This article was published in the Crowdfunding Monitoring Switzerland 2016 by the Institute of Financial Services Zug (IFZ). Download the full study (PDF, 1.3 Mb) here!
Crowdfunding – i.e. raising money via online platforms – in Switzerland is still in its infancy. Although the individual forms of funding are essentially nothing new under civil law, many uncertainties remain under tax law. The main problem affecting not only those involved in the transactions (e.g. backers, recipients of the funds and brokerage platforms), but also the tax authorities, is a lack of relevant experience. Yet taxation represents a not insignificant transaction cost, which must be reflected in business plans and financial planning. It is therefore vital that anyone entering into a crowdfunding transaction should clarify the tax situation at the onset of the project.
This analysis offers a preliminary overview of possible problem areas and demarcation issues. It starts by outlining the various types of taxation of potential relevance to crowdfunding. It then discusses these in more detail in relation to the four main categories of crowdfunding. This overview should be seen as a pragmatic guide: not only does it make no claim to be complete, it also covers only Switzerland and does not touch on the nondomestic situation.
Types of taxation
INDIVIDUAL INCOME TAX AND WEALTH TAX
Individual income tax is levied on all recurring and non-recurring income of natural persons. Capital gains on the disposal of private movable assets are tax exempt. Wealth tax is levied on all the net assets of natural persons.
CORPORATE INCOME TAX AND TAX ON CAPITAL
Corporate income tax is levied on the net profits of legal entities. Profits arising from the capital contributions of shareholders, membership subscriptions for clubs and associations, and transfers of assets to foundations are tax exempt. Furthermore, losses can be set off against profits for up to seven consecutive years. The net equity of legal entities is subject to tax on capital.
Legal entities having a public or charitable purpose are exempt from corporate income tax and tax on capital. Business purposes are not deemed charitable.
Gift tax is a (cantonal) levy on donations from one living person to another. It is levied on the beneficiary by the donor's canton of domicile at the time of the transaction. Generally speaking, beneficiaries such as spouses, direct descendants and legal entities exempt from corporate income tax (see Section Corporate tax and tax on capital) are exempt from gift tax, while other family members often benefit from tax-free allowances of one kind or another. Also exempt from tax are standard occasional gifts not exceeding a certain value (e.g. in Canton Zurich: CHF 5,000).
VALUE ADDED TAX
Anyone conducting business within Switzerland is subject to the value added tax (VAT) regime if the annual turnover arising from taxable activities (i.e. the supply of goods and services) in the country exceeds CHF 100,000. The income threshold for not-for-profit sports and cultural associations and charitable institutions is CHF 150,000. Tax liability is deemed to begin upon commencement of a new activity. Depending on the business conducted, however, it is also possible to register voluntarily for VAT.
The amount of tax due is arrived at by multiplying the consideration for a supply by the relevant rate (2.5% for e.g. food, medicines or printed matter; 3.8% for accommodation services; 8% for all other supplies). A number of statutory exemptions (with or without credit) to VAT exist. Also exempt from VAT is the exchange of non-consumable goods, such as land or money (including Bitcoin).
VAT-registered persons or entities can deduct the VAT they are charged by other persons or entities as input tax. They may not, however, deduct input tax for supplies which are tax-exempt without credit.
Equity stamp tax of one percent is levied on the issuance and increase in par value of securities (i.e. shares or bonus and participation certificates) and other capital contributions of the shareholders in excess of the first CHF 1 million.
Security transfer tax is levied on transactions involving the transfer of taxable securities if one of the contracting parties or brokers is a securities dealer. The rate is 0.15 percent for domestic and 0.3 percent for nondomestic securities.
A 35 percent withholding tax is levied on income arising from movable assets (principally dividends, interest on bonds and on savings accounts, but also deemed dividends to shareholders and related parties) and on lottery prizes. The tax is reimbursed to the recipient of the payment on which the tax has been levied in accordance with the law (or under double taxation agreements). Withholding tax is essentially designed to encourage taxpayers to declare their investment income and wealth properly.
OTHER TYPES OF TAXATION
Depending on the components of the transaction, other types of taxation (e.g. property tax, inheritance tax or entertainment tax) or even social security contributions may come into play. This analysis does not propose to discuss these further.
Brief evaluation of the various forms of crowdfunding from a taxation standpoint
Since the nature of the consideration for the delivery of the funds is a key factor when it comes to determining the tax consequences of a transaction, this analysis proposes to keep the pre-defined four categories of crowdfunding. It should be noted, however, that in reality crowdfunding offerings in the marketplace frequently exhibit a heterogeneous combination of these categories. This leads to problems of demarcation with a concomitant need for clarification.
Crowdinvesting involves a backer contributing capital into a company in exchange for a share of its equity, i.e. shares or bonus and participation certificates. Mixed forms of equity and debt (e.g. profit participating loans) are also possible.
The following tax implications need to be taken into account when making equity investments:
- Contributing capital in the form of assets in exchange for securities attracts equity stamp tax of one percent if the market value of the contribution exceeds CHF 1 million in total; the repayment of the contribution to the backer is free of tax.
- Where the backer is a private individual, the equity investment attracts wealth tax at the current market value. In the absence of a market value, the valuation is conducted in accordance with Circular No. 28 of the Swiss Tax Conference: for the founding year and the period following the development phase, the valuation is generally based on the net asset value; after that, it is based on the net asset value and the earnings value. That said, if there has been a far-reaching arm's-length transfer of ownership between independent third parties, it is the purchase price that determines the market value.
- Where the backer is a business, it can capitalise its equity investment at the acquisition price in its balance sheet, where they are declared at the carrying amount for the wealth or capital tax; in the event of a fall in value, appropriate write-downs may be tax-deductible.
- The marketing and brokerage fee charged by the platform is declared as a tax-relevant expense by the company and income by the platform; it attracts value added tax at eight percent.
- The company receiving the funds may not treat profit distributions as a tax-relevant deductible expense; a backer must declare the received distributions as an investment income that is (in part) taxable, but corporate backers may potentially apply the participation deduction; the distribution is liable to 35 percent withholding tax, which can potentially be reclaimed by the backer (encouragement of taxpayers to declare their investment income and wealth properly).
- If the domestic equity investment is sold through a securities dealer, the transaction is subject to securities transfer tax of 0.15 percent. Private individuals realise a tax-free private capital gain or loss (exception: indirect partial liquidation, transposition, professional securities dealer). In the remaining cases, the investor makes a taxable gain or loss (although corporations may potentially apply the participation deduction).
The rules on crowdlending additionally apply where mixed forms of equity and debt are present (see Section Crowdlending). It should also be noted that disproportionately high interest payments to shareholders that are not in line with the market conditions are not deductible for tax purposes and are subject to 35 percent withholding tax, which amounts to a fiscal reclassification as a dividend, e.g. in the case of profit participating loans. Disproportionately high debt financing by shareholders may lead to a reclassification from debt to equity.
Unlike investing in a legal entity, if a private investor injects capital into a partnership, the profits as well as the losses are attributed to the investor as income arising from self-employed activity. Under civil law, such investors are also liable for the obligations of the partnership to the extent of their personal assets. That is why extreme care must be taken when making investments of this nature, particularly where the investor is unable to exert any direct influence on the business activities, e.g. as a silent partner.
Crowdlending is where loans are granted that yield risk-based interest payments; the tax position is as follows:
- Interest payments in line with the market conditions needs to be declared as a deduction / expense by the debtor, and income by the lender; by law, deductions of interest on private debt are limited to the amount of the taxable investment income plus CHF 50,000.
- For the purposes of wealth tax and tax on capital, the loans must be declared as a debt by the debtor and a credit by the lender.
- In the case of disproportionately high interest payments to lenders that are not in line with the market conditions or disproportionately high debt financing by lenders see Section Crowdinvesting.
- Where funds are being provided by more than 10 lenders on the same terms or more than 20 lenders on different terms, withholding tax of 35 percent is levied on the interest payments, because of a fiscal reclassification of the loans as bonds.
- The marketing and brokerage fee charged by the platform should be declared as a tax-relevant expense by the debtor and income by the platform; the fee relating to the brokering of loans is value added tax-exempt without credit of input tax, but VAT at eight percent is levied on all other supplies.
The provision of funds without consideration is termed crowddonating. The following needs noting:
- Donations and gifts of more than CHF 100 and up to 20 percent of the donors' taxable income made to Swiss tax-exempt legal entities by natural persons are tax deductible (federal tax; subject to derogation provisions by the cantons).
- Legal entities may also, in principle, make tax-deductible donations and gifts to Swiss tax-exempt legal entities of up to 20 percent of their taxable net profit (federal tax; subject to derogation provisions by the cantons). Other deductions are permitted only if demonstrably a business expense. On the other hand, payments not shown to be business-related are added back as deemed dividends and - if made by a corporation – are subject to withholding tax of 35 percent.
- At the receiving end, depending on the circumstances and ownership structure, donations and gifts are liable to either gift tax, individual income tax or corporate income tax, or a combination of all three; relevant exemption limits and tax exemptions must be observed (see Section Corporate income tax and tax on capital and Section Gift tax).
- Value added tax is not levied on donations as a matter of principle. It is permissible to acknowledge the donor (including any logo) in a neutral way, e.g. in programme notes or a CD booklet. If, however, any farther-reaching publicity is provided, e.g. in the form of advertising which could be deemed sponsorship, the contribution is no longer deemed crowddonating, but reward-based crowdfunding, which is taxable (see Section Reward-based Crowdfunding).
- The marketing and brokerage fee charged by the platform should be declared as a tax-relevant expense by the recipient of the donation and income by the platform; it attracts value added tax at eight percent. However, publicity services for charitable institutions (e.g. free advertising on the platform) are deemed VAT-exempt supplies without credit of input tax.
Reward-based crowdfunding is where backers receive something in exchange for their payment, generally a one-off consideration such as a product, work of art or service. The relevant tax situation is as follows:
- Businesses acting as backers declare their payments as expenses for goods or services or, depending on the circumstances, capitalise them.
- In general, private individuals acting as backers cannot deduct their payments for tax purposes.
- The party initiating the project declares the sale of products, works of art or services as tax-relevant income. Payments on account, suspensive conditions and other conditions must be correctly segregated for accounting purposes. Moreover, sales are liable to value added tax at the applicable rate (2.5, 3.8 or 8 percent, depending on the supply).
- The marketing and brokerage fee charged by the platform should be declared as a tax-relevant expense by the party initiating the project and income by the platform; it attracts value added tax at eight percent.
Ambiguities arise in the event of a lack of balance between the payment and the consideration. Backers often receive a T-shirt or something similar by way of thanks for their payment, rather than consideration in the true sense of the word. This gives rise to the following issue:
- Payments made without expectation of such thank-you gift in return are arguably donations with tax implications akin to those of crowddonating (see Section Crowddonating). This presumes that the donation would have been made even in the absence of a gift. The gift should then be seen as a second donation back to the backer.
- This also applies to the value added tax situation: if the consideration offered takes the form of a small promotional gift valued at no more than CHF 5,000, it is deemed insignificant donation, provided that the backer's payment was made without expectation of the gift in return.
No one likes paying taxes. However, the good news is that taxes generally become due only when capital flows into a project, revenues are generated, or a profit is earned. For start-ups, this means that at this time the first hurdle in the quest for success has already been cleared.
That said, the backers as well as the recipients of the funds must be clear about both the financial implications of a transaction, and their respective rights and obligations. The difficulty of crowdfunding is that the tax implications differ widely, depending on the form it takes. Moreover, countless combinations (including profit participating loans, reclassification of debt as equity, mixed donations, and so forth) and cross-border issues are possible, which further complicates matters.
Crowdfunding projects at the large / complex end of the spectrum would benefit from closer analysis to identify their exact circumstances and particularities. Furthermore, this would enable the tax implications to be discussed with the relevant authorities ahead of time, in order to avoid any unpleasant surprises down the road that could jeopardise the very existence of the project.
Above all, however, it is vital that the platforms conduct detailed analyses of the tax situations of all those involved in transactions; after all, as brokers between backers and recipients, they should be assuming a clarificatory role. All sides must be able to rely on the information presented on the platforms.
Last but not least, politicians should be considering generally simplifying the fiscal and regulatory landscape relating to crowdfunding. Tax breaks for risk capital investments (e.g. making capital contributions in start-ups tax-deductible and exempting such investment from wealth tax) would greatly benefit the investment climate in Switzerland. Other countries such as the UK and USA are way ahead of us in this respect. Canton Zurich's announcement in March 2016 of its intention to ease the wealth tax burden when evaluating start-ups is a first step in the right direction. Far more needs to be done, however.