Vedanta Faces Scrutiny Over Potential FEMA Violations Amid Excess Royalty Payments

Enforcement Directorate Conducts Raids on Vedanta Limited Over Alleged Foreign Exchange Management Rule Violations

The Enforcement Directorate (ED) conducted raids on the premises of Vedanta Limited in Mumbai and Delhi on Tuesday, citing alleged violations of the Foreign Exchange Management Act (FEMA) in connection to royalty payments made by the Indian listed entity to its UK-based parent, Vedanta Resources.

The case pertains to the Indian entity allegedly making excessive royalty payments to its foreign parent, which has a debt of Rs 53,400 crore but no major sources of income apart from dividends and royalties received from Vedanta India. To facilitate debt servicing, Vedanta India has been sending money to the foreign parent through two routes: dividends and royalties. According to rating agencies, the brand fee and company dividends paid by Vedanta India will cover $800 million to $1 billion of the UK holding company's debt between FY26-29.

Vedanta Resources' Debt Profile

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Steep royalties to offshore entities have often attracted the attention of Indian regulators, who see such practices as profit shifting from India. The ED's action is part of its efforts to prevent the misuse of foreign exchange regulations.

Royalties are essentially fees paid by an entity for using the brand name and identity of a different entity. In this case, the IPs of Vedanta are copyrighted with Vedanta Resources, and the Indian entity pays a fixed fee every year for using such IPs. Brand payments are considered current account transactions covering business expenses, which can be made automatically without any approval from the Reserve Bank of India (RBI). However, the rules require that such payments have a bona fide purpose and without any such purpose, remittances under the royalty route are prohibited.

Excessive royalties are treated as deductible business expenses under Indian tax rules, allowing companies to avail beneficial tax treatment. However, if the amounts paid are deemed excessive by the tax authorities, it means the company has paid a steep fee to the foreign entity at the cost of Indian shareholder profits. This is construed as diversion of Indian resources to foreign entities, which is prohibited under the Prevention of Money Laundering Act (PMLA).

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The issue also has a tax angle, which triggers further FEMA violations. If the tax department disallows tax benefits on royalty payments, it means the company has failed to meet the arms-length test under transfer pricing rules and has given undue benefit to the foreign entity. This again triggers FEMA and PMLA, as it would mean the forex transaction involving royalty payment was illegal.

Both the ED and Income Tax Department have dealt with cases of allegedly excessive royalty payments in the past. In April 2022, the ED froze Rs 5,500 crore worth of assets of Chinese smartphone maker Xiaomi for allegedly making illegal outward remittances in the name of royalties. Samsung is currently embroiled in a legal battle with the tax department in connection to 8% royalty paid by the Indian entity to its foreign parent. Vodafone and L’Oreal have also faced regulatory issues around royalty payments in the past.