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Posted: December 6, 2013
by Mitch Silverstein

The hidden tax in crowdfunding campaigns

Crowdfunding has become a popular way for entrepreneurs to fast-track an idea into a startup business, a fact that Canadian Rylan Grayston, whose recent Kickstarter campaign generated over $650,000, knows all too well.

 

However, what many entrepreneurs eyeing crowdfunded capital may not know, is they could be setting themselves up for a nasty tax liability right out of the gate.

 

With online crowdfunding platforms like Kickstarter and Indiegogo, anyone can post their idea and plan and ask for funding. Sometimes it’s just a donation and there’s no exchange of goods or services, but sometimes donors invest a specified amount for a promise of getting an item at a later date once production begins.

 

There are two tax issues here: one, the collection and remittance of HST, and two, how the company accounts for this income on its corporate tax returns.

 

We’ll set aside the HST issue for now and focus on the corporate tax issue, whose waters are a bit murkier, given that the Canada Revenue Agency (CRA) is only now catching up with the concept of crowdfunding. Initial reports we’ve received suggest the CRA sees money generated as business income, which of course must then be reported. However, in a recent Association de Planification Fiscal et Financiére (APFF) round table with the CRA, it was claimed that the funds generated through crowdfunding could be treated as a loan, a capital contribution, a gift or regular, taxable income.

 

So, which is it? This question is the reason why we advise entrepreneurs to be cautious when considering crowdfunding. The reality is, the answer isn’t as black and white as we’d like, and until the CRA commits to one stance or another, we’ll have to settle with a shade a grey.

 

Nevertheless, given what we know, let’s take a look at Grayston as an example. He designed a 3D printer-scanner selling for $100 – 20 times cheaper than anything currently on the market.

 

His Kickstarter campaign closed at $651,091 ($601,091 more than his goal of a modest $50,000) from 4,420 people, who, for the most part, “pre-bought” the printer. From what we know about the CRA’s stance on crowdfunding, we believe the funds generated through Grayston’s campaign would be considered taxable business income. Using this case as an example, his business could face a tax liability of 15.5 per cent on the first $500,000 of taxable net income, and thereafter, 26.5 per cent on the excess. That’s a significant potential tax liability, depending on the level of tax deductible expenses incurred by Grayston in his operation for the year. Suddenly, the pot doesn’t seem quite so big anymore.

 

From what we’ve seen and heard, many entrepreneurs simply aren’t aware of, or just don’t factor in this potential tax liability when considering crowdfunding as a source of capital. That could be a significant cash outflow that must be considered and factored into any earnings and cashflow forecasts that the entrepreneur is using to make his/her future business decisions.

 

Mitch Silverstein is a Partner at Richter, the 9th largest independent financial advisory firms in Canada, and has had his thumb on the entrepreneurial pulse for over 25 years.