Funds from “Crowdfunding” Potentially Taxable

“Crowdfunding” refers to an increasingly popular method of raising funds from a large number of people through the internet, where conventional forms of fundraising might not be possible. These funds could be used for a broad range of purposes, but, from a purely commercial perspective, the intention is to benefit start-up initiatives by reducing the cost of raising capital.

A number of websites have been established to serve as platforms for crowdfunding, including IndieGoGo (2008), Kickstarter (2009), and GoFundMe (2010). Kickstarter alone claims to have helped to raise over $1 billion in funding since its inception.1

There are several types of crowdfunding financing models, including the following:

1. Donation-based: In a donation-based model, the contribution is rooted in altruism, with nothing pledged in return except a promise to complete the project that is being funded. This model is typically used for disaster relief, election campaigns and projects in the arts.
2. Rewards-based: In a rewards-based model, individuals receive something in exchange for their contribution, such as a promotional product, the privilege of ordering a company’s product in advance, or access to exclusive content.
3. Investment-based: In an investment-based model, contributors receive equity or debt in the entity being funded.

Although there are several Canadian crowdfunding portals, none currently allow equity crowdfunding. However, regulators are becoming more receptive to the idea. On June 20, 2013, the Ontario Securities Commission issued an exemptive relief order to permit the sale of securities over the internet to accredited investors by the MaRS Discovery District in Toronto, an organization dedicated to helping entrepreneurs.2 On December 6, 2013, the province of Saskatchewan began allowing small businesses to sell equity stakes to residents of the province.3 Finally, on March 20, 2014, the Canadian Securities Administrators published for comment a proposed Integrated Crowdfunding Prospectus Exemption and Start-Up Crowdfunding Prospectus and Registration Exemption, which would, subject to certain conditions, allow both public and private companies to raise money by distributing securities through internet portals.4

CRA Technical Interpretations

The Canada Revenue Agency (“CRA”) has issued three technical interpretations in the past year dealing with the Canadian income tax treatment of crowdfunding activities.5 For the most part these technical interpretations provided limited meaningful guidance, stating only that, given the variety of crowdfunding models, amounts received by a taxpayer under a crowdfunding financing could represent a loan, capital contribution, gift, income or a combination thereof, and that this classification was a question of fact, determinable only on a case-by-case basis.

However, one of these CRA technical interpretations did provide specific guidance with respect to rewards-based crowdfunding. It dealt with the tax treatment of amounts received through crowdfunding to advance a project such as producing a musical recording or developing a product for market. In return, the contributors could receive promotional gifts but no form of equity. The CRA stated that amounts received by a taxpayer from rewards-based crowdfunding activities would generally be included in the taxpayer’s income as income from carrying on a business. The CRA acknowledged that expenses related to such crowdfunding activities would generally be deductible by the taxpayer as expenses incurred for the purpose of gaining or producing income.

The CRA indicated that this position is consistent with Interpretation Bulletin IT-334R2 “Miscellaneous Receipts” (February 21, 1992) (“IT-334R2”), which states that voluntary payments received by virtue of a taxpayer’s profession or carrying on of a business are considered taxable receipts. The CRA noted that IT-334R2 also discusses non-taxable windfalls, which may exist where the taxpayer made no organized effort to receive the payment and neither sought nor solicited the payment.

This technical interpretation provides some tax clarity for start-ups and growing businesses considering crowdsourcing as a financing model. Unfortunately, in this case the clarity brings unwelcome news and the potential for unexpected income tax liabilities and a higher cost source of funds than anticipated.

This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.

If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.

 1 Kickstarter: https://www.kickstarter.com/hello
2Ontario Securities Commission (June 17, 2013), “In the Matter of the Securities Legislation of Ontario and In the Matter of Mars VX”: http://www.osc.gov.on.ca/en/SecuritiesLaw_ord_20130620_215_mars-vx.htm.
 3“Equity Crowdfunding Available in Saskatchewan”: http://www.gov.sk.ca/news?newsId=62aabd65-f166-44d4-9e42-dc6712c7f4ad.
4Canadian Securities Regulators Propose New Crowdfunding Exemptions (March 20, 2014): http://www.securities-administrators.ca/aboutcsa.aspx?id=1228.
5 CRA Document No. 2013-084941E5 “Crowdfunding” (August 16, 2013), CRA Document No. 2013-0508971E5 “Crowdfunding” (October 25, 2013) and CRA Document No. 2013-0509101E5 “Crowdfunding” (October 29, 2013).