Contributory Charges explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Six lines take a revenue forecast down to an intangible's fair value — and two of them are the ones most often got wrong.
The computation
| Particulars | % / Rs. | Year 1 | Year 2 | Year 3 |
|---|---|---|---|---|
| Net revenue associated with subject intangible | 9,000 | 16,200 | 21,870 | |
| EBIT as a % of net revenue after attrition | 20% | 1,800 | 3,240 | 4,374 |
| Less: Taxes | 30% | 540 | 972 | 1,312 |
| Profits after tax | 1,260 | 2,268 | 3,062 | |
| Less: Contributory charges | 5% | 450 | 810 | 1,094 |
| Net cash flows | 810 | 1,458 | 1,968 | |
| Discounting factor | 15% | 0.8696 | 0.7561 | 0.6575 |
| Present values | 704 | 1,102 | 1,294 |
Sum of present values of cash flows 3,100; add tax amortization benefit (TAB) 708; fair value of intangible asset 3,808.
Look at where each adjustment sits, because the order changes the result.
Attrition is inside the revenue line. The margin is described as a percentage of net revenue after attrition — the decay of the acquired customer base is applied before anything else. Applying attrition later, to the cash flow, would compound it against a base that already reflects a shrinking cohort.
Contributory charges are deducted after tax. Profits after tax of 1,260 are reduced by 450, not the other way round. This matches the rule that the rate of return on contributory assets is considered on post-tax basis — a post-tax charge against a post-tax cash flow.
Note that the charge here is expressed as 5% of revenue, not of the assets' fair values. That is the shortcut the Standard permits: an appropriate rate of return on each asset needs to be determined and shall be applied to the revenues to arrive at the CAC. The asset-level rates are converted into a single revenue percentage.
Observe the magnitude. Contributory charges take 450 out of 1,260 in year one — over a third of the post-tax profit belongs to the supporting assets, not to the subject intangible. Omit them and the valuation would be materially overstated.
Why the method values one asset only
While this method is typically used in order to determine the value of the 'primary' cash generating intangible of the business, careful consideration needs to be given as to how the company's other assets help contribute to the sales process, and the manner in which a return for these 'supporting assets' should be reflected in the valuation of the primary intangible.
The excess earnings method is not typically used to value both the primary intangible as well as other supporting intangibles due to the potential double counting of cash flow as well as issues related with 'cross charging'. Therefore, an alternative valuation method needs to be applied, where possible.
Cross charging is the specific trap. If asset A charges asset B for its support and asset B charges asset A for the same thing, both valuations are distorted and the total no longer reconciles to the business.
The tax amortisation benefit
The TAB of 708 adds roughly 23 per cent to the pre-TAB value of 3,100. It represents the value of the tax deduction a hypothetical market participant would obtain by amortising the acquired intangible — and it is added only where the asset would in fact be amortisable for tax in the relevant jurisdiction.
Common mistakes
- Deducting contributory charges before tax.
- Applying attrition to the cash flow when it is already in the revenue line.
- Running the method on the primary and a supporting intangible together.
- Adding a TAB where the asset attracts no tax amortisation.