SBP revises manual for royalty, franchise, technical fee

State Bank of Pakistan (SBP) has revised foreign exchange manual related to Royalty, Franchise and Technical Fee (RFT) for ease of doing business.

The central bank said that in order to implement the revised policy on RFT (Para 12, Chapter 14 of Foreign Exchange Manual), Authorized Dealers/banks shall set up a centralized unit to facilitate applicants.

The SBP said that the unit shall be responsible for, inter alia, review and acknowledgment of RFT agreements, issuance of internal approval to respective branch for issuance of acknowledgment letter of the agreement as well as designation of the banker and maintenance of party wise record of agreements acknowledged and remittance effected there against.

The said unit shall be staffed with officers well versed with foreign exchange regime headed by a senior officer, according to the SBP.

Authorized Dealers/banks shall submit the compliance, in this regard, to this office within 15 days of issuance of this circular dated August 05, 2021.

The said unit shall ensure strict compliance with the provisions of policy during processing the cases and referring the cases to SBP where regulatory approval is required.

In case non-compliance of the provisions of RFT policy is observed, appropriate enforcement action may be initiated against the delinquent Authorized Dealers under relevant provision of Foreign Exchange Regulation Act, 1947.

Following is the complete text of Para 12, chapter 14 of Foreign Exchange Manual:

12. Remittance of Royalty/Franchise and Technical Service Fees.

(i) Definitions: Royalty, Franchise and Technical Service (RFT) Fees are defined as under:-

a) Definition of Royalty: Royalty is a fee paid by a local firm to the foreign collaborator in consideration of right to use any patent, invention, design or model, secret formula or process, trademark or other intangible property or right. Royalty is for the right to use, transfer of all or any rights, granting of a license, receiving any information concerning their working or use and receiving of any technical, industrial, commercial or scientific knowledge, experience or skill. Essentially, Royalty signifies payment for ‘user right’ and it could be an annual payment or a pre-decided periodical payment.

b) Definition of Franchise Fee: Franchising is a specialized license where the franchisee is allowed by the franchisor in return for a fee to use a particular business model and is licensed with a bundle of Intellectual Property rights (trademarks, service marks, patents, trade secrets, copyrighted works etc.) and supported by training, technical support and mentoring.

c) Definition of Technical Service Fee (TSF): It is a fee paid (whether periodic or lump sum) by the local firm to the foreign collaborator for any managerial, technical or consultancy services. The service provider makes his technical knowledge, experience, skill, know-how etc., known to the recipient of the service, so as to equip the recipient to independently perform the technical function in future, without the help of the service provider. TSF may also cover development/ transfer of a plan or technical design. For example :-

i. Engineering and Technical Services which includes assistance in processes, testing and quality control, assistance by way of making available patented process and/or secret know-how and right to avail of the technical/confidential information resulting from continuous technical research and development etc; and

ii. Technical training of local personnel.

The difference between TSF and royalty is that in case of royalty the owner enables the user to use the technology/know how while in case of TSF the owner uses his technology to perform some services for users against certain consideration.

d) Exclusions from Royalty/Franchise & Technical Service Fee: The contract for supply of equipment, giving information/ guide the buyer to install the equipment at site would not be treated as royalty/ technical service if the same are being claimed as salary of non-residents. Similarly, providing any information in the course of advisory services from own knowhow and experience will also not amount to imparting of any information in context of royalty. Likewise, the amount must not be in the nature of capital gains or the transaction must not be an outright sale. No payments is allowed in cases where the recipient is not the owner/license holder of the underlying asset in connection with which the royalty is received. In case of doubt, the matter should be referred to the State Bank as SBP reserves the right to define the exclusions as every case of providing any information concerning commercial, industrial, technical or scientific knowledge; expertise or skill by itself would not fall under the definition of royalty/franchise or technical service. Each agreement of royalty/franchise or technical service must include the benefits for the country in the form of value addition like, export generation, import substitution, employment generation and development of technical knowhow. No technical fee shall be allowed for simple conventional processes/goods, which are being undertaken/ produced in the country without foreign technical collaboration.

(ii) Rate of Royalty/Franchise, Technical Service (RFT) Fee.

(a) Manufacturing Sector

(i) The entities belong to manufacturing sector may be allowed initial lump sum/ onetime fee payable to the foreign collaborator for providing RFT services up to USD 1,000,000/-. The recurring/ aggregate payment of royalty/franchise and technical fee should not exceed 8% of the net local sales of the unit/component (excluding sales taxes & imported cost of component) for which foreign collaborator has provided know how. In case of export sales of the unit/component, royalty/technical fee may be remitted up to 10% on net export sales (excluding sales taxes & imported cost of component) of the said units/components of the relevant period.

Permissible RFT structure for Manufacturing Sector

For manufacturing the lump sum/upfront fee is $1,000,000* with recurring royalty up to 8 per cent of net sales (excluding taxes and cost of imported components. Maximum duration of agreements (including amendments) is 10 years.

For manufacturing – export related the lump sum/ upfront fee I $1,000,000* with recurring royalty is up to 10 per cent of next export sales (excluding taxes and cost of imported components). The maximum duration of agreements (including amendments) is 15 years.

* In case upfront fee is required to be remitted beyond the above limit, the differential amount above the limit together with recurring royalty should not exceed the prescribed percentage of net sales of relevant period.

(b) Agriculture, Social, Infrastructure and Service Sector projects including international food chains (excluding financial sector)

(i) The entities belonging to above sectors may be allowed initial lump sum/onetime fee payable to the foreign collaborator providing RFT services up to USD 100,000/- with recurring payment at the rate up to 5% of the net local sales pertinent to RFT agreement (excluding sales taxes & cost of imported items).

Permissible RFT structure for Agriculture, Social, Infrastructure and Service Sector:

The lump sum/upfront fee is $100,000* with recurring royalty up to 5 per cent of net sales (excluding taxes and cost of imported items). The maximum duration of RFT Agreements (including all amendments) is 5 years.

*In case Lump sum/upfront fee is required to be remitted beyond the aforesaid limit, the differential amount above the permissible limit together with recurring royalty should not exceed the prescribed percentage of net sales of relevant period.

(ii) For mere use of brand name only, the maximum RFT fee would be restricted up to 2.0% of net sales. Example of such cases may include but not limited to RFT paid by retail stores etc. Similarly, if entities fail to provide any verifiable evidence of value addition/ transfer of technical knowhow, the RFT fee would be restricted up to 2.0% of net sales.

(i) Commercial Banks, Non-Banking Financial Institutes (NBFIs), leasing/ modaraba companies investment banks and other entities in financial sector regulated by State Bank of Pakistan or by Securities and Exchange Commission of Pakistan requiring payment of RFT fees, or any other directly related charges to the foreign entities shall approach the Foreign Exchange Operations Department, SBP-BSC on a case to case basis along with attested copy of agreement and other relevant information/documents including copy of management approval from the appropriate approving authority duly supported by the relevant regulatory framework (if applicable).

Permissible RFT structure for Financial Sector:

One time lump sum (upfront) RFT fee is $500,000* with recurring RFT, commission or handling charge/ any other directly related charges **up to 0.25 per cent in aggregated of customers’ billing net of taxes/charges. The duration of agreement is 5 years.

*Lump sum fee shall be allowed from interbank market.

**The charges would either be recovered from the customers or met through the financial institution’s own resources. No foreign exchange would be provided/utilized for this purpose from the interbank market.

(ii) Permission for standby LC/guarantee, if required, would be granted on the merit of each case.

(iii) Principles/Guidelines for RFT Agreements

With the objective of facilitating businesses, all agreements conforming to the below terms & conditions would not require any approval/ acknowledgement from SBP:-

a) The applicant’s request should clearly demonstrate the value addition/ value creation through the RFT agreements. Complete documentation pertaining to right of use, acquisition of knowledge/ technical know-how shall be provided.

b) The information submitted in the application shall be verified by the external auditor (having satisfactory QCR rating) of the company. The auditor shall verify the basis and actual calculation of the amount payable along with its comments on the value addition.

c) The fee payable under proposed RFT agreements should not be more than the prescribed ceiling rates. The applicants are expected to keep their agreements within the optimal limits and in case the maximum limit is necessary, the justification needs to be documented appropriately. All cases beyond the prescribed rate pertaining to Manufacturing Sector shall be forwarded to FEOD (SBP-BSC) with necessary details/ justifications.

d) RFT fee will be permissible maximum up to years prescribed in tables above, for any product/ brand.

e) The RFT rate needs to reflect the prevailing market price. In case the counterparty is a related party, external auditor of the applicant shall certify that principles of arms-length pricing has been be observed and the basis of pricing are transparent and verifiable.

f) RFT against imported goods (from third/related parties and sold under own/different brand) would only be allowed to the extent of the prescribed percentage of any value addition done locally i.e. local sales of component by deducting the cost of imported items & taxes from the relevant sales.

g) The RFT fee would be allowed only for those items, which are core items of franchise and have specialties of the trade name.

h) No item will be eligible for twice payment of RFT Fee. In other words, the payment of fee shall not be admissible for those items whose franchise is not held by the applicant or are sold under some other brand names. For example, fast food chains selling soft drinks. However, this condition shall not be applicable to the RFT paid under sub-para ii (b(ii)) of para 12 ibid.

i) ADs should only allow RFT for technical and unconventional processes, goods, or services, which are core for the business model and cannot be produced in the country without foreign technical collaboration.

j) RFT computation would be based on net local sales of component that will exclude all taxes and imported (Direct/Indirect) components; whereas, Export sales will be based on FOB price, net of taxes and imported components.

k) Formal agreement of RFT needs to be executed between the parties for collaboration while assuring that it is valid for business year of the resident company and contain no clause related to penalty for delayed payment.

l) Branch offices of the foreign entities will not be eligible for any RFT fee/payments.

m) Where RFT is to be allowed on deleted/localized components, it shall be based on the proportionate sales price (net of sales tax and imported components) attributed to the deleted/localized components in question.

(iv) Acknowledgement of RFT Agreements & Designation of Authorized Dealer

(a) The Authorized Dealers have general permission of SBP for remittances pertaining to RFT fees in accordance with procedure prescribed. For this purpose, Authorized Dealers shall set up a centralized unit at their Head Office, which shall be responsible for review and acknowledgment of RFT agreements. This unit shall be staffed with officers well versed with RFT instructions and shall be headed by a senior officer.

(b) The applicants whose draft agreement comply with instruction provided in para 12(iii) will approach the centralized unit of an Authorized Dealer of its convenience, through the concerned branch, on the prescribed form (Appendix V-52) for one time acknowledgement of respective agreement along following documents:

i. Application duly signed by CEO/ CFO of the company addressed to the concerned branch/head of centralized unit.

ii. Board Resolution certified by the company secretary to authorize CEO/CFO of the company to enter into respective agreement and handle relevant modalities including name of foreign counterparty, applicable rate, periodicity of remittance and name of intended banker for remittance.

iii. Certified copy of draft agreement with applicable amendments, if any. After execution of agreement, the certified copy is also required to be submitted.

iv. Undertaking by the company duly executed by the CEO/CFO to the effect that applicant has neither obtained acknowledgment/designation of the said agreement through another Authorized Dealer nor made any remittance there against. A copy of such undertaking shall be submitted to FEOD – SBP-BSC by the centralized unit of the concerned Authorized Dealer under its cover within three working days from the date of acknowledgement of agreement. In the event of misuse, SBP, SBP-BSC shall initiate penal action against delinquent entity/Authorized Dealer under relevant provision of Foreign Exchange Regulation Act, 1947.

v. The centralized unit of Authorized Dealers will review agreement (including clearance from Head of Compliance) and issue internal approval to respective branch/revenue center for issuance of acknowledgment letter of the agreement as well as designation of the banker.

vi. The applicant will make enhanced disclosures of total amount of remittance made under respective RFT agreements and name of the designated banker in the liability / expense notes of its annual audited financial statements.

vii. Where the designation of Authorized Dealer is required to be changed, the applicant will obtained approval from its Board of Directors and furnish certified copy of resolution along with above applicable documents in addition to external auditor’s certificate to confirm the amount of RFT remitted under the agreement and NOC from the centralized unit of the concerned Authorized Dealer.

viii. The centralized unit of previous designated Authorized Dealer shall be required to issue the NOC and share the record related to acknowledgment & Designation of agreement and year wise amount of remittance allowed thereunder. The issuance of NOC and transfer of relevant record should be completed within 07 working days from the date of request received from the centralized unit of new Authorized Dealer.

(c) The cases which do not comply with above parameters may be referred by the centralized unit of concerned Authorized Dealer to FEOD of SBP (BSC) with specific recommendation of Group Head-Compliance for policy guidance, waivers etc.

(d) After obtaining acknowledgment & designation letter, the applicant may remit RFT fees through the concerned branch of designated Authorized Dealer without any approval of the State Bank while observing following documents.

i. Application for remittance of the Fee is submitted by the entity concerned in the prescribed form for RFT (App. V-53).

ii. The CEO or CFO of the applicant would sign & stamp the respective invoices to verify the calculations of RFT fees.

iii. The remittances are to be allowed against invoices certified by external auditor, having satisfactory QCR rating, exhibiting necessary deduction of taxes and certifying compliance of above principles for RFT agreements.

iv. All remittances will be subject to deduction of applicable Govt. taxes, duties or fees or an exemption certificate issued by the tax authority in lieu thereof, which will be provided to centralized unit of the designated Authorized Dealer for record keeping and review of inspection/audit teams.

(e) The Group Head Compliance / Operations will ensure placement of necessary controls at their centralized unit for review of such agreements, designation of the bank and issuance of respective authorization for the field offices besides maintaining a centralized computerized MIS regarding acknowledgment of agreements and remittance of RFT fee there against for review of SBP inspection teams. Further, they shall be required to submit the details of agreement acknowledged on the following format to FEOD, SBP-BSC on monthly basis latest by 5th working day of every month: