Introduction Accountants are often the most trusted advisers of businesses. It is therefore essential that accountants also understand when key disclosures need to be made to regulators. Among other things, the Competition Act, 2002 (‘the Competition Act’), regulates merger and acquisitions (combinations) of large enterprises. Combinations that satisfy the relevant asset/turnover thresholds prescribed in Section 5 of the Competition Act require mandatory prior notification to, and approval from, the Competition Commission of India (‘CCI’). While the Act provides a relatively detailed guidance on calculating 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 taxes1. Beyond this skeletal definition, there is no other statutory guidance parties can rely on. To ensure compliance with the law, accountants should remain vigilant and work with lawyers to determine when notification to the CCI is required.
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 Competition 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 750 crores (or if target’s assets in India are below INR 250 crores). Computation of turnover by the parties will guide their decision on whether to notify transaction or not. Absent clarity on how to actually compute turnover for the purposes of the Act, businesses and their advisors face substantial uncertainty while deciding whether a transaction requires notifying to the CCI or not. Given the potentially substantial penalties that may be attracted for not notifying a transaction to the CCI, businesses and their advisors require clarity on how to calculate turnover so they can make the decision to notify or not notify with reasonable confidence.
The implications of getting it wrong are significant. A combination is void until it is cleared by the CCI as not being likely to cause an appreciable adverse effect on competition in India. In addition, substantial penalties of up to 1% of the turnover of the combination apply for failing to give the CCI notice of a notifiable combination.
Issues in turnover calculation
Here we examine 2 (two) questions which often surface in calculation of turnover while determining whether a transaction needs to be notified to CCI:
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.
What constitutes turnover ‘in India’ for the purposes of the Competition Act? – Determining turnover ‘in India’ of an enterprise is crucial as both the turnover thresholds under Section 5 of the Competition 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, the 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 the CCI can and, in some cases, has gone beyond the books of accounts to determine the turnover.
In Fair Bridge/Thomas Cook2 , the 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 Competition 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). The CCI held that Thomas Cook’s turnover would include the gross amount charged to customers and not merely the commissions earned. In interpreting turnover to include gross receipts instead of commissions, the 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 practices followed by leading tour operators worldwide.
While Fairbridge/Thomas Cook decision does clarify the CCI’s stance on turnover calculation to a certain extent, the situation is still not completely clear. The 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 the ICAI3. 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.
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 Competition Act. However, absent any statutory clarification or definitive decisional observations by the CCI, calculation of turnover continues to remain an area of interpretive ambiguity.
We would suggest that accountants work closely with lawyers to determine whether the CCI is likely to treat commissions or gross receipts as the relevant turnover as the measure of revenue.
What constitutes turnover ‘in India’?
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 u/s. 5 of the Competition Act to be considered ‘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) cwonstitute turnover in India; and (ii) whether sales in non-Indian markets by Indian companies (i.e. companies incorporated in India) constitute turnover in India.
From the CCI’s decisional practice the following also constitute turnover in India:
- revenue from sales in the Indian market by a foreign enterprise; and
- revenue from export sales by an Indian enterprise.
Again, it is not always clear what the CCI would consider constitutes turnover ‘in India’.
Conclusion
While
the CCI is continually clarifying the rules, ambiguities in calculating the
turnover for certain enterprises which work on a commission based business
model remain. Further uncertainty also exists when it comes to determining what
constitutes turnover ‘in India’. Given these ambiguities, it is important that
accountants and lawyers use each others’ expertise to ensure that compliance
with the law is achieved.
