5.0 Accounting

5.1 Accounting Periods

The majors generally account to their recording artists twice a year. On sales for which the company is paid between 1st January and 30th June, the artist will usually receive a statement ninety days later, at the end of September. On sales for which the company is paid between 1st July and 31st December, the artist will receive a statement at the end of the following March. Some record companies account for UK sales on the basis of sales information. These companies include on an accounting statement any sales notified during an accounting period. Other companies only account for sales for which the company has actually been paid. The busiest month of the year for record sales is December. The record company will probably not receive payment from its distributor for December sales until the following January. If the company only accounts for sales for which it has actually been paid then those sales would not appear on an accounting statement until the end of the following September. There are more significant delays on overseas sales. Most companies receive accountings from overseas licensees every quarter. For example, for sales between 1st October and 31st December the overseas licensee might account to the UK company in February. The sales will only appear on the artist’s royalty statement delivered at the end of the following September (nearly twelve months later). Some companies have even slower arrangements, partly for tax reasons. These companies might, for example, insist that all overseas licensees account to a particular group company which has a centralised accounting function. That company subsequently accounts to each of the other companies in the group. The artist should always check with his or her record company exactly how royalties are to be routed and what delays can be expected.

5.2 Reserves

Most record companies insist upon provisions enabling them to make reserves against returns. Although a particular royalty statement will disclose a given number of sales the record company will hold back the royalties in relation to a proportion of those sales in case the dealer returns some of the records. In the UK and in most overseas territories dealers are not usually allowed to return records unless they are faulty. In the case of the faulty record the record company must replace this and this should not impact upon the artist’s royalty. In the UK most distributors operate what is known as a 5% returns “privilege” (see paragraph 3.3). The dealer may return up to 5% of any unsold stocks. It would therefore seem unreasonable for the record company to make a reserve of more than 5% (although as explained in paragraph 3.3 it is theoretically possible for an artist to suffer returns of more than 5% under the privilege scheme). In fact, in practice, most record companies do not impose a reserve at all on account of any 5% returns privilege or similar scheme.

The issue of reserves assumes more importance in the case of records distributed on a sale or return basis. In some territories (notably the USA and Canada) most records are sold on a 100% sale or return basis. In the UK and other territories some records are distributed on this basis but usually only when there is a special campaign involved. Many companies insist upon the right to maintain a reserve of, say, 25%, but will agree that the reserve should only apply in the case of records sold on a sale or return basis. Most companies will agree that reserves should be liquidated either in the next accounting period (i.e. the reserve is then released after deducting any royalties in respect of records actually returned) or perhaps liquidated equally over two accounting periods.

Most UK record companies will accept that they may only impose reserves in respect of UK sales and that in the case of overseas sales the company will not impose any reserves beyond those imposed upon the company by its overseas licensees. It is prudent to insist upon the disclosure of the relevant details. The most important territory in this respect is the USA and Canada. The artist should ascertain what reserves the company’s North American licensee may impose against the company and over what period those reserves are to be liquidated.

5.3 Withholding Taxes

Most recording contracts include an express provision to the effect that the company may deduct from royalties and advances due to the artist any sums which the company is obliged by law to deduct by way of withholding tax. In the case of a UK company paying royalties to a UK resident no tax is required to be withheld so that withholding is generally only obviously an issue in the case of a record company and an artist situated in different territories. If withholding tax does apply then if a double taxation treaty is in force between the two territories then the artist should be entitled to a tax credit against his own taxation liabilities. A provision should be inserted to the effect that the company must give the artist all reasonable assistance in obtaining such credit (this assistance would involve the supply of an appropriate certificate of deduction and dealing with any queries raised by the revenue authorities). Sometimes, this will not be of any use to the artist because his tax affairs may be such that he has no (or insufficient) tax liabilities against which to set off the benefit of any tax credit. In those circumstances, if the record company has suffered withholding tax in respect of royalties received from its overseas licensees and has deducted a proportionate share of the withholding tax from the royalties payable to the artist but has then obtained the benefit of a tax credit the company should, in fairness, pay back to the artist a proportionate share of that benefit. In the case of some recording agreements, it may be worth the time and effort involved in investigating the record company’s overseas licensing structure in order to ensure that the artist will not suffer unduly from withholding tax problems. At best, the artist will secure a provision to the effect that any foreign withholding tax will be ignored for the purposes of calculating the artist’s royalties.

5.4 Audit Rights

Most record companies will offer the artist a right of audit. If not, then the principle of an audit right will never be resisted if the artist asks for this. However, the record company will seek to impose certain restrictions, so that, for example, audits may not be carried out more than once every, say, twelve months and may only be carried out by a reputable firm of chartered accountants. Most UK record company audits are carried out by one of the limited number of firms of accountants specialising in music industry royalty audit work. Every audit will of course be different but in the case of a relatively successful artist auditing a UK record company in relation to sales of records over a relatively successful period of say three years then, typically, perhaps two or three auditors will be involved for perhaps a week at the offices of the record company. They will then prepare a report and then spend more time with the record company in an effort to clarify any areas of confusion. Audits are therefore expensive. The auditors will normally try to spend only that amount of time which is likely to be justified by results but, typically, an audit might cost £5,000 to £10,000 or (in the case of a particularly successful artist where there have been numerous sales and where the amounts of money involved justify the accountants spending as much time as is needed) perhaps £15,000 to £30,000.

Some record company personnel seem still to interpret a request for an audit as an allegation on the part of the artist that there has been some form of financial irregularity but, more and more, it is accepted that it is merely sensible and prudent on the part of any successful artist to carry out regular audits. As we have seen, the accounting function is a complex one and mistakes (together with disagreements over points of interpretation of the relevant contractual terms) are therefore inevitable. The more enlightened record companies welcome regular audits. A successful artist should probably audit every two or three years (perhaps after each album cycle). The contract will usually state that all accounting statements are to be deemed accepted and no longer subject to any objection unless such objection is made within a specified period from when the statement was rendered (the period is usually two, three or perhaps four years). If the artist does not carry out an audit within the prescribed objection period then he (or his lawyer or accountant) should write to the record company and secure an extension. Most record companies will readily agree to this rather than put pressure on the artist to carry out an audit before the expiry of the objection period.

Most companies will accept that in the event of a discrepancy (but usually only if the discrepancy is say 5% or perhaps 10% or more of the sums properly payable) then the record company will reimburse the reasonable costs of the audit. In most cases the auditors will find a number of arithmetical errors which the company will readily accept and will also make a number of additional claims on behalf of the artist based upon how the contract should properly have been interpreted. Royalty auditors have a reputation for sometimes making some rather extravagant claims and, typically, the auditors will prepare a report detailing numerous separate heads of claim. The aggregate claim will usually be a substantial sum in excess of the 5% or 10% limit which may be specified in the contract as the amount of underpayment which triggers a liability on the part of the company to reimburse the audit costs. Accordingly, the report will include a claim not only for the aggregate unpaid royalties but also for the auditors’ fees. This is then followed by a sometimes protracted negotiation which will invariably result in the audit being settled on the basis of a round sum payment representing a fraction of the overall amount. If the settlement is higher than the amount of the audit fees then from the artist’s point of view the exercise will have been worthwhile. It usually is.