In order to raise money, crowdfunding has become one of the most popular ways for UK businesses. Whether it is launching a new product, expanding operations or testing new ideas, crowdfunding has proved to be beneficial for small businesses and startups in the UK.
Since businessmen focus primarily on crowdfunding campaign success, they often overlook taxes applied on it.
Understanding crowdfunding tax implications is necessary, since not all funds raised are tax-free. Your tax responsibilities vary depending on the type of crowdfunding, whether it is donation based, reward-based, equity, or debt.
In this article, we will talk about crowdfunding and its tax implications for the UK businesses, its types, and reporting processes.
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What Is Crowdfunding?
Crowdfunding is a method of raising capital for a project or business by collecting small contributions from a larger number of people. It is typically done through online platforms.
Entrepreneurs or individuals use online platforms to advertise their venture and gather funds from a wide range of people.
Its goal is to secure financial backing for a new product, service, business, or personal project.
Types Of Crowdfunding And Tax Implications
There are four main types of Crowdfunding and each type has different tax implications
1. Equity Crowdfunding
Funds raised by issuing shares are treated as capital for the company, not as taxable income.
- For the business: The money you receive is not subject to income tax or Corporation Tax.
- For the investors: They may be liable for Capital Gains Tax (CGT) if they sell their shares for a profit. Tax relief schemes like the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) can also be relevant.
- FCA Regulation: Platforms that offer equity crowdfunding are regulated by the Financial Conduct Authority (FCA).
2. Reward-Based Crowdfunding
In this model, contributions are essentially pre-sales of goods or services.
- Taxable Income: The funds raised are considered taxable income and must be reported in your business’s annual accounts.
- VAT: If your business is registered for VAT or your income pushes you over the threshold, you must account for VAT on the value of the rewards provided.
3. Debt-Based Crowdfunding
This is where you borrow money from the crowd.
- Loan Repayments: The funds received are a loan and are not treated as taxable income.
- Interest Payments: The interest you pay to lenders is an allowable business expense and can be deducted for Corporation Tax purposes.
- VAT: The act of lending money is an exempt supply, so it is not subject to VAT.
4. Donation-Based Crowdfunding
This involves receiving money with no financial return expected.
- No Taxable Income (for non-commercial purposes): For a business, donations are generally not taxable income, provided there is no expectation of a reward or financial return. Small, symbolic rewards like a mention on a website typically do not change this status.
- Potentially Taxable (for commercial purposes): If your business receives donations that are used for a project that generates commercial income, HMRC may view them as taxable business income.
- Gift Aid (for charities): If your campaign is for a registered charity, Gift Aid may apply. This allows the charity to reclaim an extra 25p for every £1 donated by UK taxpayers.
Is Crowdfunding Regulated In The UK?
The Financial Conduct Authority (FCA) actively regulates investment-based and loan-based crowdfunding, which are considered high-risk financial activities.
Donation-based and reward-based crowdfunding are not regulated by the FCA because they are not considered financial investments. However, the payment services used on these platforms are regulated.
What Are the Advantages Of Crowdfunding?
Following are the advantages of crowdfunding:
- A successful crowdfunding campaign validates market demand for your product and raises awareness.
- Crowdfunding can provide access to funds for businesses that might struggle to secure traditional loans due to lack of credit history.
- It helps build a community of supporters and engaged investors who are emotionally invested in your project’s success.
- Some crowdfunding types, like rewards, or donation-based, do not require you to give away equity or make regular interest payments.
- You get full ownership of your company, with reward-based, donation-based, or debt-based crowdfunding.
What Are the Disadvantages Of Crowdfunding?
Where there are advantages, there are also disadvantages of crowdfunding:
- If you fail to meet your fundings, you receive nothing. Even if a project is successful, many startups fail, leading to a total loss for investors.
- Running a successful campaign consumes significant time and effort. Thus, diverting focus from other business aspects.
- Your idea is public, so there is a high chance of risk theft. Competitors can copy it, resulting in damaging your brand’s reputation.
- There are fees charged for crowdfunding platforms. It is usually a percentage of the capital raised. Also there are additional costs for producing and delivering rewards.
How To Report Crowdfunding Income?
Firstly, determine the funding type, whether you are receiving rewards, debt, or equity.
1. Rewards-Based
- Treat the funds as revenue from a pre-sale of goods and services.
- Record this revenue in your financial statements.
- Calculate and account for VAT on any associated rewards, if you are VAT-registered.
2. Debt-Based
- Interest payments on a loan are subject to loan relationship tax rules.
- The principal amount received from the loan is not considered as income.
3. Equity-Based
The funds raised from selling shares are treated as capital and are not subject to income tax or Corporation Tax.
Investors may be liable for Capital Gains Tax (CGT) on any profits when selling their shares. They may also be able to claim tax relief schemes like the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS).
Considerations When Reporting Crowdfunding Income
Following considerations should be kept in mind when reporting crowdfunding income:
1. For rewards-based campaigns
- The money you receive is usually treated as income, just like sales from a normal shop, so it is taxable.
- If your total income goes over the VAT threshold, or if you are already VAT-registered, you must pay VAT on the value of the rewards you give out.
2. For donation-based campaigns
- Donations are not normally taxable for a business if they are a pure gift with no strings attached.
- But if the donations are used for a commercial project that will earn you money, HMRC might count them as taxable income.
3. For debt-based (loan) campaigns
- The money you get is a loan, so it is not taxable income.
- The interest you pay to your lenders, however, is a business expense that you can usually claim back against your tax.
4. For equity-based campaigns
- For your company, the money raised from selling shares is seen as capital and is not taxed as income.
- For your investors, they might have to pay Capital Gains Tax if they make a profit from selling their shares. There are also special tax relief schemes, like SEIS and EIS, that could apply.
What Risks Businesses Face With Crowdfunding?
Tax implications of crowdfunding vary depending on the type of campaign. Therefore it faces certain risks, like failing to meet a funding target, potential damage to your reputation, and the loss of intellectual property. They are explained in detail below:
1. Failure To Meet Funding Target
Since most of the platforms operate on an all “all-or-nothing” model, all pledged funds are returned if the target is not reached. This can lead to public embarrassment.
2. Damage To Reputation
Since the campaign process is highly public, a failed campaign that fails to deliver on promises can harm your brand and public image.
3. Underestimating Costs And Resources
The time and resources required for planning, marketing, and managing a campaign are often underestimated. This diverts your attention from core business activities.
4. Hidden Fees
Crowdfunding platforms charge fees. It is typically a percentage of the amount raised. The payment processing fees and other costs can reduce the net amount you receive.
5. Potential For Fraud
Fraudulent activity can damage and target the crowdfunding landscape. This can lead to loss of trust among backers. In order to mitigate this, businesses must choose a reputable platform.
Bottom Line
Crowdfunding can serve as an excellent way for UK businesses to access capital and build company support. Understanding the crowdfunding tax implications is necessary to avoid costly mistakes.
Keeping accurate records, and reporting income correctly is necessary to ensure your crowdfunding success doesn’t burdenise you later.
Knowing how crowdfunding tax implications work allows you to plan ahead, and stay compliant to grow your business confidently.
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Disclaimer: All the information provided in this article on Crowdfunding and Its Tax Implications for UK Businesses
including all the texts and graphics, is general in nature. It does not intend to disregard any of the professional advice.