What are royalties? Meaning, types and how royalty payments work

Published Thursday 18 December 2025

Table of contents

• What are business royalties?
• Types of royalty payments
• Factors affecting royalty rates
• Tax implications of royalties for business
• Understanding royalty agreements
• How to apply the royalty payment cycle
• Simplify royalty payments and business finances with Xero
• FAQs on royalties

Key takeaways

• Understand that royalties are percentage-based or fixed payments made to asset owners for using their intellectual property, with rates typically ranging from 1–15% depending on the industry and asset value.
• Establish comprehensive royalty agreements that clearly define asset usage rights, payment structures, territorial limitations, and performance-based termination clauses to protect both parties' interests.
• Maintain detailed records of all royalty transactions and seek professional tax advice, as royalties create taxable income for licensors and deductible expenses for licensees, with international payments often subject to withholding taxes.
• Implement a systematic payment cycle that includes regular usage tracking, accurate calculation based on agreed terms, and scheduled reporting to ensure compliance and maintain trust between licensors and licensees.

What are business royalties?

Royalties are payments made to asset owners for the right to use their property, typically intellectual property. They provide ongoing income for licensors while giving licensees access to valuable assets.

Key elements of royalty payments include:

• Payment structure: Usually a percentage of revenue or fixed fee per unit
• Licensor: The asset owner who receives royalty payments
• Licensee: The party who pays to use the asset
• Common assets: Patents, trademarks, copyrights, and franchise systems

Royalty agreements are most common in industries dealing with intangible assets.

Here are some industries that rely on royalties:

• Technology: Software patents and proprietary systems
• Publishing: Books, articles, and written content
• Entertainment: Music, films, and digital media
• Franchising: Brand identities and business models

Types of royalty payments

Royalties come in different forms, depending on the nature of the asset and the business model. Here are three common types.

Franchise royalties

Franchisees pay royalties to the franchisor for the right to use their business model and its elements, like branding, intellectual property (IP), and operational systems.

The franchise business model is popular in fast food; 93% of McDonald's restaurants are franchised, for example.

Franchisees usually pay royalties as a percentage of their gross or net revenue, although some agreements use flat fees.

Learn more about franchises.

Intellectual property royalties

Licensees pay intellectual property royalties for the right to use or sell protected assets like patents, trademarks, and copyrighted works. They're commonly seen in tech and manufacturing, while copyright royalties are particularly common in the publishing, music, and film industries.

Examples include a tech company licensing patented software or an author licensing their work to a publisher and earning royalties in return.

Licensing royalties for creative works

These royalties apply to music, films, artwork, writing, and other creative mediums. Instead of selling the work directly, businesses pay licensing fees to use these works in a different context (often in advertising, entertainment, or product design), such as a song licensed for a TV ad or a publisher licensing illustrations for a children's book.

Factors affecting royalty rates

Royalty rates depend on specific market and contractual factors that determine an asset's commercial value:

• Industry standards: Established rate ranges within specific sectors
• Asset value: Higher-value assets command premium rates
• Negotiating power: Strong brands or proven sales records improve terms
• Exclusivity: Exclusive rights typically cost more than shared licences
• Market demand: Popular or anticipated assets can charge higher rates

Learn more about real-world royalty rates.

Tax implications of royalties for business

Tax treatment of royalties affects both parties differently based on their role in the agreement.

For licensors (receiving royalties):

• Income tax: Royalties are typically taxable income
• Reporting: Must declare payments on tax returns

For licensees (paying royalties):

• Tax deduction: Royalty payments are usually deductible business expenses
• Record keeping: Maintain detailed payment records for compliance

International tax considerations

International royalty payments involve additional tax considerations that vary by country and existing agreements, which for Australia, includes special tax treaties with over 40 countries.

Key international tax factors:

• Withholding tax: Licensees must deduct tax from payments to foreign licensors
• Double tax agreements: Treaties that reduce or eliminate duplicate taxation
• Documentation: Specific forms required to claim treaty benefits

When you pay royalties to an overseas rights holder, you may need to withhold a portion of the royalty payment and send it to your local tax authority.

If, for example, your US-based company pays royalties to a UK rights holder, you may have to withhold 30% for the Internal Revenue Service (IRS). In Australia, a similar rule applies: if no tax treaty exists with the recipient's country, the withholding tax rate will be 30%. You send only 70% of the payment to the UK-based licensor, with 30% going to the Internal Revenue Service (IRS) by default.

Licensors therefore often receive international royalty payments with withholding tax already deducted, which can mean they are taxed twice. But they can avoid this if they live in a country that has made a double tax agreement, such as the UK–US Double Taxation Convention, that reduces or eliminates withholding tax. In Australia, such treaties are given the force of law by the International Tax Agreements Act 1953.

Tips to stay compliant

Stay compliant with these essential practices for managing royalty arrangements:

• Maintain detailed records: Document all payments, dates, and signed agreements
• Consider tax implications: Factor tax obligations into rate negotiations
• Seek professional advice: Consult tax professionals for complex or international deals

Learn more about withholding tax and other tax deductions, and here's extra information on how royalties are taxed.

Understanding royalty agreements

Royalty agreements are legally binding contracts that require careful preparation to protect both parties. It is crucial to note that in an international context, if a conflict arises between domestic tax law and a double tax agreement, the agreement's definition will override local law.

Get legal advice

Both parties should ask a lawyer to review the contract before signing.

• For the licensee, who is likely drafting the agreement, the contract needs to be legally compliant, and accurately reflect the terms of the specific arrangement.
• For the licensor, it's more about understanding each clause fully and ensuring your rights, payments, and protections are clearly outlined.

Learn the specific rules in Australia.

How to apply the royalty payment cycle

The royalty payment cycle guides you through establishing and managing ongoing licensing relationships.

This process ensures accurate payments, clear communication, and legal compliance throughout the agreement.

1. Establish a royalty agreement

Establish a royalty agreement by negotiating terms and creating comprehensive documentation.

Essential agreement elements:

• Asset definition: Clearly identify what's being licensed
• Usage rights: Specify how the asset can be used
• Payment structure: Define rates, timing, and calculation methods
• Territory and duration: Set geographical and time limitations

Here are a few practical ways to negotiate a stronger contract:

• Write a performance-based termination clause into the contract so you can end the arrangement if the asset does not meet agreed targets. This will clarify expectations and protect you if the asset doesn't generate the revenue you hoped for.
• Be clear about where and how the rights apply. Specify the countries, regions and channels (such as online or offline) covered by the licence.
• Set out whether others can license the same asset. If the licensee wants exclusive rights, the licensor can push for better terms.
• Decide the duration of the arrangement; longer deals are more stable, while shorter ones give licensors the chance to negotiate better terms sooner.

Learn more negotiation strategies.

2. Define the payment terms

Define payment terms to establish how royalties will be calculated and collected.

Common royalty structures:

• Percentage of revenue: Fast-food franchisee pays 5% of net sales
• Fixed fee per unit: Author earns $5 for every ebook sold
• Usage-based: Band receives payment each time their song is streamed

If you're the licensor, look beyond the payment amount. Think about how often you'll receive the royalties and how long you'll have to wait each month, both of which would affect your cash flow.

3. Track your usage or sales

The licensee is responsible for royalty reporting and tracking. They record how much revenue the asset generates (so the licensor understands where the numbers come from) and report to the licensor on a schedule set by the contract, such as monthly or quarterly.

Reporting sales in this way improves accuracy and trust, an essential part of a strong working relationship between the parties.

4. Calculate your payments

Next, the licensee calculates what royalty revenues are owed to the licensor based on the payment structure and the agreed terms.

Several factors can affect the final amount:

• Minimum guarantees: Asset amount you pay the licensor regardless of performance
• Advances: Payments you make upfront that are later recouped from future royalties
• Deductions: Adjustments for returns and refunds
• Escalators: Higher royalty rates that apply after your sales or revenue reach an agreed threshold

5. Make payments

The licensee makes the payment according to the agreed schedule.

The licensee may issue a royalty statement, or ask the licensor to raise an invoice for the payment amount so the transaction is documented. You can use one of Xero's free invoice templates.

6. Auditing and compliance

Most royalty agreements give the licensor the right to audit the licensee's records, either on request or at set intervals, to make sure payments are correct.

This adds a layer of protection and reassures the licensor that they are receiving the payments they agreed to.

Simplify royalty payments and business finances with Xero

Simplify royalty management with Xero's integrated accounting features designed for licensing businesses:

• Invoice creation: Generate professional royalty statements quickly
• Payment tracking: Monitor incoming and outgoing royalty payments
• Tax preparation: Maintain organised records for compliance
• Centralised management: Handle all financial aspects in one platform

Take the hassle out of royalty management and try Xero for free.

FAQs on royalties

Common questions about royalty payments and how they work in business.

What does a 7.5% royalty rate mean?

A 7.5% royalty means the licensee pays 7.5% of their revenue to the licensor. For example, if a book generates $1,000 in sales, the author receives $75 in royalties.

How do royalty rate ranges differ across industries?

Royalty rates vary significantly by industry. Publishing typically ranges from 5–15%, technology licensing from 1–10%, and franchise fees often fall between 3–8% of gross revenue.

What's the difference between gross and net royalties?

Gross royalties are calculated on total revenue before expenses, while net royalties are based on revenue after deducting costs like returns, discounts, or distribution fees.

When do you typically receive royalty payments?

Payment timing depends on your agreement but commonly occurs monthly, quarterly, or semi-annually. Most agreements specify payment within 30–60 days after the reporting period ends.

Can royalty agreements be terminated early?

Yes, most agreements include termination clauses based on performance metrics, breach of contract, or mutual consent. Review your specific contract terms for applicable conditions.