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When crowd-funding is obtained through a loan or in exchange for equity there is no related tax liability. However, if crowdfunding is used to support the development of a new product, tax can’t be avoided, but you can defer it and possibly reduce it, until you are in a stronger revenue-producing position.
In January, Ontario joined four other Canadian provinces with a program that allows startups and SMEs to raise capital through crowd-funding. Companies should learn about the regulations that need to be met to use this method of raising funds.
For pre-revenue startups or even more established companies unable to fund new product development from existing cash flow, the advantages of being able to raise capital from the general public on a tax-deferred basis are obvious. Careful planning, however, is required to avoid negative tax consequences.
Funds raised through a crowd-funding campaign are potentially taxable as income at the 15 per cent small business rate for qualifying corporations
Businesses can avoid this tax burden if they structure their crowd-funding appropriately. The key is to ensure that the crowd-funding proceeds are tied directly to the delivery of a market-ready product or service at some point in the future. If properly structured, the crowd-funding proceeds can be considered a pre-payment for the future delivery of that product or service.
This defers the tax burden until the company actually delivers a market-ready version of that product or service to that investor. Only when this “transaction” is complete does the business recognize the income and incur the associated tax burden on the amount provided by the investor. Expenses incurred to produce and deliver the product or service are deductible against this income.
Full disclosure is critical. In Ontario, companies that turn to crowd-funding are subject to tiered audit requirements based on how much money they raise. They are also monitored and held accountable for any misrepresentations to investors.
There are a number of ways to structure a crowd-funding campaign to defer and possible reduce the resulting tax burden. Be sure to talk to a qualified business tax specialist to learn what’s best for your business.