Crowdfunding is an increasingly popular way for people to raise funds. Typically facilitated through online crowdfunding platforms, this new way of reaching out to donors or investors is a great way to raise money for a new business or innovative product and can also be used to facilitate donations to good causes.
Because the business model is fairly new, the tax rules are a little hazy to say the least and it’s easy to get it wrong when you come to prepare your annual tax return.
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To help you avoid a tax headache, we’ve put together a guide to crowdfunding and tax.
Here’s everything you need to know.
The four main types of crowdfunding
The ATO has identified four main types of crowdfunding, each based on a different business model and each with potentially different tax consequences for those involved.
1. Donation-based crowdfunding
This is where a contributor makes a payment (or 'donation') to the project or venture, without receiving anything in return. The contributor's 'donation' may simply be acknowledged – for example, on the crowdfunding website.
2. Reward-based crowdfunding
This is where the promoter provides rewards (such as goods or services) to contributors in return for their payment. For example, the contributor may receive merchandise or a discount. In many cases, there are different levels or types of reward, according to the amount of contribution and whether the fundraising reaches the prescribed levels.
3. Equity-based crowdfunding
This is where the contributor makes a payment in return for a share (or equity interest) in the company undertaking the project or venture. The share in the company gives the contributor the right to share in future profits through receiving dividends as well as voting rights at board meetings, and rights to returns of capital upon winding up.
4. Debt-based crowdfunding
This is where the contributor lends money to the promoter who, in return, agrees to pay interest and repay principal on the loan.
Who are the participants in a crowdfunding arrangement and what are their tax implications?
In all the business models above, there are three participants in the crowdfunding arrangement:
The initiator of the project or venture or the campaign creator (who may act in a personal capacity or operate through a company or organisation) is known as the "promoter".
The income received by promoters in a crowdfunding arrangement may be taxable depending on the nature of the funds and the way in which they are received. This will often be the case where promoters receive funds under a donation-based or a reward-based arrangement where the funds are used to develop a new business or a new product to be used in an existing business.
The ATO gives an example of the sort of situation where funds may be assessable income to the promoter:
ATO example one: The Boiliz kettle
Liz has invented a new method for boiling water which is about 10 times faster than the common kettle. Liz’s prototype ‘Boiliz’ kettle cost her $45,000.
She estimates that, if she can produce approximately 10,000 kettles and they are all sold at $80 each, she will break even.
Although this would include buying some new machinery and hiring contractors, she decides to attempt this production.
Liz establishes an incorporated entity called Boiliz Pty Ltd (she is the only shareholder/director) and hires a financial adviser to manage her accounts.
Liz engages an intermediary to establish a project on its crowdfunding platform to obtain her funding. The intermediary charges Boiliz Pty Ltd 4.5% of all funding as a fee.
The Boiliz crowdfunding project has the following parameters:
Contributors can pledge from a minimum of $80 to a maximum of $1,000
Each contributor is guaranteed one Boiliz kettle (regardless of the amount pledged), delivered to them within 24 months of the end of the project
The target is $80,000 (under which she would receive nothing), however there is no upper limit on the funding,
The project will run for three months.
The project goes viral and receives $750,000 from contributors.
In this example, the $750,000 received from the crowdfunding project is assessable income of Boiliz Pty Ltd since the company is carrying on a business.
This contrasts with promoters who offer equity or debt based investment in their structure.
Equity investment is a capital injection which forms part of the share capital of the underlying venture and isn’t assessable income. Any returns paid in the form of dividends are also not deductible. Under a debt based arrangement, funds received are not assessable income but returns to investors, in the form of interest payments, will often be tax deductible.
ATO example two: Software application
Rajit Industries are IT developers and consultants who are in the process of developing a new computer software application to help consumers find tradesmen to perform work at their home or workplace.
They want to develop the app further and make it commercially available, but they do not have sufficient funds.
They approach a crowdfunding platform to help raise the $30,000 needed to drive development and as part of the crowdfunding arrangement, contributors are invited to loan funds for which Rajit agrees to pay interest and repay the principal.
Rajit Industries raises the $30,000 needed to develop the application but the funds received by them will not be income in their hands.
Interest repayments made to contributors will be deductible for Rajit.
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The organisation providing the crowdfunding platform, is known as the "intermediary".
Typically a crowdfunding platform is provided by an intermediary (often a web based platform or app) who charges the promoter a flat fee or a percentage of the total funds received. The fees charged by the intermediary will typically be assessable income.
Individuals or entities that contribute or pledge money, known as "contributors".
The ATO has said that in some cases a person who contributes funds to a crowdfunding venture or project may be subject to tax on any returns received.
This would be expected where the contributor is carrying on a business or is expecting to make a profit from the transaction.
Although they have yet to provide examples, a situation where the contributor will be taxed on returns might include:
An investor makes crowdfunding contributions to a number of new businesses either by way of loan (in which case interest received will be taxable) or by way of equity (in which case dividends on the shares will be taxable).
In most cases, where goods or services are received by the contributor (as happens with many reward based schemes), the acquisition of the goods or services will be purely private in nature and not assessable income. For the same reason, the contributor won’t be able to claim a tax deduction for the amounts contributed.
It is generally the case that funds contributed by an individual to a crowdfunding project will not be deductible.
A deduction can only be claimed where the contributor is carrying on a business and makes the contributions as part of the ordinary course of carrying on that business.
The ATO once again provides an example:
ATO example three: Environment-friendly waste cement disposal
New Action is in the business of supplying concrete, sand and aggregate to the local region.
The management of the company is concerned about the impact that leftover ready-mix cement can have on the environment.
To help explore innovative ways to dispose of the leftover cement, they invite public participation through a donation-based crowdfunding platform to help them identify ways to address the problem.
They have been experimenting with a special process and additive for some time with promising results but do not yet have the funds to drive development further and create a commercially-viable product.
Management explains to potential contributors that, in addition to helping the environment, if their idea takes off it will help grow the business and allow them to exploit further business opportunities with the product.
The business turns to a crowdfunding platform to help raise the $75,000 needed to drive development.
Contributors are not provided with any return or reward for their contribution but are satisfied that the contribution they make will help the environment.
Their contribution will be acknowledged on the company’s website.
One of the contributors is a business which supplies the additive and makes a donation (in the form of a grant) to encourage development of the new process. If the new process is successful it is likely to result in an immediate increase in their sales of the additive.
In this case, a deduction may be available for the contributor's donation as an ordinary business expense.
A further contributor is a local business selling hamburgers near the New Action plant, who makes a donation on the condition they will get acknowledgement and publicity for their support of the project.
As a result of the positive publicity, hamburger sales increase dramatically.
In these cases a deduction may be available to the contributor for the contributor's donation as an ordinary business expense.
Mark Chapman is director of tax communications at H&R Block.