Rising royalty payments raise risk of a clampdown but is that justified?

Before 2009, royalty payments were regulated by the government and capped at 8 percent of exports and 5 percent of domestic sales in the case of technology transfer collaborations. They were fixed at 2 percent of exports and 1 percent of domestic sales for use of trademark or brand name.  And where royalty for technology was paid, simultaneously royalty for trademark and brand usage couldn’t be paid.

Once the sluice gates were opened, India witnessed a surge in foreign exchange payments on account of royalty.  The five biggest royalty-paying companies in 2012-13 were Maruti Suzuki India Ltd, Hindustan Unilever Ltd, Nestle India Ltd, Bosch India and ABB India, according to a report of Institutional Investor Advisory Services released in September 2013. The report points out that though there was almost a 24 percent growth in royalty and related payments for the 25 highest royalty-paying listed companies, it was not in line with the growth in earnings as net sales and profits grew at a slower pace at an average 15 percent and 13.1 percent, respectively.

While the numbers speak for themselves, here are some issues to be considered when it comes to payment of royalty:

1. Royalty is taxed lightly in India under its income tax law -- 10 percent, period, as per section 115A of the Income tax Act, 1961.  Whereas on dividend not only must the Indian company pay dividend distribution tax (DDT) of 15 percent plus but also the shareholders getting more than Rs 10 lac have to pay a 10 percent tax in addition.  Naturally foreign companies supplying technology to their Indian subsidiaries deem it beneficial to camouflage their dividend as royalty now that there are no limits on royalty payments. Higher royalty hurts minority shareholders because this amount reduces the profit, and hence the dividend payable. While the share in dividend is proportionate for all shareholders, royalty goes into the parent company’s kitty only.


2. Auto major Maruti Suzuki pays an average royalty of around 5.5 percent of its net sales to its parent Suzuki.  With 56 percent equity, Suzuki not only gets a sizeable dividend from its subsidiary but also takes royalty on each car produced in India.  In addition, it also makes money hand over fist by selling to it the gear box, a vital car component, the technology for which it wants to keep under wraps.  To be sure it has put up a small gear box plant in Manesar.


3. If a foreign collaborator insists on vital parts being purchased from it, it does not lie in his mouth to insist on royalty as well;


4. Royalty ought to taper off after a period of time.  The Department for Promotion of Industry and Internal Trade (DPIIT) had proposed capping royalty for technology at 4 percent of domestic sales and 7 percent of exports for the first four years; and for the next three years the limit should be 3 percent of local sales and 6 percent of exports.  This is as it should be. It cannot be a lifelong party or binge especially if the foreign technical collaborator is also the financial collaborator with equity stakes.


5. There is a view that in the absence of royalty during the entire product cycle, the foreign collaborator would lose interest and hence the Indian company would suffer.  And on the same lines they aver that after all MNCs spend a lot on R&D, and that’s why royalty cannot be grudged. These are specious. It cannot be the case that royalty on a product can be paid out for decades. If a car model or a soap was launched 20 years ago, it is unfair that the royalty payments continue till date and at the same or higher rate.

It is not this author’s case that royalty is entirely unnecessary.  Royalty must be paid lest technological advancements and cutting edge technology become unavailable for the Indian subsidiary.  But a balance has to be struck between the inventor’s interest and public interest. The public does appreciate the role of cutting edge technology, which is partly why shares of foreign-owned technology-driven companies are typically favoured by investors.

S Murlidharan is a chartered accountant and columnist. Views are personal.