March 8th, 2013 / Insight posted in

Crowd funding: an accountant’s view

If you work in the technology or creative sector, the likelihood is that you have heard of Crowd Funding, where many individuals or sources invest small amounts in projects, businesses and good causes.

It has largely been a US phenomenon until now, but this is changing.  In the UK, £120 million was estimated to have been invested through crowd funding in 2011, so it’s small market. However it is growing fast, with twice as much money expected to be invested in 2013 compared to 2012. Predictions are that this could reach £15 billion in 3 years, set against the backdrop of the global financial crisis, which as we know has had repercussions for the banking sector, including limiting lending to SMEs.

There are several different models that have arisen, and these can be summarised as follows:
• Reward based – where the investor receives a form of reward which may be of little value, and can even be akin to a donation.
• Loan based – where the investor gets a return of his money, with varying amounts of interest.
• Equity based – the investor expects to get the return of his investment, with other rewards or intangible benefits.

Some models operate in specific sectors, and have a particular focus.  However, what they all have in common is an on-line platform which brings investors together with the business or project seeking investment, and they all tend to focus on a low cost, transparent and customer friendly approach.
There are a plethora of companies out there, such as CrowdCube and Seedrs (equity), Funding Circle and Zopa (loans), Bank To The Future (loans and equity), Kickstarter and Sponsorcraft (reward based).

Reward based

How it works: In this model of crowd funding, an investor initially makes a pledge, which may take the shape of a pre-authorisation on Paypal.  As soon as the target fundraising is reached, all monies are deducted from investors bank accounts via Paypal, with the platform taking its commission, which is typically 5%.  Whilst some platforms are set up so that funds directly hit the bank account of the business raising the funds so that the platform avoids holding “client monies”, others will accept the funds and distribute to the target, keeping their cut.

In return, the investor is often offered something of value, but this might be intrinsic. For example, Emily Diamond, a Bristol based sprinter in Team GB 2012, reached out to Sponsorcraft to successfully help raise money to achieve her Olympic dream.  She offered a signed event programme to anyone investing £25 in her project, or a signed photograph for £50. Indie games developer, Stainless Games based in the Isle of Wight, offered various exclusive content or access to its game, Carmageddon, raising significant money via Kickstarter from its die hard gaming fans.

Accounting: From the perspective of the business raising the funds, funds raised take the form of income and should be accounted for on a receivables basis- typically this is the date funds are received in a company’s bank account.

In terms of accounting for the cost of rewards given to the investors, this should be recorded at the cost incurred by the business. In the case of a signed photograph, this would simply be the cost of developing the photograph, for an event programme or a special feature in a game there may well be no such cost to account for.

For the platform that is raising the money on the businesses behalf, it is earning commissions, and should account for such in its profit & loss accounts on a receivable basis, which is expected to be the date funds are due to be released to the target business.  The funds received and distributed should be netted to show one line in the profit and loss for “commissions receivable”.

Taxation: Principal taxes to consider include corporation tax (in the case of a company), income tax (in the case of an individual), and VAT.

In the case of a company, it is liable to corporation tax if the investment provided is to fund a commercial activity, and this will apply in many cases of reward based crowd funding.  Tax is paid in the UK at 20% on profits up to £300,000, and currently at 24% over £1.5m. A marginal rate of 25% applies between these two limits.  Therefore if the net of funds received less costs incurred mean a profit has been made at the end of the year, corporation tax will be due, and some of the funds raised will need holding back to meet these liabilities after the year end.

Should the funds raised be a genuine gift, and the purpose is not to fund a taxable commercial activity, then the funds received will usually be treated as a donation or gift for tax purposes.  This would be unlikely if the platform is a limited company.

If the activity is set up as a registered charity, gift aid can be reclaimed on the funds received from individuals , although care has to be taken to ensure set limits are not breached for the value of the rewards.  For example, the value of the reward given must be 25% or less of the donation given, and up to £1,000 the value of the reward can’t be more than £25. I would suggest that these limits need to catch up with the new reality of crowd funding.

If an individual rather than company is raising the funds, as in the case of Emily Diamond, the most likely scenario is that the investment is a donation and is not liable to income tax, unless he or she is considered to be involved in a taxable activity such as trading when the funds are likely to chargeable to income tax, although of course everyone has a personal allowance which is currently £8,105.

A business is required to register for VAT once it expects annual turnover to exceed £77,000.  The primary reason for the investment should be established, and whether this was done for the purpose of obtaining the reward, or for social reasons. In most instances if what the funder has received is of intrinsic value in return for their investment, HMRC will look to argue that there is a taxable supply for VAT purposes, even if the items in question have a market value below the level of investment.  However,  for those investments which might be described as broadly philanthropic, (for example the support Emily Diamond received for her Olympic ambitions) it might be possible to argue that rewards of limited value, like signed programmes etc. are no more than a simple “thank you” and as such not subject to VAT.

Equity and loan based

Equity: In an equity based model, individual investors if based in the UK normally want to benefit from tax relief, which is dependent on the company being registered for EIS, where tax relief is 30% or SEIS where it is 50%.

This is a complex area, but companies need to ensure they do not act in such a way as to make their investors unable to benefit from the tax relief.  Investors must not receive anything of “significant” value from the company they have invested in, otherwise EIS and SEIS benefits may disappear.  “Significant” can be judgemental, and might be seen differently by HMRC to the individual.
For VAT purposes, shares, and other forms of equity are treated as an exempt supply, so there will be no need to charge VAT to the individual investor. However, the company will generally be unable to recover VAT on any associated costs.

Loan: The key here to the investor is the interest rates which are usually comparable with bank rates, periods and loan terms. However the arrangement fees are usually missing making them beneficial. Interest is tax deductible for the business making the loan, and chargeable to tax for the receiver.

Of key importance because the monies are typically larger sums, is the due diligence that has been carried out by the platform, including on the company’s track record, its credit record and management.  It is the effectiveness of the screening process that will make or break this new fledging industry in the future. Regulation will need to be brought into the mainstream if it is to succeed.

Otherwise, many of the accounting and tax implications are much the same as for traditional lending, although of course there will always be individual circumstances where there are certain specific accounting and tax implications.

Caveat

The above is given for guidance only and should not be relied upon in specific circumstances, please take further financial advice as required. All crowd funding companies mentioned here are provided as examples only and do not represent an endorsement by the writer or Kingston Smith LLP.