ITAT Labels Intra-Group Merger a Sham; Rejects Goodwill Depreciation

About the Episode

The ITAT Hyderabad recently delivered a ruling on a case involving Invesco – a decision which could have important implications for M&A and corporate restructurings. At the heart of the matter – depreciation on goodwill generated through an internal group restructuring, and the genuineness of that goodwill.

In this episode of Resolüt Audio, Hrishikesh Anand and Samaahith Addoor break down the decision, tracing the development of goodwill depreciation, and assessing the impact of the ITAT’s decision. From tightly timed valuations to questions of structure and intent, we discuss what this ruling could mean for dealmakers navigating group restructurings in the future.

Transcript

Hrishikesh: Hey, everyone. We’re here today discussing what was a pretty interesting ruling by the ITAT Hyderabad last week. And it concerns a case against Invesco where the ITAT actually set aside Invesco claiming their depreciation on goodwill and could have implications for those deal makers in the M&A space who might have similar arrangements.

I have Samaahith here with me who’d be giving us a bit of background on the case and setting out why you, as someone in the M&A space, may be concerned about what happened here. Hey, Samaahith, do you want to start us off with a bit of background?

Samaahith: Hi Hrishikesh, thanks for having me. I think before we get right into the case, I think it’ll make sense to set some context on the whole issue of depreciation and goodwill, right? So up until 2012, the position of law was not clear. There were rulings on both sides – ones which allowed goodwill to be depreciated, and others where depreciation on goodwill was not allowed. Now, all of this was put to rest when the Supreme Court in 2012 came out and said, look, goodwill is a depreciable asset. This is what the law is, and this is how we interpret it. And that was the law of the land. This was the position up until 2021 when the government came out and said, look, we know the Supreme Court ruling. They’ve said that it’s a depreciable asset. We don’t agree. We feel that there are times when the value doesn’t depreciate or in some cases even appreciates. The government felt that it was unfair for taxpayers to be claiming depreciation on goodwill and made legislative amendments to that effect. The position right now is that post-2021 goodwill is no longer a depreciable asset.

Hrishikesh: So, 2012 to 2021, goodwill is a depreciable asset. It isn’t after 2021. But wasn’t this case between in that period when you could depreciate goodwill? So why did the ITAT have an issue?

Samaahith: Yes, that’s right. So, to understand the ITAT’s issue with that, I think we’ll need to dive into the facts right now. So, this was an internal group restructuring, for a couple of subsidiaries of Invesco Limited, the asset manager. Now, what happened here was, one entity, let’s call it Invesco India, acquired shares of another subsidiary called Invesco Hyderabad from a Mauritius based entity belonging to the same group.

Now, this acquisition of shares happened at a valuation of about INR 244 crores. And they relied on a discounted cash flow valuation for this. Shortly after the acquisition was completed, there was a scheme of arrangement or a scheme of merger filed, before the NCLT where Invesco Hyderabad, the subsidiary was merged into Invesco India. Now, this happened at a valuation or Invesco Hyderabad for the purposes of this merger was valued at about INR 102 crores.

Hrishikesh: Okay, so just after the initial…

Samaahith: Yes.

Hrishikesh: I think one number probably stands out here. Where did that INR 140 crores or so go?

Samaahith: Good question. So, what happened was Invesco India said, look, this is goodwill that was generated as part of the merger because we’ve absorbed that entity into us. And the balance, so INR 102 crores was recorded as the assets that were acquired, and the balance, INR 142 crores, is recorded as goodwill on Invesco India’s books. It‘s on this goodwill that they tried claiming depreciation.

Hrishikesh: Okay, but if the law did permit it, where did the issue arise? Why did the ITAT set aside this claim of depreciation?

Samaahith: So, in ITAT’s view and the tax department’s view, they felt that this whole transaction structure was designed to artificially create that goodwill, that there was no goodwill that existed with the Invesco Hyderabad entity. It was all one big engineered transaction, so to say, to create the goodwill, claim depreciation on it and reduce the taxable income in India.

Hrishikesh: And did they have some sort of basis upon which they were basing this on?

Samaahith: Yeah. So, couple of facts that are relevant to how the ITAT reached their conclusion. Now, the first was, remember the two numbers that we talked about, INR 244 crores and INR 102 crores. Now, these were arrived at basis, two different valuation methodologies. But the issue here was they were closely dated. So, one was dated as of 31 March, 2016. The other was dated as of 01 April, 2016. The ITAT questioned how one entity can have two vastly different values very close to each other. They said that didn’t make sense at all.

The second issue here was they questioned the appropriateness of using the discounted cash flow method, to value a subsidiary, which ceases to exist as a subsidiary because the appointed date for the merger was 01 April 2016. So that’s when the entity ceases to exist and it would be folded into Invesco India. So, they came out and said, look, the entity doesn’t exist from 2016, but how are you predicting cash flows for that entity for 2017, 2018, 2019, 2021?

And the final point I think was also how they looked at the Mauritius entity there. So, to recap, Invesco India acquired shares of Invesco Hyderabad from a Mauritius based entity. Now this transaction happened prior to 2017. Under the India-Mauritius DTAA, these transactions are grandfathered. So, the ITAT also looked at this and said, look, you’ve designed, this whole thing has been designed to upstream cash to your parent entity and also in the process create an artificial goodwill, claim depreciation on it and reduce your taxable income.

Hrishikesh: So, a couple of factors, having that Mauritius link there, having two different valuations and maybe you could have even argued that they could have just achieved this by a simple merger.

Samaahith: That’s correct. I think anyone looking at the fact set would realize that, look, why did you have to make it a two-step transaction? You could have simply merged because it’s a group entity. They’re all group entities. Could have simply folded the two entities into each other. One scheme of arrangement, one valuation report.

Hrishikesh: Do you think if I‘m someone in the M&A space, if I’m someone who’s restructured my business operations recently and I’ve also maybe been depreciating my goodwill, do you think I should be concerned that the IT department is going to send me a notice one of these days?

Samaahith: The thing here is that if you’ve been depreciating now/ recently, you could get into some trouble. The 2021 amendments have clarified that goodwill is not a depreciable asset anymore. So, if you’ve been claiming depreciation on goodwill as recent as now, you’re likely to get a, or your case is going to get picked up for scrutiny. But otherwise, between 2012 and 2021, if you’re indulged in a genuine amalgamation or a merger without the jugglery that we’ve seen here, I think you should be good.

Hrishikesh:So this is probably like a very, very specific, one of kind of fact pattern.

Samaahith: Yes, very peculiar set of facts that I think ultimately led to ITAT, reaching the conclusion that it did.

Hrishikesh: But just out of curiosity, how does the ITAT have the powers to pick this up? Because, I mean, wouldn’t they have been able to look at this whole scheme when it probably went before the NCLT?

Samaahith: You’re right. Under Indian company law, whenever a scheme of arrangement is presented before the national company law tribunal notice is given to various regulators including the income tax department. They have at that level the opportunity to raise objections.

Now in this case, basis the orders that we’ve seen, they did not. This was also argued by the taxpayer in this case. But the tribunal said look that‘s fine – the tax department did not raise objections back then but they’re raising it now and there are sufficient precedents that allow them to do it. So, on that count, I think this may not be the strongest argument to make.