Royalty vs profit share

S. Murlidharan | Updated on March 31, 2011

At stake is their livelihood when mining projects come up on their land.   -  The Hindu+SEP+THE HINDU

In mining projects, tribals should opt for royalty on sales rather than the 26-per-cent share of actual profits, as proposed.

A timid author with no stomach for fight sues for peace and settles for outright payment either upfront or in instalments or a combination of both. His book may sell like hot cakes, but he has no means of verifying the actual sale with which his fortunes are tied. In the event, it is his word against that of the publisher and the latter often ends up laughing all the way to bank after having laughed up his sleeve at the naivete of the learned author.

Wizened authors, wiser from series of depressing experiences, counsel their proteges to settle for a modest lump sum rather than the theoretically more alluring never-ending series of periodic royalty streams which at the end of the day turns out to be a mirage. While this is the general experience of the small tribe of intellectuals, there is a small bunch of publishers who scrupulously maintain and furnish honest account of books sold and pay the promised royalty . But their tribe is fast dwindling and heading towards extinction.

Industrial royalty

Not everyone is as helpless as an author of books. Companies in possession of cutting edge technology watch over their interests with intrusive presence and hawkish eyes. Suzuki has been getting sizeable royalties from its 55-per-cent Indian subsidiary Maruti for more than three decades now despite questions being raised of the propriety of a parent charging fee from his child.

Foreign collaborators cannot be fobbed off with a pittance through clever accounting for the simple reason that accounts are prepared under their very nose. In fact, they strive hard to increase production because each unit produced means that much more financial reward for them. The Indian government allows a generous 5 per cent royalty to overseas suppliers of technology on domestic sales and 8 per cent on exports.

Wise foreign companies settle for a lesser percentage knowing as they do the power of volumes. This is reminiscent of company promoters settling for just say 2 per cent of profits as managerial remuneration as against the permitted 5 per cent.

With such clever posturing, they look a lot less rapacious. , Honda, another Japanese company, also seems to have plumped for royalty instead of for capital gains while handing over its 26-per-cent stake to its Indian collaborator Hero in their joint venture Hero Honda Ltd. The deal has come in for criticism on the ground that the Hero group while getting the shares cheap has exposed the shareholders to the prospect of reduced profits and lessdividend, with heightened royalties putting a huge shovel into the profits.

The above discussion leads to the question of the appropriateness of the proposed 26-per-cent share of profits to the tribals from mining companies. The government's heart is at the right place, but the Planning Commission's Deputy Chairman, Mr Montek Singh Ahluwalia, rightly apprehends that the impressive percentage may boil down to a zilch thanks to a combination of clever accounting and rude realities.

A 26-per-cent share of profits being earmarked for tribal welfare is theoretically more alluring but like the credulous authors, the more credulous tribals could also be in for an anti-climactic end to their dreams. They should therefore instead be given a royalty which does not depend on profits, but on production. Fastening one's recompense on production is likely to bring in a steady stream of income for the tribals.

Less volatile

Of course, there must be someone to keep an eagle eye on production and sale. The point is if hard-headed businessmen can plump for royalty a fortiori, the more naive tribals also should, lest they are fobbed off with a pittance. It would be any day wiser to get a small percentage of the turnover rather than a high percentage of profits. Production and sales are less volatile and less amenable to tinkering.

Alternatively, minerals may be auctioned and the tribals may be paid equitably a share of the auction money received by the government.

This would be a throwback to what intellectuals with no stomach for fight settle for wisely but like with any via-media, there could be a huge compromise involved in hindsight should the mines auctioned turn out to be a cornucopia. Royalty, especially the one that is ad valerom, ties the fortunes of its earner with the fortunes of the economy, industry and the promoter. In the event, the tribals should plump for royalty on sales rather than the mirage of a 26 per cent share of actual profits. Tribals cannot be expected to display the same alacrity as the doughty private equity participants or the hands-on foreign collaborators.

(The author is a Delhi-based chartered accountant.)

Published on March 31, 2011

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