When the COVID-19 pandemic hit, the music industry was significantly affected as live events were essentially shut down and projects were put on hold. Despite this, the past two years have seen unprecedented sales of music catalogs at a soaring valuation.

Music catalogs are sold not only to traditional music companies but also to institutional investors who consider them a stable asset class whose growth potential is uncorrelated to the stock market. This rise in music catalog sales is creating opportunities for songwriters, artists and producers to cash in for an upfront lump-sum payment instead of waiting for royalty income to trickle in over years.

In this article, we will share a few things to help buyers and sellers navigate the complexities of the music-publishing world.

UNDERSTANDING DIFFERENT TYPES OF MUSIC PUBLISHING ROYALTIES

In many cases, music rights owners, especially new buyers, may be unfamiliar with the complicated way in which royalties are generated and paid. To help investors understand what they are buying into and to help rights owners understand the types of earnings derived from the rights they own, this blog will cover the basics of different types of music publishing royalties generated from the use of musical compositions. Note that music-recording royalties, a different type of royalty related to the use of sound recordings, are beyond the scope of this article.

There are three main types of music publishing royalties:

• Performance royalties are generated whenever a song is streamed on digital platforms (e.g., Spotify), played by radio stations and TV channels or played in public venues such as restaurants, clubs and so forth. Performance rights organizations (PROs) manage the collection and distribution of performance royalties. PROs pay out royalties directly to songwriters for the writer’s share and separately to publishers for the publisher’s share.

• Mechanical royalties are due when a song is reproduced in either physical or digital form. This means every time a consumer purchases a song, whether in physical media (such as a cassette, vinyl or CD) or through digital downloads from online sources such as iTunes, mechanical royalties are generated. Additionally, every time a song is streamed on digital platforms such as Spotify, the streaming services pay out mechanical royalties.

• Sync licensing fees are paid out when a song is licensed to be synchronized with another type of content. When a song appears in commercials, TV shows or video games, sync licensing fees are generated.

It is worth noting that music publishing income is typically split 50-50 between the writer’s share and publisher’s share, although a songwriter may also be entitled to a portion of the publisher’s share, depending on the specific deal arrangements. Although the writer’s share of performance royalties is paid directly by PROs to songwriters, other music publishing royalties are usually collected by publishers, who then pay songwriters their share of the income.

REVIEWING MUSIC PUBLISHING ROYALTY REPORTING

Whether a buying or selling a music catalog, it is important to review statements from the last several years to gain an understanding of the earning trend. What is the rate of growth/decline in earnings? Which songs generated the highest royalties? What are the trends within each type of revenue source? All of this information, along with evolving industry trends and other factors, will be evaluated to determine a catalog’s value.

Further, catalog owners receiving royalty payments may want to review the statements periodically to mitigate the risk of underreporting, considering the complexities of music publishing royalty collection structures and the constantly changing industry.

In an internal review of music publishing royalties, it is important to consider evaluating the following risk factors:

• Late reporting and late payment: Music publishing agreements often include contractual stipulations on the timing of when source receipts should be processed and when royalty statements and payments are due. Considering the high volume of transactions and the limited resources available to publishers, there could be delays in processing receipts and preparing statements, resulting in delayed payments of royalties.

• Gaps in revenue reporting: As music publishing involves many revenue sources and the copyright registrations and collections vary from country to country, there is an inherent risk of incomplete reporting of revenue. Examples of red flags include missing revenue from a particular song, territory, revenue source or specific period of time. The risk of omissions of revenue is even higher in situations where there is a transfer of copyright ownership.

• Incorrect royalty shares and royalty rates: The royalty shares and rates are based on variables such as revenue sources, licensing channels, songwriter’s shares in each composition and statutory rates. Improper application of royalty shares and rates may result in underpayments to rights owners. Generally, the more variables there are in the catalog and the publishing arrangement, the higher the risk of errors.

• Unreported licensed uses: With the continued growth of music uses in film, TV and other projects, as well as in new areas such as in-home fitness, there is an increased risk of unreported uses or exploitations. If any unreported uses are identified, this could represent a red flag.

If any of the above risks are present, it may be beneficial to consult an auditor with expertise in royalty accounting.

TAX CONSIDERATIONS

Artists selling their catalogs should also consider the tax implications of sale transactions. To the extent that certain requirements are satisfied, any income from the sale of music catalogs may be treated as capital gains subject to a preferential tax rate (up to 20 percent), rather than ordinary income which can be taxed at as much as 37 percent.

However, the tax treatment of music catalog sales is not always straightforward.

“Legislative uncertainty and contractual ambiguity over many decades has led to uncertain tax treatment on catalog sales,” says Shane Nix, Partner at Willkie Farr & Gallagher LLP. “Not all sales are eligible for capital gain, and it is important to carefully analyze the pre-existing relationship between the music talent and the publisher or record label, as applicable, to evaluate whether there is a path to capital gain. Prospectively, talent and their music lawyers should consult with a tax lawyer to structure new publishing and recording deals to better plan for capital gains on an exit.”

Shane recently went into detail about the tax considerations for catalog sales in an article for Los Angeles Lawyer.

Please reach out to a member of GHJ’s Royalty and Licensing Team to learn more about this topic.