MNCs have increasingly begun to use the royalty route to extract disproportionate returns from their Indian arms, especially since the government relaxed the curbs on remittances a few years ago.
C.A. Dr. V.M.Govilkar
Nothing is available free of cost in business. One has to pay the price for everything. The fact that Indian government has been offering red carpet treatment to multinational companies (MNCs) with the expectation that they will contribute capital, will bring in technology and expertise, will enhance production capacities, will generate employment opportunities, will increase exports, and will satisfy the market demand and what not, has not had as good impact on Indian economy as was expected.
It was in 1991 after we accepted the Liberalization, Polarization, and Globalization (LPG) policy in 1991 that the MNCs made its way to India to utilize its untapped Indian market, when it was being claimed that inviting MNCs in India will create a win- win situation for the both. But twenty years three years down the line, the MNCs have scripted a different story that is weighing heavy on the Indian economy.
The MNCs either form their subsidiaries in India or enter into joint ventures with Indian companies. These subsidiaries or joint ventures have to pay royalty for the technical know-how and also for the use of their international brands. And this has been perfectly acceptable on commercial as well as legal fronts. The Commerce Minister Mr. Anand Sharma in a letter to Finance Ministry, said on 23rd Dec 2013 that given the current economic situation and a high quantum of outflows on this account, there is a need to take a view on whether the ceiling on royalty payments and fee for technical services should be reintroduced in the FDI policy to check the large outflows and prevent possible misuse of this window. “It is a great concern…. We are assessing the situation. It needs a close watch especially in cases where there is no transfer of technology,” a senior DIPP official told press.
These statements are more relevant in the backdrop of two key decisions taken by the government-
1. Before 2009, royalty was regulated by the Indian government and was capped at 8% of exports and 5% of domestic sales in case of technological transfer, and fixed at 2% of exports and 1% of domestic sales for use of trademark and brand name. Commerce Ministry had, in 2009, successfully pressed for lifting restrictions on royalty payments by Indian company to an MNC to make India look investor friendly.
2. To discourage higher royalty payments, the government had in the budget 2013, raised the tax rate on royalty and fee for technical services paid to overseas entities to 25% from the earlier 10%.
How big are the figures of royalty and other payments? Data is available from three sources
1. In the special report titled ‘Paying the price: Multinationals, Royalty Payments and Minority Shareholders’, Institutional Investor Advisory Services (IiAS) analyzed royalty related data of 25 companies and developed the “IiAS Royalty Signal,” which classifies companies on the basis of how increased royalty payments have impacted company financials.
2. The study of 15 MNCs conducted by Ambit Capital.
3. The letter of Commerce Ministry to the Finance Ministry asking for re-imposition of restrictions on royalty and other payments.
The following data is revealed by these sources
Increase in the amount of royalty and other payments: The five highest royalty paying companies Maruti Suzuki, Hindustan Unilever, Nestle India, Bosch and ABB India, remitted Rs.3979 Cr in FY13, up from Rs.3124 Cr in FY12 (a jump of 27.4%).
For the listed 25 companies that pay highest royalties (excluding Gulf Oil and P&G), royalty and related payments increased by 23.8% to Rs.4952 Cr in FY13 from Rs.3999 Cr in FY12.
A study of 20 such companies showed that royalty payments to foreign parents tripled to Rs.3, 601 crore in 2011-12 compared with Rs.1, 196 crore in the year ended March 2008 i.e. a rise of almost three times.
No relationship of increased royalty with volume of sales: For 25 companies referred above, the increase in sales was only 13.1% while the royalty payment went up by 23.8%.
Is increase in royalty payment in tune with increase in profits? For 25 companies referred above, the increase in sales was only 13.1% while the royalty payment went up by 23.8% n FY13. This was not in-line with growth in earnings as net profits grew only at 13.1%. In FY13, companies such as ABB and Maruti Suzuki paid over 300% and 100% of their PAT as royalty and related payments. This indicates that the payment to their parent companies is more than the profit available to shareholders of the companies. Royalty payments alone
contribute to 1.5% of Suzuki Motor Corp’s net sales and 47.0% of its PAT for 2012-13. Does it not indicate the intentions of MNCs to earn as much as possible from their subsidiaries or joint ventures?
In principle it is true that royalties are a company’s decision and are approved by the board and shareholders. However, despite local investor’s protests, companies continue to press for increase in royalty, and minority shareholders bear the brunt of these payments as royalties crimp profits available with the company for distribution in the form of dividends. On the other hand, foreign promoters get a disproportionate share of the income compared to their shareholding.
n Hindustan Unilever Limited (HUL) proposed to increase royalty from 1.40% to 3.15% of turnover, in a phased manner from February 2013 to March 2018.
n Nestle proposed to increase such costs from 3.5% to 4.5% of sales over a five years, starting 2014.
n Outflow of foreign currency compared with FDI. The removal of restrictions on royalty payments has now led to a sharp increase in royalty payments – 18% of FDI inflows in 2012-13 from 13% in 2009-10 .About $4.4 billion went out of India as royalty payments in 2012-13, nearly 20% of the $22.4 billion in foreign direct investment received by the country in the year. The outflows on account of royalty and fee for technical services, taken together, are in the range of 16-33 per cent of the foreign direct investment (FDI) inflows over the period 2009-10 and 2012-13.
n Minority shareholders bear the brunt of these payments as royalties crimp profits available with the company for distribution in the form of dividends. Foreign promoters get a disproportionate share of the income compared to their shareholding. Companies such as 3M India, Timken India, Whirlpool of India and Asahi India Glass have paid royalty in the range of 1.2 per cent to 2.6 per cent of net sales to their foreign partners but have not paid any dividends to shareholders since 2008 (excluding one-off dividend payments). Had these companies paid dividends in lieu of royalty to foreign partners, shareholders could have enjoyed the monetary benefits. n
The flurry to increase royalty rates may look inconsequential in percentage terms but they result in-
1. Huge outflow of money from the country every year.
2. MNCs have increasingly begun to use the royalty route to extract disproportionate returns from their Indian arms, especially since the government relaxed the curbs on remittances a few years ago.
3. The interests of the minority shareholders are not properly taken care of.
4. Royalties have resulted in no improvement in technical know-how of a foreign company's Indian partner and hence are a drain on the economy.
Will the Finance Ministry take the letter of Commerce Ministry in right spirit and act in the interest of the nation? If the present Finance Minister does not, the new one will have to.
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