Crowdfunding and Taxation
In the last few years, there has been a massive increase in the use of Crowdfunding to raise capital for small business enterprises. Crowdfunding works on the principle of finding large numbers of small investors, in contrast to the traditional method of finding a small number of large investors or a bank loan. Typically, it is an internet-based vehicle for raising money, with specialised websites offering access to their platform in return for a fee. On websites such as kickstarter.com, and Indiegogo.com, “creators” or initiators of a fundraising campaign seek contributors or “backers” to finance their projects. Other sites such as gofundme.com or causes.com, feature fundraisers for personal or charitable endeavours.
There are three types of crowdfunding: Debt, equity and donations (with or without rewards).
When crowdfunding is provided through debt, often referred to as peer-to-peer (P2P) lending, the tax treatment will generally follow that of any other debt. The lender is taxed on the receipt of interest and the borrower, assuming it is a business, normally receives a tax deduction for the interest payable but peer-to-peer lending benefits from other rules.
For investments made through platforms authorised by Financial Conduct Authority, interest payments made after 6 April 2017 are not subject to the usual deduction of tax at source regime (ITA 2007 s888E). This is good for regulated investing but not ‘friends and family’ situations, where income tax at basic rate would need to be deducted. However, the requirement to deduct tax only applies to ‘yearly’ interest. This is generally interpreted to mean interest on a loan of more than 12 months duration. HMRC manuals state that it is the intention of the parties that determines whether a loan is classified as being for more than 12 months although it is likely HMRC would need a lot of convincing that the loan was intended to have a term of less than a year.
If a business fails and a loan becomes irrecoverable income tax relief is provided by offsetting the loss on the principal amount of the loan – to the extent it has not already been repaid or assigned – against interest income received, both on the irrecoverable loan and other peer-to-peer loans made through the same platform. The relief is automatic when loans become irrecoverable after 6 April 2016 but require a claim for the prior year.
Any unrelieved loss can be offset against interest arising on other peer-to-peer platforms or carried forward and offset against interest receipts of the next four years. Subsequent recoveries would be treated as income in the year of receipt and taxed in the usual way.
These rules help the more professional investor but more informal investors will have to look to claiming a capital loss under TCGA 1992, s253.
Funds can also be raised by issuing equity. The tax issues are generally the same as those of most other equity investments. Dividends received by a UK resident individual will normally be subject to income tax. On the disposal of shares, a capital gain or loss will arise. It also offers the opportunity to issue shares under EIS and SEIS and benefit from the consequent tax reliefs. There was a recent boost to this funding route as changes to the EU’s 2003 Prospectus Directive (effective 21 July 2018) meaning UK companies can raise €8m without the need for publishing a costly prospectus. This should allow individuals to make small investments in early-stage companies via online systems.
Crowdfunding has grown rapidly and in 2017 accounted for as many seed (early-stage) equity deals as the private equity industry, according to a report by the British Business Bank, a state-owned wholesale lender. The Bank found that each sector accounted for 30% of seed stage deals. There was an 11% year-on-year increase in the number of crowdfunding deals of all sizes to 350, out of 1,487 total deals. The average amount of equity raised via crowdfunding has increased from £2.2m per deal in 2013 to £4.9m in 2017.
Donations are made by people who invest because they believe in their cause. In return rewards may be offered, such as acknowledgement in a rock band’s cover, tickets to an event, regular news updates, free gifts and so on. A donation will generally not be tax deductible for the donor. The exception is where the donation is made to a qualifying charity under gift aid. In this case any reward to the donor could be deemed a return on benefits and would need to fall below the relevant benefit limits (ITA 2007, s418).
The taxation consequences for the recipient are more problematic. A voluntary receipt would not normally be subject to income or corporation tax when received in a personal capacity. If crowdfunding were used to fund an operation for a sick child, such money would not be taxable on the recipient. Equally no income or corporation tax should arise on a registered charity that receives a donation.
The position is less attractive when the funds are being raised to finance business activities. In that case, the question of whether the voluntary payment is a receipt of the trade must be considered. E.g. if a rock band raises money from its fan base to fund the recording of an album, the money paid, in effect, is an advance payment for the album, which the supporters obtain without any further payment. This must be a taxable receipt. The position depends on the facts, but case law gives some guidance.
When there is a reward for the payment, the situation becomes more complex. First, could the business in effect be selling goods or services to the “supporter” rather than simply receiving a donation? This is a problem for direct tax and VAT. Each case is different and it is important to review precisely what has been agreed between the business and its supporter. The likelihood is that, if goods and services are provided in return for a donation, this is a supply for VAT and a trading receipt for income and corporation tax purposes.
If the gift is one of goods from the business to the donor, the relevant income and corporation tax disallowance for business gifts should be considered. The gifts will be disallowable (ITTOIA 2005 s45 to s77) unless:
They are items which are the trader’s trade to provide and are made for advertising purposes; or
They incorporate an advertisement for the trade and do not consist of food, drink, tobacco or a voucher exchangeable for goods and the cost to the trader of all such gifts to the same person in the same period does not exceed £50.
It is also necessary to consider the position if the value of the reward is greater than the consideration received but this is unlikely under most crowdfunding cases.
Another issue is the impact the supporters’ place of residence and/or their business or non-business status will have on the VAT treatment of any supply.