What are royalties in business?

Published Tuesday 29th April 2025

Business royalties: a definition

Royalties are payments to the owner of an asset – often intellectual property (IP) – for the right to use it.

These payments are usually a percentage of revenue earned from the asset, or a fixed fee per unit sold.

The asset owner – who receives the royalty – is known as the licensor. The licensee pays the licensor for permission to use the asset.

Royalty agreements are common in industries like music and entertainment, publishing, and technology where the product or service is intangible – a digital file, patented technology, or a brand identity, say – rather than a physical item.

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, 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

The rates licensors can charge are affected by all sorts of commercial, contractual, and market factors.

• Industry standards – industry-specific royalty structures often dictate what’s paid – for example, music and publishing royalties often fall within recognized ranges.
• Asset value– high-value assets can support higher royalty rates.
• Negotiating power – well-known artists often command better terms, while licensees with strong distribution, wide marketing reach, and proven sales records are in a strong position.
• Exclusivity – Licensees might pay a premium for exclusive rights or a non-compete clause in a licensing agreement.
• Market demand – licensors can get higher rates for hotly anticipated assets.

Learn more about real-world royalty rates

Tax implications of royalties for business

Both licensees and licensors should account for royalties properly and reflect them in their tax returns.

Usually, you’ll have to pay tax on royalties you receive, or if you pay royalties they’ll probably be tax deductible.

International tax considerations

When dealing with international royalty agreements, there are two extra things to think about: withholding tax and double tax agreements. Here’s how they affect licensees and licensors.

Licensees apply withholding tax to international royalty payments by withholding a portion of your royalty payment and sending 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 IRS. You send only 70% of the payment to the UK-based licensor, with 30% going to the IRS by default.

Licensors therefore often receive international royalty payments with holding tax already deducted – meaning they’re 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.

Under the UK–US agreement, UK licensors can get 100% of the royalties (before domestic tax is applied). So if you’re the UK rights holder in this situation, just provide the paperwork (such as a certificate of residence and a Form W-8BEN), to avoid being taxed in both jurisdictions.

Tips to stay compliant

Here’s some tips to help you stay compliant while getting the most out of your royalty arrangement.

• Keep detailed records of royalty payments, dates, and signed agreements.
• Think about your taxes when negotiating royalty rates and payment terms.
• Speak with your tax professional – especially when licensing across borders or negotiating with unfamiliar tax jurisdictions.

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. This means its terms must be clear, transparent, and enforceable so both parties understand what they’re agreeing to, and what happens if the terms aren’t met.

Whichever side of the arrangement you’re on, invest time upfront to get the agreement right.

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.

How to apply the royalty payment cycle

Here are the basics on how a typical royalty arrangement works in practice – so you’re prepared for when you want to buy or sell usage rights to an asset..

1. Establish a royalty agreement

A royalty arrangement starts with the licensor and licensee negotiating and drafting a formal licensing agreement. A strong contract should outline the asset being licensed, how it can be used, and the structure of the royalty payments.

Here are a few insider strategies for negotiating a stronger contract:

• Don’t get locked into an underperforming arrangement – it’s a good idea to write a termination clause into the contract that is tied to performance. 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 domains (such as on- or offline) where the rights apply
• 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 to negotiate better terms sooner

Learn more negotiation strategies.

2. Define the payment terms

Set out exactly how the royalty payments will work. Royalty structures usually fall into one of three categories:

• Percentage of revenue – a fast-food licensee might pay the franchisor 5% of net sales, for example
• Fixed fee per unit – an author could get $5, say, for every copy of an ebook sold
• Usage-based – a band can earn royalties each time a song of theirs is streamed on a music platform

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 – a set amount the licensor is paid regardless of performance
• Advances – payments made upfront and recouped on future royalties
• Deductions – adjustments for returns and refunds
• Escalators – higher royalty rates that apply after reaching certain sales or revenue thresholds

5. Make payments

Finally, the licensee makes the payment according to the agreed schedule.

The licensee may issue a royalty statement or request that the licensor raises an invoice for the payment amount to document the transaction.

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 (on request, or every so often) to make sure payments are correct.

This is an extra layer of protection that gives the licensor comfort they’re receiving the payments they agreed.

Simplify royalty payments and business finances with Xero

Whether you’re paying or receiving royalties, Xero helps you stay organized.

Create and track invoices, monitor incoming and outgoing payments, and keep clear records for tax time – all in one place.

Take the hassle out of royalty management with Xero