A royalty agreement is a legal contract between a lessor and a lessee. The agreement grants the right to the licensee to use the lessor's property in exchange for royalty payments. This contract specifies:

• The parties involved (lessor and lessee)
• The rights granted
• The royalty rate and payment terms
• The period of use of the licensed property

Patent Royalties

These are payments made to innovators or creators who have patented their products. When a third party wants to use a patented product, they must pay royalties to the patent owner. Examples include new electronic devices, new engines, and pharmaceutical drugs.

Mineral Royalties

These are royalties paid by mineral extractors to landowners for the right to extract natural resources. They apply to oil, gas, coal, metal ores, gemstones, and other minerals. The payment is usually based on revenue or on units extracted (such as tonnes of coal or barrels of oil).

Copyright Royalties

A copyright is the exclusive right granted to the creator of an artistic work. Copyright protection covers music, paintings, films, books, and other creative works. Anyone wishing to use copyrighted material must obtain authorization and pay royalties to the copyright owner.

Examples include:

• Book royalties: Authors receive royalties from publishers
• Performance royalties: Musicians receive royalties when their music is played on radio, used in movies, or performed at concerts

Franchise Royalties

A franchise is a license granted by a business owner (the franchisor) to a third party (the franchisee) to use their brand, operational model, and support in exchange for a fee and/or share of income. The franchisee pays an ongoing royalty fee to the franchisor.

In Tanzania, examples include Coca-Cola Kwanza Ltd. franchising to other operators, and international food chains like KFC operating through local franchisees.

Although the terms "royalty" and "rent" are sometimes used interchangeably, they are different:

Minimum Rent

Minimum rent (also called dead rent or flat rent) is the fixed amount that a lessee must pay to the lessor, regardless of the actual usage of the asset. It is a guaranteed payment to ensure the lessor receives a minimum amount even if the lessee does not generate sufficient revenue.

At the end of each period, the lessee pays either:

• The actual royalty based on production, or
• The minimum rent, whichever is higher

Short Workings

Short workings occur when the actual royalty based on usage falls below the minimum rent. The shortfall represents the amount paid in excess of the actual royalty earned. This amount may be carried forward and adjusted against future excess payments.

Formula: $Short \ Workings = Minimum \ Rent - Actual \ Royalty$

Surplus

When the actual royalty exceeds the minimum rent, the excess is called surplus. In this case, the lessee pays the actual royalty.

$Surplus = Actual \ Royalty - Minimum \ Rent$

Worked Example 1: Minimum Rent and Short Workings

Kwetu Traders leased a machine for sunflower oil refining from Ukuta Company. The agreed minimum rent is TZS 36,000,000 per annum, with a royalty of TZS 1,000 per litre of sunflower oil refined.

• Year 1: 48,000 litres refined
• Year 2: 32,000 litres refined

Calculate the royalty paid in each year.

Solution:

In Year 1, actual royalty (TZS 48,000,000) exceeds minimum rent, so the lessee pays TZS 48,000,000. In Year 2, actual royalty (TZS 32,000,000) is less than minimum rent, so short workings of TZS 4,000,000 (36,000,000 − 32,000,000) arise, and the lessee pays the minimum rent of TZS 36,000,000.

Recoupment is the process by which a lessee recovers short workings from previous periods when actual royalties exceed the minimum rent in future periods. Royalty agreements often include provisions allowing the lessee to carry forward short workings and recover them from future surplus.

Rights of Recoupment

Fixed Right

The lessee has the right to recoup short workings for a fixed time period. For example, the lessor may allow recovery only during the first five years of the contract. Any balance of short workings not recouped after this period is transferred to the statement of profit or loss.

Floating Right

The lessee has the right to recover short workings of any year during the next agreed number of years following the payment. For example, if the recoverable period is two years, short workings of Year 1 can be recouped in Year 2 and/or Year 3.

Worked Example 2: Recoupment of Short Workings

Mkwakwani Drilling Group (MDG) Ltd. granted a mining lease to Pangani Ltd. with:

• Royalty: TZS 30,000 per tonne of ore mined
• Minimum rent: TZS 10,000,000 per year
• Right to recoup short workings within the first four years

In 2020 and 2021, actual royalties were below minimum rent, creating short workings of TZS 4,000,000 and TZS 1,000,000 respectively. In 2022, actual royalty exceeded minimum rent by TZS 2,000,000, which was used to recoup part of the accumulated short workings. In 2023, another TZS 1,000,000 shortfall occurred, and the remaining short workings were fully recouped.

If short workings cannot be recouped within the agreed period, the unrecouped amount is transferred to the statement of profit or loss as an expense for the lessee and income for the lessor.

In Tanzania, a small-scale Tanzanite miner in Mererani may pay a royalty to the landowner for the right to extract gemstones from their property. If the miner's monthly sales are low, they pay a minimum rent to the landowner. In months when sales are high, they pay the actual royalty, which may exceed the minimum rent and allow them to recover earlier short workings. Understanding these royalty concepts helps the miner budget for seasonal fluctuations in gemstone sales and negotiate fair lease terms with landowners.