Royalty refers to a contractual payment by a person for the use of assets belonging to another person. The payment includes royalty for the use of intangible assets, such as copyrights, trademarks, or franchise model agreements. Royalty is also paid for the use of natural resources, such as mining leases. Royalty agreements generally give limited right to use assets or resources.
There are two parties to a royalty agreement—the party granting the right to use an asset or resource is the licensor and the party who accepts the right to use and pays for the right is the licensee. Royalty agreements are often meant for commercial exploitation of assets or resources.
The person paying royalty generally pays it as a percentage of the turnover or gross receipt. Royalty agreements are legal in nature and can involve elaborate negotiations on the terms and conditions of the grant of right to use. The commonly known royalty agreements are music rights or publishing rights of books in return for a percentage of the sales.
Royalty is a passive income stream, providing benefit to people who create intangible assets or work of art. Musicians owning music rights, cinema rights, and authors often grant the right to use their copyrighted material and earn income. Royalty agreement includes licence agreements to use assets or properties in return for a payment.
In the case of non-renewable energy sources, royalties are generally paid to the government of the State. An example of royalty paid to the State is mining royalty. Also, in the case of extraction of oil and natural gas, royalties are paid to the State. In respect of television channels, royalties are paid by television channels to satellite companies.
A royalty agreement specifies the terms and conditions of grant of right to use under the agreement. The agreement also mentions the consideration for the right to use and the duration. From a tax perspective, royalty agreements should be on an arms-length basis. The taxation, however, depends on the law of each country.
