Royalty Savings explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Value the asset by asking what it would cost to rent it from someone else — then subtract tax, discount, and be careful about what happens after year five.
The idea
Under relief-from-royalty-method, the value of an intangible asset is determined by estimating the value of total costs saved that would have otherwise been paid by the user as royalty payments, if had been taken on lease from another party. Alternatively, it could also indicate the value of an intangible asset that could have fetched cash flows in the form of royalty payments, had it been leased to a third party.
Any associated costs expected to be incurred by the licensee needs to be adjusted from the forecasted revenues.
The seven steps
- Obtain the projected income statement associated with the intangible asset to be valued over the remaining useful life — forecasted revenue is royalty computed as a percentage of revenue using an appropriate royalty rate, adjusted with associated expenses like maintenance or marketing.
- Analyse the projected income statement and its underlying assumptions to assess the reasonableness.
- Select the appropriate royalty rate based on market-based royalty rates for similar intangible assets — which can be based on royalty rates of similar transactions or can be determined using the profit-split method.
- Apply the selected royalty rate to the future income attributable to the said asset.
- Use the appropriate marginal tax rate or such other appropriate tax rate to arrive at an after-tax royalty savings.
- Discount the after-tax royalty savings to arrive at the present value using an appropriate discount rate.
- Tax amortization benefit (TAB), if appropriate considering nature of the asset and purpose of the engagement, should be added to the overall value of the intangible asset.
What drives the rate, beyond comparables: the significance of the intangible asset to be valued to its owner and the expected economic life of the intangible asset with any risks relating to obsolescence.
Illustration 8 — Om Ltd
| INR Mn | 2020 | 2021 | 2022 | 2023 | 2024 | Terminal |
|---|---|---|---|---|---|---|
| Net Sales | 400.00 | 520.00 | 650.00 | 780.00 | 858.00 | 875.16 |
| Relief from Royalty before tax @ 9% | 36.00 | 46.80 | 58.50 | 70.20 | 77.22 | 78.76 |
| Income tax @ 30% | 10.80 | 14.04 | 17.55 | 21.06 | 23.17 | 23.63 |
| After-tax royalty savings | 25.20 | 32.76 | 40.95 | 49.14 | 54.05 | 55.14 |
| Discounting factor @ 18% | 0.8475 | 0.7182 | 0.6086 | 0.5158 | 0.4371 | |
| PV of cash flows | 21.36 | 23.53 | 24.92 | 25.35 | 23.63 | 424.12 |
Sum of PV of cash flows 118.78; PV of terminal value 185.39; value of intangible 304.17; value of intangible 361.23 — the second figure being after the tax amortisation benefit over the 5-year tax amortisation period.
The Standard elsewhere says valuers should generally, not apply a Terminal Value since that would imply an infinite life of the intangible. Illustration 8 applies one — and then explains the exception.
It should be noted that the intangibles may have a finite life (in which case a terminal value may not be calculated) or an indefinite life. Indefinite life does not mean infinite life.
An indefinite life is one with no foreseeable limit — a brand that is renewed and maintained. The cash flows are modelled beyond the explicit period because there is no known end date, not because the asset is assumed to last forever.
Note how much of the answer this drives. Of the total 304.17, the terminal value contributes 185.39 — over 60 per cent. That is exactly why the default is to omit it: on a finite-life intangible, a terminal value would fabricate the majority of the value.
And a consequence follows for the last of the seven steps. Intangibles with indefinite lives are not subject to amortization and are subject to impairment. Therefore, TAB factor may practically not be applicable for assets with indefinite life. The illustration adds a TAB on a 5-year amortisation period, which sits awkwardly with an indefinite-life terminal value — a reminder that both adjustments must be justified on the same set of facts.
Why royalty savings are taken after tax
The saving is a reduction in a deductible expense. Not paying a royalty of 36.00 does not put 36.00 in the owner's pocket — it increases taxable profit, so the benefit is 36.00 less tax at 30%, or 25.20.
Discounting a pre-tax saving at a post-tax discount rate would overstate the value by the whole tax charge.
Common mistakes
- Discounting pre-tax royalty savings at a post-tax rate.
- Applying a terminal value to a finite-life intangible.
- Adding a TAB to an indefinite-life asset that will never be amortised.
- Taking a comparable royalty rate without adjusting for the asset, rights and returns.