What is crowdfunding?
Crowdfunding is a type of a finance model whereby the public are asked for contributions to a project, or business start-up. In view of how crowdfunding platforms work statistics for the amounts raised are difficult to assemble but government figures estimate that over £1.2 billion was raised for commercial projects in 2016 with the figures for 2018 expected to exceed these figures.
Rewards are offered to the contributor based on the level of investment.
There are three types of crowdfunding:
1) Donations (with or without rewards);
2) Debt; and
Donations are made by people who invest because they believe in the cause. In return, rewards may be offered. 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 of benefits and would need to fall below the relevant benefit limits.
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. Equally, no income or corporation tax should arise on a registered charity that receives a donation.
A payment of cash made with a gratuitous intent would be a potentially exempt transfer for the donor for inheritance tax purposes, although the sums for crowdfunding will normally fall under the £250 small gift limit or the £3,000 annual exemption. A gift to a registered charity would be exempt.
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.
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 Value Added Tax (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 the 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 unless:
1) They are items which are the trader’s trade to provide and are made for advertising purposes; or
2) 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.
When the crowdfunding is provided through debt, often referred to as peer-to-peer lending, the tax treatment depends on whether the lender is a company or an individual, with special rules for individuals.
Dealing first with companies, where the lender is a company the tax treatment of its debits and credits fall within the loan relationship rules. In practice this means that the tax treatment will follow broadly the tax treatment, with tax relief where a loan goes bad.
Where the lender is an individual the rules are somewhat more complicated;
• Peer- to – peer lending qualifies for the Personal Savings Allowance and the first £1,000 of interest earned by a basic rate (£500 for a higher rate) taxpayer is received tax free.
• Generally speaking borrowers should not deduct tax at source from interest payments.
• Interest only becomes taxable when received.
• Where a loan goes bad the capital loss can be set off against interest received on other peer – to peer loans.
• The relief is given “automatically” where the loss and the interest received relate to the same platform, otherwise the loss must be claimed .
• Where the interest received in the year of loss is insufficient to absorb the loss the loss can be carried forward a set against other peer- to – peer lending (but cannot be set against other income).
• Where peer- to peer loss relief does not apply capital gains loss relief for loans to traders may be available.
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 but will qualify for the tax-exempt dividend allowance (currently £2,000) and will in many instances have no tax cost.
On the disposal of the shares, a capital gain or loss will arise.
It used to be difficult to issue shares for crowdfunding under Enterprise investment scheme (EIS) because it required a minimum subscription of £500. However, this was abolished from 6 April 2012 to allow crowdfunding to qualify. Similarly, there is no minimum investment requirement for Seed Enterprise investment Scheme (SEIS).
Crowdfunding is a relatively new and exciting area of finance that raises a range of taxation issues. The receipt of donations by a business will almost inevitably give rise to taxable income and, although quite straightforward, is not a tax effective route. There are also VAT considerations.
Crowdfunding through debt is attractive and has become even more attractive with the peer-to-peer lending relief.
Crowdfunding through equity offers the tax reliefs of SEIS and EIS. The most suitable method will depend on the requirements of the recipient or business and should be undertaken with careful consideration.