“I don’t know what they want from me, it’s like the more money we come across, the more problems we see”. As hard as it is to believe that tax and hip-hop could exist in the same sentence, the lyric’s from The Notorious B.I.G.’s hit single Mo Money Mo Problems could not ring truer with regards to startups and the different techniques used to raise cash. While the golden age of hip-hip ushered in a new platform and direction for today’s artists, it too can be argued that today’s online world of raising cash, specifically crowdfunding, is setting the tone for the future while also bringing in new problems.
For those not familiar with crowdfunding, it is a way by which to fund projects, business ventures, or not-for-profit organizations through online websites made available to large crowds of people who will then “donate” or contribute money to the cause if it resonates with them. Crowdfunding has gained traction in the last few years, with 2016 seeing crowdfunding platforms such as Indiegogo, Crowdfunder and Kickstarter become household names in the startup world.
Currently, there are two types of crowdfunding methods, with the first model being more of a donation or contribution style and the second model being an investment or equity style based concept. The first model is usually where a large number of individuals will place differing amount of monies to finance a specific project in exchange for a reward or some form of recognition by the issuer (for example Kickstarter). The second model is where businesses seeking capital injection, source equity or debt stakes in their companies to venture capitalists or large groups of investors online (for example Crowdfunder).
With startups and business ventures raising financing from crowdfunding models at an estimated $34 billion US in 2015, it really hits home when you consider that B.C. is home to the second highest percentage of small and early-stage businesses in Canada. A good chunk of these businesses in B.C. use alternative sources of raising capital and equity with a good number of them using online crowdfunding platforms. While crowdfunding is a relatively easy way to obtain necessary capital to finance your business or ventures, it is also not without its legal and tax implications.
Currently, there is no official tax policy in Canada with regards to revenues and funding received by businesses or individuals for the use of business or income purposes. Depending on the facts and circumstances, income received by a taxpayer under a crowdfunding arrangement could represent a loan, capital contribution, gift, income, or a combination of these methods. Since the terms and conditions of these types of arrangements may vary greatly from one situation to another, the CRA’s approach is to evaluate each situation on a case-by-case basis before making a determination on the income tax consequences of a particular crowdfunding arrangement. However, CRA has issued two specific rulings in 2013 and 2015 with regards to their view on the taxation of these monies received by businesses and individuals. Generally speaking, where funds are received by you as a result of crowdfunding for the use in a business or a business venture, the CRA generally considers such funds to be taxable income under subsection 9(1) of the Income Tax Act. The funds are not taxable if it can be shown that they clearly represent a loan, capital contribution or other form of equity. Interestingly under the equity method of crowdfunding CRA has no official position to date or any ruling letters.
From a legal perspective, B.C. is one of the few provinces in Canada that has adopted crowdfunding registration and prospectus exemptions aimed at non-public startups and early stage businesses. Startups and early stage issuers intending to rely on the new exemptions must use a funding portal that is either relying on the crowdfunding exemptions or is operated by a registered dealer. In B.C. registrants would have to comply with the Startup Crowdfunding Exemption and ensure that they meet ongoing disclosure requirements, annual financial statements, and annual disclosure on how proceeds are used.
While most certainly, the more money startups and businesses do come across the more problems they see, it is also a sign of the times where non-conventional methods of capital raising are perhaps ushering in a new era of financing for small businesses and startups. As always, depending on which method of crowdfunding you do proceed to use, please remember to consult a qualified lawyer and tax accountant on the pitfalls within securities regulation and tax compliance.