What is Crowdfunding?
As the name suggests, crowdfunding is a manner of raising funds from a large number of people. Recently, websites such as Kickstarter, Kiva, IndieGoGo, and Microventures have drawn attention to the practice.
But crowdfunding has a long history. During the Second World War, Canada crowdfunded its military by issuing Victory Bonds. The nineteenth-century French philosopher, Auguste Comte, famously raised funds for his future works by soliciting pre-orders from fellow Parisians. In 1885, a New York newspaper raised $100,000 in donations from over 160,000 of its readers. The cash bankrolled the base for the Statue of Liberty.
Crowdfunding Models and Their Canadian Income-Tax Implications
Depending on the crowdfunding model, the money that you raise from a crowdfunding campaign could be income, a gift, a loan, or a capital contribution. (Of course, it could also be some combination thereof.) So, the income-tax implications of raised funds depend on the crowdfunding model.
Taxation of Reward-based crowdfunding
Probably the most popular crowdfunding model, the reward-based model, involves raising small amounts of capital from numerous contributors to fund a specific business or product. In exchange, the contributors receive rewards as incentives. For instance, the contributor might receive an early version of the product or a promotional item, like a T-shirt. But contributors do not receive an equity stake in the project or business. In 2013, the Canada Revenue Agency released a document addressing its stance on the income-tax implications of the rewards-based model (2013-0484941E5). The CRA considers funds received from rewards-based crowdfunding to generally be business income. As usual, the Canada Revenue Agency would permit the fundraiser to claim deductions for expenses incurred to earn business income:
- In our view, amounts received by a taxpayer from crowdfunding activities would generally be included in income… as income from carrying on a business. …
- Whether certain expenses are deductible is a question of fact. Expenses related to crowdfunding efforts incurred by a taxpayer for the purpose of gaining or producing income from a business… may be deductible.
In 2015, the Canada Revenue Agency released a subsequent document confirming that funds raised for product development are business income barring evidence that the funds were a loan or equity investment (2015-0579031I7):
- 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).
The CRA has yet to issue any guidance on the GST/HST implications of rewards-based crowdfunding. Both documents mentioned above were released by the CRA’s Income Tax Rulings Directorate. In its 2013 document, the Income Tax Rulings Directorate mentioned that it had forwarded to the GST/HST Rulings Directorate an inquiry concerning the GST/HST implications of the rewards-based model. So far, we have yet to hear from the GST/HST Rulings Directorate on this issue.
Still, this does not relieve users of the obligation to register for, collect, and remit GST/HST if the Excise Tax Act requires them to do so.
Taxation of Donation-based crowdfunding
On this model, the fundraiser solicits donations for altruistic purposes. For instance, one might raise funds using a GoFundMe account so that a sick child can attend an Ariana Grande concert or to aid a family facing eviction.
Fundraisers using the donation-based model probably do not need to report the funds that they receive as income. These funds would likely constitute a gift since, presumably, those contributing money to the specified cause are doing so without receiving anything valuable in exchange. A recipient of a gift is not required to report that gift as taxable income unless it stems from an employer. Gifts from an employer will typically constitute a taxable employee benefit if the gift exceeds a certain value.
Donors, on the other hand, should not expect a donation tax credit for their contributions unless they are donating to a crowdfunding campaign established by a registered Canadian charity.
Taxation of Debt-based crowdfunding
With debt-based crowdfunding, borrowers apply for credit online. An automated system reviews and verifies their application. The system also determines a borrower’s credit risk and interest rate. The loans come from investors, who buy securities in a fund that makes the loans to individual borrowers. Investors earn interest on the loans. The system’s operators earn a service fee, which is calculated as a percentage of the loaned amount.
Popular debt-based crowdfunding platforms include Zopa, the Lending Club, and Prosper.
Canada Revenue Agency has not offered its official take on the taxation of this model of debt based crowdfunding. But, presumably, the tax rules applying to debt would apply. For instance, investors would be required to report their interest earnings as investment income. And the borrower would be allowed to deduct interest payments if the borrower took on the underlying loan to earn business or investment income.
Taxation of Equity-based crowdfunding
Equity-based crowdfunding involves the fundraiser’s offering equity in a venture in exchange for a capital contribution. For instance, a corporation may list an offer of its shares on a crowdfunding site.
While the CRA has not specifically addressed equity-based crowdfunding, Canada’s Income Tax Act already speaks to the tax implications of capital contributions. The Income Tax Act provides for various rollover rules, which effectively render a capital contribution a non-taxable event. These rules allow the investor to contribute a capital property to the venture on a cost basis. In turn, the recipient inherits the property’s tax attributes as they stood in the investor’s hands. In consequence, the investor does not incur a taxable gain for transferring property into the venture,and the recipient’s tax cost for acquiring the property equals the property’s tax cost to the investor.
And the same holds true where a person provides a cash investment—as opposed to contributing a capital property. The investment remains a non-taxable event. The recipient need not report the investment funds as income, and, since cash is a non-capital property, the investor does not incur a taxable gain. Any subsequent disposition of the investment will give rise to a capital gain or loss.
Tax law has yet to catch up with technology. And web-based crowdfunding platforms offer increasing flexibility to users—such as hybrid crowdfunding models. So, legislators may enact new rules with different outcomes than those pertaining to traditional transactions. And courts may be convinced that the rules applying to conventional investment transactions should apply differently in the crowdfunding context. The end result is uncertainty for both fundraisers and donors.
With this in mind, if you wish to raise or contribute funds through a crowdfunding platform, please consult one of our expert Canadian tax lawyers. They can provide the tax-planning and tax-compliance advice that may save you from unexpected tax problems.