Tax treatment of crowdfunding

This article discusses the tax treatment of crowdfunding and the issues for both investors and the recipient.

What is crowdfunding?

Crowdfunding is a form of finance model where the general public are invited to contribute. This can be to either a project, or a business start-up. A reward is usually offered to incentivise the contributor which is based on the level of their investment.

tax treatment of crowdfunding

There are several different variations of crowdfunding scheme. The tax treatment of crowdfunding will vary accordingly depending on the type of scheme involved. The person who provides the funds is known as the 'backer'. Whereas the recipient is known as 'the project'

Crowdfunding by donation

In this case the backer makes a contribution to the project with little or no expectation of receiving a return from the project. Therefore unless the project is a registered charity the backer receives no tax relief on their contribution. 

If the project is a charity then it may be possible to claim tax relief under gift aid. However if  a potential reward is offered to the backer (see above), tax relief might also be lost. Although this would depend on whether the donation is deemed to be tainted (see here).

Any contribution by the backer would also be treated as a potentially exempt transfer for inheritance tax purposes.

From the project's perspective there are two main tax issues to consider:

  • If a small reward is offered in return for the investment then this might be treated as a VATable supply. This view by HM Revenue  was determined in a recent tax case. Conversely if no VATable supply is made this may restrict any recovery of VAT on costs
  • Any contributions to the project may be regarded as trading income. The recent 'Lunar Missions' tax case referred to above springs to mind.

Crowdfunding by debt

Crowdfunding by debt is regarded as peer to peer lending. In the UK this is regulated by the Financial Conduct Authority. The tax treatment varies depending on whether the lender is an individual or a company.

If the lender is an individual then special rules apply for any interest payments - they fall in the remit of peer to peer leading. If the loan becomes irrecoverable then it may be possible to claim for a capital loss - see here.

Where the lender is a company then the tax treatment of any interest payments or loan write-off fall within the corporate loan relationship rules.

Crowdfunding with rewards

In this type of scheme the backer contributes in the expectation of receiving a reward. For example for a film this might be an exclusive invitation to the premiere. Any contribution in these circumstances is considered an advance payment for this reward. Some issues to be considered are as follows:

  • The contribution made by the backer is potentially VATable turnover. As the contribution is considered to be VAT inclusive, the registration date needs to be considered carefully. The rewards will also determine the timing of the supply and the effective date of VAT registration
  • Any contribution is considered to be VAT inclusive. Therefore, the net contribution will be the turnover for income or corporation tax purposes. 
  • There may be a timing difference between the backer's contribution and the receipt of the reward meaning income is deferred
  • Any tax relief due to the backer need to be considered. For example is any contribution made wholly and exclusively for the purposes of the backer's trade

Crowdfunding with equity

Crowdfunding by equity is regulated by the FCA. The tax treatment of crowdfunding in this case means it may be possible to obtain relief under the Enterprise Investment Scheme or Seed Enterprise Investment Scheme

If the shares become worthless or a sold at a loss it may be possible to claim capital gains tax or income tax loss relief.

Crowdfunding  - other issues

When there is a group of investors who pool their funds and a manager invests these on their behalf, this might create a Collective Investment Scheme. If not authorised or recognised by the FCA, it is regarded as an unregulated Collective Investment Scheme. 

Unregulated Collective Investment Schemes are illegal in the UK and there can be heavy fines for creating these in the UK.

For more useful information, check out our Ebooks here.

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