A REPORT

ON

“ROYALTY Payments in industries”

Submitted by:
Niraj Kumar Agrawal
NF121312

A report submitted in partial fulfillment of the requirements of
PGP – FM Program of

National Institute of Financial Management
Sector – 48, Pali Road, Faridabad, Haryana – 121 001

Faculty Guide

Dr. A. M. Sherry

Acknowledgements

I express my deep sense of gratitude to my Faculty guide Dr. A.M.Sherry. He is intellectual person and an expert in his field of taxation. He has got a very rich experience into field of Accounting & Taxation; He has done eminent in the field of taxation. He has been constant source of guidance and inspiration behind the ideas employed in the study. The project could only be completed through the little that I could borrow from the vast sea of his knowledge in this field. I have indeed no formal words to acknowledge the valuable guidance and co-operation extended by him during the project work.

I am also thankful to my colleagues for helping me successfully conducting data mining. I extend my gratifications to Mr.Sumit Gupta for his support in collecting the data thru various sites.

NIRAJ KUMAR AGRAWAL
Roll No: NF121329
Course: PGP - FM

Declaration

I hereby declare that this project work entitled “Royalty payments by industries“ has been done by me during the academic year 2012-13 under the guidance of my faculty guide Dr. A.M. Sherry

I also declare that this project is the result of my effort and has not been submitted to any other University or Institution for the award of any degree, diploma or personal favor whatsoever. All the details and analysis provided in the report hold true to the best of my knowledge..

Place: NIFM, Faridabad Niraj Kumar Agrawal
Date: 12th January 2013 Roll No: NF12131

Royalty payment in the industries

Abstract

This paper examines the trend followed by the industries to paying the royalties to the other industries, also the strategies adopted by for the tax benefits by the listed & unlisted company. The above statement is supported by a detail study on the top 1160 companies who are paying the royalties, this includes listed (in Stock Exchange) as well as the unlisted companies. The finding vividly reveals that both type of companies are paying some part of their income as the royalties. The payment of royalty includes technical know-how, patent, copyright, trademark, even for using name of the family. It is also found out that the it varies with the sectors. The industrial royalty average is 9.56% to the sales. This is significantly varied with the different sector. During the study it is also find out that some of the companies are paying the abnormal royalties to the other companies. Their percentage shoot up even to 5000% of their sales. This is the area of concern.
The study is divided into two parts, in macro level & micro level. In the first part of the paper we will see the how the companies are paying the royalties to the other companies, while in the second part of the paper we will deeply study the purpose of paying the royalties there has been substantial impact on the PAT due to the payment of these royalties. This ultimately also influenced the sentimental of the investor. The findings of the study also magnify the pattern of the payment of royalties.

Introduction

“What’s in a name? that which we call a rose by any other name would smell as sweet” this is often quoted dialogue from William shakespeare’s Romeo and Juliet.

But look like Shakespeare might have to rewrite this dialogue had he been alive today and had been a part of India Incorporation. Companies spend crores in establishing their brand name, creating an equity which probably its biggest intangible asset and if they are told, “what’s in a name?” they are sure to mighty miffed.

Companies have always been charging royalty for usage of their name-family or parent (foreign) name. The charging of royalty is as old as our history is.

The history of trade & commerce practice in India is as old as the its civilization itself. Trade & commerce has played an important role in the Indian history. The Trade operation & mining is so significant in the civilization that definite law existed to regulate the operation and accrual of revenue to the state there from. According to the ancient law, even though the King represented the state the mineral/ technical know-how wealth did not vest in the king, but the king was entitled to receive the desired tax or revenue for the production. This concept however, underwent a drastic change after kautilya wrote his” Arthashastra” which claimed to pertain to the period BC 321-296. When India was ruled by The Chandra Gupta Maurya, According to the Kautilya, Trade, commerce & mineral are the monopoly of the state.
There was a system in ancient period of giving lagan or Malgujari to the malgujar. The Malgujar is the authorized person by the king of the state to collect the malgujari from the occupants/ farmers of the territory of the state. In Devnagri malgujar is made by two words “Mal” & “Gujar”. The meaning of mal is material like Grain or money which is given in the form of tax to the malgujar. The meaning of gujar is to remain alive or continue his life or continue the system or proper continuation of administration of state by the kings. So far proper administration & protection of the state which is provided by the king to the citizen of the state, the resident of the state had to pay the taxes, Malgujari or lagan to the King. During the ancient period when mining of the ore is being carried out in any state then a definite amount of tax was necessary to be paid to the king by the exploiter/extractor of the mineral.

In the Modern world the very nature of the term Royalty indicates a disguised share of profit and it is paid for acquiring a very valuable knowhow are technique that assist a person in nourishing his sales.

Definition

The term royalty has been defined in various dictionaries, case law and other sources, which are as follows –

1. Wharton’s Law Lexicon

Royalty, payment to a patentee by agreement on every article made according to his patent; or to an author by publisher on every copy of his book sold; or to the owner of minerals for the right of working the same on every ton or other weight raised.

2. Jowitt’s Dictionary of English Law

Royalty, a payment reserved by the grantor of a patent, lease of a mine or similar right, and payable proportionately to the use made of the right by the grantee, but may be a payment in kind, that is, of part of the produce of the exercise of the right. Rent, when a mine, quarry, brick, works, or similar property is leased, the lessor usually reserves not only a fixed yearly rent but also royalty, consisting of royalties varying with the quantity of minerals, bricks, etc. produced during each year. In this case the fixed rent is called a dead rent. A footage rent is payable for every acre and refers to a foot thick of minerals, and so in proportion for a greater or less thickness. A spoil bank rent is a sum payable according to the quantity of rubbish from a mine deposited on land belonging to the lessee (Vol. 5, P. 1544).

3. Strond’s Judicial Dictionary

In its secondary sense, the word ‘royalties’ signifies, in mining leases, that part of the reddendum which is variable, and depends upon the quantity of mineral gotten.

4. Bouvier’s Law Dictionary

Royalty, a payment reserved by the grantor of a patent, mining lease, etc., and payable proportionately to the use made of such right.

5. Mozlev and Whitelev’s Law Dictionary

A pro rata payment to a grantor or lessor, on the working of the property leased, or otherwise on the profits of the grant or lease. The word is especially used with reference to mines, patents and copyrights.

6. The Oxford Companion to Law

(Also) a periodical payment to the owner of minerals by a party authorized to extract and remove the minerals.

7. New Webster’s Dictionary

Royalty: A compensation or portion of proceeds paid to the owner of right, as an oil right or a patent, for the use of it; a royal right, as over minerals; granted by a sovereign to a person or corporation; the payment made for such a right.

8. Dictionary of Economics by. M.C. Madian

Compensation for the use of a patent, copyright, or other property, often calculated as a percentage of the sales value of the article or service.

9. The New Encyclopedia Britannica

Royalty, in law, the payment made to the owners of certain types of rights by those who are permitted by the owners to exercise the rights. The rights concerned are literary, musical, and artistic copyright; patent rights in inventions and designs; and rights in mineral deposits, including oil and natural gas. The term (i.e. royalty) originated from the fact that in Great Britain for centuries gold and silver mines were the property of the crown such “royal” metals could be mined only if a payment (royalty) were made to the crown. When owners of rights make arrangement for such exploitation by others, the remuneration that they receive in exchange is often in the term of a royalty, usually based on the actual extent of the exploitation. Mineral deposits are often exploited by persons other than the owners upon payment of royalties.

The Treatment of Royalty in different context of Indian Tax Law:-

Royalty under Foreign Exchange Management Act 1999:

Royalty agreement has to be carefully drafted so as to incorporate the correct method of computation of royalty. It may be noted that effect from 16.12.2009. Royalty is permitted through automatic route (i.e. without RBI approval necessity) at any percentage without any ceiling (previously it was 5% on domestic sales & 8% on exports). But the condition remains that the standard procedure prescribed by RBI has to be followed and that a certification to this effect will be required from statutory auditor which has to be filled with RBI. The standard procedure is net sales minus cost of standard bought out components minus landed cost of imported components (irrespective of the source of procurement) including ocean freight and insurance. The word used is component instead of raw material for the simple reason the royalty is payable on the value addition generate on a sub part through materials and further processing which is due to the knowhow acquired from a third party.

Royalty under Customs Act. 1962:

Royalty which is conditional to the sales agreement as payable by the buyer either directly or indirectly is to be added to the invoice price under the customs ( valuation of imported goods) Rules, 1988.

Royalty under Service Tax Law:

Royalty is categorized under intellectual property service payment by the finance act 1994. Service tax @ 12.3% (existing) as well as R& D cess @ 5%is payable with the facility to set off the R&D cess against the service tax liability and this service tax is available as cenvat credit, payment of service tax @12.3% and ignoring the R&D cess is not an excuse.

TDS on Royalty payment under IT Act, 1961:

Royalty payments are subjected to TDS under Sec. 195 if they are nonresident or under Sec 194J if they are paid to the resident. DTAA the respective country becomes into the picture to restrict the tax rates if it is a foreign payment. As such the current TDS rate where the payment exceeds Rs 1 Crore is @ 10.5575% and below Rs.1crore is @ 10.3 %. An important aspect to notice here is in the case of a cross border transaction service Tax is not to be added to the basic amount to compute TDS unlike how it is being done for local payments. The fundamental point of distinction here is the service tax liability as per law is that of the service recipient hence there is no justice on subjecting the service provider to TDS on the service tax portion.

Royalty accounting under Indian GAAP:

At the moment there is no dedicated Accounting standard for royalty as such, but currently AS-26 does cover an intangible asset accounting at cost and further amortization depending upon the available legal right period with a rebuttable presumption of 10 years( this presumption is said to vanish under the forthcoming converged Indian AS equivalent to IAS-38). This is of course subject to fulfillment of the asset recognition of the asset recognition criteria. Also foreign exchange fluctuation on the the outstanding Royalty payable as a monetary item will have to be dealt with as per AS-11(Effect of Foreign Exchange Fluctuation).

Objective:

The study is conducted on the top 1200 companies who are paying the royalty. The company is so chosen on the basis of the royalty payments. The selections of the companies are purely based on the payment of the royalty. Out of these 1200 companies due to data insufficiencies in some of the companies we have discarded almost 44 companies, so we have the sample size of 1156 companies, which is considerable enough to study.
In this study we are trying to find out the following:- 1. Is there any trend in paying the royalty by the listed and unlisted company? 2. How Different sectors affect the payment of the Royalties? 3. What is the general percentage payment of royalty in different sectors? 4. Is it possible for the companies to use this as a tax evasion? 5. What is the percentage of amount going outside india?

Sample

There were 1156 companies were randomly selected based on the payments of the royalty. The selected companies are so chosen that it will nullify the impact of any specific sector, if any. The sample comprises different set of companies listed as well as unlisted. Apart from that we have tried to include the maximum number of sectors like auto, cement, hotel, etc. we have divided these companies into total sixteen different sectors. We have included Private Ltd. Companies, Public Ltd Companies, Semi Government, State Government, etc. We also tried to best of our effort and also knowledge to add the maximum number of participation from across the industry.

Table 1 represents that the total no of companies taken in the study. The companies include different set of industry i.e. some are listed as well as some are unlisted
Different Set of Companies:-
|Sample Companies |No |
|Listed |337 |
|Unlisted |819 |
|Total |1156 |

Different set of Sectors of listed companies:-
|S.No. |Sector |No of Companies |
|1 |AUTO |45 |
|2 |CAPITAL GOOD |53 |
|3 |CEMENT |20 |
|4 |CHEMICAL |19 |
|5 |CONSTRUCTION |20 |
|6 |FINANCE-INVESTMENT |3 |
|7 |FMCG |31 |
|8 |HOTEL |9 |
|9 |METAL &MINING |30 |
|10 |MISC |20 |
|11 |OIL& PETRO |9 |
|12 |PHARMA |14 |
|13 |PROCESSING |35 |
|14 |SHIPPING |8 |
|15 |SOFTWARE |11 |
|16 |TELECOM |10 |
|Total |337 |

Methodology

The methodology used in this study is by choosing the companies based on their last payment of royalties, however for collection of necessary primary data, We had collected the data from the some of the reliable public domain. Before finalizing the companies we have also try to eliminate the companies who don’t have any royalty payment. A conscious effort has been made to include both listed and unlisted companies. However in order to ensure good quality we have eliminate some incomplete data, without compromising on the quantity of relevant information sought for the purposes of the study. The study has divided into the following broad parameters:

• To distinguish the listed and unlisted companies.

• Two distinguish the different sector in the listed companies • The percentage payment by the different set of sectors,this would be till the individual company.

The results of the study have then been utilized to conclude on the following hypotheses regarding the companies used this as tax evasion purpose.

Findings

The findings of the study are discussed below :

1. Basis of listing criteria

We had started the study with the hypothesis that the unlisted companies are more prone to pay royalties then unlisted company. In the study it is prove that the number of unlisted companies are much more then the listed companies. It is again one more interesting fact that almost listed companies are 1/3 to the listed companies
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2. Perceptions about payment percentage

In order to understand the perceptions about the royalty payment percentage, the study has started with the assumption that the unlisted companies are paying more royalty then the listed companies and also some sectors are paying more than rest.
But when we have analyzed the data it is found that the Royalty was paid by the listed companies are much more than the unlisted companies. The industrial average as whole is paying almost 9.56% but when we have bifurcated into listed and unlisted the average is 16.56% and 6.76% which is completely opposite to our assumption. but it is also found that the companies not listed in the exchanges are sometimes paying to extend of 5000% of their sales ,which is again very suspicious and the subject matter of more research.
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We have also done the cross sectional analysis of different segment of the industry, and it is found that the normally all the companies are paying the Royalty in the range between 0.% -5%. But there is an exception as some sector specially Finance & investment are paying almost 39%, which exceptionally high for any sector.
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3. Receivers of Royalty in the different set
In order to find out the receivers of the royalties payment we have tried to analyses the report of the companies, the founding from it is very interesting, we have found out that the payments are released as royalty for different reason i.e. from the technical knowhow, patent, copyright, to even for the using of the name, family name, etc. we Have also during the study found that there is some grey area which is the subject of the more research. From the initial studies it is again suspected that there are companies who are also used royalties for the tax evasion purpose. But to study more on this regards we need to do more deep research. Also due to limited resources it is very difficult to finding from the annual reports of the companies.

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Conclusion

The findings are presented in this paper shows that out of a sample size of 1156 companies which comprises of both listed and unlisted companies contribute a significant amount towards royalty payments. However, the study clearly shows that out the total base of 1156 companies 71% of them are unlisted ones and 29% are only the listed companies that shed towards royalty payments. Hence the findings have made it explicit that contribution towards royalty payments are more by unlisted companies than those of listed companies.
Something more interesting that came up from the research is at what rate are the royalty payments made? Findings from the paper show that the industry, on an average sheds royalty payment at the rate of 9.56% which brings us to the most amusing conclusion of the research that although the contribution towards royalty payments are higher by the unlisted companies than that of listed companies however the rate of royalty payments are higher by the listed companies than that of unlisted companies. Listed companies give royalty on an average of 16.56% whereas unlisted companies shed the same on an average of 6.76 %.
Finding of the paper has also drawn the attention towards the sector that gives maximum royalty payments. It has been observed that companies underlying in the Finance & Investment sector give the extra ordinary royalty payments.
Research also helps in understanding receiver of the royalty payments. Benefits accepted are broadly categorized into four segments and this research includes a sample size of 168 companies. Findings of the research concludes that the maximum benefit of royalty payments are done to the government than to parent companies followed by promoters and lastly to foreign companies. Out of the sample size of 168 companies, 48 have made payment to the government than 45 have transferred to their parent companies followed by promoter with 40 companies and lastly 35 companies pass on to foreign companies.

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[National Institute of Financial Management]

2012-13

ROYALTY PAYMENTS IN INDUSTRIES

By Niraj Kumar Agrawal

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