Saturday, April 7, 2012

Crowdfunding... and taxes???

So, I was reading a few forums today, and crossed around this page, about the tax implications of crowdfunding.

I don't know how it's currently being handled. Probably the way it's been suggested by the posters.

I'm not in the US, nor am I familiar with their tax laws, but I am familiar with the one's in my country and Taxation Theory in general. I would like to develop further on the concept; since my soon-to-be accountant mind can't stop guessing about it:

The problem with crowdfunding, as I addressed previously in another post, is that it's not well defined what it actually is. And hence, it's hard to tell how it should be taxed.

It looks like a pre-sale on most aspects, except that if the project isn't delivered, the money is lost; which is why it also shares some aspects with an investment, because backers take a risk. Or it could be seen as a simple donation.

Note: When I speak about "some laws" I'm referring to "laws in different countries".

Is it a pre-sale?

If it's a presale, then the company is owing something. In accountancy terms, that money doesn't constitute accrued revenues yet.
Some tax laws impose the obligation to pay the tax the moment the money enters the company's pocket, but most of the time, the obligation comes when the revenue becomes accrued.

This means the tax will be paid the moment the game is sold (or when the project gets cancelled, unless the money could somehow be handed back to their backers. Although this would bankrupt any start up company)

Is it a donation?

If it is, then the moment to pay is when the money enter's the company's pockets unless it's a non-profit organization. Seemingly easy case.

Except when the company then "gives away" their game to their backers, it constitutes a donation (which is actually a delievery of what's been promised), this time from the company to the backers.

The thing is, some laws prevent or impose limits to substracting donations from their Gross profit, resulting in higher gross profit(*). Therefore such "donation" is taxed again. This constitutes double-taxation, so proper care must be taken to explain your local Country's IRS of the situation.

Another approach to the double-taxation problem is that it's not a donation at all, but rather a necessary cost to sustain the Source of Earnings, therefore the limits to substract donations from net sales don't apply.

(*) I simplified it since most of the readers aren't tax experts. Donations are actually substracted from gross profit, resulting in higher net income. Doesn't really change the point of the discussion.

Is it an investement?

A long discussed argument. I won't go into why it is, and why it is not.
But if it is, then investments aren't taxed. The moment the investors pay their revenues varies wildly per country. Normally, variations include:
  • Investors pay their taxes when they receive their dividends.
  • Investors pay their taxes when the distribution of dividends has been decided.
  • Investors don't pay, because the Company already paid for them.
    • The company is not allowed to substract dividends from their Gross profit, resulting in higher Net income. Paying a tax on the dividends would be double-taxation, so nothing is done.
    • The company is allowed to substract dividends from their Gross profit. The tax is separately paid by the company either when the dividends have been approved or when the investors actually receive the money.
  • There are also hybrid models (investors pay a portion of the tax, the company pays the other part)
  • etc....

The thing is, none of the backers receive dividends. Therefore the money they put in, is never taxed; but we could do a bit more reasoning behind it:
  • If the final game is worth more than the ammount the backer "invested", that difference is a taxable result. Thing is, unless some law says otherwise (i.e. for the sake of simplicity), it is the backer the one who should pay the tax, not the company! It should be noted though, the company ought to be able to deduce that difference from their gross profit (see donations above); in which case the total ammount the Government receives is cancelled. As a result, tax laws should consider not to pay in this case; as it doesn't make sense to spend effort on this. But unless there's a law allowing it, it is the backer who ought to pay the tax.
  • If the final game is worth less than the ammount the backer "invested", that difference is also a taxable result! The company received more money than it should and must pay taxes for that. As for the backer, unless he makes games for a living (the backer is either another game company or an indie developer), he probably can't substract that donation (depends on the each law). This difference is a taxable result.
Since the only way crowdfunding can be taxed is, in this line of thought, when the final game is worth less than the ammount the backer invested; this is clearly the worst option for the Government, and the most beneficial to videogame companies and the "investor"; from a taxation perspective of course.



My personal opinion, crowdfunding resembles a lot like pre-sales, and should be taxed as such. The alternatives are way too complex; while the pre-sale method of handling taxes is widely used and well understood. Furthermore it is the most fair and provides incentives for start up companies, since tax payment is delayed until the game is produced & released, allowing a company to use funds obtained from crowdfunding with more freedom; provided there's an exception for start ups in case they fail to deliver the project.


Well, this ended up being longer than expected, but I think I fully covered the issue. Hopefully we'll start seeing some more serious debate about it.
I'm hoping to see some feedback, as well as some of you sharing your stories or your a view from your Country's legislation in the comments.

Cheers!
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10 comments:

  1. I planned to start a crowdfunding campaign, but before I got into it, I wanted to check on all details so I could calculate everything correctly. Apparently, there is no way to know how you pay the taxes. I know I have to pay 10% in my country, but since the crowdfunding site is registered in the US I dont know if I have to pay taxes there as well. If I have to pay twice taxes, than I wont even bother to start raising funds, as it becomes pointles to try and collect 5000 USD when you really need 2500 (roughly)...

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  2. Most Countries follow the same principles, and the US is among them. Generally:
    - You're most likely a "non-resident alien". Which means all your income originated from a US "source" must be withheld by the payer.
    - This means the one paying you is responsible for substracting the necessary amount to pay the tax (most cases, it's 30%). He was supposed to pay you $1000? then he'll pay you $700 and the $300 go for the IRS
    - If the payer fails/forgets to withhold the tax, most likely both you and the payer are responsible for it until someone pays.
    - Note that if he pays $1000 and forgets to withold, then the law will most likely assume he was supposed to pay you $1.428.57 (1000/70%) and withhold $428.57 for tax purposes, which is more than 30% of $1000
    - Note that not always the 100% of the income is assumed to be of "US Source", which means the actual tax to pay is lower than 30%.
    - The payer will ask you to fill a form for him, which could be Form 1040NR, 1040NR-EZ, W-8BEN, etc.
    - Your local Country laws may probably allow you to deduct all or part of that withheld money so that it doesn't get double-taxed.
    - Tax treaties between the US and you Country may be available, which may reduce the amount to pay or even alter this procedure completely. You'll have to dig them up.

    A few Gotchas:
    1. It's VERY, VERY important to establish the "SOURCE OF INCOME" (and how much of it). If the US Law says none of the money being paid to you is of "US Source", then most likely you won't have to pay a single tax in the US. And you'll have *most likely* nothing to worry about all the above except for filling a W-8BEN form or a similar one.
    Here's a summary table:
    http://www.irs.gov/businesses/small/international/article/0,,id=96459,00.html

    For example a US resident paying a compensation for a personal service performed in Germany by a non-resident alien german is not subject to withholding (doesn't pay US taxes). But a compensation for a personal service performed by that german inside the US is; and that's because according to the table the criteria for personal services is "Where services performed".
    You'll have to find where the activity you're going to do suits the criteria. Are you going to use your personal talent (i.e. services)? Are you going to produce goods? Are those goods going to be produced in the US? Are you going to fill a patent? is that patent going to be used inside the US? etc...
    The table is a summary of chapter 2, the link is below.

    2. Are you a non-resident alien or a resident alien? The IRS site explains it very well, it even has a flowchart:
    http://www.irs.gov/publications/p519/ch01.html

    3. Other useful stuff:
    http://www.irs.gov/publications/p519/ar01.html#en_US_2011_publink1000268570
    http://www.irs.gov/publications/p519/ch02.html -> Contains example cases to help understand! Also detailed version of the source of earnings criteria.
    http://www.irs.gov/publications/p519/ch03.html -> Contains example cases to help understand!

    4. GO ASK A PROFESSIONAL TAX EXPERT. Preferibly, experts in Foreign Exchange. I don't know the Country you're from and not familiar with it's laws (unless you're from Argentina), I'm not very familiar with US laws either, and on top of all that; I'm not familiar with the activity you're planning to do.
    A single mistake may end up you getting tax withholding at a higher rate than what you're obliged to (or payers didn't notice you were exempt) and/or not being able to deduct the whithheld amount from your local Country's taxes.
    Most likely you're going to do a service outside the US, since services are common in Kickstarter, and therefore you may not end up paying US taxes. But do not take my word for granted.

    Best of luck with your project!

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    Replies
    1. Thank you for your elaborate explanation on the subject of taxes. It was really helpful, and I'll check all of the links you've provided.

      I'm from Macedonia, and the project is a sci-fi book. The money raised in the campaign(if the campaign is successful, of course) will be used for professional copy-editing to enhance book's readability and reading experience as I want the reader to fully enjoy the book and not get distracted with writing errors.

      The thing is, I'd be giving a copy of the e-book one week before it goes to sale to the contributors, and as you've written in the article above - that may be considered a pre-sale. That's why I can't figure out if I have to pay income taxes in the US (as I would have to when the book goes to sale on Amazon and other on-line retailers).

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    2. From what I can see, it resembles a lot like import (standing from US side) which shouldn't be taxed for income (but it may be taxed for VAT; that would be subject for a whole article itself). You will still have to pay income taxes in your local Country though.
      Book sales tend to have lots of exemptions across the world, so it's worth checking them out (and if they apply to e-books too).

      If you're planning on also sending a physical book (or a copy on a physical disc, like CDs, DVDs) then it's a whole different world since you have to deal with Customs, which is likely going to be out of your budget or increase the price of the book considerably.

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  3. Thank you for your time and effort to explain these things, it was really helpful.

    I also think you should write more articles on the subject as there are little to none(or at least I couldn't find any).

    When my book is finished (no matter if the crowdfunding succeeds or not) I will send you a copy of the book as a thank you.

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  4. How about the taxes that non resident alien donors need to pay to IRS if investing in a crowdfunding company (that is based in US). Any advice or clear regulations on this?

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    Replies
    1. By "crowdfunding company" I assume you mean crowdfunded company.
      And do you mean it as a backer? as the owner of the crowdfunded company? or as a traditional investor?

      If you mean as a backer, I believe you're worried about the "Is it an investement?" section and the two scenarios (final product is worth more than backed amount, final product is worth less than backed amount) take in mind that as far as I know there is no clear legislation on the treatment (i.e. you're assuming it should be treated as an investment) and second, as the explanation goes, in the first case the taxable amount gets cancelled (so in theory there is no harm to the IRS) and in the second case, there is taxable result... for the company to pay.
      So I'm having a hard time understanding why would you be worried, as a backer. Note that this article is directed towards Crowfunded company owners, Lawmakers, and other tax professional peers; not backers.

      Beware as a backer, you may have to comply with local regulations from your own Country. Usually unless it's a sizable amount, and you've paid with a credit card, it's probably going to be seen as an import of a product or services for personal consumption. In many countries there are restrictions when it comes to international purchases. If you're really worried then you should consult a tax professional in your Country.

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    2. Dear Matias,

      Thank you for taking the time to clarify.

      Yes, I meant as 'crowdfunded company'.

      And I meant as 'making an investment' on a company that is trying to raise money using a crowdfunding platform. The company where I want to invest is a formal company in US which has a solid PPM.

      I understand it could be considered as an investment, from a non resident alien.

      My concern is about if this means I would need to pay taxes to IRS in US, for an investment OR for for future payments made by distributing dividends.

      (Investment in the range of $10k to 30k)

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    3. I see. This is can be a complex issue and you should seek a tax professional in your Country of residence, and preferably get in touch with the US company's accountant as well.

      As a very broad overview, normally there wouldn't be many issues at the time of making the investment... assuming there is no reason to doubt about the source of funds e.g. you should be in a condition to justify how you got that money to your local Government to make clear you didn't dodge taxes while earning it (In many Countries 10k-30k USDs can be a lot of money!); and to US agencies (not just the IRS) due to money laundry requirements.
      Assuming you can justify your source of income, often this only translates to a ton of paperwork to deal with.

      The IRS normally comes into play when there's time to make payments of any kind to the investors (not at the time of the investment). Generally both the company and yourself are both liable if taxes aren't withhold properly, and the IRS will try to collect from whoever of the two can (usually the Company first as it is easier since its under US jurisdiction).

      It's not simple since sales from the company already generate taxes, and taxing dividend distribution would incur in double taxation. So there's that to account to avoid you paying more than you should.

      Then there's the matter of seeing if there's a tax treaty between your countries to take benefit and also prevent double taxation (your local Government may try to tax your dividends as "income" without recognizing the amount paid abroad).

      As you can see, it depends on your country of origin. It can also become a complex scenario or not. I only gave you the general overview so you wouldn't end all scared.
      You should see an accountant in your Country, particularly experienced in Foreign Trade (COMEX in Spanish, short for COMercio EXterior) and do things properly early to save you a headache later and losing money unnecessarily.

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    4. Great info.
      Thank you very much for your response.

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