Plugging the royalty gap

Payments to MNC parents need checks and balances

Royalty payments by Indian subsidiaries of multinational firms has been a sticky issue for many years. While multinational companies should be compensated for brand and technology, a high amount hurts minority shareholders who do not have a say in determining the royalty fees. Thus, the reported move of the Securities and Exchange Board of India’s (Sebi’s) corporate governance committee to take a close look at the royalty payments issue should be welcomed.

The government had removed restrictions on royalty payments in the wake of the global slowdown after the financial crisis in 2009, and subsequently many multinationals, including Maruti Suzuki, Hindustan Unilever and Nestlé, began increasing royalty payments to their parents in a phased manner over a number of years. Since then royalty payments have increased faster than the growth in revenues and profits and this is not a healthy trend. A study by proxy advisory firm Institutional Investor Advisory Services (IiAS) showed that 32 multinationals in the BSE 500 index paid royalty of Rs 7,100 crore in 2015-16, which was 21 per cent of their pre-tax pre-royalty profits. In fact, for the five years ending 2015-16, MNC royalty payments grew at 13 per cent, in excess of their pre-tax profits which grew at 9.6 per cent.

The royalty issue has vexed the government, investors and proxy advisory firms for nearly a decade after the norms were relaxed. Obviously, minority shareholders bear the brunt of high royalty payments, as this favours one class of shareholder — the promoter — over all others. For the government, royalty payment is an outflow of foreign exchange, which will subsequently have an impact on the country’s macroeconomic management. While the government tried to address it in the 2013-14 Budget by increasing the tax on royalty from 10 per cent to 25 per cent, its impact has not been significant as there are double taxation avoidance agreements with most countries where the royalty is being paid. 

Before 2009, royalty payment was regulated by the government and capped at 8 per cent of exports and 5 per cent of domestic sales in the case of technology transfer collaborations and was fixed at 2 per cent of exports and 1 per cent of domestic sales for use of trademark or brand name. While a return of a blanket cap might not be the best way out, there are some options that the government can exercise to protect its tax revenues, slow down forex outgo as well as protect minority shareholders. The Sebi panel is in favour of putting more checks and balances to arrive at royalty payments and wants the company boards to be more mindful of approving royalty agreements. Many solutions are possible such as having it linked to sales and profit growth or the value addition that can be attributed to the brand or the technology. Progressive taxation on certain types of royalty, wherein taxes rise as royalty increases above a threshold in terms of percentage of sales, too is an option. Besides informing minority shareholders about the amount and duration of royalty payment, they should also be made aware of the impact on margins and shareholder returns. Above a certain amount, there could be a vote at a general meeting with appropriate majority. At a time when industry after industry is going through disruption, what products and technologies merit royalty payment should also be answered.