Royalty is the amount paid to the parent company, by the domestic subsidiary collaborated for the transfer of technology, brands trademarks etc. Until 2009, there was a statutory upper limit to this. Where the fees or royalties were higher than these limits, the government approval was required to make the payment.
To attract more foreign investors, the government relaxed the rules in December 2009 and these limits were removed -
1. Flow of income
According to a report by Mumbai-based proxy advisory firm Institutional Investor Service(IiAS), in 2014-15, the royalty payments by Indian subsidiaries of 32 multinational companies was Rs 6,300 crore, which grew 10% from the previous year.
Companies such as Maruti Suzuki, Nestle India Ltd, ABB India Ltd, Hindustan Unilever Ltd and Bosch Ltd have paid absurd amounts as royalty in the past five years. HUL, which is the India’s largest consumer goods maker, has doubled its royalty payment to Unilever from the previous 1.4% to 3.15%.
McDonald’s, a US based fast food company signed an agreement with its Indian franchisee Hardcastle Restaurants Private Ltd to increase the Royalty fee by 8% of net sales by 2020 from 3% previously. Nestle india also agreed to increase the royalty payment from 3.5% to 4.5% of sales, for a period of five years starting from 2014
2. Royalty affects shareholders
Analysts explain that by increasing reliance on royalties, instead of dividend, MNCs are de-risking their returns from the Indian markets. “Royalty payments are calculated on revenues, while dividend income depends upon the profitability of local subsidiaries that can vary a lot during a business cycle,” says G Chokkalingam, founder Economics Research & Advisory. Besides, dividend income has to be shared with non-promoter (minority) shareholders, unlike royalty amount.
A higher dependence on royalty also incentivises the local subsidiaries to focus on revenue and sales maximization, rather than profits. It hurts minority shareholders, especially during an economic down-cycle, when profit and dividends are compromised for revenues.
3. Decrease in direct tax collections
Royalty payment is deducted to calculate earnings before tax, this results in decrease of direct tax collections from the Indian subsidiary.so after the royalty payment is deducted the tax in the earning is calculated, when Indian subsidiaries pay more royalty there will be less payment of tax to the government. Hence to stop this government in asking for suggestions from stakeholders as to how to deal best with the issue. Hope that government will arrive at a solution that is more reasonable and does not weaken investor’s confidence.
By - Dattakumar Jawalkar
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