How India Can Stem $8.63 Billion Outflow Of Foreign IP Payouts

When a distinctly indigenous B2B brand like National Stock Exchange gets its theme song registered as a 'sound mark', the auditory version of a trademark, you know that India's intellectual property (IP) consciousness is coming of age as the world transitions from manufacturing to knowledge economy.

But realising the potential of its IPs will be a long, arduous road, just as it was for China. In 2008, India's northern neighbour started transforming itself from 'wild west' of IPs engaged in low-value manufacturing, to becoming a global industrial powerhouse. It set a strategic goal of attaining high levels of creation, utilisation, protection and administration of IP rights, and in 2015 filed the highest number of IP applications. In 2019, it filed 25 times more patent applications than India, and two times more than US. In 2019, it was granted 64 lakh-plus trademarks and more than 5.5 lakh design rights, while India was granted 2.94 lakh trademarks and about 12,000 design rights, as per data from Department of Promotion of Industry and Internal Trade.

It is time for India to learn IP kung-fu moves from its neighbour as using IP created by foreign entities is proving to be costly. As per IMF Balance of Payments data, India paid $8.63 billion for use of foreign IP in 2021, 56,862% more than $15.1 million in 1981. In comparison, IP owned by Indian entities netted merely $870.1 million. This underlines the need to improve IP protection laws and systems to encourage creation of IP by Indian entities. In 2021, the Parliamentary Standing Committee on Commerce said a mere 1% improvement in copyright protection increases foreign direct investment (FDI) by 6.8%. The same improvement in protection for patent and trademark increases FDI by 2.8% and 3.8%, respectively.

There has been some improvement in the situation, though. Four decades back, India paid 80 times more for use of foreign IP than what it earned from its own IP. Though this fell to 10 times in 2021, it's clear that the country continues to pay a heavy price for not creating enough IP assets.

The Cost of IP

IP rights (IPR) can be classified into industrial IPRs, marketing IPRs and creative IPRs. Industrial IPRs stem from knowledge and research and include patents, trade secrets, technical knowledge and industrial design. Marketing IPRs result from marketing efforts that build the value of trademarks, product-design, etc. Creative IPRs include copyrights of creative products such as books, cinema, performance by artistes, software, etc. As per Fortune India-CapitalLine data, India Inc. paid 'Royalty And Technical Know-How Fees' of ₹46,447 crore in FY21 versus ₹43,710 crore in FY20, a rise of 6.2%. This is exclusive of metal, mining and petrochemical sectors that pay mineral royalty to government of India.

There are two means by which an Indian subsidiary pays its parent entity on foreign soil — royalty and dividend. Royalty is charged as percentage of sales revenue whereas dividend is paid on profit after tax. Hence, royalty is probably a better way to ensure bigger pay-outs. Royalty also reduces taxable profits of subsidiaries, hence their overall tax burden.

Companies usually prefer to receive royalty in a country with lower tax rates. A small part of that royalty is then paid to the parent entity in higher tax jurisdictions. For instance, many multinational companies based in high tax regions like G7 and Organisation for Economic Co-operation and Development (OECD) nations prefer to form R&D companies in low corporate tax countries like Ireland (12.5%), Cyprus (12.5%) and Cayman Islands (Nil). Tax Foundation, a non-profit tax research organisation, says average corporate tax rates in G-7 and OECD nations were 26.69% and 23%, respectively, in 2021.

Questionnaires sent by Fortune India to Kia Motors, Hyundai Motor India, Wipro Ltd., Tata Steel, Maruti Suzuki and Herbalife International India about royalty payments did not elicit any response. Here's what the major sectors of the economy are paying as royalty.

IT Sector: IT companies were among the top 10 payers of royalty and technical knowledge fee from FY19 to FY21. They paid ₹18,234.54 crore in FY21, as per Fortune CapitalLine data. Wipro paid the most, ₹8,360.90 crore, followed by Microsoft Corporation India, which paid ₹5,361.8 crore. IBM India paid ₹2,709 crore.

Consumer Goods & Services: The branded consumer goods and services segment also pays heavily for using foreign brand names. An analysis of Fortune India-CapitalLine data shows that companies belonging to sectors like FMCG, consumer durables, alcoholic beverages, hotels, F&B, readymade garments, textiles, mobile handsets, and companies trading in these goods and services, paid more than ₹5,836.45 crore for royalties and technical knowledge in FY21. Many brands of companies like Hindustan Unilever, Proctor & Gamble and Colgate Palmolive have been in India since colonial times, so it may be presumed that, for three-quarters of a century, the Indian consumer has been indirectly paying huge amounts to foreign companies, largely for the brand perception. Even the relatively new consumer brands like Xiaomi and McDonalds have found Indian mass market a great source of royalty income (see Xiaomi Tops Among Trading and FMCG Firms).

Automobile sector: It is the largest employment generator in India after IT. All foreign manufacturers may be charging 3-4% of net sales as royalty for sharing their technology, says an auto expert, on condition of anonymity. The automobile and ancillary sector paid ₹9,639.14 crore as royalty and technical fee in FY21 (see In Auto, Maruti Is Top Payer). Maruti Suzuki paid 3.6% of its net sales as royalty and technical fee to parent company Suzuki Motor Corporation, Japan. The fee was the second-highest cost after steel, which was 10% of net sales. On the brighter side, though, Maruti Suzuki brings forex to India as 15% of its sales come from exports. It opened an R&D facility in Rohtak in FY14 but it's not clear how much it spends on R&D in India as queries to the company went unanswered. A questionnaire sent to Hyundai Motor India and Kia India was not answered.

Why Indian Companies Lag?

Brand consultant Harish Bijoor says India has gone through dominance of agriculture, followed by industrialisation, and both these had no concept of value creation via IP. Only when the country became a technology-based economy did it realise the importance of IP. Bijoor says foreign companies such as HUL earn heavy royalty from brands as they believe their brand is all that is to a product. Indian brands need a robust product offering too in order to command the same premium, he says.

Brand and advertising expert Ambi Parameswaran says India has not created impactful brands in developed markets as it's a very expensive process. However, Indian brands like Bajaj, Mahindra & Mahindra and Dabur are quiet sought after in many developing and third-world markets. Fortune India asked many Indian companies whether they charge royalty from their foreign subsidiaries. However, none had responded till the time of publishing of this article.

Now, the key questions are: Why is India lagging? And can it match the developed world and create an IP revolution?

The Legal System

Indian laws have major lacunae that impede registration of certain kinds of IPRs. For instance, they have no provision for commercialising and protecting an innovation as 'patent pending' during the period the application is being processed. Since the application details all aspects of the innovation and puts it in public domain, unscrupulous entities start copying the innovation and marketing it way before the patent is granted. The innovator has no legal remedy to fight such infringement.

Another major loophole in current laws is absence of provisions for protection of works and solutions generated through artificial intelligence (AI). As per Section 3(k) of the Indian Patent Act, 1970, a mathematical or a business method or a computer programme or algorithm run by AI is not patentable. The Copyright Act, 1957, is also not equipped to facilitate authorship and ownership by AI.

A Stronger IP Regime

The Economic Advisory Council to the Prime Minister recently released a report titled "Why India Needs to Urgently Invest in its Patent Ecosystem?" which points out that the Office of Controller General of Patents, Designs & Trade Marks has only 860 people in the patent office as compared to 13,704 in China and 8,132 in the US. Hence, approximately 1.64 lakh applications were pending at the controller level as on March 31, 2022.

A majority of experts, as well as the 2021 Parliamentary Standing Committee Report, point out lack of focus on R&D in India. Small government spending on R&D, coupled with propensity of businesses to source technology from foreign players rather than invest in own R&D, stifle creation of IP assets. As per the parliamentary report, India spends a mere 0.7% of its GDP on R&D, way less than China (2.1%), Brazil (1.3%), Russia (1.1%) and South Africa (0.8%). No wonder, foreign entities account for 64% patents filed in India. As per World Bank data, the world has 1,597 researchers per million people. In 2018, India had 253 researchers per million people. The numbers for China, Russia, Malaysia, Iran, Thailand are close to the global average. South Korea had 8,714 researchers per million people, the highest in the world.

What IP Regime Needs

For a nation of 140 crore people, more than half of whom are young, India's contribution to global intellectual assets is way less than expected. Its rich culture of artistry, traditional knowledge of medicine, agriculture and industries, opulent biodiversity, geographical clusters of traditional crafts and foods, coupled with vast manpower engaged in technological pursuits, can create abundant IP for the world.

Bijoor says Indian companies need to focus on five things — patience to keep investing in brand building; luxury mindset; ability to market; talent to harness consumer insights; ability to adjust to forever changing matrix of marketing. He believes the Indian machinery sector will bring forth many product innovations.

Ambi Parameswaran is optimistic about the Indian IT sector leading the way. "The next wave of IPs will come from the IT sector. In the past, Indian IT companies were service-oriented but today they are focusing on products. And in IT, innovative products are IPs," he says.

Arun Prabhu, partner and head, Technology, Media and Telecom at law firm Cyril Amarchand Mangaldas, says encouraging R&D by providing more impactful incentives for innovations as compared to generic businesses will encourage IP creation in India. As businesses progress from dominance of manufacturing to supremacy of technology, IP will become pivotal to strength of an economy.

The inclination of businesses to develop own technologies rather than borrowing from foreign entities, a long-term branding mindset rather than short-term profitability approach, and governance that supports and celebrates creation of IP, all need to come together to transform India into a global IP powerhouse.