Key Difference – Working Interest vs Royalty Interest
Mining mineral wealth requires specialized technical and financial resources that are not owned by many landowners. Due to this reason, many landowners lease their property to a mining firm who has the necessary skills and capacity to extract resources such as oil and gas. The key difference between working interest and royalty interest is that while working interest refers to the right granted to a mining company to extract resources from a property in which case the landowner is responsible for the ongoing costs associated with mining operations whereas royal interest is a right where the landowner’s cost is limited to the initial investment.
What is Working Interest
Also referred to as ‘operating interest’, working interest refer to the form of investment where the owner is responsible for a portion of the ongoing costs associated with exploration, drilling and production of minerals on a cash or penalty basis. As a result, the owner receives a portion of profits (share of production) in case the mining operation becomes successful. The share of production can also be assigned to another party at the discretion of the working interest owner. The party granting the lease is referred to as the ‘lessor’ and the party to which the lease is granted is referred to as the ‘lessee’. The working interest’s share of revenue is the amount that remains after deducting the share of the royalty interest.
A working interest is usually created through a lease where the owner of the land leases the right to extract resources to an operator, generally a mining company. The lease is generally granted for a period of one to five years during which the mining company has the right to drill and extract resources. Once production is obtained, the lease remains intact as long as the production continues.
Most working interest income is treated as self-employment income, thus, will be taxed by the Internal Revenue Service (IRS). However, a portion of tax may be deductible since the landowner incurs operating costs.
What is Royalty Interest
This refers to the agreement where mineral rights are leased. In this arrangement, the rights are retained by the landowner when entering into the lease agreement with the energy company. In royalty interest, the landowner is not liable for ongoing operating costs since his contribution is limited to the initial investment. However, the owner is entitled to receive a share of the production income. Exploration, development of the property, production and mining is the responsibility of the energy company since the landowner is said to have a ‘non-working interest’. Monthly income is paid to the owners for as long as the property provides an economic benefit.
There are 3 main types of Royalty Interests as follows.
Landowner’s Royalty Interest
This is the landowner’s compensation for granting the lease. Presently this is considered to be 3/16th; however, this will vary depending on the level of production land concerned.
Nonparticipating Royalty Interest
The landowner does not share bonus, rentals from the lease or right to make decisions regarding the execution of leases.
Overriding Royalty Interest
This is the right to receive revenue from the production of resources, free of the cost of the production. The ownership will expire when the lease is terminated due to the end of production. Unlike in royalty interest, the owner of an overriding royalty does not own the minerals under the ground, only proceeds from the production of minerals
Landowners’ specific rights are broken down in the leasing contract. Lease conditions often depend on the amount of land leased, nearness to proven wells and competition among producers. In addition, a lease typically gives a drilling company rights to use the surface land for production. However, it must clean up the property or pay damages at the end of the term.
What is the difference between Working Interest and Royalty Interest?
Working Interest vs Royalty Interest
|Working interest grants the right to a mining company to extract resources from a property where the land owner is responsible for the ongoing costs associated with mining operations.||Royalty interest grants the right to a mining company to extract resources from a property in which case the landowner’s cost is limited to the initial investment.|
|Involvement in the Production|
|Working interest owner actively takes production decisions.||Royalty interest owner has no right to be involved in production decisions.|
|Working interest owner can deduct intangible drilling and development costs.||Intangible drilling and development costs are not tax deductible by Royalty Interest owner.|
Summary – Working Interest vs Royalty Interest
The main difference between working interest and royalty interest remains with the initial and ongoing contribution by the land owner. If the land owner only contributes with initial capital, it is classified as a royalty interest whereas if the landowner continues to inject ongoing capital it is named as a working interest.
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