The underlying transaction between a project creator and backer via an online crowdfunding platform can be difficult to understand. It is not clear if the pledge is a gift or donation to the project creator, or a sale of a product from the project creator to the backer. The type of transaction has a direct bearing on your rights and responsibilities as a backer.
Adding to the confusion is that crowdfunding platforms tend to list a mix of non-profitable cause projects and rewards-based projects, even though some platforms specifically state which types of projects they list. It also becomes obvious that project creators themselves get confused about what the underlying transaction is, and how to communicate this to backers, when one reads project descriptions or interviews with project creators. Lastly, the crowdfunding terminology can also be confusing when trying to understand the transaction.
Remember that the underlying transaction is between the backer and the project creator. The crowdfunding platform, such as Kickstarter, is only an online listing platform for projects, similar to a community notice board.
- Always check where the online platform is hosted, because the country’s laws will govern the platform and its business.
- Try to determine where the project creator is based for tax residency purposes, because this will impact how the transaction is defined.
- In general for American-based crowdfunding platforms:
- A gift is made if the reward is intangible, a token and not equal in value to the reward offered.
- A donation can only be made to a registered charity or non-profit.
- A sale is made if the reward is equal in value to the pledge, if the reward is tangible and has a market value.
Tax residency basically means where a person or company is resident for tax purposes.
For example, if I set up a company in London, the laws and regulations of the United Kingdom govern my company’s set-up and determines which accounting method I should use when reporting my financials. I will also need to file my taxes as per the UK tax authority’s principles and codes. Similarly, if I set up my company in the US, then US law and tax would govern my company. In a personal capacity, if I mainly work and live in London, I would be considered a UK tax resident. This is regardless of my actual citizenship; for example I could be a French citizen but a UK tax resident.
The majority of crowdfunding platforms are currently located and hosted in the US. This means that the US tax authority and accounting principles should apply when considering the crowdfunding transaction.
Kickstarter is based on America, and as per its terms and conditions, only American-resident project creators can list on the US platform. Accordingly, one needs review the American accounting principles and the Amercian tax code to understand the underlying transaction. If a backer uses the UK version of Kickstarter, then the UK laws should apply. The location of the backer is irrelevant when examining the underlying transaction.
As a backer, you should always determine:
- where the platform is hosted; and
- where the project creator is resident for tax purposes.
Backers need to understand where the crowdfunding platform is hosted, because the laws of that country will govern any term, condition and policy of the platform.
It is also important to understand the tax residency status of project creators because this will influence how the actual crowdfunding transaction is viewed by the tax authorities, and accordingly, what the rights and responsibilities are of all parties involved in the transaction. Any project creator on the US Kickstarter platform has to be a US tax resident.
Transaction with Kickstarter
If you back a project via Kickstarter, then the underlying transaction with Kickstarter is a simple service agreement. At the end of the funding campaign, the service agreement ends and Kickstarter takes its 5% fees. This is a simple service transaction and the fees are classified as service revenue.
Transaction with project creator
If you back a project via a rewards-based crowdfunding platform, such as Kickstarter, then there are three likely transactions between yourself and the project creator. The transaction is when a backer pledges for a reward. The transaction can be classified as a:
- donation; or
In any crowdfunding campaign, it is typical to see a blend of gifts and sales offered in the reward tiers to backers.
For example, for any project, the first reward tier is typically a $1 pledge. This could be classified as a gift. In the same project, there could be another reward tier at $40 for the core product, including any unlocked stretch goals. This would be classified as a sale.
Let’s look at each in more detail.
The transaction is recognised as a “gift” if the reward is intangible, or a token, and not equal in value to the value of the pledge. For example, a $10 pledge to get a thank you note via mail is a gift. This is because the thank you note is intangible and does not cost $10 to manufacture.
There is a limit of how much funds can be raised as “gifts” received from backers.
The transaction is specifically recognised as a “donation” if the project creator is a registered non-profit or charity in the US for US-based crowdfunding platforms. If the project creator is not a registered charity, then the pledge cannot be treated as a donation. This is because the word “donation” has specific implications in accounting and tax, and confers tax benefits on both the project creator and backer.
For example, assume that I am based in the UK and I donated £10 to Oxfam in my personal capacity. When I file my annual tax return, I can deduct the donation from my taxes. I also have the option of making the donation a Gift Aid, which gives greater tax benefits to the charity. It is reasonable to assume that similar tax benefits exists for US-based charities.
Note that Kickstarter specifically states in its terms and conditions that any cause or donation projects cannot be listed on its platform.
The transaction is recognised as a “sale” if the reward offered is tangible, has a market value, attracts a sales tax, and is equal in value to the pledge. For example, if I pledge $40 for a board game that has a retail value of $50, then the crowdfunding transaction is a sale. The board game is tangible and the reward level is equal to a market price.
Any funds that the project creator raises in the crowdfunding campaign with tangible rewards are classified as sales income and treated as such from an accounting and tax viewpoint.
The main difference between a crowdfunding transaction and a sale or a pre-order is that legal title over the product is only transferred at a later stage, even through money was exchanged when the campaign ended. I look at the differences between a pre-order and a crowdfunding transaction in this post.
Transaction with Amazon Payments
In most cases, when you back a project via Kickstarter, Amazon Payments will process the pledges on Kickstarter’s behalf. The issue of tax residency and where Amazon Payments is located is also important, because this impacts whether or not you can request a charge back. Amazon Payments is regulated by the US financial regulations.
Different types of backers
Because there are these different types of transactions, the types of backers are also different.
Project creators need to carefully understand who the target backers are, and backers similarly need to understand what type of backers they are. If I am interested in backing a project for a cause, then my motivations, goals and expectations are very different compared to if I am keen to back a project for a newly launched product.
The majority of reward levels for a project listed on Kickstarter would be either a gift or sale transaction, and indeed, many projects have a blend of gifts and sale rewards. As a backer, you need to understand what the transaction is, as this has direct implications on your rights and responsibilities.