Proxy advisory questions payment of royalties by local subsidiaries of MNCs

Are royalties paid by Indian subsidiaries of multinational companies a cause of concern? A report by proxy advisory Institutional Investor Advisory Services Shareholders indicates that 32 MNCs in the BSE500 paid royalty aggregating ₹6,300 crore in FY 2015, amounting to 21 per cent of their pre-royalty pre-tax profits, to their global parent.

Over the past five years, aggregate royalty and related payments for these MNCs increased at a five-year CAGR of approximately 20 per cent compared to an approximate 7 per cent growth in their pre-royalty pre-tax profits.

Shareholders must demand a greater say in how much royalties Indian subsidiaries of multinational companies pay to their foreign parents, the report states.

Maruti Suzuki, HUL, ABB, Nestlé and Bosch have paid out the maximum amount as royalty in the past three years, according to IiAS’s statistics. Aggregate royalty payouts of these five companies was ₹4,780 crore, or approximately 24 per cent of aggregated pre-royalty pre-tax profits. In fact, Maruti’s and ABB’s payouts aggregated 30 per cent of their pre-royalty pre-tax profits in FY15, IiAS found.

The steady increase in royalty payments can be largely attributed to a change in regulations in December 2009, which liberalised the payment of foreign technology collaborations and royalty fees under the automatic route, “including lump sum payments for transfer of technology, payments for the use of trademark and brand name.” The unintended consequences of waiving restrictions on royalty payments are reflected in the “steady increase in technical know-how, royalty, consultancy fees etc. by foreign partners since 2009, without a commensurate increase in either sales or margins,” the note adds.

The advisory recommends that performance should be a benchmark for royalty payments, especially when these 32 companies have underperformed their peers in the BSE 200. “The BSE 200 companies have reported better growth and margins than these 32 MNCs in FY15. This begs the question, what are companies paying for if their local competitors are growing faster and earning better margins?”

IiAS has also designed a “Royalty Signal” that assesses the appropriateness of royalty payout levels in the context of revenues, margins and dividends. Companies are then assigned a score which determines if they are in the red (where they have performed weaker than peers in the BSE 200, or if royalty payouts are higher than dividends), amber (if royalty outpaces the increase in sales and/or profits) and green (if dividends are higher than royalty or if royalty is increasing at a slower pace than sales and profits).

According to this ranking, BASF India, Schneider Electric, 3M India, Alstom T&D and Heidelberg Cement were the biggest transgressors. IiAS said that even though companies claim royalty payouts are made on “arm’s length pricing”, companies don’t explain how the price has been arrived at or what the impact of R&D by the parent on the subsidiary’s products has been.

“Maruti, for example, has flip-flopped on royalty payouts a number of times in the past few years in order to accommodate Suzuki’s demands. For instance, they increased royalty payouts to account for the rupee-yen exchange rate fluctuations: but why did Maruti’s board cave into absorbing all the exchange losses?” it asks.

Investors and shareholders must engage with companies to understand the terms and conditions based on which royalty is being paid since under current regulations, this does not require shareholder approval. The report concludes by suggesting that this should be brought under the ambit of shareholder approval and until then, “investors must engage with MNCs in India and actively push them to rationalise royalty payouts.”

However, Riaz Thiangna, Director, Grant Thornton Advisory, believes it would not be right to link IP-related royalty payments to profitability record.