Re-imposing curbs on royalty payments to foreigners

Background

We had earlier reported that the Indian government, in 2009, waived the requirement of prior government

approval in case of payment of royalty by Indian companies to multinational corporations and allowed such payments through the automatic route. Later, we also carried a Business Standard report which stated that the aforesaid relaxation is being used by the MNCs to divert a major portion of the profits made by their Indian arms in the form of royalty payments and technology transfer fees. This deprives the minority investors in those Indian concerns of their rightful dividends. 

Re-imposing curbs on royalty payments to foreigners

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According to Economic Times report dated 8 August 2013, the GoI is considering the re-imposition of restrictions on royalty payments in the light of sudden surge in outflows post-relaxation. The royalty payments in 2012-13 was to the tune of $4.4 billion, nearly 20% of the $22.4 billion in foreign direct investment received by the country in that year.

The report points out that most MNCs have increased the rate of royalty payments after the liberalization of the policy. For instance, Hindustan Unilever had last year increased the royalty payment to its parent Unilever in phased manner from 1.4% of turnover to 3.15% of turnover by the financial year ending 31st March 2018. DIPP is concerned over the higher percentage of royalty payments sans any transfer of technology or critical components and designs.

Fix the leaking tap

The outflow is, of course, worrisome considering the rising current account deficit and the consequent disastrous results.  The Indian rupee is depreciating at an alarming level.  Further, the rate of inflation is not anywhere near the comfort zone. In this context, outflows in the form of royalty payments (devoid of any major addition to technical know-how) is worrisome especially when experts are suggesting proactive steps  such as issuing NRI bonds, sovereign debt offers, raising FII debt limits, FDI limits etc to recoup foreign exchange reserves. In other words, it is quite imperative to fix the leaking tap!! According to news reports dated 23 August 2013, the Finance Minister noted that the government and the RBI do not intend to impose capital controls [see here]. This stance of the government contradicts the Economic Times report dated 8 August 2013. I am not getting into the merits of this stance of government. But I do hold the view that royalty payments, which do not result in any major addition to technical know-how, is detrimental to the economy. Any outflow from the nation must bring in commensurate benefits. Else, it is a drain on the economy - a drain which denudes the nation of its productive capital. [Curiously, it sounds more like the economic drain theory put forward by Dadabhai Naoroji against British colonialism!!] Of course, imposing absolute capital controls may dent the investor confidence. We cannot afford it at this juncture. But imposing restrictions on royalty payments, which do not bring in commensurate benefits, is within the best interests of the nation. Therefore, I suggest a closer look at the policy. 

Even otherwise, the royalty payments also raise some pertinent issues on corporate governance. I wonder whether the decision to relax norms was taken after due consideration and consultation. Prof. Umakanth succinctly and incisively analysed the issue [‘Royalty payments and Corporate governance’] and noted as follows: “Such royalty payments are a classic case of related party transactions (RPTs) between the company and a controlling shareholder. As we have previously lamented, the regulation of RPTs in India is far from the desirable. Current corporate governance norms only require appropriate disclosure in the financial statements, a responsibility imposed on the auditors and the audit committee. One way of approaching the issue is to consider disclosure as fulfilling an important function because investors can then decide their further course of action depending on the nature of disclosures. However, there are problems with disclosure as the sole option. First, disclosures can sometimes lack meaning if they are not appropriately and accurately made. Second, disclosures tend to acquire an element of standardization over a period of time thereby leaving investors with little information to distinguish among companies that make the royalty payments.

Due to the failure of disclosure as an adequate option, it is necessary to consider other possibilities through amendment to corporate governance norms. Essential among them is the need for a committee of independent directors to specifically consider and approve such royalty payments (or any other material RPTs for that matter) after specifically expressing their views on the impact of such transaction on the interest of minority shareholders. Another option would be to mandate shareholder approval for such royalty payments (or other RPTs), wherein the recipient of the royalty payment (i.e. the parent company) must be required to abstain from voting in view of the conflict of interest.

Unless such checks and balances are introduced, the minority shareholders in such MNC subsidiaries will be exposed to considerable risk that the parent companies will likely treat the Indian listed companies as if they are merely arms of themselves.”