India: Govt Reconsidering Limits On Royalty Payouts To Foreign Parents

Last Updated: 15 March 2019
Article by Essenese Obhan and Sumathi Chandrashekaran

The government of India is reportedly considering a proposal to once again introduce limits on the amount of royalty payable by Indian subsidiaries to their foreign parent firms for the use of trademarks and brand names, or for technical services. These limits were last applied in India nearly a decade ago.

A report published in Economic Times in December 2018 ago (See) suggests that the Department of Industrial Policy and Promotion (DIPP), under the Ministry of Commerce, is preparing a note for consideration by the Union Cabinet along these lines.

According to the report, the royalty payout from firms for intellectual property alone is estimated to be equal to 20% of the total foreign direct investment (FDI) into the country. As per official data, these royalty payments amounted to Rs 27,000 crore (about $4 billion) in 2017-18, which was a significant increase from the Rs 22,728 crore in the previous financial year. Independent research by experts at the Indian Institute of Management, Bangalore studied royalty payments for the period between 2006 and 2016, across 11 different sectors, and found that there was a general increasing trend in such payouts (See).

The current status on the issue dates back to amendments made in May 2010 to the Foreign Exchange Management Rules (Current Account Transactions), 2000. Before these amendments came about, companies had to obtain approval from the Commerce Ministry to repatriate royalty payments to their parent firms for technical services exceeding 5% of domestic sales and 8% of export sales; and for the use of trademark and brand names exceeding 2% of exports and 1% of domestic sales. The amendments (applicable with retrospective effect from December 2009) removed these limits, and the Commerce Ministry no longer had to approve the amount of royalty paid. This allowed Indian subsidiaries to send unlimited amounts as royalty to their parents The amendments were part of a wave of regulatory and statutory changes brought about to increase foreign investment into India. (See).

The new proposal reportedly in the works seeks to reintroduce the limits on royalty payments, effectively restoring the status from before the May 2010 amendments. However, it is speculated that the caps on transfers in case of technology transfer collaborations will be kept at 4% of domestic sales and 7% of exports, in contrast to the 5% and 8% previously. There is no indication of the proposed caps on royalty payouts on the use of trademarks or brand names.

Sectors where firms pay high royalties to their parents are likely to be most affected. These include firms dealing automobile and auto parts, IT and IT enabled services, petroleum and petrochemicals, power and energy, electronics including computer hardware, engineering goods, cement, mining and construction, wholesale trading and food processing.

The implementation of this proposal rests on multiple factors. A major consideration is the extent to which it will affect the health of FDI into India, and whether the revival of these limits will discourage players from participating in the Indian markets. While structuring most FDI transactions, repatriation of funds is of significance. Since declaration of dividend may not occur for a few years, most transactions are structured with a license agreement in place and the parent company / licensor receiving royalty payments. Amendments in the regulations that impact royalty payments will also lead to the existing structures being re-examined and undergoing a change.

Further, it is also important to study the extent to which such limits will be valid in the context of India's trade and tax commitments under free trade agreements, and bilateral investment and tax avoidance treaties. Many of these agreements/treaties do not allow the imposition of any restrictions or conditions on technology transfer or investments, except in very specific circumstances, such as the existence of an international treaty to the contrary, or prevailing international law. With a history of treaty arbitration decisions having gone against india in the past few years, it will be interesting to see how the government proceeds on this account.

Finally, India is due to enter election-mode in the next few weeks, and it is unlikely that any important policy changes will take place in the interim. The interim budget placed before Parliament earlier this month did not mention this proposal, and any major regulatory amendments will take place only after the new government takes charge.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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