RoyaltyStat Blog

Royalty Rates for Licensed Intangibles and Minerals

Posted by Ednaldo Silva

Like other expressions, economic categories reflect reality, and the term royalty isn't an exception.

Michiel de Vaa’s Etymological Dictionary of Latin and the Other Italic Languages (Brill, 2008) has no entry for royalty or its lemma. See his near-neighbor entry (Vaa, pp. 517-518): rego ("to direct, guide, govern"), but the listed cognates don't refer to payments or other economics allusions.

The Oxford English Dictionary, an erudite arbiter of the English language, includes several meanings for royalty (noun (plural royalties)), and attributes its origin from Old French roialté, from roial (regal): 

“The sense ‘royal right (especially over minerals)’ (late 15th century) developed into the sense ‘payment made by a mineral producer to the site owner’ (mid-19th century), which was then transferred to payments for the use of patents, trademarks, and copyrighted materials.”

See the Oxford English Dictionary. Cite: “royalty, n.”

For pleasure, read Lynda Mugglestone (editor), Lexicography and the OED, Oxford University Press, 2000; A. Cowie (editor), English Lexicography, Vols. I and II, Oxford University Press, 2009; and Henri Béjoint, The Lexicography of English, Oxford University Press, 2010. 

The Dicionario de la Lengua Española (Real Academia Española (22nd edition, 2001)), Vol. II, affirms that regalía (royalty) comes from Latin regalisregio (regal, royal); however, unlike Vaa's impressive compendium or the superlative Oxford English Dictionary, the Dicionario doesn’t provide the date of first use or literary citations. In Brazilian Portuguese, regalia is derived from Spanish and includes two meanings (rights of kings, and advantage, privilege, prerogative). See Aurélio de Holanda, Novo Dicionário da Língua Portugesa (1st edition, 15th printing), Editora Nova Fonteira, 1975, p. 1206. This canonical dictionary is rich in literary citations, but poor in references about royalties (reflecting the absence of this economic phenomenon in Brazil contra our oblique magic realism).

Late 15th century, noted by the Oxford English Dictionary, is much after the Norman conquest of England (circa 1066) and, for example, we don’t find the lemma or headword “roial” in the Domesday Book (a record of a survey of English lands and landholdings made for tax collection purposes by order of William the Conqueror in 1086. First known use of Domesday Book: 1591).

Thus, from this cursory finding, we infer that royalty payments for minerals (ownership rights belonging to the crown or royalty) and then also for copyright, patent, and trademark rights are a recent form of payment in European economic history.

We infer also that because royalties are subsumed under rent in national income and tax accounts (e.g., in US IRS Statistics of Income program publications), the economic relevance of royalty income for the licensor or royalty payment for the licensee as a separate economic category has been small compared to rent; thus, royalty distinct from rent has been unnoticed by major past economists.

We find rent defined in the Oxford English Dictionary as follows: Anglo-Norman and Old French, Middle French, French rente (also rende) return payment, restitution (early 12th cent. in Anglo-Norman), tax, toll, tribute, or similar charge to be regularly paid for the use of movable or immovable property (circa 1119 in Anglo-Norman). We find rent; however, we don’t find an economic treatment of royalties in Adam Smith (Scottish economist, born 1723); or in James Steuart (English economist, born 1707), Smith’s immediate predecessor; or among French economic treatises (prior to Adam Smith) written by Richard Cantillon (an Irish-French economist, born 1680) or by Jacques Turgot (French economist, born 1727).

For a survey of some of these preclassical economists, see Tony Aspromourgos, On the Origins of Classical Economics, Routledge, 1996 (covering William Petty (English economist, born 1623), Richard Cantillon, François Quesnay (French economist, born 1694), James Steuart, and Adam Smith). It’s telling that no results for “royalty” were found in Aspromourgos’s survey.

Nearer our time, Colin Clark's The National Income (1924-1931) (Macmillan, 1932) (an early treatment of UK national accounts) considers wages and salaries, profits, and rent; however, there is no entry for royalty income or royalty expense. Likewise, there is no separate treatment of royalties in the United Nations System of National Accounts (SNA, 2008), which is the agreed platform of the United Nations, OECD, World Bank, IMF, and the statistics division of most countries for compiling GDP data and its major income components. See https://unstats.un.org/unsd/nationalaccount/docs/SNA2008.pdf

See also an SNA summary (“The regular payments made by the lessees of natural resources such as subsoil assets are often described as royalties, but they are treated as rent in the SNA.”), section 7.110, p. 88: https://unstats.un.org/unsd/nationalaccount/docs/2008SNA-ConceptsBrief.pdf

Today, the relevance of intangibles ascribed by certain pundits to MNE is exaggerated, and the related claim that over 80% of total assets of large MNE are intangibles is inconsistent with the stable ratios of research and development and advertising expenses to net sales in aggregate national accounts and in the individual accounts of large MNEs.

Also, we don’t find an upward trend in royalty rates in RoyaltyStat's data or an upward trend in MNE profit rates that would reflect the premium attributed to the supposed growing importance of intangibles in MNE and GDP accounts.

As recognized by the OECD regarding the creation of marketing intangibles, “advertising generates unique and valuable marketing intangibles, e.g. in consumer goods where the value of marketing intangibles is affected by advertising.” OECD, Revised Guidance on the Application of the Transactional Profit Split Method: Inclusive Framework on BEPS: Action 10 (2018), ¶ 2.181.

Royalty rates in fact, not fancy

We selected a large fraction of royalty rates extracted from the unredacted license agreements developed by RoyaltyStat and created two subsets of royalty rates based on net sales (revenue).

One dataset of royalty rates covers intangibles such as copyright, patent, and trademarks, and another dataset covers natural resources such as minerals and oil and gas.

Royalty rates for these two forms of licensing rights should not be mixed because they represent different types of assets: the first subset, intangibles, are produced by research & development and by advertising (marketing) investments, whereas the second subset is derived from investments in natural resources.

For each dataset, we tested to determine if there is a statistical difference between the quartiles of royalty rates disclosed in original SEC filings compared to undisclosed (but later disclosed by freedom of information (FOI) request) license agreements.

We found no major differences in quartiles, as can be verified by these statistical results (FOI = 0 are disclosed in original SEC filings; FOI = 1 are disclosed by subsequent legal request):

     Intangibles                 FOI      Count     Q1     Median     Q3

                                               0       12091       4.0     5.0             10.0

                                               1         4445       3.0     6.0             10.75

     Natural Resources    FOI      Count     Q1     Median     Q3

                                               0            645       3.0     5.0             10.0

                                               1              15       4.5     5.0              10.0

Royalties separate from rent

When royalty income becomes a more discernible economic category in the financial accounts of MNE, or better reflected in the national income accounts, we can become confident that royalties will be recorded separately from rent and not subsumed in rent.

In US IRS Form 1120 (Corporation Income Tax Return), rent income (line 6) is recorded separately from royalty income (line 7); however, royalty payments do not have a separate record in itemized deductions.

In Form 1120, rent payments have a separate line item 16, but royalty payments remain hidden in the unstructured statement within the other deductions. This omission by IRS is inexcusable, and as a result of this faulty policy, we remain bound to an understanding of royalty payments obtained only from nongovernment sources, such as the valuable royalty rates corpora or data repository developed by RoyaltyStat.

Intangible assets and royalties are important in economics and their relevance is growing; however, the volcanic eruption of intangible assets and what we would expect to be the associated super-royalty rates and premium profit rates disclosed in public filings are probable larva in the imagination of ill-informed pundits.

US Title 17, Chapter II, Part 229 (Standard Instructions for Filing Forms under the Securities Act of 1933, Securities Exchange Act of 1934 and Energy Policy and Conservation Act of 1975, Regulation S-K) prescribe that material contracts be filed. The filer can request confidential treatment, and many material contracts are redacted. This confidential treatment largesse is a pitiful SEC disclosure rule.

Analyses of RoyaltyStat’s substantial corpora of transactional licensing contracts suggest that royalty rates are stable magnitudes, with quartiles varying from 3% to 10% of the net sales of the licensee. Also, as typical of large datasets, we observe a certain fraction of anomalous royalty rates (outliers) that exceed 12% of the net sales of the licensee. 

Published on Dec 5, 2019 9:28:36 PM

Ednaldo Silva (Ph.D.) is founder and managing director of RoyaltyStat. He helped draft the US transfer pricing regulations and developed the comparable profits method called TNNM by the OECD. He can be contacted at: esilva@royaltystat.com

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Topics: Royalty Rates