Mid-Year Convention 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.
Nothing about the business changes. Only the assumption about when in the year the money arrives — and the answer moves by seven per cent.
The assignment
Abhishek is engaged by XYZ Ltd to value Know-How — specifically, one know-how on how to produce a special asset for the use of handicapped persons, on which the major work of the XYZ ltd. depends. The company is in the process of a merger deal.
| Input | Value |
|---|---|
| Life of know-how | 5 years |
| Revenue in current year | 400 Cr. |
| Royalty rate in similar assets in the industry | 10% |
| Growth rate in revenue expected | 20% |
| Income tax rate | 26% |
| Weighted average cost of capital | 12% |
| Weighted average rate of return on intangible assets | 15% |
Mid-year convention
| Particulars | 0.5 | 1.5 | 2.5 | 3.5 | 4.5 |
|---|---|---|---|---|---|
| Revenue (growth @ 20%) | 480 | 576 | 691.2 | 829.44 | 995.33 |
| Royalty rate @ 10% | 48 | 57.6 | 69.12 | 82.94 | 99.53 |
| Taxes @ 26% | 12.48 | 14.98 | 17.97 | 21.57 | 25.88 |
| Post-tax royalty | 35.52 | 42.62 | 51.15 | 61.38 | 73.65 |
| Present value @ 15% | 33.12 | 34.56 | 36.07 | 37.63 | 39.27 |
Fair value without TAB: 180.65.
End-year convention
| Particulars | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|
| Post-tax royalty | 35.52 | 42.62 | 51.15 | 61.38 | 73.65 |
| Present value @ 15% | 30.89 | 32.23 | 33.63 | 35.09 | 36.62 |
Fair value without TAB: 168.46.
The cash flows are identical in both tables — 35.52, 42.62, 51.15, 61.38, 73.65. Only the discount periods change: 0.5 to 4.5 against 1 to 5.
The end-year convention assumes every year's cash arrives on the last day of the year. That is almost never true. Royalties, sales and margins accrue throughout the period, so the average rupee arrives around the middle — which is what the mid-year convention models.
The effect is a uniform uplift of half a year's discounting: at 15 per cent, roughly 7.2 per cent on every present value. Here that is 12.19 crore of a 168 crore valuation.
Which is correct depends on the facts. A business with continuous revenue supports the mid-year convention. An asset paying a single annual royalty on a fixed date does not — its cash genuinely arrives once, and the convention should match the payment terms.
Note the other choice this illustration makes, which is at least as important. The discount rate is 15%, the weighted average return on intangible assets, not the 12% WACC. The Standard's rule is that the company rate is a starting point with suitable adjustments to consider the risk etc. of the intangible assets in comparison with the company as a whole — here, a 300 basis point premium. Using 12% instead would have raised the answer by around 8 per cent.
Why the tax is deducted before discounting
The royalty saving reduces a deductible expense, so the benefit is net of tax. At a 26 per cent rate, a royalty of 48 produces a saving of 35.52 — and discounting the gross 48 at a post-tax rate would overstate the value by the whole tax charge.
Common mistakes
- Applying the mid-year convention where royalties are paid on a single annual date.
- Using the WACC rather than a rate adjusted for the intangible's risk.
- Discounting pre-tax royalty savings.
- Presenting a value without stating which convention was used.