Putting a Lid on Royalty Outflows — How the RBI can Help Reduce India's IP Costs

Posted by Sanjana Govil at Jun 17, 2011 10:05 AM | Permalink

Filed under: Intellectual Property Rights, Access to Knowledge

While entrepreneurs, IP rights-holders and everyone else who has a stake continue to voice their opinions on the appropriate shape that the Indian IP regime ought to take, they tend to narrow their discussions to the language of substantive IP laws. However, there are regulations that cannot be found in the Patent Act, Copyright Act or Trademarks Act which nevertheless have an impact on how much one is paying for intellectual property. Paying attention to these external factors might just provide a simple solution to your IP woes.

One such factor is the regulation of foreign technology agreements. A foreign technology agreement is an agreement under which a transfer of technology occurs from a foreign source to an Indian entity. This transfer may include anything from the creation of an Indian wholly-owned subsidiary of a foreign parent company to the transfer of manufacturing or design know-how.

Regulation of these agreements in India is carried out by the Ministry of Commerce and Industry as well as the Reserve Bank of India. In 1991, the Ministry’s Department of Industrial Development (DID) released Press Note No.10 which stated the following:

“39 C. Foreign Technology Agreements

i) Automatic permission will be given for foreign technology agreements in high priority industries (Annex III)* upto a lumpsum payment of Rs. 1 crore, 5% royalty for domestic sales and 8% for exports, subject to total payments of 8% of sales over a 10 year period from date of agreement or 7 years from commencement of production. The prescribed royalty rates are net of taxes and will be calculated according to standard procedures."

As a consequence, automatic approval could only be granted to high priority industries whose royalty payments fell within the prescribed limits. In every other case, the approval of the Secretariat of Industrial Approvals (SIA), DID and the RBI had to be sought. It must be noted that in theory this regulation did not place an absolute ban on royalty outflows above the 5% and 8% ceilings since the possibility of securing government approval for the same did exist. However, considering that a mere 8062 approvals were granted between 1991 and 2009[1], the ceiling was in effect almost absolute.

It appears that the stance of the government of the time was one of strict regulation. From the perspective of Indian entrepreneurs, shareholders and consumers, this was a good thing. To illustrate, imagine a foreign company which manufactures a networked camera cell phone. The company will be paying royalties for several of its features such as the camera, USB port, operating system, etc. This company then sets up a subsidiary in India to manufacture the same phones. Though the total royalties being paid by the parent company are likely to far exceed five per cent of its sales, it cannot charge the subsidiary royalties above this ceiling. Therefore, the costs for the Indian subsidiary reduce significantly. This reduction will be reflected in an increased dividend for shareholders and a reduced cost for consumers.

While the benefits of this royalty ceiling are manifold, it is evident that foreign rights-holders are adversely affected. Therefore, the Government has, unfortunately, gradually “liberalized” its approach towards royalty payments over the years. First the 7 or 10 year duration restrictions were done away with and next the lump sum ceiling was increased from Rs.1 crore to USD 2 million. Ultimately, the ceiling was removed altogether through the Department of Industrial Policy and Promotion’s Press Note No.8 of 2009 in the name of liberalization. The adverse impacts on Indian manufacturers were almost immediate as foreign rights-holders began to revise their license agreements.[2]]

Why was this ceiling introduced in the first place? Some say it was due to the acute balance of payments deficit that existed in the country in 1991[3]; when India found itself overspending on imported oil. This urged the government at the time to ensure that foreign collaboration in the private sector was well regulated. Since then, the balance of payments situation in India has comparatively stabilized (though a deficit still does exist[4]) and so there appears to be no immediate need to continue to regulate foreign technology collaboration. However, one can’t help but remember Mark Getty’s prediction that intellectual property will be the "oil of the twenty-first century".[5]