By TIOL News Service

MUMBAI, JAN 08, 2015: THE issue before the Bench is - Whether the sums agreed to be paid to the retiring partners on account of their capital as outstanding in the firms' books of account can be considered as goodwill and therefore, there is no question of denying depreciation on it. And the answer is YES.

Facts of the case

The assessee, a partnership firm, is engaged in the business of supply of equipments for shooting and editing telefilms with computerized digital graphics on hire. Two of its partners, holding 20% share each in the profits (or losses) of the firm, retired there-from during the financial year and were paid their share of 'goodwill'. Assessee claimed depreciation on goodwill, as an intangible asset of the firm. AO disallowed the claimed stating that 'Goodwill', it was the constant refrain, was not an intangible asset within the meaning of Explanation 3(b) to section 32(1)(ii).

After hearing both the parties, the ITAT held that,

++ no 'goodwill' has been actually acquired by the firm on the payment of the impugned sum/s. There is nothing on record to show that the sums stated in the retirement deeds are paid over and above the balance outstanding in the capital (or the current) account of the retiring partners. True, in that case the payments, to that extent, would get debited to their respective accounts, and not to the 'goodwill' account. The book value of a partner's capital account only represents his share in the partnership, including undefined share in its assets. As such, the payments agreed to be paid to the retiring partners include that due on account of their capital as outstanding in the firms' books of account. So, however, this aspect only involves the quantum or the amount which could be considered as paid toward 'goodwill' and, accordingly, verifiable with reference to the assessee's books by AO;

++ what has been paid is not by the firm per se, but by the continuing partners, toward the purchase of the share of the retiring partners in the assets of the firm – nothing more and nothing less. The said payment shall not by itself create a capital asset in the hands of the firm. Goodwill, tenancy rights and permit licence, already exist with the firm prior to the retirement/s, and continues therewith, post it, as do all other assets, in-as-much as the business survives the retirement/s, which is thus on a going concern basis. That is, there is no accretion to the asset base of the assessee-firm. What all has been done by and through the said payment to the retiring partners - which could be financed by either borrowing capital or introducing funds by the continuing partners, is that they have thereby ensured that there is no depletion in the capital base of the firm;

++ the only difference between these intangible assets, i.e., goodwill, tenancy rights and permit licence, and the other assets of the firm, is that while the latter are accounted, the former are not. The payment to the erstwhile partners would not imply acquisition of these assets, but is in fact toward the share of the retiring partners in the existing assets. The retiring partners, he continued, could start their own venture, greatly impeding the firm's, whose name carries a brand value in the trade, built over time, prospects/business. It is to restrain them from so doing that the payment, by purchasing their share in the intangible assets of the firm, had been made. As such, all that the payment signifies is that the firm has been able to retain its' operational capability consequent to the retirement/s. There is no purchase or acquisition of any asset, tangible or intangible. Rather, to the extent goodwill of the firm is attached to the partners, representing its human – and thus most vital, resource, a part of the goodwill of the firm stands definitely eroded;

++ no 'goodwill' or any other tangible or intangible asset, thus, stands acquired by the firm consequent to the payment to the retiring partners in pursuance of the retiring deed/s. Rather, the second retiring partner, having along with the other continuing partners, acquired share (20%) in the goodwill of the firm of the first retiring partner, the payment to him subsequently includes his share in the said share, so that there is in fact to that extent a double payment, i.e., vis-à-vis the total share in the firms' assets of the two partners;

++ the assessee, in the event of having not acquired 'goodwill', or any other depreciable asset for that matter, thus, i.e., upon payment of the impugned sums to the retiring partners, gets reversed to any extent, so that the assessee's claim becomes valid (to that extent), the same shall have to be allowed. Without prejudice to our decision that the assessee's claim for depreciation is not valid, hold that the same shall in any case be restricted to the claim as preferred per the original return. The assessee's claim for additional depreciation, on the basis of having not been allowed deprecation is rejected.

(See 2015-TIOL-29-ITAT-MUM)