Crowdfunding is defined as the practice of funding a project by raising monetary contributions from a large number of people, often amounts typically vary from as little as $5 to as much as the contributor wants to invest or give.

The inventor or entrepreneur (“inventor” advertises their product, potential product, or service, on a crowdfunding platform and waits for the public’s monetary response. Currently, there are abundant crowdfunding platforms available, all internet based, each taking a fee ranging from 5% to 9% of the monies raised.

Crowdfunding is predominantly raised through lending, rewards, donations and equity.

  • Lending occurs when the investors lends the inventor smaller amounts,
  • Reward based crowdfunding occurs when the inventor offers a reward, such a limited edition of the final product, or a gift ,
  • Donations arise when contributors donate an amount to the inventor and,
  • Equity crowdfunding is when investors are given shares of the inventors company in exchange for their monetary contribution. It is important to note that because equity crowdfunding is the act of a company offering shares to the general public the transaction is regulated by exchange commissions or security acts and is even forbidden in certain jurisdictions.

After crowdfunding, the investor, who is excited and ready to start operations, might see themselves with a large tax bill.

The income tax act (“act”) requires that all amounts of a taxpayer’s income from office, employment, business and property, be taxed unless specifically exempted by the act. While this is a very broad spectrum, the Canada Revenue Agency (“CRA”) has issued many interpretations on the topic to help taxpayers identify what income is taxable and what is exempt. First, we must determine whether crowdfunding qualifies as income and then we must examine whether it meets any of the exclusions specifically identified in the act and if not we must scrutinize the CRA opinion.

The CRA considers crowdfunding income from business. The act defines business generally as an undertaking of any kind. Furthermore, the CRA considers a business to have started when some significant activity began or the activity would either be part of the regular business or required to start the business. Therefore, according to the CRA, it appears as if the act of crowdfunding is the beginning of a business activity.

Crowdfunding, in itself, is not specifically exempt from income by the act, and therefore we must rely on the CRA interpretations. Crowdfunding could potentially fall into two common exemptions from income:

  • gifts and
  • Other voluntary payments and windfalls.

Gift and other voluntary payments specifically exclude receipts from carrying on a business. As crowdfunding is considered a business, the income can't be considered a gift or a voluntary payment. In order to be considered a windfall, the recipient has to have made no organized effort to receive the payment. As this goes against the idea of crowdfunding, it appears as if the income is not exempt under windfalls either.

However, all hope is not lost. According to the CRA’s interpretation, specifically addressing crowdfunding, they state that crowdfunding activities are taxable. However, the CRA does acknowledge that multiple crowdfunding arrangements exist and crowdfunding arrangements could result in a loan, capital contribution, gift, income, or a combination thereof. The CRA therefore clarifies an overall opinion, absent of specific facts and circumstance, cannot be issued. In addition, the CRA completes the interpretations by defining the word gift as voluntary and the donator has no obligation to make such a transfer. This seemingly odd ending to their interpretation leads many readers to believe that a true gift or donations received through a crowdfunding arrangement might not be taxable.

It appears that the taxation of the crowdfunding might not be unavoidable, but the tax rate applied to the crowdfunding profits can be adjusted. If the inventor has incorporated, the corporation who receives the fund will pay corporate rate, whereas inventors who does not will be subjected to personal marginal rates. A corporation that is eligible for the small business deduction, only pays an 11% federal tax rate while an individual in the lowest bracket must pay 15% tax federally.