Canada: Crowdfunding receipts: Are they taxable?
21 August 2014
Posted by: Author: BDO Canada
Author: BDO Canada
Recently, it seems like social media has been touting a stream of crowdfunding stories where entrepreneurs have been wildly successful at raising huge amounts of money to fund commercial pursuits. For example, Pebble far exceeded its initial fundraising goal of $100,000, and went on to raise over $10 million to finance the production of the Pebble Smartwatch. And fans of Reading Rainbow, a favourite children’s TV show that began in the eighties, helped raise $5.4 million to fund the development of a web-based literacy application derived from the series. These and other successes have led us to wonder: has crowdfunding become a panacea for raising funds?
Although the stories reported by the media are exceptional, crowdfunding is catching on and is fast becoming a mainstream way to generate money quickly, while circumventing the need for traditional financing channels. But with this new approach to generating cash comes new questions, including those concerning the income tax implications of raising money this way. In this article, we will take a closer look at crowdfunding within the context of raising money to finance entrepreneurial pursuits. We will also discuss the Canada Revenue Agency’s (CRA’s) position with respect to the income tax treatment of crowdfunding receipts.
What is crowdfunding?
In its simplest form, crowdfunding is an innovative way to use the Internet and social media networks to connect those seeking financial backing with those that can provide funds. Generally, small individual contributions are received through Internet portals, or websites, and these contributions are pooled together to fund the project. Crowdfunding is used to raise money for a variety of purposes, in addition to start-up initiatives. For example, crowdfunding may be used to finance campaigns in support of charities, personal causes, art or media productions, and research projects. From a purely commercial standpoint, the intent and purpose of crowdfunding is to raise money for a start-up business while avoiding the often prohibitive costs associated with financing start-up ventures via traditional means (such as financial institutions, underwriters or venture capitalists).
There are several basic crowdfunding models:
Donation-based and reward-based models
True donation-based crowdfunding is rooted in altruism, where donors contribute to charities, election campaigns, or disaster-relief and the recipient pledges nothing in return other than a commitment to complete the project being funded. A variation of the donation-based model, called "reward-based crowdfunding”, can be used to fund start-up enterprises. A reward-based campaign allows those contributing funds to receive something in return for their pledge. A typical reward could include promotional products, advance order of product, or the receipt of some sort of exclusive item or content. Financial rewards are not typical, and the donor would not own any rights to the business or idea being funded.
This model of crowdfunding offers an alternative source for traditional lending. Lenders and borrowers enter into traditional loan agreements and there is an expectation that interest will be paid. There are other, less conventional, borrowing options as well. For example, the "pre-sales lending model” would allow for a loan to be repaid in the form of product. In this case, the contribution or loan would be equal to the fair market value of the finished product. As with donation-based crowdfunding, contributions under this model would not be considered an investment in the business and donors would not have any rights to the product or service being marketed.
Equity (or investment)-based model
Under this model, contributors invest in companies and receive equity in the company in return for amounts pledged. Currently, this form of crowdfunding is under consideration by Canadian securities regulators. To date, only Saskatchewan allows specific crowdfunding exemptions from existing provincial securities regulations. However, there appears to be a lot of impetus to move equity crowdfunding forward in Canada, so we are likely to see more of this type of investment being allowed in the future.
Are crowdfunding receipts taxable?
Since crowdfunding is a relatively new arrangement, very little has been issued by the CRA on this topic. In fact, it wasn’t until the later part of 2013 that the CRA issued its first technical interpretations giving guidance to taxpayers in respect of certain crowdfunding receipts.
In making its statements, the CRA restricted its comments to general guidance rather than to specific tax treatment. The CRA acknowledged that, based on the variety of crowdfunding models that can be used, amounts received could represent a loan, a capital contribution, a gift, income, or even a combination. In recognition of the fact that the terms and conditions of these types of arrangements may vary greatly, the CRA has indicated that it will ultimately make determinations on tax treatment on a case-by-case basis.
Despite this caveat, the CRA did provide some guidelines in respect of the treatment of receipts using the reward-based crowdfunding model. In its comments, the CRA indicated that receipts from a reward-based crowdfunding campaign would generally be taxed as income from carrying on a business. This may come as a bit of a surprise, as those who ran such campaigns may have assumed that the money they received was a gift and thus non-taxable. However, on the flip-side, the CRA did indicate that any expenses incurred in connection with the campaign, for the purpose of gaining or producing income from the business, would be deductible. Such expenses would likely include the cost to the business of providing the donor gifts, as well as any fees paid to undertake the crowdfunding campaign. As such, it is likely that a portion of the income from any receipts could be offset.
Some questions remain unanswered
Given the CRA’s limited comments with respect to the tax implications of crowdfunding, there are some other tax questions to consider. For example:
- How might crowdfunding receipts impact a project’s potential claim or eligibility for federal (or provincial) tax credits?
- Depending on the crowdfunding arrangement, what (if any) are the GST/HST implications?
- Would businesses who utilize crowdfunding sites to raise funds have additional internet business activity reporting requirements to the CRA?
- Would funding for the creation of a capital asset affect the determination of its capital cost?
In light of these types of questions, along with the increasing popularity of crowdfunding, we can expect to see more guidance provided by the CRA on this topic.
This article first appeared on bdo.ca.