Royalties on a patent or amortization of the cost of purchasing a patent or patent rights necessary for the proper performance of the contract and applicable to contract products or processes are allowable unless:
- the Government has a license or the right to a free use of the patent;
- the patent has been adjudicated to be invalid, or has been administratively determined to be invalid;
- the patent is considered to be unenforceable; or
- the patent is expired.
Attempting to determine whether the Government has a license or right to a free use of a particular patent is often times difficult and there are frequent disputes between the Government and patent holders as to the Government's rights. The Government is usually aggressive in asserting its rights, especially when it feels that it has already contributed to the value of the patent.
Auditors are often concerned about the costs of royalties when there is not an arms-length transaction involved. They are especially attuned to royalties paid to persons, including corporations, affiliated with the contractor, paid to unaffiliated parties, including corporations, under an agreement entered into in contemplation that a Government contract would be awarded, and paid under an agreement entered into after the contract award.
In cases where a patent was formerly owned by the contractor, the royalty amount allowed cannot exceed the cost which would have been allowed had the contractor retained title. Acquiring records to support the costs that would have been allowed is usually problematic for contractors. The auditor's going-in position is usually zero dollars.