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Setting royalty fee

March 03, 2013

The money paid in ‘royalty’ to non-resident companies and foreign investors came under fire in the Senate on June 6, 2012 during a meeting of the Senate’s Standing Committee on Finance, which sat to review Finance Bill 2012-13.

The senators voiced concern over what they suspected was “considerable wealth repatriated by international firms investing in Pakistan on account of royalties”. They asked for amendments in the law to make royalty time bound for 20 or 25 years, instead of allowing it for an indefinite period.

Some senators also cited the example of companies established in 1947, which were still dolling out royalties to their overseas parents. The finance secretary agreed over the need to chalk out a draft policy on the subject in consultation with the ministry of finance, State Bank of Pakistan (SBP), and the Federal Board of Revenue (FBR).

Is the aggregate sum paid out in ‘royalties’ really a big drain on national resources? According to a World Bank report published last year, an amount of $123 million was paid by Pakistan in royalty and licence fees in 2010 . In rupee terms that would convert to Rs11 billion. The figure does tower over the meagre sum of Rs7.8 billion allocated for education by the government in Finance Bill 2012-13.

Yet, a corporate lawyer, Mohammad Samiullah asserted: “When you count the costs, do also count the benefits”. He asserted that major multinational companies (MNCs) mainly in the food and pharmaceutical sectors are currently represented through franchisees. A franchise means an authority given by a franchiser to a franchisee (under a contract) to produce, manufacture, sell or trade or to do any other business activity relating to goods or provide services. The franchiser also supplies technology, technical skills, managerial know-how, patents, licences and trademarks. And for all of that such MNCs are paid royalties, technical fee and a slice of the profit.

The franchise agreement may provide that ‘royalty’ would be paid on the amount calculated as a percentage of either net sales proceeds, or on gross turnover.

“The foreign principals however prefer to levy a lump sum amount”, a franchisee of a food outlet, on condition of anonymity said. His reason was that where the firms or companies are private and present unaudited accounts, the principals can hardly shake off the suspicion that the books may have been ‘cooked’ to show lesser sales, mainly to save on tax and other payments including royalties.

Franchising is of benefit to MNCs for they provide such companies with a swift and easy way to enter the market without a major capital commitment. By operating through local franchisees, foreign firms can gain access to local expertise and significantly reduce the problems of adjusting to the country's business environment.

A representative of foreign franchise said that franchising in Pakistan has potential drawbacks, which include quality control, intensity of marketing efforts by the local franchisee, and possible conflict of interest on part of the franchisee. "The local affiliate may end up as a competitor once the franchise agreement expires or is terminated", he observed.

Major US companies are currently represented in Pakistan through franchisees. They include Day’s Inn, Best Western, Pizza Hut, KFC, Subway, McDonald's, Dunkin Donuts, Dominoes’ Pizza, Papa John’s Pizza, Hardees, Nike Retail, UPS, FedEx, Princeton Review, Berlitz, Gymboree, Gloria Jean’s Coffee, Hertz and Avis.

“There are many more seeking an entry mainly in the food segment”, said a person in the know of things. He asserted that returns in the food outlets outweigh perceived country risks since there is scarce fixed investment involved.

The companies have to seek approval of the central bank for all agreements of royalty, fee for technical services and franchise agreement entered into with foreign entities. The rate of tax imposed on payments to non-residents was 15 per cent of the gross amount of the royalty or fee for technical services.

Yet, the question lingers: does franchising and payment of ‘royalties’ bring benefits to Pakistan?

Relevant people who discussed the issue with Dawn were on both sides of the divide. An economist puts forward the example of one of the largest multinational pharmaceutical companies in Pakistan.

The company’s last annual accounts for the year 2011 showed payment of Rs133 million under the head ‘royalty’ to an associated company; the sum had climbed up from Rs88 million a year ago. The company also repatriated to the holding company an amount of Rs641 million in dividend payout for 2011. This person disputed payment of ‘royalty’, when the company’s principal was already taking the biggest pie of yearly profit in dividends. According to the SBP statistics, repatriation of profit/dividend by subsidiaries of foreign companies in the latest July-Jan (2012-13) seven months period stood at a staggering $508.4 million.

But a possible pragmatist counted several blessings of franchises of food outlets to the host country and its people. “They move the wheel of host of ancillary industries such as packaging, advertisement, furniture, real estate and agricultural products: tomatoes, potatoes, bread, meat and milk and its by-products”, he said. And best of all, such outlets provide employment to youngsters.