Boosting foreign technology transfers and brand licensing

Foreign direct investment (FDI) in India is principally governed by the Foreign Exchange Management Act, 1999 (FEMA), alongside FDI policy issued by India’s government from time to time. In addition, the Department of Industrial Policy and Promotion (DIPP) issues various press notes from time to time, modifying the sectoral limits on FDI and specifying additional conditions for FDI in India.

The first hint of liberalisation of the IP regulatory framework came in November 2006, prior to which the regulatory rules required the Reserve Bank of India’s (RBI’s) approval for the purchase of a trademark or franchise.

This restriction was removed and the RBI took a step towards liberalisation with a November 28, 2006 circular allowing an Indian entity to draw foreign exchange and freely pay for the purchase of trademarks and franchises in India without prior approval of the RBI.

The next and arguably more substantial step came recently concerning the remittance of royalty and lump sum payments associated with technical collaboration or the use of trademarks and brand names. The Foreign Exchange Management (Current Account Transaction) Rules, 2000, until recently, allowed technical collaboration agreements to be entered into without prior government approval if:

(i) Any lump sum payable did not exceed $2 million

(ii) Any royalties payable did not exceed five percent for domestic sales and eight percent for exports (applicable regardless of the duration of royalty payment).

Royalties were calculated using the net ex-factory sale price of the product, exclusive of excise duties, minus the cost of standard and imported components, irrespective of the source of procurement, including ocean freight, insurance and customs duties.

Similarly, licensing agreements for the use of trademarks and brand names could be entered into without prior government approval if the royalties payable did not exceed two percent for exports and one percent for domestic sales.

Any payment associated with a technology transfer or licensing arrangement that exceeded these limits required government approval.

Step towards liberalisation

However, a DIPP press note dated December 2009 heralded a radical departure from this position by permitting technology transfer and licensing agreements to be entered into without prior government approval, regardless of the value of the lump sum fees or royalties involved.

“The government has significantly liberalised the regime for foreign technology agreements and trademark licensing agreements, which is surely a step in the right direction.”

It is interesting to note that although the press note unambiguously stated that royalty and lump sum payments for technical collaboration and use of a trademark would no longer be subject to the earlier limits, it also noted that such payments would be subject to the Current Account Transaction Rules, which still maintain the prior limits.

Since a press note has the force of law, a statutory amendment is required to the Current Account Transaction Rules in order to synchronise them with the press note and, ultimately, the government’s liberalisation policy.

Further clarity on the procedures for the payment of lump sums and royalties will be forthcoming when the government decides on the postreporting system for technology transfer and collaborations, and licensing of trademarks and brand names, as promised by the press note.

Boost to foreign investment

This development will potentially not only boost technology transfer to India but also act as an incentive for foreign entities to enter the Indian market. This will be further assisted by the provisions of a 2003 press note, which permitted the issuance of equity shares in lieu of the payment of lump sum fees and royalty payments.

Prior to the 2009 press note, the issuance of shares in lieu of royalty or lump sum payments above the stated limits required government approval. But since the recent press note removed these limits, shares can now be issued in lieu of royalty or lump sum payments without prior government approval.

However, the sectoral limits for FDI in India remain applicable and investments beyond these limits continue to require approval in the relevant sectors. In the telecommunications sector, for example, companies engaged in providing unified access services and national/international long distance services may receive foreign investment of up to 74 percent of the total share capital, as can Internet service providers, with gateways, radio paging and provision of end-to-end bandwidth, out of which up to 49 percent can be sourced without prior government approval.

On a critical note, now that royalty payments are outside the purview of government regulation and will be determined through negotiation between the parties involved, it may compromise the bargaining position of an Indian subsidiary against its multinational parent. For example, a parent company could charge its Indian subsidiary excessive royalties, which could adversely affect the interests of the subsidiary’s minority shareholders.

In conclusion, the government has significantly liberalised the regime for foreign technology agreements and trademark licensing arrangements, which is surely a step in the right direction, leading to growth of the Indian market and making Indian companies more competitive. That said, the true impact of the change—both on procedural matters and collaboration efforts—is not yet known.

Nirupam Lodha is an associate at Luthra & Luthra Law Offices. He can be contacted at: nlodha@luthra.com

Kshitij Sharma is an associate at Luthra & Luthra Law Offices. He can be contacted at: kshitijs@luthra.com