Royalties: What They Are, Types, and How Payments Work

Published Thursday 8 January 2026

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

• Negotiate royalty agreements carefully by including performance-based termination clauses, clearly defining geographic and usage rights, and specifying whether licensing rights are exclusive or non-exclusive to protect your interests and secure better terms.
• Maintain detailed records of all royalty payments, dates, and signed agreements to ensure tax compliance and audit protection, as royalties are taxable income for recipients and typically deductible business expenses for payers.
• Consider international tax implications when dealing with cross-border royalty payments, as withholding taxes may apply and double tax agreements between countries can help avoid being taxed twice on the same income.
• Implement a structured six-step royalty payment cycle that includes establishing clear agreements, defining payment terms, tracking usage or sales, calculating payments accurately, making timely payments, and conducting regular audits to ensure compliance.

What are business royalties?

Royalties are payments made to asset owners for the right to use their property. This creates a revenue stream without transferring ownership.

How royalty payments work:

• Payment structure: Usually a percentage of revenue or fixed fee per unit sold
• Licensor: The asset owner who receives royalty payments
• Licensee: The business that pays for permission to use the asset

Common royalty industries include:

• Technology: Patents, software, and digital products
• Entertainment: Music, films, and creative content
• Publishing: Books, articles, and written works
• Franchising: Brand names and business systems

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

Franchise royalties are ongoing payments franchisees make to use an established business model.

What franchise royalties cover:

• Brand usage: Company name and logo rights
• Operational systems: Proven business processes and training
• Ongoing support: Marketing, technology, and business guidance

Payment structure: Typically 4-8% of gross revenue, though some use flat monthly 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. Tax authorities may allow for minimum percentages for expenses, such as 35% for patents and 25% for trademarks, to be deducted from this income.

They're commonly seen in tech and manufacturing, while copyright royalties are particularly common in the publishing, music, and film industries.

Licensing royalties for creative works

These royalties apply to music, films, artwork, writing and other creative media. 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 business and market conditions that determine an asset's value and negotiating power.

Key factors affecting royalty rates:

• Industry standards: Music royalties typically range 8–15%, while software patents often command 3–5%
• Asset value: High-demand intellectual property supports premium rates
• Negotiating power: Established brands and proven sales records strengthen bargaining position
• Exclusivity agreements: Exclusive licensing rights typically cost 25-50% more than non-exclusive deals
• Market demand: Popular or trending assets command higher rates due to competition

Learn more about real-world royalty rates.

Tax implications of royalties for business

Tax treatment of royalties varies depending on whether you're paying or receiving them.

For royalty recipients (licensors):

• Income tax: Royalties count as taxable business income
• Reporting: Must be declared in annual tax returns

For royalty payers (licensees):

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

International tax considerations

When you pay or receive royalties across borders, you need to think about two main types of tax:

• Withholding tax: Governments require payers to deduct tax from royalty payments before sending money overseas. In New Zealand, for instance, this non-resident withholding tax is set at a flat rate of 15 percent on gross payments for royalties and know-how.
• Double tax agreements: These are treaties between countries that prevent licensors from being taxed twice on the same income. For example, the agreement between New Zealand and Hong Kong sets the maximum withholding tax rate for royalties at 5%.

When you pay royalties overseas, you must withhold a portion of the payment and send it to your local tax authority as withholding tax. In New Zealand, this tax must be paid by the 20th of the month following the month in which the payment was made.

If, for example, your United States (US)-based company pays royalties to a UK rights holder, you may have to withhold 30% for the Internal Revenue Service (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 withholding tax already deducted, meaning they're taxed twice. They can avoid this if they live in a country that has a double tax agreement, such as the UK–US Double Taxation Convention, which reduces or eliminates withholding tax.

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

Tips to stay compliant

Compliance strategies help you avoid tax penalties and maximise your royalty arrangement benefits:

• Maintain detailed records: Document all payments, dates, and signed agreements for audit protection
• Factor in tax implications: Consider tax costs when negotiating rates and payment schedules
• Consult tax professionals: Get expert advice for cross-border deals and complex jurisdictions

Learn more about withholding tax and other tax deductions, and see detailed guidance on how royalties are taxed.

Understanding royalty agreements

Royalty agreements are legally binding contracts. Their terms must be clear, transparent and enforceable so both parties understand what they are agreeing to and what happens if the terms are not 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.

Learn the specific rules in New Zealand.

How to apply the royalty payment cycle

The royalty payment cycle creates a structured system for licensing assets and ensuring fair compensation. This six-step process protects both parties and establishes clear expectations.

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.

Contract negotiation strategies help you secure better terms and avoid common pitfalls:

• Include performance-based termination clauses: Protect yourself from underperforming arrangements by setting minimum revenue thresholds
• 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

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 confidence they are receiving the payments they agreed to.

Simplify royalty payments and business finances with Xero

Royalty management becomes simpler when you centralise your financial tracking. Xero helps you handle both sides of royalty arrangements.

For royalty recipients:

• Create professional invoices: Bill licensees accurately and on schedule
• Track incoming payments: Monitor which royalties are paid and outstanding
• Maintain tax records: Keep detailed records for compliance and auditing

For royalty payers:

• Schedule recurring payments: Automate regular royalty payments to avoid delays
• Track deductible expenses: Categorise royalty costs for tax optimisation
• Generate payment reports: Provide licensors with detailed payment summaries

Take the hassle out of royalty management with Xero. Try Xero for free.

FAQs on royalties

Below are answers to common questions about royalties.

What does a 5% royalty mean?

A 5% royalty means the person using the asset (the licensee) pays 5% of their revenue to the asset's owner (the licensor). For example, if your business earns $10,000 in sales from a licensed product, you would pay $500 in royalties to the owner.

Can royalty rates change over time?

Yes, royalty rates can change. This is often built into the royalty agreement. For example, an 'escalator' clause might increase the royalty percentage after you reach a certain sales target. Rates can also be renegotiated when a contract is renewed.

What's the difference between a royalty and a license fee?

A license fee is typically a one-time, upfront payment for the right to use an asset. Royalties, on the other hand, are ongoing payments based on usage or revenue. Some agreements can include both an initial license fee and recurring royalty payments.