On November 11, 2015, the EU Value Added Tax Committee released its findings concerning the liability to VAT in the crowdfunding industry. While the guidelines of this advisory committee have no legally binding force upon the Member States, their recommendations serve as guidance for interpreting the EU VAT Directive at the national level. Taking into account that each measure contemplated was either unanimously [1] or almost unanimously1 accepted by the members of the committee, it is highly likely the Member States will closely follow and speedily adopt these guidelines.
It should come as no surprise that the success of the crowdfunding industry piqued the interest of national tax authorities of the EU Member States. It should also come as no surprise that tax implications would eventually get caught up in the EU level focus on how crowdfunding fits into the wider financial ecosystem. These interests prompted the EU Commission to ask its Value Added Tax Committee to review the VAT implications and propose guidelines for the treatment of crowdfunding activities. The Committee’s much anticipated ruling was recently published and they deal a major blow to, particularly, reward-based crowdfunding.
The VAT Committee is merely shining a spotlight on already existing VAT codes and voicing that their application are apropos to the crowdfunding industry. However, what makes this announcement potentially unsettling to the industry is that a large part of the crowdfunding participatory base is the fledgling business and the inexperienced investor. Simply seeking the capital to grow, or the opportunity to be a part of the next big innovative project, these stakeholders may be shocked and unprepared to realize the burden of this tax liability revelation.
Summary of the VAT Committee Ruling
The European Commission defines crowdfunding as an emerging source of financing involving open calls to the public, generally via the internet, to finance projects through donations, monetary contributions in exchange for a reward, product pre-ordering, lending, or investment. The industry is further grouped into two categories: Non-financial return models (donation-based and reward-based crowdfunding) and Financial return models (crowd investing and crowd lending).
The Non-Financial Return Models
Donation-based crowdfunding: These donations are freely given with no benefit in return to the contributor. The Committee has determined that these activities fall outside of the scope of VAT.
Reward-based crowdfunding: These transactions allow a contributor to give funds to a crowdfunding campaign and receive a non-financial reward in the form of goods and services in exchange. VAT is chargeable on these transactions upon receipt of payment if: (a) there is a direct link between the supply of goods or services and its corresponding consideration collected by way of crowdfunding, and (b) the entrepreneur is a taxable person acting as such. However, the transaction can be treated as a donation in the event that (a) the open market value of the goods and services is lower than the contribution received, and (b) the benefits derived from such good or service are negligible or totally unrelated to the amount of the contribution.
The Financial Return Models
Equity-based crowdfunding (crowd investing): The Committee has determined that the investments made in this crowdfunding model, where the rewards are in the form of securities such as shares or bonds, are exempt from VAT liability[2]. However, if the reward for this investment takes the form of participation in future earnings via intellectual property rights, it shall be considered a taxable supply.
Lending-based crowdfunding: The financial reward in this crowdfunding model takes the form of interests on loans. Such transactions are exempt form VAT charges.
Crowdfunding Platforms: The services provided by these intermediaries which facilitate the relationship between contributors and entrepreneurs do fall under the scope of VAT.
Dissecting the Impact on Reward-based Crowdfunding
According to Massoulution’s 2015 Crowdfunding Report, reward-based crowdfunding enjoyed 84% growth in 2014. Popular amongst musicians, filmmakers and artists, those wishing to test markets and promote their products, its hallmarks are the rewards, or perks, offered to contributors. These rewards can be in the form of pre-sales[3] , discounts, services, recognition or swag (items such as t-shirts, posters, autographed photos, etc., exclusive to contributors of the campaign). These rewards are used to incentivize backers to contribute at varying monetary levels.
The unique characteristics that make reward-based crowdfunding attractive to its participants are now clearly identified as VAT liable. The implications may greatly alter industry dynamics for all stakeholder groups.
The Impact On Project Sponsors
Crowdfunding offers an unprecedented avenue to funds for small businesses and individuals seeking to promote a project. A carefully crafted crowdfunding campaign can place these small players in an arena that allows them to potentially garner large amounts of capital. Often, the budding businesses that turn to crowdfunding are looking to use the capital to develop and bolster their business practices. The infrastructure of such business may not be developed to the point to manage the tax implications of a successful, lucrative campaign, which may place them within the VAT threshold. Under an obligation to apply VAT, project sponsors are faced with the responsibility of registering, collecting, processing and reporting these funds.The requirement, especially if it comes suddenly, may place a burden on the business’ nascent infrastructure. According to established VAT guidelines, registration is compulsory if the amount of taxable goods exceeds the threshold (currently £82,000) in a twelve month period. Furthermore, the company must register within 30 days of the business turnover exceeding the threshold. If they register late, you must pay what you owe from when you should have registered.
Project sponsors may have to more intently asses their crowdfunding strategy when they initiate a campaign; they must now raise more capital to launch their product or service. The lure of quick, relatively easy funding must be balanced with great preparation and calculations and honest evaluation of the ability to accept such funds.
Exorbitant VAT charges also have the potential to effect the cross-border competitiveness of EU based companies. The added expense could diminish the attractiveness of some campaigns.
Campaign Contributors
A popular reward structure used in the reward-based crowdfunding model is pre-sales. Here, the project sponsor collect funds to develop a future product or service and reserves a product for that contributor. Pre-sales are an excellent way to build a customer base, promote a product and plan inventory and manufacturing needs. The key is that the product or service has not materialized.The purpose of the crowdfunding campaign is to generate the capital to actualize its production.
The VAT Committee guidelines shut down any contemplation of viewing the pre-sales scenario as VAT exempt. These goods and services have been clearly marked as a taxable transaction. Citing Article 65 of the VAT Directive, the VAT Committee unanimously agreed that, “the contribution may be regarded as a payment made on account of those goods or services on which VAT shall become chargeable upon receipt of the payment, provided that the goods or services to be supplied are precisely identified when the payment on account is made”.
The VAT obligation upon pre-sales rewards introduces an additional risk area for contributors to consider. While the possibility that a project sponsor may not fulfill their campaign promises and the final product may never manifest has always been a risk, the financial risk is further compounded as the non-recoverable price of VAT on this item will have been charged at the time of the contribution payment.
Contributors to reward-based crowdfunding campaigns typically get very excited about SWAG. SWAG, an acronym for Stuff We All Get, is customized merchandise, usually exclusive to the crowdfunding contributor. SWAG is typically used to incentivize small contribution amounts, but may also be used to entice contributors to move up to a higher contributory level. These items may be seen as more “symbolic” in value, and instead serve to create an emotional connection to the project. Many contributors regard these rewards as merely a thank-you gift and their contribution as a donation. However, while a gift consists of a supply of goods or services made for no consideration, in this case the consideration is in principle the income received from the contributor.
The SWAG reward is generally of small value and therefore may be safe from VAT, making the contribution akin to a donation. The VAT Committee almost unanimously agreed that
“where the open market value of the goods or services supplied by the entrepreneur in return for the contribution given is lower than the amount of the contribution received, crowdfunding may be assimilated to a donation but only in cases where the benefit received by the contributor is negligible or totally unrelated to the amount of the contribution.”
but,:
“In such circumstances, where the benefit received by the contributor consists of goods forming part of the business assets of the entrepreneur other than goods applied for business use as samples or as gifts of small value, or of services that the entrepreneur carries out, the VAT Committee concurs almost unanimously that the application of those goods or the carrying out of those services shall be subject to VAT in accordance with Articles 16 or 26 of the VAT Directive.”
In ensuring that the contribution that sparks these rewards remain clear of VAT implications, the value of the item must remain below that of the contribution AND remain detached from the entrepreneur’s business assets. Contributors may see the quality of SWAG decline significantly, to the point of no longer serving as a motivating factor.
Moving forward, the national authorities of the Member States will look to fold these guidelines into their national tax schemes. Hopefully, their actions are tempered by the realization that crowdfunding offers great alternative financing benefit to small and medium sized enterprises. VAT charges could could upset the delicate motivational economics of crowdfunding and thereby impede its necessary growth and vitality.
[1] The EU VAT Committee is comprised of representatives of the EU member states and the European Commission. Guidelines agreed upon by the VAT Committee are agreed to unanimously/ all (agreed by all 28 Member States), almost unanimously (27-24 Member States), or a large majority (23-19 Member States).
[2] Pursuant to Article 135(1)(f) of the VAT Directive.
[3] The VAT Committee has chosen to group the pre-sales category of crowdfunding under the reward-based crowdfunding category, as the lines between them are blurred.
