What are royalties? Definition, types and examples

Published Friday 20 February 2026

Table of contents

• What is a royalty?
• Types of royalty payments
• Examples of royalty payments
• How royalties work
• Factors affecting royalty rates
• Understanding royalty agreements
• Tax implications of royalties for business
• Track royalties with Xero
• FAQs on royalties

Key takeaways

• Negotiate clear royalty agreements that specify payment structure (percentage of revenue, fixed fee per unit, or usage-based), geographic rights, exclusivity terms, and audit provisions to protect both parties and prevent disputes.
• Calculate royalty rates based on industry standards, asset value, and negotiating power, with typical ranges including 4-8% for franchise royalties and 10-15% for book publishing royalties.
• Track all royalty transactions meticulously and report them accurately on tax returns, as royalty income is generally taxable while royalty expenses can typically be deducted as business costs.
• Consider international tax implications when dealing with cross-border royalty payments, including withholding tax requirements and double taxation agreements that may reduce your tax burden.

What is a royalty?

A royalty is a payment made to the owner of an asset for the right to use it. These payments are typically a percentage of revenue earned from the asset or a fixed fee per unit sold.

The asset owner who receives the royalty is the licensor. The party paying for permission to use the asset is the licensee.

Royalty agreements are common in industries with intangible products or services:

• music and entertainment
• publishing
• technology and software
• franchising

Types of royalty payments

Royalty payments are the funds transferred from a licensee to a licensor for using an asset. The structure of these payments varies based on the asset type and business model.

Here are three common types of royalty payments:

Franchise royalties

Franchise royalties are ongoing payments franchisees make to franchisors for the right to use their business model, branding, and operational systems.

Franchisees typically pay royalties as:

• a percentage of gross or net revenue (commonly 4 to 8%)
• a flat monthly or annual fee

For example, if a franchisee earns $50,000 in monthly revenue and pays a 5% royalty, they owe $2,500 to the franchisor that month.

The franchise model is widespread in fast food, where 93% of McDonald's restaurants operate as franchises. The company earned $12.5 billion in franchise fees and royalties in 2023 alone.

Learn more about franchises.

Intellectual property royalties

Intellectual property (IP) royalties are payments for the right to use or sell protected assets like patents, trademarks, and copyrighted works.

IP royalties are common in:

• Technology and manufacturing: Companies license patented software or processes
• Publishing: Authors typically earn royalties of 10 to 15% on a book's cover price, though for ebooks, 25% of net receipts has become the current standard rate
• Music and film: Creators receive royalties each time their work is played or distributed

For example, an author with a 10% royalty on a $20 book earns $2 per copy sold.

Licensing royalties for creative works

Licensing royalties are payments businesses make to use creative works in a new context, rather than purchasing the work outright.

Common licensing scenarios include:

• a song licensed for a television advertisement
• artwork licensed for product packaging
• illustrations licensed for a children's book
• film clips licensed for marketing campaigns

Licensing royalties may be structured as a one-time fee, ongoing payments based on usage, or a percentage of revenue generated from the licensed content.

Examples of royalty payments

When you understand how royalties work in practice, you can evaluate whether a royalty arrangement makes sense for your business. Here are worked examples across different industries.

Franchise royalty example

A coffee shop franchisee pays a 6% royalty on gross sales. If monthly sales total $40,000, the royalty payment is $2,400.

What 6% means: For every $100 in sales, $6 goes to the franchisor.

Music streaming royalty example

A songwriter earns $0.004 per stream on a music platform. If their song is streamed 100,000 times in a month, they earn $400 in royalties.

Some music platforms calculate royalties as a percentage of advertising or subscription revenue instead of per-stream rates.

Patent licensing royalty example

A manufacturer licenses patented technology and pays a 5% royalty on net sales. If they sell $200,000 worth of products using the patent, they owe $10,000 in royalties.

What 5%, 7.5%, and 10% royalty rates mean:

• 5% royalty: $5 paid per $100 of revenue
• 7.5% royalty: $7.50 paid per $100 of revenue
• 10% royalty: $10 paid per $100 of revenue

Higher percentages typically apply to high-value or exclusive assets.

How royalties work

The royalty payment cycle describes how licensors and licensees establish, track, and fulfil royalty obligations. When you understand this cycle, you can manage payments accurately and maintain strong business relationships.

Here's how a typical royalty arrangement works in practice:

1. Establish a royalty agreement

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

Consider these strategies when negotiating your contract:

• Include a performance-based termination clause: Protect yourself if the asset doesn't generate expected revenue
• Specify geographic and usage rights: Define the countries, regions, and domains (online or offline) where rights apply
• Clarify exclusivity terms: Determine whether others can license the same asset, as exclusive rights typically command higher rates
• Set the agreement duration: Balance stability (longer terms) against flexibility to renegotiate (shorter terms)

2. Define the payment terms

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

• Percentage of revenue: The licensee pays a set percentage of sales (for example, a franchisee paying 5% of net sales)
• Fixed fee per unit: The licensor receives a set amount per item sold (for example, an author earning $5 per ebook)
• Usage-based: The licensor earns payment each time the asset is used (for example, a songwriter earning per stream)

If you're the licensor, consider payment frequency and timing alongside the rate itself. Monthly payments with 30-day terms affect your cash flow differently than quarterly payments with 60-day terms.

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 licensee pays the licensor regardless of performance
• Advances: payments made upfront and recouped on future royalties
• Deductions: adjustments for returns and refunds, which in the publishing industry can be as high as 35 to 50% of reported sales
• 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 raise 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 extra protection ensures the licensor receives the payments they agreed to.

Factors affecting royalty rates

A combination of market conditions, asset characteristics, and negotiating leverage determines royalty rates. When you understand these factors, you can set or evaluate fair terms.

Financial measures like profit sharing analysis often determine key factors that influence royalty rates, while one survey found nearly a quarter of respondents used the 25% rule as a starting point. Key factors include:

• Industry standards: Established norms within sectors often set baseline rates (for example, book royalties typically range from 10 to 15%)
• Asset value: Higher-value or more unique assets command higher royalty rates
• Negotiating power: Well-known creators or licensees with strong distribution networks can secure better terms
• Exclusivity: Exclusive licensing rights typically carry premium rates compared to non-exclusive arrangements
• Market demand: High-demand or trending assets support higher rates than niche offerings

Learn more about real-world royalty rates.

Understanding royalty agreements

A royalty agreement legally binds both parties and defines the terms under which a licensee can use a licensor's asset. Clear, enforceable terms protect both parties and prevent disputes.

A well-drafted royalty agreement should include:

• the asset being licensed and permitted uses
• royalty rate and payment structure
• payment schedule and method
• duration of the agreement
• geographic and usage restrictions
• audit rights and compliance provisions
• termination conditions

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

Get legal advice

Both parties should have a lawyer review the contract before signing.

• For licensees (typically drafting the agreement): Ensure the contract is legally compliant and accurately reflects the negotiated terms
• For licensors: Verify that your rights, payment terms, and protections are clearly defined in every clause

Tax implications of royalties for business

You must generally pay tax on royalty income, and you can typically deduct royalty expenses from your taxable income. Both licensors and licensees must account for royalties accurately in their tax returns.

Here's the basic tax treatment:

• If you receive royalties: Report them as income and pay applicable taxes
• If you pay royalties: Deduct them as a business expense to reduce taxable income

International tax considerations

When dealing with international royalty agreements, two key concepts affect your tax obligations: withholding tax and double tax agreements.

Withholding tax for licensees: Local tax authorities may require licensees to withhold a portion of royalty payments. For example, a US-based company paying royalties to a nonresident must apply a 30% Federal Tax withholding for the IRS, sending only 70% to the licensor, unless a tax treaty applies.

Double taxation for licensors: Licensors receiving international payments often have withholding tax already deducted, which can result in being taxed in both countries.

How to avoid double taxation: You can take steps to avoid double taxation. If your country has a double tax agreement with the payer's country, you may reduce or eliminate withholding tax. For example, under the UK–US Double Taxation Convention, UK residents who receive royalties don't pay tax on them in the US. To claim this benefit, provide the required paperwork, such as a certificate of residence and IRS Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting).

Tips to stay compliant

Follow these practices to stay compliant and maximise the value of your royalty arrangement:

• Keep detailed records: Document all royalty payments, dates, and signed agreements
• Factor in taxes during negotiations: Consider tax implications when setting royalty rates and payment terms
• Consult a tax professional: Seek expert advice when licensing across borders or dealing with unfamiliar tax jurisdictions

Learn more about withholding tax and other tax deductions.

Track royalties with Xero

Managing royalty payments requires good record-keeping and financial tracking. Whether you're paying or receiving royalties, Xero helps you stay organised and tax-ready.

With Xero, you can:

• Create and track invoices: Generate professional invoices for royalty payments and monitor their status
• Monitor cash flow: See incoming and outgoing royalty payments in real time
• Keep clear records: Store documentation for tax time and audits in one place
• Automate reconciliation: Match royalty payments to bank transactions automatically

Ready to simplify your royalty tracking? Get one month free and see how Xero streamlines invoicing, expense tracking, and tax reporting for royalty payments.

FAQs on royalties

Here are answers to common questions about royalty payments.

What's an example of a royalty payment?

A franchisee paying 5% of monthly sales to the franchisor is a common royalty example. If sales total $40,000, the royalty payment is $2,000.

What does a 5% royalty rate mean?

A 5% royalty rate means the licensee pays $5 for every $100 of revenue generated using the licensed asset.

How are royalties different from licensing fees?

Royalties are ongoing payments based on usage or sales, while licensing fees are typically one-time or upfront payments for the right to use an asset.

Do I have to pay tax on royalty income?

Yes, royalty income is generally taxable. Report royalties as income on your tax return and consult a tax professional for guidance on deductions and international considerations.

How often are royalties typically paid?

Royalty payment frequency varies by agreement but is commonly monthly, quarterly, or annually. The schedule should be clearly defined in your royalty agreement.