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How Do Royalties Work?

How Do Royalties Work?

Do you receive royalties? About to enter into a royalty agreement? Common in the arts industry, they exist in other industries. Read on to find out more.

21st May 2019

Have you recently published a book, licensed the rights to your trademark or are a franchisor? You will receive royalties from both. In the past, we covered trademark licensing, but in this article, we will cover royalties more broadly.

What are royalties?

Royalties are payments for using another’s property. This is usually IP property, but in the case of mining, it can be for land as well. These can be for a set percentage of revenue, a variable percentage of revenue, or for a fixed fee. Often, the royalty payment rate differs depending on the value placed on the property itself. They commonly exist in the music, film, publishing, franchise and mineral and oil mining industries. Some famous examples of royalty arrangements are YouTube and its uploaders, Apple Music and its artists, Batman and its actors, Mcdonalds and its various outlets across the world and BHP and the federal government.      

Example A

Jack seeks permission to stream Max’s song on his music download platform. Jack makes money from users paying an annual subscription fee to use his platform. Max and Jack’s royalty arrangement is for Jack to pay $0.01 for every play of Max’s song. This is an example of a set percentage of revenue.

Example B

Melissa wants to become a franchisee of Donkey’s Milkshakes in her area of Sunnyville. She goes ahead and enters into a franchise agreement with them. As well as paying initial fees, Melissa must also pay a monthly set fee of $300. This monthly fee represents the franchisor’s royalties for allowing the franchisee to use the Donkey Milkshake’s brand and products. This shows how a fixed fee royalty system works.

Example C

BHP enters into a licence agreement with the Western Australian government to mine gold in Western Australia. BHP pays 5% of its gold profits to Western Australia. This represents a typical mining royalty scheme between governments and industry.

What is the difference between royalties and licences?

Confusion can arise from licence and royalty arrangements. Royalties are fees paid for the ongoing use of someone’s property. On the other hand, a licence is the right to use the property itself. For example, a licence to drive a car is the legal right to drive a car on public roads. It does not necessarily have to come with payment. Licences and royalties usually go hand-in-hand. But the two are separate, the licence is the right, the royalties are a payment for exercising the right.

Tax

You may be wondering, do royalty earners pay tax on their royalties? Royalties are a part of one’s taxable income. Depending on whether the royalty earner is a corporation or individual will determine how their tax is processed. If you are personally receiving royalties, then it will count towards your supplemental income on your tax return. If it is a corporation, then the royalties will form part of the corporation’s balance sheet. Generally, tax on royalties is payable for the year in which they are received.

On the other side of the coin, if a business is the one paying royalties, it may be able to offset it as a business expense. This means the royalty can be taken away from whatever the business owes in taxes.

As this article shows, royalty arrangements are varied and can exist in multiple forms. You should seek legal advice before entering into a royalty agreement, as they are tricky to navigate.

Want to know more? Contact a LawPath consultant on 1800 529 728 to learn more about how royalties work, and to obtain a fixed-fee quote from Australia’s largest legal marketplace.    

Author
Vincent Appleton

Vincent is a Legal Tech Intern at Lawpath as part of the Content Team. He is in the second year of his Juris Doctor law degree at Macquarie University. He is interested in both International Commercial Law and Criminal Law.