India: A 22% Return On Capital Employed – Affording Overprotection Or Failing To Protect?

As a practice for the determination of non-injurious price, DGTR has been considering 22% return on the average capital employed by the Indian industry as a benchmark for calculation of a fair selling price. A party opposing the imposition of anti-dumping duty might argue that a return of 22% is too high, when the interest rates are so low. However, the domestic industry would contend that considering that the return covers not only interest and taxes, but also profit on equity, a 22% return is necessary. In fact, in certain cases, such as where assets are quite depreciated, a 22% return may be too low, to allow due protection to the domestic industry. This article talks about the adequacy of consideration of 22% return.

What is non injurious price?

The WTO allows levy of anti-dumping or anti-subsidy duty upto the extent of dumping or subsidy margin. However, India follows a practice which is known as "lesser duty rule". Under this rule, the duties are imposed considering the lower of injury margin or dumping/subsidy margin. While lesser duty rule has its own share of advocates and critics, the manner in which the injury margin is determined in India has been a hotly debated issue for long.

Non-injurious price is considered to be a price level at which if the imports occur, no injury will be caused to the domestic industry. The domestic industry is expected to be able to recover its costs and earn a reasonable return on the investment made by it at such non-injurious price. One of the major critiques in determine of the non-injurious price is the complex calculation methodology involved therein. Non-injurious price is determined as per Annexure – III of Customs Tariff (Identification, Assessment and Collection of Anti-Dumping Duty on Dumped Articles and for Determination of Injury) Rules, 1995 (Rules). As per the Rules, non-injurious price is determined considering an optimized cost of production for the domestic industry, with a mark-up allowed towards return allowable on the capital employed. Therefore, the determination of non-injurious price envisages not only a determination of an appropriate cost of production for the domestic industry, but also an appropriate or reasonable return to be allowed over such cost. A key issue that arises here is the manner in which such return should be determined.

Manner of determination of return on capital employed.

Annexure III provides that "a reasonable return (pre-tax) on average capital employed for the product may be allowed for recovery of interest, corporate tax and profit." Here, capital employed is determined as the sum of average net fixed assets and working capital employed by the domestic industry. However, the law or Rules do not provide any specific rate of return to be considered as "reasonable". The Directorate General of Trade Remedies (DGTR) has been considering 22% as reasonable rate of return on capital employed as a practice.

Why a return of 22%

The origin of the benchmark rate of return of 22% can be traced to Drug (Prices Control) Order, 1987, wherein the fixation of price of bulk drug was provided as under: -

While the order provided for 3 alternative approaches for calculation of return, only one is applicable in case of trade remedies, that is 22%. This is because Annexure – III to the Rules envisages return being calculated only as a percentage of capital employed, and not as a return on net worth of long-term marginal costing. Accordingly, the same was adopted by the DGTR in its determinations.

"Reasonableness" of the return considered.

The whole debate around reasonableness of 22% return on capital employed revolves around two accounts – (a) adequacy of 22% return and (b) appropriateness of its application on the net fixed assets.

The parties opposing the anti-dumping measures often argue that a 22% return is too high considering the extremely low interest rates. Indian borrowing rates are in the range of 8% to 10% and overseas funds can be borrowed at 2.5% - 3%, based on LIBOR rate. Therefore, it is contended that a return of 22% is too high and does not reflect the real business situation.

On the contrary, the domestic industry argues that a 22% return is appropriate considering the cost of both debt and equity. While the cost of debt is low, in the range of 8 to 10%, the cost of equity is much higher.

The Indian Courts have taken different views in the matter in different cases. The Customs Excise and Service Tax Appellate Tribunal, in the matter of Bridge Stone Tyre Manufacturing (Thailand) vs Designated Authority, - (2011 (270) E.L.T. 696 (T)) held that determination of non-injurious price assuming 22% return on investment gives an inflated picture of price underselling. Similarly, in the matter of Indian Spinners Association vs Designated Authority, the Tribunal ordered the domestic industry to file data considering the historical return and held that claim for 22% return on capital employed was not justified.

However, in several recent cases such as Perstorp Chemicals Gmbh & Ors. vs Designated Authority - 2017 (357), Gujarat Fluorochemicals Ltd. vs Designated Authority - 2017 (345) E.L.T. 144 (Tri. - Del.), and Tangshan Sanyou Group Hong Kong International Trade Co. Ltd. vs Union of India - 2017 (349) E.L.T. 667 (Tri. - Del.), the Tribunal held that a return of 22% is appropriate considering the consistent practice of the DGTR.

However, a key issue raised by the domestic industry routinely is that the rate of 22% is not adequate in all cases and may fail to afford due protection in several cases. For instance, in a case where the plants are old and largely depreciated, the return allowed on the net fixed assets will be unreasonably low, and may not ensure viability of operations, or allow for upgradation of plants. A return on the fully depreciated plant will result in a non-injurious price that is so low, that no new producer would be able to invest in setting up a new plant if dumped imports continue to happen. It is also important to note that Annexure – III does not allow consideration of any revaluation in the value of assets and this implies that even though the asset may have been valued in the books of accounts at fair value, the return is allowed on the depreciated value. If an old plant earns profits at such a low rate, it will not generate sufficient funds to fuel further investments and would go against the re-investment economics.

Further, in some cases, the working capital may be negative, even due to the effects of injurious imports. Again, in such cases, the capital employed may be understated, leading to lower returns. This implies that the domestic industry suffers on both ends, (a) the injurious effects of dumping which may be adversely impacting its liquidity, and (b) lower non-injurious price being determined as a result, as a result of which it would not receive due protection.

Practice in other countries

The practice in India is at contrast with the practice in other jurisdictions. Other jurisdictions such as Australia, Brazil, Canada, European Union and United Kingdom also calculate non-injurious price or the fair selling price. However, the non-injurious price or injury margin is calculated in a far more liberal manner than that in India.

For instance, the Australian Anti-dumping Commission would determine non-injurious price based on the price that the industry could reasonably achieve in the market in the absence of dumped or subsidized imports. The Commission constructs non-injurious price on the basis of actual cost of the domestic industry to make and sell, plus a profit either based on weighted average profit rate achieved in the most recent period unaffected by dumping or profit rate from industries operating in similar category of goods.

Similarly, the European Commission determines the non-injurious price based on actual cost and after adding profit earned by the industry under normal conditions of competition in the absence of dumped/subsidized imports. Importantly, both the countries consider actual cost of production of the domestic industry, and not an optimized cost.

Therefore, the other global authorities do not follow a fixed rate of return for non-injurious price determination and instead consider past profits to determine the reasonable return. This allows for a flexibility to determine the return, having regard to the facts and circumstances of each case. The same approach can be adopted in India as well. The Indian Authority can consider past profits as an appropriate benchmark for determining the return in calculation of non-injurious price. Appropriate profit margin for a newly established industry can be based on the project report or financial feasibility report.

However, in a situation where the industry has been in continuous losses, selection of the appropriate profit margin will be a challenge. Selection of appropriate rate of return in case of fluctuating profit will also invite quite a few arguments by the parties. While the domestic industry will emphasize on selection of the highest rate of profits, the other interested parties will claim that lowest rate be considered. Such issues can be resolved through reference to returns earned over longer periods, returns earned by other producers in similar sectors, returns earned by the same producer in other comparable products, returns earned by producers in other similar economies etc. Nevertheless, it would allow the Authority to determine the appropriate rate, having regard to the merits of each case and the need for remedy for the industry.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.