By Lynne Gowers on 24th May 2017

A Guide to Crowdfunding and Taxes

Crowdfunding has become something of an online phenomenon of our age. It works on the principle of securing financial backing from large numbers of small investors, rather than relying on injections of capital from larger investors or a bank loan. The practice has been growing in momentum in recent years, with a number of dedicated websites popping up offering entrepreneurs opportunities to secure funding, and everyone else the opportunity to invest in those businesses.

Investments can be as little as £10 (or less) or even just a small reward, such as the chance to try the product exclusively before it’s launched, or trial it as it’s being developed.

It can be an attractive idea to those who have big dreams but lack the financing to bring them to fruition. However due to the nature of crowdfunding and its sudden boom in popularity, the taxation of income generated this way is complicated.

There are a few different models when it comes to crowdfunding. These can be summed up as the following:

  • Reward Based

This is where the backer receives a sort of reward or gift of small value, in a similar vein to a donation. In this model, the backer makes a pledge, usually in the form of pre-authorisation through Paypal.
Once the fundraising target has been reached (unless it’s a part-funding model) all monies are deducted from investors’ bank accounts via Paypal, with the platform taking its commission (typically around 5%).

  • Loan Based

The backer will get a return on their money, with the amount subject to variations in interest rates. This model is a lot like getting a loan from the bank, except you get your funding from a crowd of people, and it is on your terms, not a bank’s.

  • Equity Based

Investors can buy equity in the business. Huge returns are possible if you pick the next Twitter or Facebook. Failure, however means your entire investment could be lost, so this can be risky.

In an equity based model, individual investors, if based in the UK, normally want to benefit from tax relief, which is dependent on the company being registered for EIS (Enterprise Investment Scheme), where tax relief is 30% or SEIS (Seed Enterprise Investment Scheme) where it is 50%, up to specified investment limits.

  • “Micro-financing” or Peer-to-Peer lending (P2P)

People contribute with the intent to create a pool for all to borrow against. This model has been popular in many countries for years, where banks loans are not available, via sites such as LendingClub and Kiva.

It’s high risk, but the appeal is in the ability to get small loans easily and potentially excellent returns from the interest.

Let’s talk taxes

Back in the day, it was wrongly believed that buying and selling over the internet was just a hobby, not a serious trading activity (in terms of taxable income). Of course the big players running the show –  Amazon and eBay – were taxed appropriately. But Mrs Adams, sat in her front room selling hand-knitted socks for cats with just a laptop and a lot of spare time was not inclined to classify herself as a “real” business.

Perhaps it’s the virtuality of the internet that confuses people. If Mrs Adams set up The Dapper Kitty’s Hand Knitted Boutique on her local high street, she’d be more likely to consider herself as a bona fide business person with taxable profits.

It’s the same with crowdfunding. If a business raises money through crowdfunding, giving its funders goods or services in return, it’s hard to see how this wouldn’t make the ‘donation’ taxable income for both direct (income or corporation) tax and indirect (VAT) tax.

While the donation may be completely voluntary and might not be to gain whatever’s offered in return, the law says that if a trader receives a voluntary donation towards their business expenses, it’s a taxable receipt of trade.

If the donation results in an exchange of goods or services – even as a “gift” –  the position is even clearer. The trader has received money and then gives the payer its services or some of its trading stock. This is a trading transaction.

In a lot of cases, the investors are in the position of lenders. They’ll receive interest and have a repayment plan, or they’ll hold some kind of equity in the business, usually in the form of shares. These shares will often qualify for tax relief under the enterprise investment scheme, or the seed enterprise investment scheme.

On a smaller scale, some investors may get nothing in return but the good feeling of contributing to something they find interesting and want to feel a part of. In some cases there might be a further reward –  perhaps a mention on the business’s website.

None of this needs to cause a problem;  the rules for debt and equity are clear, and the tax implications for creditors and shareholders are well known. The same rules apply to ‘personal’ crowdfunding efforts, to fund treatment for illness or to raise donations to a registered charity for example.

Been involved in crowdfunding, and not sure where you stand tax-wise?

Whether you are a business being funded in this way, or an investor, the team at Boox can give you all the help and advice you need.

Ask us about our awesome accounting software

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Lynne Gowers Written by Lynne Gowers

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