Royalties – un­der­stand­ing ad­di­tion­al forms of income

In the pro­fes­sion­al world, there are different types of com­pen­sa­tion, including salaries, fees, com­mis­sions, bonuses and royalties. As with a bonus or com­mis­sion how high a royalty rate is depends on the success of a re­spec­tive company. But what exactly is meant by a royalty?

There are two main groups of pro­fes­sion­als who receive royalties. The first includes musicians, authors and artists who are often paid ex­clu­sive­ly in royalties or in addition to extra income streams.

The second group includes in­di­vid­u­als working in companies. For many employees in senior positions, royalties are com­mon­place. An example is members of a cor­po­ra­tion’s man­age­ment board, who often receive regular bonuses related to their per­for­mance in the company.

These royalties are generally con­tin­gent on the per­for­mance of the company and are designed to encourage strong per­for­mance from senior members of staff.

In the corporate world, royalties refer to ad­di­tion­al revenue directly linked to the success of the business. From a tax per­spec­tive, royalties count as income and are taxed according to income tax law. Whether an employee is entitled to royalties is usually specified in their em­ploy­ment contract.

Royalties refer to a bonus whereby the recipient receives a certain portion of the profit as ad­di­tion­al income. There is no binding right to a royalty, however, once it has been guar­an­teed in the em­ploy­ment contract it cannot be suspended.

Royalties and com­mis­sion are not the same. The com­mis­sion is paid in relation to the per­for­mance of an employee (for example, a suc­cess­ful business deal or their sales per­for­mance). Royalties, on the other hand, are payments made to owners of in­tel­lec­tu­al property in exchange for usage or licensing rights of that property over a specified period of time.

In most cases, royalties are cal­cu­lat­ed as a per­cent­age of revenue - revenue being net sales, i.e. sales after the deduction of taxes and other items defined in a license.

Where the licensor prefers a simpler re­la­tion­ship with licensees in certain countries or industry segments, royalties are specified in amounts per item/unit. Im­por­tant­ly, it may be less ad­ver­sar­i­al to ask for man­u­fac­tur­ing or shipping reports from licensees (that may include com­peti­tors) than request financial dis­clo­sure of sales reports.

The rate and frequency at which royalties are paid must be stip­u­lat­ed in the contract. There are no fixed rules.

Guar­an­teed royalties differ to this arrange­ment somewhat. While royalties are usually based on revenue, guar­an­teed royalties will be dis­trib­uted ir­re­spec­tive of how well an invention performs. Even if the company has made little or no profit, the agreed royalty still has to be paid.

Dis­cre­tionary royalties work a little dif­fer­ent­ly. This amount is not tied to a con­trac­tu­al­ly agreed per­cent­age but awarded by the employer or su­per­vi­so­ry board at its own dis­cre­tion. The employer has dis­cre­tion over the rate, but it is generally con­sid­ered prudent for the amount to be in rea­son­able relation to the success of the company for tax purposes.

The dis­cre­tionary bonus is stated in the em­ploy­ment contract and the criteria is used to determine the size of the pay-out specified in the bonus scheme.

Royalties are treated as taxable income. Most royalties are not paid until January of the following tax year, but this may vary from company to company.

Even where a payment relates to the previous financial year, the funds are generally not received by an employee until the following financial year.

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