Royalties: Advantages, disadvantages and calculation

Bonuses are a widespread form of performance-related remuneration, which are mainly used in management positions and in the creative sector. Before they are used, companies should be aware of the legal and tax aspects that need to be considered and the advantages and disadvantages of this remuneration model.

This article provides a well-founded and practical explanation of royalties and how they differ from other special remuneration.

Definition: What does royalty mean?

A bonus is a performance-related additional remuneration that a company pays to certain employees. Managing directors, board members or senior executives usually benefit from this, but creative professionals such as authors can also receive royalties.

The term comes from the French: “Tantième” means “the so much part”. This already makes the most important characteristic of this remuneration clear: it is measured against a fixed quota of a key figure.

In contrast to commissions or bonuses, bonuses do not reward individual performance, but rather the overall or departmental success of a company. This also distinguishes them from Bonuseswhich are usually paid independently of economic indicators.

Examples of royalties

A classic example is the profit bonus for managing directors. Let’s assume a company achieves an annual profit of one million euros and has stipulated a profit bonus of five percent in the employment contracts. In this case, the additional remuneration for the managing director would amount to €50,000.

Another example can be found in the publishing industry. Authors often receive a contractually agreed share of sales from the books sold. For example, if this amounts to ten percent and the book achieves total sales of €500,000, this results in a royalty of €50,000 for the author.

Bonuses are also common in start-ups or in the case of company investments. Here, managers often receive a percentage share in the increase in value of the company over a certain period of time.

How are royalties calculated?

The calculation of a bonus depends on the agreed assessment basis. There are various models, each of which has different economic effects.

• Profit bonus:
  Remuneration is based on a certain percentage of the annual profit. This is the most common form, as it establishes a direct link between the company’s success and remuneration.

• Sales bonus:
  The amount of the bonus is calculated on the basis of the turnover achieved. This variant is less common, as a high turnover does not necessarily go hand in hand with a positive company profit.

• Guaranteed royalty:
  The employee receives a fixed remuneration irrespective of economic success. This offers financial planning security for the recipient, but can represent a risk for the company.

• Discretionary bonus:
  A bonus is determined flexibly depending on the economic situation and individual decisions of the company. However, this entails the risk of a lack of transparency and dissatisfaction.

What is the legal situation regarding royalties?

Bonuses must be clearly regulated in the employment or management contracts. This applies in particular to the assessment basis, the payment cycle and possible cut-off date clauses. Companies that grant bonuses should take the following points into account:

1. Contractual definition: A bonus should be clearly defined in the employment contract. Not only the basis for calculation and the percentage rate should be specified, but also provisions for adjustment or reduction in the event of a poor company situation.
2. Tax classification: Bonuses are considered income from non-self-employed work and are therefore subject to income tax. The upper tax limit is particularly important: if bonuses exceed 50% of the company’s profit under commercial law, the tax office can assess this as a hidden profit distribution, which has considerable tax consequences. In addition, the bonus should not exceed 25% of a person’s annual salary.
3. Hidden profit distribution: Particularly in the case of shareholders or managing directors without an employment contract with a third party, a high bonus can lead to the tax office classifying this as a hidden profit distribution. In such cases, additional tax payments may be due.

Royalties as a strategic remuneration model

Royalties can be used specifically as a corporate management tool to increase commitment managers and senior executives to the success of the company.

A well-thought-out bonus model can significantly increase employee commitment and motivation. Those who benefit directly from economic success are often prepared to think entrepreneurially in the long term and make decisions that benefit the company as a whole.

However, there are also challenges. While bonuses represent attractive additional remuneration in successful years, economic downturns can lead to employees unexpectedly having to forego part of their income. This can lead to dissatisfaction and fluctuation if the model is not properly communicated and supplemented by alternative remuneration structures.

Employees must therefore always be able to understand how their remuneration is calculated and have the feeling that they are being treated fairly.

Conclusion: For whom do royalties make sense?

According to a study of the Federal Ministry of Labor and Social Affairs, around 60% of all companies use variable remuneration models such as bonuses. Bonuses are particularly suitable for companies that want to bind their managers to the company’s success in the long term. They offer a financial incentive to make strategic decisions with a view to sustainable growth.

In any case, anyone who uses bonuses as a remuneration model should implement this with clear contractual regulations, a comprehensible basis for calculation and open communication with employees.

Keeping an eye on royalties

The Teamhero personnel management software helps to keep an eye on contractual agreements. Important documents can be retrieved digitally at any time using the digital document management function. The employee database primarily helps companies with a large number of employees to keep track of their entire workforce at all times.

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