Royalties

How BC law treats it

Royalty terms are set by the licence or royalty agreement and enforced as contract. The underlying rights come from federal statutes: the Copyright Act, RSC 1985, c C-42, the Patent Act, RSC 1985, c P-4 and the Trademarks Act, RSC 1985, c T-13. The owner of the right is the 'royalty owner' and the payment stream can itself be sold or assigned, which is how royalty financing works. The key commercial term is the royalty base. A gross royalty is calculated on total sales; a net royalty allows defined deductions, such as returns, discounts, taxes and shipping. Agreements usually add minimum annual royalties, an advance against future royalties, reporting deadlines, interest on late payments, and audit rights allowing the owner to inspect the licensee's books and recover the audit cost if an underpayment exceeds a set percentage. Under Part XIII of the Income Tax Act, RSC 1985, c 1 (5th Supp), s. 212(1)(d), a Canadian payer must withhold 25% tax on most royalties paid to non-residents and remit it to the Canada Revenue Agency, unless a tax treaty reduces the rate. Certain royalties, including some for copyright in literary works and computer software, may be exempt under specific treaties. The payer is liable for tax it fails to withhold. Royalties received by a Canadian business are ordinary taxable income.

What it means for your business

Royalties turn intellectual property into recurring revenue without the cost of manufacturing or distribution, but the agreement decides how much is actually received. A vague definition of 'net sales' can cut payments sharply. For licensees, royalties affect pricing and margins, and failing to withhold tax on payments to a foreign licensor can make the Canadian business liable for the unpaid tax, interest and penalties. Example: A Vancouver game studio licenses its character to a US toy maker for 6% of net sales, with a minimum annual royalty and audit rights. When it pays a separate royalty to a German composer for music, it checks the Canada Germany tax treaty, which may reduce or eliminate the 25% withholding, before paying.

Risks and common mistakes

Defining 'net sales' loosely, so the licensee deducts marketing and overhead before calculating royalties. Omitting audit rights, leaving no way to verify the licensee's royalty reports. Paying royalties to a foreign owner without withholding Part XIII tax or confirming the treaty rate. Failing to set minimum royalties or performance targets, so an exclusive licensee can sit on the rights. Not addressing whether royalties continue after a patent expires or the licence ends.