Editorial. Royal(ty) ride – The Hindu BusinessLine

It is an unfortunate fact that whenever regulations are relaxed for ease of doing business, they end up being misused. Corporate India’s practices on royalty payments seem to fit this description. In 2009, Indian companies were exempted from getting prior government approval for royalty payments. This led to a sharp spike in royalty outflows, prompting a rethink. In 2017, based on the recommendations of the Uday Kotak Committee, Securities and Exchange Board of India (SEBI) mandated that listed companies would need minority shareholder approval to pay 5 per cent or more of their turnover as royalty to a related party. A recent SEBI study of 233 companies between FY14 and FY23 shows that this has led to companies keeping their royalty payments below the 5 per cent mark but indulging in dodgy practices.

Royalty payments are supposed to compensate for technical knowhow or brand advantage. But the study found weak correlation between companies’ royalty payouts and their turnover and profit growth. Sixty-three of the 233 companies that paid royalties made losses at least in one year; 18 saw royalty payments outpace their turnover and net profits. When companies share profits with their promoter by way of dividends, minority shareholders always receive their due. But royalty can be expensed in the P&L and paid exclusively to a chosen party. This may be why there were 315 instances of companies skipping dividends but keeping up royalty payments, and 417 cases where royalty payouts amounted to three times the dividend payout. While companies were careful to keep their royalty payouts below 5 per cent of their turnover to avoid seeking shareholder approval, there were many cases where royalties took a big bite out of profits. In 102 cases, royalties amounted to over 40 per cent of profits and 74 cases where they were over 100 per cent of profits.

Some companies house their brands/trademarks in unlisted entities owned by the promoter, so that a part of profits can be siphoned off as royalty. Others pay hefty royalty to group companies for trademarks that add no material value to their market position. There are cases of consumer firms paying brand royalty to multi-national parents for products they build from scratch and exclusively sell in India. Some listed companies disguise royalty payments as “management fees”, or make payments to multiple related parties to keep them under the 5 per cent limit.

Given that royalty payments are a legitimate business expense, SEBI cannot crackdown on the practice in toto. However, it can lower the 5 per cent-of-turnover threshold for minority shareholder approval on royalty payments and require companies to periodically renew their royalty contracts. Loss-making and dividend-skipping companies can be mandated to seek shareholder approval, irrespective of the size of their royalties. Annual report disclosures on the exact nature of benefits that companies are reaping from their royalty deals may also serve as a deterrent to frivolous payouts.