Should the govt cap royalty payments?

May 14 2014, 20:38 IST
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SummaryA liberal royalty regime assists FDI inflows. Capping will be a regressive step and may not even succeed in curbing royalty payments

Recent news suggests that the government of India is considering reintroducing the restrictions on royalty payments paid by the Indian subsidiaries to their foreign partners. It is believed that the excessive outflow of funds from the country in lieu of the technology transfers and know-how, use of brand/trademark fees, etc, provided by the foreign sponsors has triggered this move.

Clearly, increasing tax on royalty from 10% to 25% in the previous budget has not met the Centreís expectations; given the current double taxation avoidance agreements with most countries, it was not expected too.

Until late 2009, while lump-sum payments for technical collaboration were capped at $2 million, running royalties were capped at 8% of exports and 5% of domestic sales. Similarly, royalty payable for the use of trademark and brand name of foreign collaborator were capped at 2% of exports and 1% of the domestic sales. Caps aside, the approval process was cumbersome, with a higher likelihood of rejection rather than approval.

However, in December 2009, the Indian government liberalised the payment of foreign technology collaborations and royalty fees bringing it under the Ďautomatic routeí to boost FDI.

While this may have brought in the best practices from repositories globally through technical consultancies and services, it has had a few unintended consequences.

Data for royalty and related payments (which include know-how, technical and trademark charges, as well as fees for licences, professional consultancies, managerial and administrative related services and, information and technology related fees) of 25 multinational companies suggests that these payments have gone up substantially without a commensurate increase in either sales or margins.

While in FY09, these 25 companies paid about R1,900 crore as royalty and related payments, this number jumped to over R4,950 crore in FY13. In comparison, net sales have grown by a meagre 71% while the bottom line of these 25 companies has grown by an even lower percentage at 36%.

Does this mean that the earlier royalty ceiling be reintroduced? The FY13 data shows only two of the 25 companies would breach the 5% cap on domestic sales and 13 the 2% cap. So, reimposing caps on royalty payments at the earlier levels may not serve much purpose.

I also believe companies are inventive: even if this cap is lowered, companies will structure technical collaboration fees, brand and trademark fees to circumvent the administrative hoops required for approval.

In any commercial arrangement between listed companies and related parties, transparency and disclosures levels are

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