1. Royalty
Royalty is a periodical payment made by a user (lessee, tenant, publisher, or manufacturer) to the owner (lessor) for using assets such as mines, patents, copyright, trademarks, land, or natural resources. It is generally paid on the basis of output produced, quantity extracted, or copies sold. Royalty ensures that the owner receives a fair return for allowing others to commercially use their property or rights.
Royalty is a major concept in business, mineral extraction, and intellectual property. It can be paid monthly, quarterly, or annually. The amount often fluctuates depending on production volume. The royalty system creates a win-win arrangement: the owner earns income without directly engaging in operations, while the user gains legal permission to exploit the asset.
Examples:
- A book publisher pays royalty to an author according to the number of copies sold.
- A mining company pays royalty based on coal or mineral extraction.
- A company pays royalty for using patented technology.
Royalty paid is an expense for the lessee and income for the landlord/lessor.
2. Minimum Rent / Dead Rent
Minimum Rent (also called Dead Rent) is the minimum amount that the lessee must pay to the lessor, irrespective of the actual royalty earned. It is a guaranteed amount that ensures the owner receives a fixed minimum income even if production is low.
Minimum Rent protects the lessor from losses in periods of low production. If the royalty based on production is lower than the Minimum Rent, the lessee must still pay the Minimum Rent. However, if royalty exceeds Minimum Rent, the lessee pays only the royalty.
Why Minimum Rent is important?
- It secures a fixed income for the lessor.
- It acts as a safeguard during years of low activity.
- It ensures commercial viability of the lease agreement.
Example: If Minimum Rent = ₹50,000 and Royalty = ₹32,000, the lessee must still pay ₹50,000.
3. Short Working
Short Working occurs when the actual royalty amount is less than the Minimum Rent. It represents the deficit amount that the lessee pays extra over the royalty due. Short Working indicates underperformance in production or lower-than-expected output.
Formula: Short Working = Minimum Rent – Actual Royalty
Key Features of Short Working:
- It arises due to low production or sales.
- It is treated as an asset for the lessee (if recoupable).
- It may be recouped in future years if allowed by the agreement.
Example: If Minimum Rent = ₹60,000 and Royalty = ₹45,000, Short Working = ₹15,000.
4. Recoupment of Short Working
Recoupment means recovery of Short Working in years where royalty exceeds the Minimum Rent. Many royalty agreements give the lessee the right to recover past Short Working over a fixed number of future years (called Recoupment Period).
Types of Recoupment:
- Fixed Period Recoupment: Recoverable within specific years, e.g., first 3 years.
- Fluctuating Period Recoupment: Recoverable whenever royalty exceeds Minimum Rent without a fixed timeline.
Process of Recoupment:
- In later years, if actual royalty exceeds Minimum Rent, excess royalty is used to recover past Short Working.
- Recouped Short Working is treated as income for the lessee and reduces the Short Working account.
- Unrecouped Short Working after the expiry of the recoupment period is transferred to the Profit & Loss Account.
Illustration:
If Short Working = ₹20,000 in Year 1 and royalty exceeds Minimum Rent by ₹12,000 in Year 2, then ₹12,000 is recouped. The remaining ₹8,000 may be recouped in Year 3 if permitted.
Recoupment encourages the lessee to increase production and recover earlier losses, balancing commercial efficiency.
5. Sub-Lease
Sub-Lease refers to a secondary lease created when the original lessee (called Head Lessee) leases out the same asset to another party (called Sub-Lessee). In this arrangement, the head lessee becomes both a lessee (to the original lessor) and a lessor (to the sub-lessee).
Sub-Lease is common in mining, land development, industrial operations, and copyright systems where the primary lessee may not use the full capacity and allows another party to work under them.
Features of Sub-Lease:
- The sub-lessee pays royalty to the head lessee.
- The head lessee continues to pay royalty to the original landlord.
- The difference between royalty received and royalty paid is the income of the head lessee.
- All responsibilities toward the original lessor remain with the head lessee.
Advantages:
- Makes use of excess capacity.
- Reduces burden on head lessee.
- Creates a profit opportunity through margin of royalty.
Example: A mining company leases land and then sub-leases a part to another operator. The sub-lessee extracts minerals, pays royalty to the head lessee, while the head lessee pays the main royalty to the landowner.
This structure leads to multi-level royalty accounting and requires accurate maintenance of Primary Royalty Account and Sub-Lease Royalty Account.