Jurisdiction - India
Reports and Analysis
India – Calculating Turnover: Challenges & Ambiguities.

14 July, 2014

 

 

Introduction


The Competition Act, 2002 (‘Act’), inter alia, seeks to regulate mergers and acquisitions (combinations). Such combinations that satisfy the relevant asset/turnover thresholds prescribed under Section 5 of the Act require mandatory prior notification to, and approval from, the Competition Commission of India (‘CCI’). While the Act provides a relatively detailed guidance on computation of the value of assets, the definition of “turnover” is very wide. “Turnover” is defined to include the value of sale of goods or services, excluding indirect taxes.1 Beyond this skeletal definition, there is no other statutory guidance parties can rely on.


Importance Of Turnover


Turnover calculation is critical from a merger control perspective as the very requirement to notify a transaction often hinges on the turnover of the parties involved. Transactions where the parties fail to meet the asset and turnover thresholds under Section 5 of the Act, need not be notified. Further, to assess whether a transaction qualifies for the exemption under the Government of India notification S.O. 482(E) dated March 4, 2011 (‘Target Based Exemption’), parties need to assess if the target’s turnover in India is below INR 7.5bn (or if the target’s assets in India are below INR 2.5bn). Computation of turnover by the parties will guide their decision on whether to notify a transaction or not. Absent clarity on how to actually compute turnover for the purposes of the Act, businesses face substantial uncertainty while deciding whether a transaction requires notifying CCI or not. Given the potentially substantial penalties that may be attracted for not notifying a transaction to CCI, businesses require clarity on how to calculate turnover so they can make the decision to notify or not notify with reasonable confidence.


Issues In Turnover Calculation


Here, we examine two questions which often surface in calculation of turnover while determining whether a transaction needs to be notified to CCI:


i. How to calculate turnover of enterprises which generate their revenue from commissions (i.e. enterprises which receive a gross amount which they subsequently transfer to another enterprise while retaining a percentage as their commission)? — It is possible that considering only the commissions earned while calculating turnover could lead to a decision not to notify a transaction to CCI, whereas a turnover calculation based on gross receipts would require that a notification be made.

 

ii. What constitutes turnover “in India” for the purposes of the Act? — Determining turnover “in India” of an enterprise is crucial, as both the turnover thresholds under Section 5 of the Act as well as the de minimis thresholds under the Target Based Exemption have an India nexus requirement (i.e. a certain amount of turnover should be “in India”). Despite the critical importance of determining the residency of an enterprise’s turnover, when it comes to determining what constitutes turnover “in India”, there are no statutory guidelines, at all.


Calculation Of Turnover For Enterprises Which Generate Their Revenue From Commissions


To determine the turnover of an enterprise, in practice, in most cases, CCI looks at the audited books of accounts of an enterprise. However, in certain cases a simple reading of the books of accounts does not suffice and CCI can and, in some cases has, gone beyond the books of accounts to determine the turnover.


In Fair Bridge/Thomas Cook2, CCI refused to consider the turnover figures for Thomas Cook (India) Limited (‘Thomas Cook’), as reflected in its books of accounts, as the “turnover” for the purposes of the Act. Considering the nature of Thomas Cook’s package tour operating business wherein Thomas Cook charges a consolidated amount for a packaged tour (which includes transportation, boarding, lodging, sightseeing and similar services), CCI held that Thomas Cook’s turnover would include the gross amount charged to the customers and not merely the commissions earned. In interpreting turnover to include gross receipts instead of commissions, CCI relied on mainly two grounds – (i) Lack of a principal-agent relationship between Thomas Cook and the vendors who actually provided the lodging, boarding, sightseeing and similar services; and (ii) Provisions in Accounting Standards and Guidance Notes issued by the Institute of Chartered Accounts of India (‘ICAI’) as well as internationally accepted accounting practicesfollowed by leading tour operators worldwide.


While Fairbridge/Thomas Cook decision does clarify CCI’s stance on turnover calculation to a certain extent, the situation is still not completely clear. CCI has considered commissions and not gross receipts to be the correct measurement of turnover of an enterprise acting as an agent for another entity, which is in line with the Indian Accounting Standards issued by ICAI.However, can this be interpreted to mean that in all situations where there is no principal-agent relationship, gross receipts are the correct measure of revenue? The answer is far from clear.


To take an example, consider the online retail market where online retailers do not really act as agents for the vendors but rather, provide a platform for vendors and buyers to interact. The payment from the buyer to the vendor may pass through the online retailer who would pass it on to the vendor after taking its commission. Though there is a lack of a principal-agent relationship in this case, to consider the total amount (i.e. the price of the good sold), which flows through the online retailer as its turnover would be a stretch. Particularly, as there may be no passage of title to the online retailer nor would the total amounts be routed through its books of accounts. The online retailer is better understood as a service provider whose turnover ought to be measured correctly as the commission it earns on each sale made through its platform. Moreover, the (European) Commission Consolidated Jurisdictional Notice under Council Regulation (EC) No. 139/2004 (‘EC Jurisdictional Notice’) recognises that services may be sold through intermediaries and that the turnover of a service undertaking which acts as an intermediary may consist solely of the amount of commissions which it receives, even if the intermediary invoices the entire amount to the final customer.4


Thus, it appears that a mere lack of a principal-agent relationship need not necessarily imply taking the gross amounts which flow through an intermediary (such as an online retailer) as the turnover for the purposes of the Act. However, absent any statutory clarification or definitive decisional observations by CCI, calculation of turnover continues to remain an area of interpretive ambiguity.


What Constitutes Turnover “In India”?


As stated earlier, there are no statutory guidelines on determining what constitutes turnover “in India”. Calculating turnover “in India” for an enterprise is crucial as: (i) parties involved in a transaction need to satisfy the asset/turnover thresholds under Section 5 of the Act to be considered for “combinations” and these thresholds have an India-nexus requirement, i.e. a certain amount of assets/turnover must be “in India”; and (ii) the applicability of the Target Based Exemption depends upon the target’s turnover “in India”.


Two issues which arise in determining an enterprise’s turnover “in India” are: (i) whether the value of sales in the Indian market by a foreign company (i.e. a company not incorporated in India) constitute turnover in India; and (ii) whether sales in non-Indian markets by Indian companies (i.e. companies incorporated in India) constitute turnover in India.


It is fairly clear from CCI’s decisional practice that revenue from sales in the Indian market by a foreign enterprise is considered part of its turnover in India. This is also in line with economic reasoning, as a foreign enterprise’s sales in India constitute a reasonable proxy for the extent of its presence in the Indian market. However, in what appears to be a counter-intuitive position, CCI has also treated revenue from export sales by an Indian enterprise as part of its turnover in India. This does not align well with the economic rationale that the values of sales in a market are a reasonable proxy for the extent of presence in that market. Given that the export sales by an Indian enterprise are made to consumers situated outside India, prima facie, there appears to be no potential adverse effect on the market in India. In other words, CCI’s counter-intuitive approach towards determining turnover in India is not in line with aneffects based approach and also leads to “double counting”, once by the recipient of the export country, and once by the Indian competition authority.


The European position is divergent from CCI’s approach, as Article 5(1) of the Council Regulation (EC) No. 139/2004 (‘EC Merger Regulations’) states that turnover in particular member state shall comprise of products sold and services provided to undertakings or consumers in that particular member state. However, interestingly, several foreign jurisdictions such as Canada and the United States also adopt an approach similar to that taken by CCI when it comes to calculating turnover for the limited purposes of determining jurisdictional thresholds.5

 

Conclusion


Considering the existing ambiguities in calculating the turnover for certain enterprises which work on a commission based business model, it would be ideal if CCI issued clear guidelines in this regard and considered only the commissions earned as part of such enterprises’ turnover. Further, when it comes to determining what constitutes turnover “in India”, it would be ideal if CCI were to expressly articulate its approach or, even better, expressly adopt an effects based interpretation to exclude revenue from export sales as part of an enterprise’s turnover “in India”. These steps would go a long way in reducing the uncertainty currently faced by businesses and help align CCI’s practice with sound antitrust principles.

 

End Notes:

 

1 Section 2(y), Competition Act read with Note 6, Notes to Form II, Schedule II, Combination Regulations.


2 Notice for acquisition given by Fairbridge Capital (Mauritius) Limited and Thomas Cook (India) Limited, Case No. C-2012/06/60

 

3 Paragraph 8, Indian Accounting Standard – 18 reads: “… in an agency relationship, the gross inflows of economic benefits include amounts collected on behalf of the principal and which do not result in increases in equity for the entity. The amounts collected on behalf of the principal are not revenue. Instead, revenue is the amount of commission.”


4 Paragraph 159 of the Commission Consolidated Jurisdictional Notice under Council Regulation (EC) No 139/2004 on the control of concentrations between undertakings (2008/C 95/01) which categorically states – “Even if the intermediary invoices the entire amount to the final customer, the turnover of the undertaking acting as an intermediary consists solely of the amount of its commission.”


5 For Canada, see Section 109(1)(b), Competition Act (R.S.C., 1985, c. C-34) which reads – “109. (1) This Part does not apply in respect of a proposed transaction unless the parties thereto, together with their affiliates, … (b) had gross revenues from sales in, from or into Canada, determined for such annual period and in such manner as may be prescribed, that exceed four hundred million dollars in aggregate value, or such greater amount as may be prescribed. For the United States, see Hart-Scott-Rodino regulations Section 801.11(a) – “The annual net sales and total assets of a person shall include all net sales and all assets held, whether foreign or domestic, except as provided in paragraphs (d) and (e) of this section.”

 

AZB

 

For further information, please contact:

 

Zia Mody, AZB & Partners
zia.mody@azbpartners.com

 

Abhijit Joshi, AZB & Partners 
abhijit.joshi@azbpartners.com

Shuva Mandal, AZB & Partners 
shuva.mandal@azbpartners.com

 

Samir Gandhi, AZB & Partners
samir.gandhi@azbpartners.com

Percy Billimoria, AZB & Partners 
percy.billimoria@azbpartners.com

 

Aditya Bhat, AZB & Partners 
aditya.bhat@azbpartners.com

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