What are royalties in business? Types, tax and payments

Published Monday 26 October 2026

Table of contents

• What are royalties?
• How do royalties work?
• Types of royalty payments
• Factors affecting royalty rates
• Understanding royalty agreements
• Setting up royalty payments
• Tax implications of royalties for business
• Withholding tax on royalties paid to non-residents
• Manage royalty payments with Xero
• FAQs on royalties in business

Key takeaways

• Negotiate royalty agreements carefully, whichever side of the deal you're on. Include a performance-based termination clause and define the scope and exclusivity of the rights.
• Choose a payment structure that suits your business model and cash flow. Options include a percentage of revenue (like 5% of gross sales), a fixed fee per unit or usage-based payments.
• Royalties you receive are taxable income, and royalties you pay are usually tax-deductible if they're at arm's length and any withholding tax due is paid. If you pay royalties to a non-resident, withhold 10% tax and pay it to the Inland Revenue Board of Malaysia (LHDN) within one month.
• Include audit provisions so the licensor can check payment accuracy. Many agreements make the licensee cover audit costs if significant discrepancies turn up.

What are royalties?

Royalties are payments made to an asset owner for the right to use that asset. The owner who receives payment is the licensor, and the party paying for usage rights is the licensee.

These payments usually take one of two forms:

• Percentage of revenue: a share of the earnings the asset generates
• Fixed fee per unit: a set amount for each unit sold or used

Royalty agreements are common in industries like music, publishing, software and film, where products are intangible rather than physical.

How do royalties work?

Royalty payments flow from the licensee (the party using the asset) to the licensor (the asset owner) under a licensing agreement. The agreement sets out how much is owed and when payments are due. It also sets out how usage is tracked.

Here's a simple example: a franchisee agrees to pay 5% of gross revenue to the franchisor. If the franchisee earns RM100,000 in sales, they owe RM5,000 in royalties.

The basic process works like this:

1. Agreement: both parties negotiate and sign a licensing contract.
2. Usage: the licensee uses the asset to generate revenue.
3. Tracking: the licensee records sales or usage data.
4. Payment: the licensee calculates and pays royalties on the agreed schedule.

Payment schedules vary by agreement. Some royalties are paid monthly, others quarterly or annually.

Types of royalty payments

Royalty payments fall into three main categories: franchise royalties, intellectual property royalties and licensing royalties for creative works. The type you'll come across depends on the asset involved and your business model.

Franchise royalties

Franchise royalties are payments franchisees make to use a franchisor's brand and business systems.

Most franchisees pay a percentage of revenue. Rates vary by brand and industry. At a 5% rate, a franchisee with RM100,000 in sales pays the franchisor RM5,000, though some agreements use flat fees instead.

The franchise model is common in fast food: about 95% of McDonald's restaurants were franchised at the end of 2023, according to the company's 2023 annual report (Form 10-K). If you're weighing up buying into one, read up on how franchising works.

Intellectual property royalties

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

These royalties appear across several industries:

• Tech and manufacturing: companies license patented software or technology
• Publishing: authors earn royalties when their books sell
• Music and film: creators get paid when their work is used or distributed
• Consumer goods: brands license trademarks, such as characters or logos, for use on products

Licensing royalties for creative works

Licensing royalties for creative works apply when businesses pay to use music, films, artwork or writing rather than buying the work outright.

Common examples include:

• Advertising: a song licensed for a TV commercial
• Publishing: illustrations licensed for a children's book
• Product design: artwork licensed for merchandise
• Digital media: a photo licensed for a website or social media campaign

Factors affecting royalty rates

Royalty rates vary with the asset itself, the market around it and the terms each side can negotiate. Knowing these factors helps you agree fair terms as a payer or a recipient.

Key factors that influence rates include:

• Industry standards: rates vary widely by industry and deal structure, so compare deals in your sector before agreeing terms
• Asset value: high-value or proven assets can command higher rates
• Negotiating power: well-known creators often secure better terms, and licensees with wide distribution have bargaining power too
• Exclusivity: licensees usually pay a premium for exclusive rights or non-compete clauses
• Market demand: highly anticipated assets attract higher rates

Understanding royalty agreements

Royalty agreements are legally binding contracts that set out how and when royalties are paid, and under what conditions. Clear, enforceable terms help both parties understand their obligations and what happens if either side breaks them.

Time spent getting the agreement right upfront pays off for licensors and licensees alike.

Get legal advice

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

• Licensees drafting agreements: make sure the contract is legally compliant and reflects the specific arrangement
• Licensors reviewing agreements: understand each clause and confirm your payments and protections are clearly set out

Setting up royalty payments

Setting up a royalty arrangement takes six steps, starting with the agreement and ending with audits. Here's how the process usually works.

1. Establish a royalty agreement

A royalty arrangement starts with the licensor and licensee negotiating and drafting a formal licensing agreement. A strong contract sets out the licensed asset, how it can be used and how royalty payments are structured.

These negotiation points make for a stronger contract:

• Performance-based termination clause: this lets you exit if the asset earns less revenue than expected
• Geographic and usage scope: define the countries or regions where rights apply, and whether they cover online or offline use
• Exclusivity terms: if the licensee wants exclusive rights, the licensor can negotiate a better rate
• Contract duration: longer deals offer stability, while shorter terms let licensors renegotiate sooner

2. Define the payment terms

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

• Percentage of revenue: the licensee pays a share of earnings, such as 5% of net sales
• Fixed fee per unit: the licensor receives a set amount per sale, such as RM5 per ebook
• Usage-based: the licensor earns a payment each time the asset is used, such as per stream on a music platform

If you're the licensor, look beyond the payment amount. Payment frequency and timing both affect your cash flow.

3. Track your usage or sales

The licensee tracks how much revenue the asset generates. They report to the licensor on the schedule set by the contract, usually monthly or quarterly.

Clear reporting improves accuracy and builds trust between both parties.

4. Calculate your payments

The licensee calculates the royalties owed based on the payment structure and agreed terms.

Several factors can change the final amount:

• Minimum guarantees: a set amount paid to the licensor regardless of performance
• Advances: upfront payments recouped from future royalties
• Deductions: adjustments for returns and refunds
• Escalators: higher rates that apply once sales pass set thresholds

5. Make payments

The licensee pays on the agreed schedule. They may issue a royalty statement or ask the licensor to send an invoice to document the transaction.

To save time on paperwork, start with one of Xero's free invoice templates.

6. Audit payments for accuracy

Royalty agreements usually include audit rights, so the licensor can review the licensee's records and check accuracy. For extra protection, agreements often require the licensee to reimburse the licensor for audit costs if underpayments exceed an agreed threshold.

Tax implications of royalties for business

Royalty income derived from Malaysia, or received in Malaysia from abroad, is taxable income for licensors who receive it. Licensees can usually claim a deduction for royalties they pay. The payments must be at arm's length, priced as they'd be between unrelated parties, and any withholding tax due must be deducted and paid. If you're a licensor, record your passive royalty income alongside your other earnings, as it counts towards your taxable income.

Royalties paid to non-residents are generally subject to 10% withholding tax under section 109 of the Income Tax Act 1967. A double taxation agreement (DTA) may set a lower rate. The payer pays this tax to the Inland Revenue Board of Malaysia (LHDN) within one month of paying or crediting the royalty.

International tax considerations

Paying royalties overseas brings withholding tax and DTAs into your planning. Here's how they apply to a Malaysian payer.

Say a Malaysian company pays RM50,000 in royalties to an overseas licensor. It withholds RM5,000 (10%), pays the licensor RM45,000 and pays the RM5,000 to LHDN within one month. You'll find the full process under paying withholding tax on overseas royalties.

If Malaysia has a DTA with the licensor's country, a lower rate may apply. A letter or certificate from the licensor's tax authority confirming their residence supports your claim to the DTA rate.

Tips to stay compliant

These tips help you stay compliant while getting the most from your royalty arrangement:

• Record keeping: document every royalty payment, its date and the signed agreement
• Tax planning: factor tax into your negotiations on rates and payment terms
• Withholding deadlines: pay withholding tax on overseas royalties to LHDN within one month
• Professional advice: speak to a tax professional when licensing across borders or in unfamiliar tax jurisdictions

To see what else your business can claim, read up on tax deductions in Malaysia.

Withholding tax on royalties paid to non-residents

Withholding tax in Malaysia is tax a Malaysian payer deducts from certain payments to non-residents and pays to LHDN. For royalties, it's 10% of the gross amount under section 109 of the Income Tax Act 1967, unless a DTA sets a lower rate.

For the non-resident licensor, it's a final tax, so it settles their Malaysian tax on that royalty.

How to pay withholding tax on a royalty

If you're paying a royalty to a licensor based overseas, follow these steps.

1. Check the payee and payment: confirm the licensor is non-resident and the payment is a royalty.
2. Work out the rate: apply 10% to the gross royalty, or the DTA rate if one applies.
3. Pay the licensor: send the royalty minus the tax you've withheld.
4. Pay LHDN: submit form CP37 and pay the withheld tax within one month of paying or crediting the royalty.

Worked example: a RM20,000 royalty

Say you owe a RM20,000 royalty to an overseas licensor, and no DTA rate applies. You withhold RM2,000 (10%), pay the licensor RM18,000 and pay the RM2,000 to LHDN within one month.

Penalties for late payment

Paying on time keeps your costs predictable. If you pay late, LHDN increases the unpaid tax by 10%, so the RM2,000 in the example above would become RM2,200.

Tax you fail to withhold gets the same 10% increase. The royalty is also disallowed as a deduction until the tax and the 10% increase are paid. Withholding and paying on time keeps the expense deductible.

Manage royalty payments with Xero

Royalties are easier to manage when your records sit in one place, as a payer or a recipient. With Xero, you can create and track invoices, monitor payments in and out, reconcile transactions with bank feeds and keep clear records for tax time.

Simplify your royalty management and get one month free with Xero.

FAQs on royalties in business

Here are answers to some common questions about royalties in business.

What's the difference between royalties and licensing fees?

A licensing fee is usually a one-time or upfront payment for usage rights, while royalties are ongoing payments based on sales, revenue or usage. Some agreements include both.

What does a 5% royalty rate mean in practice?

A 5% royalty rate means the licensee pays 5% of their revenue to the licensor. For example, if you earn RM50,000 in sales from a licensed product, you'd pay RM2,500 in royalties.

Are royalty payments tax-deductible?

Yes, royalties you pay as a business expense are usually tax-deductible if they're at arm's length and any withholding tax due is paid. Royalties you receive count as taxable income, and a tax professional can confirm how the rules apply to your situation.

How often are royalties typically paid?

Payment frequency depends on the agreement, with monthly, quarterly and annual schedules all common. The contract should say when payments are due and how they're calculated.

Can I negotiate royalty rates?

Yes, royalty rates are negotiable. Asset value, exclusivity, market demand and each party's negotiating power all shape the final terms.