The Securities and Exchange Board of India (SEBI) has conducted an in-depth study analyzing royalty payments made by listed companies to Related Parties (RPs). Covering a decade-long period (FY 2013-14 to FY 2022-23), the study examined 233 listed companies across various sectors in India. These companies collectively made royalty payments amounting to less than 5% of their turnover during the period.
A royalty payment to related parties is when a company pays money to a related business or individual, like its parent company, subsidiary, or an affiliate, to use things like intellectual property, technology, brand names, patents, or other assets that aren’t physical. These payments are usually based on agreements that explain the rules and how the payment amount is calculated.
Key Findings of the Study:
1. Royalty Payments by Profit-Making Companies
- In 1 out of 4 instances, listed companies paid royalties exceeding 20% of their net profits to RPs.
- In 50% of the cases, companies paying royalty either did not declare dividends or paid more royalty to RPs than dividends to non-RP shareholders.
2. Royalty Payments by Loss-Making Companies
- From FY 2013-14 to FY 2022-23, there were 185 instances where 63 loss-making companies paid ₹1,355 crore in royalties to RPs.
- 10 companies incurred net losses for at least five years but still paid ₹228 crore as royalties.
3. Consistent Royalty-Paying Companies
- 79 companies consistently paid royalties to RPs over the entire 10-year period. While these payments aligned with growth in turnover and profits until FY 2019, there was a decline post-FY 2019.
- For 18 companies, royalty payments outpaced both turnover and net profit growth throughout the period, with a compound annual growth rate (CAGR) of 14.6%, significantly higher than the CAGR for turnover (6.5%) and net profits (6.0%).
- 11 of these 79 companies consistently paid royalties exceeding 20% of net profits for all 10 years.
Issues Raised by Proxy Advisory Firms
- Disconnect Between Royalty and Company Performance
- Royalty payments often lack correlation with revenue or profitability.
- Companies paying royalties do not consistently outperform peers who do not pay royalties.
- Corporate Governance Concerns
- Companies sometimes seek perpetual approval for royalty payments, violating governance principles.
- Payments for brand usage remain high, despite significant spending by companies on brand promotion.
- Non-Royalty Payments to RPs
- Payments termed as “Management Fees” or “Technology License Fees” fall outside regulatory scrutiny and are often substantial.
- Transparency Issues
- Poor disclosure practices hinder shareholder understanding of the rationale and benefits of royalty payments.
- Shareholders of Indian subsidiaries of MNCs lack visibility into royalty rates charged across other geographies.
- Subjectivity in Valuation
- Independent valuations of royalty payments show significant inconsistencies, raising questions about fairness and accuracy.
What is Royalty Payment?
Royalty payment to related parties refers to a financial transaction in which a company pays a fee to a related party—such as a parent company, subsidiary, affiliate, or an entity owned or controlled by common stakeholders—for the use of intellectual property, technology, trademarks, patents, or other intangible assets. These payments are typically governed by agreements defining the terms and the basis for calculating the royalty.
Key Aspects of Royalty Payments to Related Parties:
- Definition of Related Parties
Related parties are entities or individuals with a close relationship to the company, such as:- Parent companies.
- Subsidiaries or sister companies.
- Major shareholders.
- Key managerial personnel or their family members.
- Purpose of Royalty Payments
- Brand Usage: Companies may pay for the right to use trademarks or brand names owned by the related party.
- Technology Transfer: Payments for proprietary technology or technical know-how.
- Intellectual Property: Fees for patents, copyrights, or exclusive manufacturing processes.
- Why It Can Be Controversial
- Conflict of Interest: These transactions might favor the related party, potentially at the expense of other shareholders.
- Excessive Payments: Unreasonably high royalties can lead to profit erosion in the paying entity.
- Transparency Issues: Limited disclosures may obscure the fairness of the transaction.
- Tax Implications: Payments may be structured to reduce taxable income in jurisdictions with higher tax rates (a practice known as “transfer pricing”).
- Regulatory Oversight
- Regulators, such as SEBI in India, scrutinize these payments to ensure they are reasonable and comply with corporate governance norms.
- Payments above a certain threshold often require approval from minority shareholders to safeguard their interests.
Example
A multinational company might charge its Indian subsidiary a royalty fee for using its global brand name and technology. While the payment could be legitimate, regulators check whether the amount aligns with the value provided and doesn’t disproportionately benefit the parent company at the subsidiary’s cost. These transactions are common in sectors like manufacturing, pharmaceuticals, consumer goods, and technology, where intellectual property and brand value play critical roles.
