Royalty payments: should they be taxed now?

India Infoline News Service | Mumbai |

In recent times, royalty route is the most preferred route of paying the parent. I was surprised to know that Indian units of MNCs paid US$866mn as royalties, which is up 4.7 times in six years. Simple average royalty rate is up 1.6% of revenue in FY12 from 1.2% of revenue in FY06. And on EBITDA basis it doubles to 14.7% from 7.3%.

Our IIFL institution research team has written a very interesting piece on MNC royalty payments. Co-incidentally, The Economist also had an article on MNCs who have stayed on invested in India and the benefits reaped. Given the way the HUL stock reacted after it announced an increased royalty payment to the parent company, I thought this is a good topic to write, comment, discuss and deliberate. Most of the MNC companies in India take royalty as a percentage of sales. This is a good tax efficient way of taking money out to the parent. Most of the MNCs take royalty on account of brand, technology, know-how, patent, usage and a host of other reasons.


Earlier, remittances to foreign collaborators were capped and royalty payment could not exceed 5% on annual domestic sales or 8% on exports without approvals. All the caps which were in place were removed as a part of ongoing globalization programme of India.


Earlier, MNCs used to pay hefty dividends. Go back in time and see how companies like Colgate, HUL (then HLL) used to give high dividends. Post the imposition of dividend distribution tax, percentage of royalty has increased.


Over a period of time, most MNCs have tried to delist and turn 100% private but have got stuck due to regulatory hassles and sometimes the huge costs associated with buying out the floating shares. Incidentally in the 70s they were forced to list if they wanted to continue to do business in India. IBM and Coke walked out, if you care to know because they did not want to list.


In recent times, royalty route is the most preferred route of paying the parent. I was surprised to know that Indian units of MNCs paid US$866mn as royalties, which is up 4.7 times in six years. Simple average royalty rate is up 1.6% of revenue in FY12 from 1.2% of revenue in FY06. And on EBITDA basis it doubles to 14.7% from 7.3%. Most of them are increasing their royalties. The biggest royalty payment takes place in FMCG and auto. An interesting statistic is that Maruti and ABB pay out more than 70% EBITDA as royalty. Surprisingly, pharma companies do not pay high royalty but there is a kind of compensation as they often buy huge amounts of raw material from the parent company.


In comparison Indian group companies have paid on 0.2% of the revenue and 1.7% EBIDA as brand fees. And even if the Indian promoter tries to charge brand fee and royalty payment, he is beaten black and blue by analysts who say that investors are getting cheated. I am surprised that only a few analysts ever make a noise when MNCs do similar things. Is it because we are still enamoured by the white skin and we look at ourselves like second class citizens? A case to point is Havells India. The promoters have decided to transfer ownership of the “Havells” brand from one of the promoter group companies to the listed entity from April 1, 2016 without any consideration.


I find it difficult to explain think and understand why FMCG companies should pay royalty to the parent. It is not that these brands are coming to India for the first time and hence there is some logic for paying royalty. If you look at brands like Surf and others, they are more or less an Indian brand. HUL has spent crores in building these brands and it is not that all these expenses incurred by the Indian company have been subsidised by the foreign partner. So on one hand all the Indian shareholders have paid the price of brand building in terms of advertisement expenses and then to rub salt on the wound, they are paying royalty fees also to the MNC. The interesting thing is that Wheel is 100% Indian brand. It was conceived and built to face the challenge of Nirma. I do not know what is the total extent of Wheel sales; whether it is significant or not. But still, royalty is paid on full revenue. So what is the contribution of HUL plc to building a brand like Wheel apart from global gyaan and superior management techniques?


Earlier, say 10-15 years ago I am sure that all defunct products which were not in use in other countries were shipped to India. Cutting edge products and systems were still the domain of US and Europe which were fast growing markets. In the recent past, be it Hollywood movies or product launches, they often take place simultaneously in India, which is sign of India’s purchasing power.


The Honourable Finance Minister is looking at different ways to tax and increase the net. If the salaried Indian is going to see another round of tax increases, and there are rumours that dividend in hands of recipient will see some taxes, then why not tax royalties?

 

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