Ltd. v. CIT [1972] 85 ITR 599 (SC), decided 31 July 1972.
• Padmini Products (P.) Ltd. v. Deputy CIT, Karnataka High Court, ITA No. 154 of 2014, decided 5 October 2020.
• Pr. CIT v. Zydus Wellness Ltd. [2017] 87 taxmann.com 82 (Gujarat).
• United Breweries Ltd. v. ACIT [2016] 76 taxmann.com 103 (Bangalore Tribunal), ITA No. 722/Bang/2014, assessment year 2007-08.
• Invesco (India) (P.) Ltd. v. DCIT [2025] 176 taxmann.com 784 (Hyderabad Tribunal).
• Aptara Technologies (P.) Ltd. v. DCIT [2026] 183 taxmann.com 571 (Pune Tribunal), ITA No. 63/PUN/2020, assessment year 2015-16, decided 17 February 2026.
• Technova Imaging Systems Ltd. v. DCIT, Bombay High Court, ITA No. 405 of 2003, decided 9 April 2025 (approval under section 72A is not a condition for an amalgamated company to work out written down value and claim depreciation).

Related Reading

• Depreciation on Goodwill in Amalgamations: From Smifs Securities to the Finance Act, 2021
• Is Goodwill an “Asset” for Depreciation? Smifs Securities and Explanation 3(b)
• Pooling of Interests vs Purchase Method: Can Goodwill Arise on Amalgamation?
• Book Entries Do Not Decide Tax: Kedarnath Jute, Tuticorin Alkali and Court-Sanctioned Schemes
• Goodwill Removed from Depreciable Assets: The Finance Act 2021, Its Transition and Its Fallout

The post The Cost-Step-Up Cap on Amalgamation: The Sixth Proviso to Section 32(1) and Explanation 7 to Section 43(1) appeared first on Bhatt & Joshi Associates.

Imagine two long-established companies deciding to merge. The stronger company absorbs the weaker one under a scheme of amalgamation sanctioned by the High Court, and in exchange issues its own shares to the shareholders of the company that disappears. When the accountants sit down to record the transaction, they find that the price effectively paid — the value of the shares issued — is larger than the net worth of the assets and liabilities actually taken over. That difference does not vanish; it has to be parked somewhere on the balance sheet. Accountants have a name for it: goodwill. It represents the premium a buyer pays for reputation, customer relationships, distribution networks, brand loyalty and the simple fact that an established business is worth more than the sum of its tangible parts.

The question that has occupied the Indian tax system for the better part of two decades is deceptively simple: can a company claim depreciation on goodwill recognised in its books following an amalgamation, in the same way it would on a factory building or a patent? The answer has moved through three distinct phases, and knowing which phase a given year falls into is essential, because the law that governs an amalgamation in 2004 is not the law that governs one in 2024.

Section 32(1)(ii): Depreciation on Intangible Assets

Depreciation is governed by section 32 of the Income-tax Act, 1961. For most of the Act’s life, depreciation was confined to tangible assets — buildings, machinery, plant and furniture. That changed with the Finance (No. 2) Act, 1998, which, with effect from assessment year 1999-2000, extended depreciation to a defined class of intangible assets under section 32(1)(ii). (An “assessment year” is the year in which the previous year’s income is taxed; assessment year 1999-2000 corresponds to income earned in the financial year 1998-99.)

What counts as an intangible asset is spelt out in Explanation 3 to section 32(1). It defines “asset” to mean an intangible asset “being know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature.” The list is closed at the front but open at the back: after naming six specific intangibles, it adds the residual phrase in clause (b) — “any other business or commercial rights of similar nature.” The entire controversy about goodwill turns on whether it can be squeezed into that residual clause, because goodwill is conspicuously not named among the six.

The Pre-2012 Debate: Is Goodwill “of Similar Nature”?

Before the Supreme Court intervened, the position was genuinely contestable, and both sides had respectable arguments.

The Revenue’s case rested on a canon of interpretation called ejusdem generis — literally, “of the same kind.” Where a general phrase follows a list of specific items, the general phrase is read as limited to things of the same genus as those items. Know-how, patents, copyrights, trademarks, licences and franchises, the Department argued, are all rights that can be separately identified, separately owned and separately transferred. Goodwill, by contrast, is inseparable from the business itself; it cannot be sold on its own without selling the undertaking. On that view goodwill was not “of similar nature” to the named intangibles and fell outside Explanation 3(b) altogether. The Revenue frequently added a second objection rooted in accounting: goodwill arising on amalgamation is often merely a balancing figure — the plug that makes the two sides of the entry agree — and a book-keeping residue should not attract a real deduction.

The assessee’s case was that the residual clause was deliberately worded broadly. Goodwill is unquestionably a “commercial right” — it is the very asset that gives a business its earning capacity above the value of its net tangible assets. When a company acquires that earning capacity by paying a premium in an amalgamation, it has paid real consideration for a real commercial advantage, and there is no principled reason to treat it differently from a franchise or a licence, both of which are equally bound up with the goodwill of the business they attach to. On this reading the phrase “of similar nature” describes the commercial character of the right, not a narrow structural test of separability.

Smifs Securities: Supreme Court Ruling on Depreciation of Goodwill (2012)

The debate was resolved by the Supreme Court in CIT v. Smifs Securities Ltd., [2012] 348 ITR 302 (SC) (also reported at [2012] 24 taxmann.com 222 and 210 Taxman 428), decided on 22 August 2012 by a Bench of Chief Justice S. H. Kapadia and Justice Madan B. Lokur. The facts were the classic amalgamation scenario described at the outset: YSN Shares & Securities merged into Smifs, the consideration exceeded the net assets taken over, the excess was recorded as goodwill, and the company claimed depreciation of roughly ₹54 lakh on it for assessment year 2003-04. The Assessing Officer disallowed the claim on the ground that goodwill did not fall within Explanation 3 to section 32(1).

The Court held, in favour of the assessee, that goodwill is an asset within Explanation 3(b). Turning the Revenue’s own canon against it, the Court reasoned that a reading of the words “any other business or commercial rights of similar nature” in clause (b) shows that goodwill would fall within that expression — and that “the principle of ejusdem generis would strictly apply while interpreting the said expression.” In other words, applied honestly, the genus of the named intangibles is “business or commercial rights,” and goodwill belongs squarely to that genus. The Court concluded that goodwill is an asset under Explanation 3(b) and that depreciation on goodwill is allowable under section 32.

Two features of the judgment are frequently overlooked and deserve emphasis, because they explain why Smifs did not end all litigation. First, the Court recorded a caveat of fact. The Assessing Officer had also found, as a matter of fact, that “no amount was actually paid on account of goodwill”; but the Commissioner (Appeals) and the Tribunal had found the opposite — that the difference between the consideration and the net assets did constitute goodwill and that a capital right had genuinely been acquired — and the Revenue had not appealed that factual finding to the High Court. The Supreme Court therefore left the finding of fact undisturbed. The legal proposition (goodwill is a depreciable asset) was thus decided against a factual backdrop the Revenue had not contested. Second, the same order held that a stock exchange membership card is a depreciable asset, following Techno Shares & Stocks Ltd. v. CIT, [2010] 327 ITR 323 (SC) — a useful reminder that the residual clause has always been read to accommodate commercial rights that are not obviously “property.”

After Smifs: Consolidation and the Questions Left Open

High Courts across the country applied Smifs without hesitation. In the Gujarat High Court, PCIT v. Zydus Wellness Ltd., [2017] 87 taxmann.com 82 (Guj), decided on 3 October 2017 by Justices Akil Kureshi and Biren Vaishnav, is representative. The Revenue there challenged depreciation of some ₹7.19 crore on goodwill recognised on amalgamation, arguing that it was “only a book entry” with no goodwill in the commercial sense. The Court held that Smifs “would squarely apply,” and that the Assessing Officer had pointed to no material to show the claim was fictitious; a bare assertion that an intangible acquired on amalgamation cannot be depreciated was, the Court said, directly opposed to Smifs. The Bombay High Court had reached a similar result in CIT v. Pruthvi Brokers & Shareholders (P.) Ltd., [2012] 349 ITR 336 (Bom).

Yet Smifs did not answer two harder questions, and it is here that the Revenue continued to litigate successfully in appropriate cases. The first is whether goodwill genuinely exists at all on the facts, as opposed to being an accounting plug — precisely the factual enquiry the Supreme Court had left open in its own caveat. The second is how much goodwill may be recognised where the asset comes across in an amalgamation. This is not left to the parties’ valuation. Explanation 7 to section 43(1), read with the sixth proviso to section 32(1), caps the cost of assets transferred in an amalgamation at the written-down value in the hands of the amalgamating company and requires depreciation to be apportioned as if the amalgamation had not taken place. The Department’s recurring argument was that a company cannot manufacture a fresh, depreciable goodwill simply by paying a premium over book value in a court-sanctioned scheme, when the underlying assets carry their historical cost across the merger.

Lurking behind all of this is a deeper doctrinal tension with CIT v. B. C. Srinivasa Setty, [1981] 128 ITR 294 (SC). That case, decided in the capital-gains context, held that self-generated goodwill has no ascertainable “cost of acquisition,” so the computation machinery of section 48 fails and its transfer cannot be taxed. The principle cuts both ways in the depreciation debate. If self-generated goodwill has no cost, can it be depreciated? Smifs answers this by confining itself to acquired goodwill — goodwill for which a measurable premium was actually paid on amalgamation — leaving self-generated goodwill, which never enters the books at a cost, outside the depreciation net for want of an actual cost to write down.

Finance Act 2021: Removal of Goodwill from Depreciable Assets

For nearly a decade after Smifs, acquired goodwill was depreciable. Parliament then intervened decisively. The Finance Act, 2021, with effect from assessment year 2021-22, removed goodwill of a business or profession from the depreciation regime altogether. It did so on three fronts at once: it amended the definition of “block of assets” in section 2(11) to exclude goodwill; it inserted a proviso to section 32(1)(ii) stating that goodwill of a business or profession shall not be an asset eligible for depreciation; and it amended section 55(2)(a) to prescribe how the cost of acquisition of goodwill is to be determined for capital-gains purposes. The Memorandum explaining the Bill was candid that the object was to reverse the effect of Smifs.

Because taxpayers had legitimately claimed depreciation on goodwill for years before 2021, a transitional mechanism was necessary. The CBDT supplied it through Rule 8AC of the Income-tax Rules, 1962, notified by Notification No. 77/2021 dated 7 July 2021. Rule 8AC prescribes how the written-down value of the “intangible” block is to be reduced to strip out the goodwill component on which depreciation had already been allowed up to 31 March 2020, and how any resulting excess is to be brought to tax as a short-term capital gain under section 50. In plain terms: depreciation legitimately claimed in earlier years is not reopened, but the goodwill is carved out of the block going forward, and where the depreciation already granted exceeds what the revised block can absorb, the difference is taxed.

The transition has generated its own disputes, and again both positions are respectable. Taxpayers contend — and several Tribunals have accepted — that the 2021 amendment operates prospectively, so that depreciation lawfully claimed on goodwill for years up to and including assessment year 2020-21 cannot be disturbed, Smifs governing those years. The Revenue’s counter is narrower: it does not generally reopen past years, but it insists on strict application of the Rule 8AC computation at the point of transition, so that the accumulated benefit is squared off rather than carried forward indefinitely. The safest reading for any given year, therefore, is chronological: identify the assessment year, and apply the law as it stood then.

The Position at a Glance, by Period

The following table states the depreciation position for acquired goodwill by time period. It is a summary only; the governing statute and the leading authority are cited in each row.

Frequently Asked Questions

Sources & Citations

• Income-tax Act, 1961 — section 32(1)(ii) and Explanation 3 (intangible assets), inserted by the Finance (No. 2) Act, 1998, w.e.f. assessment year 1999-2000; sixth proviso to section 32(1) and Explanation 7 to section 43(1) (amalgamation cost cap).
• CIT v. Smifs Securities Ltd., [2012] 348 ITR 302 (SC) = [2012] 24 taxmann.com 222 = [2012] 210 Taxman 428 = [2012] 252 CTR 233 (SC), decided 22 August 2012 (Kapadia CJI and Lokur J).
• Techno Shares & Stocks Ltd. v. CIT, [2010] 327 ITR 323 (SC) (stock exchange membership card as a depreciable asset).
• PCIT v. Zydus Wellness Ltd., [2017] 87 taxmann.com 82 (Gujarat), Tax Appeal No. 779 of 2017, decided 3 October 2017 (Akil Kureshi and Biren Vaishnav JJ).
• CIT v. Pruthvi Brokers & Shareholders (P.) Ltd., [2012] 349 ITR 336 (Bombay).
• CIT v. B. C. Srinivasa Setty, [1981] 128 ITR 294 (SC) (self-generated goodwill has no ascertainable cost of acquisition).
• Finance Act, 2021 — amendments to sections 2(11), 32(1)(ii) and 55(2)(a) of the Income-tax Act, 1961, w.e.f. assessment year 2021-22; Memorandum Explaining the Provisions of the Finance Bill, 2021.
• Rule 8AC, Income-tax Rules, 1962, inserted by the Income-tax (19th Amendment) Rules, 2021, CBDT Notification No. 77/2021 dated 7 July 2021 (computation of WDV and short-term capital gain under section 50 where depreciation on goodwill was obtained).

Related Reading

• Depreciation on Goodwill in Amalgamations: From Smifs Securities to the Finance Act, 2021
• Goodwill Removed from Depreciable Assets: The Finance Act 2021, Its Transition and Its Fallout
• Pooling of Interests vs Purchase Method: Can Goodwill Arise on Amalgamation?
• The Cost-Step-Up Cap on Amalgamation: The Sixth Proviso to Section 32(1) and Explanation 7 to Section 43(1)
• Bogus Purchases and Accommodation Entries: Burden of Proof and Commission-Rate Additions

© Bhatt & Joshi Associates. This article is for general information and academic discussion only; it is not legal advice and should not be relied upon without professional consultation on the specific facts.

The post Is Goodwill an “Asset” for Depreciation? Smifs Securities and Explanation 3(b) appeared first on Bhatt & Joshi Associates.

Suppose a company pays one hundred crore rupees to take over a business whose assets, once its debts are set off, are worth seventy crore. What has it bought with the extra thirty crore? In both accounting and tax law that premium has a name — goodwill — and it stands for something quite real if intangible: the reputation of the business, the loyalty of its customers, the pull of its brand, and the reasonable expectation that those customers will keep returning. For the better part of a decade, Indian companies were permitted to claim depreciation on goodwill on amalgamation, treating the acquired goodwill as a wasting asset and writing down a quarter of its value every year against their taxable profits. The Finance Act, 2021 brought that practice to an end for the future, even as it left a decade of past claims to be contested in the tribunals and courts. This article traces how the law arrived at its present position, sets out the competing arguments with equal care, and explains what it all means today — for a business weighing a merger, for the adviser who must caution it, and for the general reader trying to follow a subject that sits exactly where accounting meets tax.

What Goodwill Is and Why Depreciation on Amalgamation Mattered

Goodwill is best understood as the part of a purchase price that cannot be pinned to any identifiable asset. When a buyer pays more than the fair value of the tangible assets and identifiable intangibles it acquires, the excess is recorded as goodwill. It is, in a sense, the accountant’s way of capturing the difference between a business as a going concern and the sum of its separable parts.

Depreciation is the mechanism by which the law lets a taxpayer spread the cost of an asset over the years it is used, deducting a slice of that cost from profits each year. For intangible assets the rate was twenty-five per cent on the written-down value. It is easy to see why a large goodwill figure was attractive: capitalised at that rate, it could shelter substantial profits from tax over several years without any cash ever leaving the company again. That very attractiveness is what turned a technical question — is goodwill the kind of asset on which depreciation may be claimed? — into one of the most heavily litigated issues in Indian corporate tax.

The Turning Point: Smifs Securities

The question of depreciation on goodwill on amalgamation reached the Supreme Court in CIT v. Smifs Securities Ltd. [2012] 348 ITR 302. Section 32 allows depreciation on intangible assets, which Explanation 3(b) to section 32(1) describes as know-how, patents, copyrights, trade marks, licences, franchises “or any other business or commercial rights of similar nature.” The Court held that goodwill falls within that closing phrase. Applying the interpretive principle of ejusdem generis — by which general words that follow a list of specific things take their colour from that list — it reasoned that goodwill is a commercial right of the same broad character as the trade marks and licences that precede it, and is therefore a depreciable intangible.

Two features of the decision are often forgotten, and both matter a great deal to the disputes that continue today. First, the Court proceeded on a concurrent finding of fact that a genuine excess consideration had been paid and that the assessee had, through the amalgamation, acquired a real capital right whose market worth had increased. Second, the Revenue had not challenged that finding before the High Court. Smifs, in other words, decides a question of law — that goodwill can be a depreciable asset — but it does not certify that every figure a company chooses to label “goodwill” is genuine or beyond scrutiny. Much of what has happened since is an argument about that distinction.

How Goodwill “Arises” on a Merger: Two Accounting Roads

Whether goodwill can come into existence at all depends on how the merger is accounted for, a question that directly affects claims for depreciation on goodwill arising from amalgamation. Here, the law borrows directly from accounting standards. Under the purchase method, the acquiring company records what it takes over at fair value, and any excess of the consideration over the net assets becomes goodwill. Under the pooling of interests method — historically prescribed by Accounting Standard 14 for certain amalgamations, particularly of entities already under common ownership — the assets and liabilities are simply carried over at their existing book values, and any difference between the consideration and those book values is adjusted against reserves. Crucially, under pooling, goodwill is not supposed to arise at all.

This is the fault line beneath a large part of the litigation. Where a scheme of amalgamation adopts the pooling method but a clause nonetheless directs the resulting difference to be debited to a “Goodwill” account, the tax authorities contend that the goodwill is a manufactured balancing figure rather than the price of anything acquired. The move from AS-14 to Ind AS 103, which applies an acquisition model and treats common-control combinations on yet another footing, has only sharpened these questions for combinations governed by the newer standards.

The Debate, Fairly Stated

The case for allowing depreciation. Taxpayers, and a good many tribunals and High Courts, rest on solid ground. Smifs is a decision of the Supreme Court holding squarely that goodwill arising on amalgamation is a depreciable intangible, and coordinate benches are bound to follow it; the Gujarat High Court did so in PCIT v. Zydus Wellness Ltd. [2017] 87 taxmann.com 82. A scheme of amalgamation sanctioned by the High Court or the National Company Law Tribunal carries statutory force, and where the sanctioned scheme itself directs the accounting treatment, that treatment is said to be legitimate rather than contrived. And once the existence of the goodwill and the payment of consideration are accepted, its precise valuation and the statutory apportionment become questions of computation, not grounds for refusing the deduction outright. Section 32, it is pointed out, contains no general fiction reducing the cost of acquired goodwill to nil, unlike the specific rule the legislature enacted for capital gains.

The Revenue’s answer. The Department replies that Smifs settled only the abstract character of goodwill and left standing a deliberate architecture of anti-abuse provisions designed to prevent a merger from manufacturing a tax deduction out of nothing. The sixth proviso to section 32(1) limits the depreciation for the year of amalgamation to what would have been allowable had the amalgamation not occurred, so that a transaction cannot enlarge the pool of depreciation. Explanation 7 to section 43(1) and Explanation 2 to section 43(6) carry the written-down value of a transferred asset across at the figure it stood at in the amalgamating company’s hands — so that if the predecessor held no goodwill, the successor inherits none. Beyond these specific provisions lies a settled principle that book entries do not determine tax: entitlement to a deduction depends on the law and not on the ledger (Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363), and accountancy cannot override the Act (Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT [1997] 227 ITR 172). Company-law sanction, the Department adds, is not a grant of tax immunity; Marshall Sons & Co. (India) Ltd. v. ITO [1997] 223 ITR 809 fixes the effective date of an amalgamation but does not bar the assessing officer from testing its substance. And where a transaction has been arranged with no commercial purpose beyond the tax advantage, the substance-over-form principle running from McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 through Vodafone International Holdings BV v. Union of India [2012] 341 ITR 1 — now reinforced by the General Anti-Avoidance Rules — permits it to be disregarded.

The Intra-Group Flashpoint

The sharpest of the surviving disputes concerns the merger of two companies under common control, where no cash changes hands, only shares are issued, and the “goodwill” is simply the gap between an earlier investment figure and book value. In Aptara Technologies (P.) Ltd. v. DCIT [2026] 183 taxmann.com 571, the Pune Tribunal held that goodwill generated in exactly this way — an intra-group merger under the pooling method, with no genuine acquisition of a business, customers or commercial rights — was an artificial creation and a colourable device; and that, the asset itself being artificial, no depreciation could follow. The Tribunal was willing to look past the scheme-compliant book entry to the reality beneath it.

Fairness requires the contrary view to be stated with equal clarity, for it remains strong. Several benches have declined to brand amalgamation goodwill a colourable device, particularly where the Department raised no objection when the scheme was sanctioned, where an independent valuation supported the consideration, or where a genuine operating business with real customers was actually absorbed. On that view, once the transaction is accepted as authentic, Smifs governs and the depreciation follows as a matter of course. The dividing line, in practice, is not the presence or absence of the word “goodwill” but the genuineness and commercial substance of what lies behind it — a question of fact that turns on the evidence in each case.

The Watershed: The Finance Act, 2021

Parliament ultimately resolved the question of depreciation on goodwill on amalgamation for the future in the plainest possible terms. With effect from assessment year 2021-22, the Finance Act, 2021 amended section 2(11), section 32 and Explanation 3 to section 32(1) so that goodwill of a business or profession is no longer a depreciable asset at all — irrespective of how it was acquired, whether by outright purchase or on an amalgamation or succession. The long argument about the character of goodwill was, prospectively, brought to a close by legislation rather than by the courts.

The change did more than switch off future claims. Under section 50 read with Rule 8AC of the Income-tax Rules, notified in July 2021, where depreciation had already been obtained on goodwill up to assessment year 2020-21, the goodwill is removed from the relevant block of assets and its written-down value is adjusted; in defined circumstances the excess depreciation claimed in the past is treated as a short-term capital gain and taxed accordingly. A claim that looked entirely benign when made can therefore surface, years later, as a present tax cost — a point easily missed and worth checking carefully.

Where the Law Stands Today

The legal position on depreciation on goodwill on amalgamation is best understood period by period.

What it Means in Practice

For any merger or acquisition being structured now, the practical lesson is simple: goodwill depreciation is no longer available, and financial models should not assume it. Attention shifts instead to whether the transaction genuinely brings in identifiable intangibles — know-how, patents, licences, trade marks — which remain depreciable in their own right and must be identified and valued as such rather than swept into an undifferentiated goodwill figure. For the assessment years still open, a company defending a past claim should be ready to demonstrate that its goodwill was real: an independent valuation, evidence of a genuine transfer of business and customers, and consistency between the accounting clause in its scheme and the standard actually applied will matter far more than the label. Past positions also deserve a second look for the transitional consequences, since the interaction of section 50 and Rule 8AC can convert a historic depreciation claim into a taxable gain. And in group reorganisations in particular, the commercial rationale should be documented as it happens, because the colourable-device and sixth-proviso arguments are now made as a matter of routine, and a contemporaneous record is the best answer to them.

Frequently Asked Questions

Sources & Citations

• CIT v. Smifs Securities Ltd. [2012] 348 ITR 302 / 24 taxmann.com 222 (SC).
• PCIT v. Zydus Wellness Ltd. [2017] 87 taxmann.com 82 (Gujarat).
• Aptara Technologies (P.) Ltd. v. DCIT [2026] 183 taxmann.com 571 (Pune – Trib.).
• Kedarnath Jute Mfg. Co. Ltd. v. CIT [1971] 82 ITR 363 (SC).
• Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT [1997] 227 ITR 172 (SC).
• Marshall Sons & Co. (India) Ltd. v. ITO [1997] 223 ITR 809 (SC).
• McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 (SC); Vodafone International Holdings BV v. Union of India [2012] 341 ITR 1 (SC).
• Income-tax Act, 1961 — sections 32(1)(ii) and Explanation 3, sixth proviso to section 32(1), 2(11), Explanation 7 to section 43(1), Explanation 2 to section 43(6), and 50.
• Finance Act, 2021; Income-tax (19th Amendment) Rules, 2021 — Rule 8AC (CBDT notification, 7 July 2021).

Related Reading

• Is Goodwill an “Asset” for Depreciation? Smifs Securities and Explanation 3(b)
• Pooling of Interests vs Purchase Method: Can Goodwill Arise on Amalgamation?
• The Cost-Step-Up Cap on Amalgamation: The Sixth Proviso to Section 32(1) and Explanation 7 to Section 43(1)
• Goodwill Removed from Depreciable Assets: The Finance Act 2021, Its Transition and Its Fallout
• Bogus Purchases and Accommodation Entries: Burden of Proof and Commission-Rate Additions

Disclaimer: This article is for general information and does not constitute legal advice. The law is stated as understood in 2026 and continues to evolve; readers should take advice on their specific facts. © Bhatt & Joshi Associates.

The post Depreciation on Goodwill in Amalgamations: From Smifs Securities to the Finance Act, 2021 appeared first on Bhatt & Joshi Associates.