Crowdfunding: Tax issues

What is crowdfunding? What are the tax issues relating to crowdfunding?

This is a freeview 'At a glance' guide to crowdfunding and tax issues.

Crowdfunding is a type of finance model whereby the public are solicited for contributions to a project, or business start-up. Rewards are offered to the contributor based on the level of investment.

We have separate guides on the related topics of Interest: Peer-to-peer lending and the Innovative Finance ISA & crowdfunding.

At a glance

There are a number of types of crowdfunding. In this note, the person providing funding is referred to as the 'backer' and the recipient as the 'project'.

1. Donations

• The backer makes a contribution to the project with little or no expectation of anything in return.
• Unless the project is a charity, no tax relief is available to the backer. If it is a charity, Gift Aid can be claimed, providing the relevant conditions are met. Note also that relief can be lost if a benefit is provided to the backer, with the limit depending on the amount of the donation.
• From an Inheritance Tax (IHT) perspective, the contribution is likely to be a potentially exempt transfer. See IHT: Transfers of Value. It is possible that the contribution would be exempt from IHT, if it fell within the annual exemption or small gifts exemption, see IHT: Gifts.
• From the project’s perspective, the treatment depends on what the funds are to be used for. In any case, if no supply is being made no output VAT arises, however, this may impact on the recoverability of input VAT.
• Strictly, a small reward, such as a newsletter or badge would constitute a supply for VAT, but HMRC will allow an acknowledgement in a list of donors, annual report or similar or by means of a badge or certificate to be ignored.
• The contribution may, however, still constitute trading income. While no cases on crowdfunding yet exist, there are a couple of other cases that seem to provide guidance on the courts’ view, though they may be a bit dated.
  • In CIR v Falkirk Ice Rink Ltd [1975] STC 434, a club gifted £1,500 to the ice rink in order to ensure it could continue to provide curling services for which it charged the public. The Commissioners held that this was a trading receipt.
  • Wing v O’Connell [1927] IR 84 related to an unsolicited gift made to a jockey when he won the Irish Derby. This was held to be taxable as it was made “for successfully accomplishing the object of his professional engagement”.

2. Rewards

• The backer makes a contribution with the expectation of receiving a special reward.
• The contribution is considered an advance payment for the reward.
• On first principles, a supply is being made. This means that the VAT position needs to be considered and, if VAT is due, any contribution will be deemed to include output VAT. The VAT treatment will follow the liability of the goods or services provided. The rewards themselves will also determine the Time of supply and may affect the VAT registration date. See Lunar Missions Limited v HMRC [2018] TC06286.
• The net contribution will be turnover for Income Tax or Corporation Tax purposes (whichever is relevant, depending on the legal identity of the project), though the actual timing difference between receipt of contribution and dispatch of reward may mean the income is deferred.
• The backer treats the contribution as a payment in advance. Whether any tax relief is available will go back to first principles; i.e. is the reward capital or revenue in nature? Is the expenditure Wholly and Exclusively for the purposes of the backers’ trade? etc.
• There is a high likelihood that the contribution and reward will fall into different accounting periods so GAAP will treat the contribution as a prepayment. For VAT purposes, the tax point needs to be considered. See Time of supply.
• Where there is a large disparity between the amount of contribution and the value of the reward further issues may arise. The reward could be considered a Business gift so potentially the cost of providing the reward could be disallowed for the project. If the contribution is higher than the value of the reward, there may be an element of donation for the backer.

3. Debt

• Crowdfunding by debt is peer-to-peer (P2P) lending.
• In the UK, this is regulated by the Financial Conduct Authority (FCA).
• If the lender is an individual, special rules apply for interest see Interest: Peer to peer lending. In the event that the loan becomes irrecoverable Capital Gains Tax Loans to traders relief may be available if the loan is made through a regulated UK platform.
• Where the lender is a company, the tax treatment of its debits and credits fall within the Loan Relationships rules.
• Where the project is charitable (including a Community Investment Company or Community Benefit Society) Social Investment Tax Relief (SITR) may be available, although SITR closed to new investments from 6 April 2023.

• For VAT purposes the lender is granting credit in the form of a loan and will receive interest in return. The value of the supply is the gross interest or other sum received and not the repayment of the loan. The interest received is the consideration for an exempt supply of credit.

4. Equity

• Crowdfunding by equity is as with any other equity investment; the only difference is how investors are identified or located.
• Crowdfunding by equity is regulated by the FCA.
• Tax relief on equity investment may be available under the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).
• In the event that the shares become of a Negligible value or are sold at a loss, Capitals Gains Tax (CGT) or Income Tax Loss relief may be available.

• Following the decision of the ECJ in Kreztechnik, the issue of shares and securities by the business to investors will not be a supply for VAT purposes provided the purpose of the issue is to raise finance. Where there is a sale, transfer of or trading in existing shares in the course of a business, it is exempt under item 6 Group 5 schedule 9 VATA 1994.

 Pitfalls

• When a group of investors pool their funds and a manager invests these, they may create a Collective Investment Scheme. If such a scheme is not authorised or recognised by the FCA, it is considered an Unregulated Collective Investment Scheme (UCIS).
• UCISs are illegal in the UK: there can be heavy fines for creating a UCIS in the UK, see Accountants' scheme stopped by FSA.

Reward funding example

A project to create a new boardgame: a backer would receive tiered benefits based on their investment in the project:

The £10 level is effectively a donation; the acknowledgement is unlikely to be treated as a supply for VAT.

It is clearly a trading receipt for the project.

A suitable backer might be able to produce an argument that this is an advertising cost. HMRC seem unlikely to accept this approach.

The higher levels are rewards. A supply is clearly being made, so the contribution will potentially need to include VAT, and the project will need to treat the net contribution as trading income. The backer has made a prepayment for the products to be supplied and could theoretically claim a deduction and recover input VAT under general principles.