Royalties are a great additional source of income for many self-employed. The payments can arise from a variety of things, from software to music. In the modern digital economy, a lot of people are getting in on the action even when their bread and butter comes from somewhere else. But how does royalty taxation work and what should you know about it?
What are royalties?
A royalty is a payment one party makes to another party owning a particular asset for the on-going use of that asset. A common example could include music in which a songwriter receives royalties from those with the right to use the music – for example, radio stations. Another common example is book royalties that authors receive from the sale of their books.
Typically, royalties are agreed upon a percentage of gross or net revenues made from the sale of the asset but there are numerous ways of calculating them, depending on the industry and the asset in question. Royalties can arise in things such as:
- Patents
- Copyright and software
- Arts, including literature and music
The issue of royalties has become especially prevalent in the era of the digital economy, with many new options for creating content. This is why HMRC has also looked into royalties a bit closer, as we’ll discuss later on.
How are royalties taxed?
The important part to understand involves the way royalties are taxed. Royalties are part of business income, counting towards your annual tax. If you receive royalties from your books or music, then you need to declare the earnings as part of your self-assessment.
However, it is important to note that if your income from royalties is below £1,000 in the tax year for the first time, you don’t need to register and return a tax return – for that income at least! If you have any other self-employed income that pushes you above the threshold then you will still need to register. If your royalties exceed £1,000, you will need to register as a self-employed sole trader with HMRC. Alternatively, you can set up a company and pay Corporate Tax.
Royalties will be declared in the other taxable income section. They will count as part of your income and you will need to pay tax on your earnings. Remember that tax is only paid for the tax year 2019/20 on income exceeding £12,500. Furthermore, you should always make sure to deduct any expenses from your income – this includes expenses that arose for the work you did to receive royalties. For example, you can deduct any expenses you had while writing a book (if those expenses arose during that specific tax year, of course). Royalty taxation works similarly to your other income in this regard.
When it comes to registering as a self-employed sole trader, don’t forget to read our previous blog posts that cover the process more closely. You can find out about the registration process here and a blog post on costly self-assessment mistakes here.
How to use the Trading Allowance
When declaring your income, including royalties, it’s a good idea to remember the use of the Trading Allowance. This allows you to use it against your self-employment income instead of claiming expenses separately. This applies to instances where the expenses are £1,000 or less.
Here’s an example of the Trading Allowance in action. If your royalties for the tax year are £1,700, then you can claim the trading allowance and make a taxable profit of £700. If that is your only self-employed income for the tax year, you will not have to pay income tax on that.
The key thing to remember is that you are not allowed to claim tax relief for business expenses. It’s important to carefully calculate what option works the best – in some circumstances, it can be worth it to avoid claiming the Trading Allowance.
What should you know about the withholding tax for royalties?
In terms of royalty taxation, you might be aware of the withholding tax on royalties. The Government had an extensive consultation a few years back to look at the impact of the digital economy, with its ability to sell goods or stream content. The consultation resulted in certain changes, including tweaks on royalty taxation. Under the current system, companies making royalty payments in specific areas will need to deduct withholding tax at 20% from those royalties. This involves royalties that arise in the United Kingdom, even in situations where the entity has no taxable presence in the UK. If you are receiving royalties, those payments might, therefore, have been subject to withholding tax.
It’s important to note here that under the EU Interest and Royalties Directive (IRD), EU companies are allowed to make certain interest and royalty payments to associated companies and permanent establishments within the EU without the need to deduct tax. However, the IRD will not apply to the UK after Brexit. HMRC has a note about withholding taxes and royalties in the event of a no-deal Brexit and the guideline can be useful to read if your business pays royalties. While the UK is likely to leave with a deal, the guidance can help understand what might happen after the transition period.
Get help with royalty taxation
Royalties can cause a bit of a headache to self-employed. But like with any income, it’s crucial to get to the bottom of how their taxation works to ensure you don’t run into trouble. That’s why we are here to help you every step of the way.
At Devonshire Green, we specialise in helping small businesses and sole traders in all areas of taxation. We can make sure you declare royalties correctly and make the most of the Trading Allowance. Contact us today and let’s look at your royalties. Together we can make them work for you!
