James Bailey warns businesses seeking finance through ‘crowdfunding’ to be aware of the tax implications.
In the last few years, there has been a massive increase in the use of crowdfunding to raise capital for small business enterprises.
How does it work?
‘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 online phenomenon, with specialised websites offering exposure in exchange for a fee.
In many cases, the investors are in the position of lenders, and receive interest and have a timetable for repayment, or they become owners of some of the equity in the business, usually in the form of shares and quite often, these shares will themselves qualify for tax relief under the enterprise investment scheme or its more generous little sister, the seed enterprise investment scheme.
At the smaller end of the scale, however, the investors get nothing in return beyond the satisfaction of contributing to something they approve of and want to feel a part of.
In some cases there is a further reward, such as a mention on the recipient’s website, or in its literature, or (in the case of a struggling pop group) on the DVD or album cover.
None of this need cause a problem – the rules for debt and equity are well known, and the tax implications for creditors and shareholders are clear. The same applies to what might be called ‘personal’ crowdfunding where the money is being raised for personal reasons – to fund treatment for a sick child, for example, or to raise donations to a registered charity.
Taxable transactions?
Some crowdfunding offers, however, give something in return for the money donated to them. It may be tickets to a concert or a play, or a sample of the goods produced by the fundraising entity.
I fear this may be another example of tax law not fitting well with modern society. There was a time when it was widely (and wrongly) believed that buying and selling over the internet was a sort of hobby, and not a taxable trading activity. Obviously, the giants such as Amazon were taxable (at least to some extent!) but Mr Jones in his front room with his laptop somehow thought he was not really in business. It was, I think, the novelty of the medium that confused people – if Mr Jones had rented a shop for his buying and selling, he would have thought of himself as a dealer in goods, and taxable on his profits.
If a business raises money through crowdfunding, and in return gives its funders goods or services in return, it is difficult to see how this could fail to make the ‘donation’ taxable income for both direct (income or corporation) tax and indirect (VAT) tax.
People are confused because the motive for the donation may not be to acquire whatever is offered in return, and as a ‘donation’ it is entirely voluntary. Unfortunately, there is good case law to support the proposition that if a trader receives a voluntary donation towards its business expenses, the donation is a taxable receipt of the trade.
Where the donation leads to a ‘gift’ of goods or services, the position is even clearer. A trader has received money, and in accordance with the terms offered on the crowdfunding website, the trader gives the payer its services or some of its trading stock. In what way is that not a trading transaction?
Practical Tip:
If you decide to raise money for a business through crowdfunding, make quite sure you are aware of the tax implications, and avoid an unexpected bill for income tax, corporation tax, or VAT.
