Crowdfunding is a new way to raise money; however, be careful of the tax implications.
One of the latest means of raising money to start a new business, raise operating funds, or tackle costly research and development projects is to make a broad-based appeal for funds with crowdfunding.
Crowdfunding is not new; it was used in the nineteenth century, especially in small communities, to fund local projects through subscription. For example, the monumental base for the Statue of Liberty was financed by a New York newspaper that gathered small donations from 160,000 donors. More recently, it has been used to fund tours of rock bands, and to produce movies, video games and inventions.
Social media have expanded the use of crowdfunding. Social media make it possible to reach a large audience that might be willing to make personal contributions for families with unmanageable medical bills or to help needy individuals recover from catastrophic personal financial loss.
Why crowdfunding is so beguiling is anyone’s guess, but its success cannot be understated. In 2013, an estimated $51 billion was provided to crowdfunding appeals around the globe.
Crowdfunding and Business
Business entrepreneurs have also discovered crowdfunding as a new means of raising funds because it creates an alternative to traditional financial institutions. Further, the receipt of funds from complete strangers through crowdfunding removes the need for a business to provide the donor with shares, a promissory note, or to pay interest or dividends. At first blush, the recipient might think crowdfunding income meets all of the criteria of a windfall.
Crowdfunding is treated as income and therefore is subject to tax.
Not a Windfall
Because funds raised through crowdfunding are not a windfall or gift, they are treated as income and thus, are subject to income tax.
According to Dec. 9, 2014, Income Tax Folio S3-F9-C1, Lottery Winnings, Miscellaneous Receipts, and Income (and Losses) from Crime, the CRA states that crowdfunding is a taxable benefit. As a starting point, the income tax folio states:
1.5 However, sometimes individuals receive a voluntary payment or other valuable transfer or benefit by virtue of an office or employment from an employer, or from some other person. In such cases, the amount of the payment or the value of the transfer or benefit is generally included in employment income pursuant to subsection 5(1) or paragraph 6(1) (a). (See also Guide T4130, Employers’ Guide — Taxable Benefits and Allowances.) Similarly, voluntary payments (or other transfers or benefits) received by virtue of a profession or in the course of carrying on a business are taxable receipts.
The Folio continues with an example specific to crowdfunding:
Assume a business uses crowdfunding as a method of raising funds for the development of a new product and the contributors do not receive any form of equity. The amounts received by the business would be included in its income pursuant to subsection 9(1).
Subject to Tax
Whether the business organizational structure is a proprietorship, a partnership or a corporation, funds received from crowdfunding are subject to tax. If, as part of the crowdfunding activity, consideration is provided in the form of thank-you plaques, pens, T-shirts, etc., then these costs are deductible expenses. In addition, many campaigns raise money for a particular purpose. If spent for that purpose, little or no taxable income may result. If one also considers that financing costs are minimized along with the need for debt repayment and perhaps personal guarantees for the borrowed money, the income tax cost, if any, may not be onerous.
Some entrepreneurs want to use crowdfunding to raise equity capital. Securities regulators of British Columbia, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia have implemented or expect to implement registration and prospectus exemptions that will enable start-ups and early-stage companies to do just that. Companies will be allowed to raise up to $500,000 in a year through approved Internet funding sites. No more than $250,000 of this can be raised in one offering, however. No individual can invest more than $1,500 per distribution. People will have the right to withdraw their money within 48 hours. Ontario has decided to develop separate standards. As would be expected, funds raised through an equity issue are not taxable to the recipient company, but any dividends or capital gains received by the contributors will be subject to income tax.
Be Aware of the Tax Implications
Raising money through crowdfunding, whether for operational, developmental or equity issue, is a relatively new means of raising funds and many budding entrepreneurs may not realize the tax implication of receiving crowdfunding money. For businesses or corporate entities considering using crowdfunding as a means of generating operating capital, it would be wise to consult your chartered professional accountant to determine the amount of tax for which they may be liable.
Dami Okunade CPA, CA, CFA