Royalty payments by some listed companies exceed 20% of profits

Synopsis

A new study by the Securities and Exchange Board of India (SEBI) has revealed that listed companies in India frequently pay substantial royalties to related parties, often exceeding 20% of their net profits. The regulator is considering stricter regulations, including cumulative royalty limits and sunset provisions, to address concerns about potential financial risks and shareholder value erosion.

Mumbai : Listed companies paid royalty to related parties in excess of 20% of their net profits on one out of four occasions, flagging the need for change in norms, a study published by the Securities and Exchange Board of India (Sebi) Thursday showed.
“The data suggests that though the royalty payments made by companies are reasonably within the stipulated threshold, such payments are unjustifiably high in terms of their profitability,” Sebi said.

“While the necessity of royalty payment to be considered as an expenditure from the perspective of business growth is acknowledged, such payments when viewed through the profitability lens reveal too pressing an issue to be overlooked,” it said.
In one out of two occasions that listed companies paid such levels of royalty, they did not pay dividends, or paid more royalty to related parties than dividend paid to other shareholders.

The study asked whether companies that skip dividend payments but pay royalty be subject to enhanced scrutiny from shareholders.

The regulator said there were 185 instances of royalty payments by 63 companies that made net losses. In such instances, these companies made royalty payments of Rs 1,355 crore to related parties during FY14-FY23.

It sought views on whether there should be additional regulatory requirements for loss-making royalty payers.

Typically, listed companies make royalty payments to the ir holding companies or fellow subsidiaries—referred to as related parties—towards the purposes of brand usage and transfer of technology.

Currently, shareholder approval for royalty is required if payment to a related party exceeds the threshold of 5% of consolidated turnover.

Some royalty-paying companies pay less than 5% to more than one related party without requiring shareholder approval, while the cumulative payment to all related parties together is much in excess of the regulatory threshold, Sebi said.

It sought views on whether rules should be changed so that the threshold applies to cumulative royalty pay-out to multiple related parties.

The regulator also raised concerns about companies at times seeking shareholder approval for royalty payments in perpetuity.
It suggested the need for sunset provisions in royalty agreements between the royalty-paying company and its parent company so that payments are not for perpetuity.

Sebi’s analysis is based on annual, company level data, in respect of 233 listed companies across sectors in India. These companies have made royalty payments, amounting to less than 5% of turnover to their related parties, during the 10-year period from FY14 to FY23.

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