Inventors hold the special right to their inventions, which lets them earn royal payments through licensing. Licensing enables the inventor to remain the owner of the patent and enjoy the benefits of licensing it to the licensee (the buyer).
Usually, royalty payments vary according to the type of product they license. Depending upon the contract they make during licensing, a certain amount is deducted from the royalties for various purposes. In this blog, let us look at the royalties and the types of deductions they impose on royalties.
An overview of Royalties
If you have an idea to invent something, you can license it to others so that they can manufacture it and market it. This process is called licensing. The licensor (inventor) gets some profit from the licensee (buyer) based on the net sales the licensee makes from the product. If the net sales are higher, the licensor gets more profit (royalty), and vice versa in case of lower sales.
The royalties are meant for using or marketing the inventor’s property with their permission. Royalties are believed to be beneficial for inventors. However, the deductions affect the amount of money they get from royalties. Deductions are made according to various factors. Read on to learn more about deductions and their types.
Royalty deductions are so many types. Some are the most common and agreeable, while others may not. Let us look at the deduction types and how to manage them.
- Tax-related deductions: Every country has a certain tax amount for every item that is transacted within the country. A licensee can impose a deduction on your royalty based on the tax he paid. This is one of the most expected deductions, and it is better to be well aware of the country’s rules on tax payments for the products you licensed.
- Deduction based on the credits and returns: The defective or not sold products will come under the term of credit and returns. The licensee can deduct these credits and returns from the royalties, which is totally reasonable.
- Shipping costs deductions: Generally, the shipping costs of the products will be included in the deductions, and most buyers expect this deduction from the licensor.
- Quantity-based deductions: To promote overall sales, the licensee can offer a discount on orders of large quantity (or volume). Accepting this deduction on net sales is more profitable as it may increase sales and lead to more royalty benefits. However, the licensor should monitor the sales periodically to check whether the deduction amount is reasonable.
- Commissions-based deductions: A licensee may opt for a salesperson or a third party during the product sale to increase sales. For this, the licensor should pay a sales commission amount to them, which they may try to impose on the licensor’s royalties as a deduction. A licensor doesn’t need to accept this kind of deduction, as it is the licensee’s decision to opt for a salesperson.
- Deductions for marketing and promotions: The manufacturer (licensee) should take care of the activities such as marketing, promotion, and advertising. Some may try to impose these costs in the name of deductions which a licensor should not accept.
- Poor business deductions: Sometimes, a licensee doesn’t want to pay royalties because of poor business activities, such as customers not paying for the products they bought from the licensee. A licensor should not encourage these kinds of deductions from licensees as it never comes under a licensor’s fault.
- Other unnecessary deductions: Some licensees will try to reduce the royalty amount by imposing unspecific fees such as processing fees. Unless a fee is specifically mentioned and explained, a licensor may avoid it.
How to avoid unnecessary deductions from the royalty?
The licensors must understand the necessary deductions from the net sales and their limits. Since royalties are important for the licensors, he should be very clear about the limit of deduction amount at the time of making the license agreement. He should precisely mention the deduction amount in terms of the percentage of the product’s gross sales. If the license agreement is transparent about the deduction limits, unnecessary deductions from the royalty amount can be avoided.
Royalties mean so much for the licensors, as they may be an important income stream. A licensor can be an artist, a singer, an author, or anyone who tries to generate income from their work or invention. A certain limit of deduction is acceptable to compensate for the expenses of a licensee. However, a licensor doesn’t need to accept unreasonable deductions. I hope this blog gives you an overview of deductions, their types, and how to avoid unnecessary deductions.