What are royalties? Definition, types and examples

Published Tuesday 6 October 2026

Table of contents

• What are royalties?
• Types of royalties
• Royalty payment examples
• How royalty payments work
• What affects royalty rates?
• What to include in a royalty agreement
• How royalties are taxed
• Manage royalty payments with Xero
• FAQs on royalties

Key takeaways

• A royalty is an ongoing payment for the right to use someone else's asset, and the owner keeps ownership of it
• Royalties are usually a percentage of revenue or a fixed amount per unit or use, with franchise rates commonly 4–8% and book royalties 10–15%
• A clear royalty agreement sets the rate, payment terms, usage rights, exclusivity and audit rights, which helps prevent disputes
• Royalty income is generally taxable and royalty expenses are usually deductible, and Indonesian royalty payments generally face 15% or 20% withholding tax

What are royalties?

A royalty is an ongoing payment to the owner of an asset, usually intellectual property, a brand or a natural resource, for the right to use it. It's typically calculated as a percentage of revenue or a fixed amount per unit or use.

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

The licensor keeps ownership of the asset, while the licensee pays for the right to use it. Royalty agreements are common in industries with intangible products or services and natural resources: music and entertainment; publishing; technology and software; franchising; natural resources, for example, mining and oil and gas.

Types of royalties

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. Around 95% of McDonald's restaurants worldwide were franchised at the end of 2025, and the company reported $16.5 billion in franchised revenues, which include rent, royalties and initial fees, for 2025.

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.

Royalty payment examples

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

For illustration, if a platform paid a songwriter $0.004 per stream and their song was streamed 100,000 times in a month, they'd earn $400 in royalties. Actual rates vary by platform, and some music platforms calculate royalties as a percentage of advertising or subscription revenue instead of per-stream rates.

Software licence royalty example

A software reseller pays a developer $10 per user per month for the right to sell access to the developer's app. With 150 users, the reseller pays the developer $1,500 in royalties each month.

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 royalty payments 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.

Licensors can then track unpaid royalty invoices in accounts receivable until the licensee pays.

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.

What affects 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.

Many licensors start with profit sharing. Under the 25% rule, a common rule of thumb, the licensee pays about 25% of its expected profit from the asset as a royalty. Both parties then adjust the rate from there. 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: The higher the value of the asset, or the more unique it is, the higher the royalty rate it commands
• 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

What to include in a royalty agreement

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

How royalties are taxed

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

A few simple habits keep your royalty tax obligations on track.

• 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.

Manage royalty payments 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.

How are royalties taxed in Indonesia?

Royalties paid to Indonesian residents are generally subject to 15% Article 23 withholding tax (PPh 23), according to PwC Worldwide Tax Summaries. Royalties paid to non-residents generally face 20% Article 26 withholding tax (PPh 26), which a tax treaty may reduce.