Many people think that if they invest in a startup, the capital from those investments would be tax-free. But there are many countries around the world where this is not true.
In fact, in some countries, it’s even taxed at a higher rate than income tax! So before you make your next investment, let’s find out what taxes will come into play for you.
The USA – Generally, in the USA, if you are a freelancer or independent contractor, then yes, the startup capital is taxable.
In most ways, small business is grouped with other types of self-employment (i.e., freelance work) and tax for this class of citizenship varies depending on the state where you live and your income level.
So generally speaking, when it comes to cost to employ someone who has not yet incorporated their business or sold stuff to customers, they are considered as a freelancer and at the same time an individual taxpayer despite being seen as employed by their corporation because they take home what is left over after taxes.
A company usually hires an “employee” instead of a contractor so that money can be taxed at lower rates.
The IRS has two different types of taxes and one is an income tax, and the other is a capital gains tax.
An income tax is when you’re paid wages or get interested in your bank account; both are taxable.
All capital gains are taxable.
The United States federal government taxes “capital gains,” which the IRS defines as “the difference between the amount you paid for something and the amount you received when you sold it.”
A capital gains tax is for things that you invest in and make more money off of (such as stocks) because they aren’t taxed until you sell them – unless the asset is entirely converted to cash while still in possession, all profits from investments are not fully taxed until one sells an investment.
The U.K. – The short answer is yes, that startup capital is taxable. The long answer to this question is that what happens with the U.K. in terms of taxation depends on whether you’re talking about sole businesses, limited companies, or partnerships.
Sole traders are treated differently from limited company members, which carries through to how they are taxed.
For example, where returns on a capital property or trading profits exceed £150k (approximately $203k), then there’s a high probability that it will be classified as “deemed” income under the Income Tax legislation for 2015-16 and therefore subject to taxation.
A limited company is treated as a separate legal entity for income tax purposes, and this means that it pays corporation tax on any profits made by the business. Still, shareholders will not have to pay corporation tax on their dividends from this company.
Partnerships are taxed in the U.K. Individual’s profits from the sale of partnership capital would be taxable at their rates, taking into account any loss relief they may have received.
Also, keep in mind, partnerships are taxable in the U.K. if one or more partners is U.K. resident.
Canada – As a general principle, any income generated by business activities in Canada is generally taxable, regardless of where the money is made.
Generally speaking, if you receive interest or some dividend on Canadian Dollars, there will be no additional taxes for this money.
If you generate revenue from exporting products to another country and not spending the funds in Canada, then the tax rate may favor shifting this income out of Canada.
Australia – All income earned by Australian companies or individuals is taxable at the corporate level, starting when a company makes its first dollar.
It is possible to earn capital on your Australia-held assets without having the income taxed. These assets include stocks, shares, bonds, and money from term deposits and investments. However, for a capital gain to not be taxable, it must remain invested or reinvested in an Australian asset for at least 12 months continuously.
Experts suggest that with this time frame set, there would be multiple instances of favorable tax implications instead of what may happen if the investor made a decision based purely on financial considerations rather than tax implications.
Is Startup Investment Taxable?
The USA – Yes, investment income is taxable for individuals in the USA and includes capital gains on investment securities.
Venture capital income, which is an investment in private ventures, is taxable. This includes profit (above what was paid for) and any proceeds from selling shares or taking partial ownership of a company.
Taxable investment income includes capital gains on investment securities. On top of these capital gains, 20% of a realized gain is deducted monthly.
This deduction can be accelerated by making installment payments to cover one’s estimated tax liability for the year, which results in lower total interest and less waiting time between when investment gains value and when it’s taxed.
Those who make or have made more than $400K/year ($200K single filers) will also need to pay 3.8 percent tax on their net income from trades as part of their income taxes.
The IRS reviewed the startup-taxable business tax on March 15th, 2013, and (effective July 16th, 2014) ruled that income from equity investments in startups is taxable.
The first time an investment is sold, it may be considered “unrecognized,” thus not subject to taxes; however, once a sale is finalized, taxes are due for that year.
The U.K. – Yes. Any income from trade, business, or profession is always taxable in the U.K.
If your investment is from a U.K. bank account, it’s taxable. It would be taxable if you invested funds directly from a U.K. source, such as income from employment or pensions. The United Kingdom government does not tax overseas asset investments.
In general, any compensation you receive when you give up your equity in your company to someone who has given money to the company is a taxable event. However, you will pay more or less tax depending on whether or not it was a “gain” for that person.
Canada – Investment income is taxable in Canada, and a corporation’s income is generally taxed as the Corporation Tax Act specifies.
If you classify as self-employed, you may be considered a “small business owner” and incur the additional expense of paying taxes on your investment income.
For the most part, any savings investment would be considered taxable income.
However, this isn’t always the case since it depends on what type of investment it is – for example, Registered Education Saving Plans are often excluded from taxation.
Australia – Startup investment is a taxable Australian business asset.
According to the Australian Tax Office (ATO), funds coming from gains made during currency speculation are considered business or trading income and taxable accordingly based on your marginal rate.
Other investments like loans would also be taxed accordingly if they provided an ongoing return. This answer applies only to Australian taxes on assets that generate some return.
Financial support of A$500 or more from a company in the same financial year will be treated as financial assistance and is taxable.
This includes shares, property, loans, debentures, or any other form of loan agreement where this amount has been advanced to the recipient to provide funds for business expenditure. This also includes withdrawing capital from a company via dividends paid out regularly or a single large dividend.
Is Angel Investing Tax Free?
The USA – It would not be tax-free for angel investors in the U.S., as investments are treated as ordinary income and subject to federal and state taxes.
The IRS generally treats investments in angel deals as capital gains or losses – and the 10% “long-term” capital gains rate will apply to 50% of your investment profits more than $100,000 after subtracting all associated costs.
This treatment is also available to taxpayers who earn income other than from an investment. It is just that dividends are not subject to long-term capital rates, whereas they are subject to short-term rates.
To qualify for this treatment, a taxpayer must pass two tests: the “10 year holding period” test and the “private company shareholding interest” test.
The U.K. – Angel investing is a form of investment that is tax-free in the U.K.
You can make an angel investment or loan agreement without having to worry about the tax rules associated with this type of transaction because it’s not a taxable event for the investor nor the company receiving your money.
The company repays you after they’ve sold your shares, and in most cases, until then, you are treated as though you had some passive income investments in their company.
Very few countries have tax-free investment programs like the U.K. does for angel investments; investors will usually only be exempt from paying capital gains taxes when they invest in less risky parts of an economy or in companies that are non-profit.
Canada – Taxation of Angel Investing is not made explicit in Canada. That being said, angel investing should not be treated as a passive investment because you are actively involved with the company, and “passive income” is an investment that does not include active participation in the management or control of a business.
Within Canada, investing is taxed as income and capital gains, just like any other type of investment.
However, there are some concerns. Losses from angel investing can offset Gains, but only the net profit would then be an income that could be taxed depending on your tax situation (tax bracket) or if you are in a corporate structure.
Australia – You might not be aware, but the Aussie government taxes investment income and capital gains.
Angel investors are just like other types of investors. Their investments are taxed, and they cannot use them as a tax deduction for any current-year losses.
For example, suppose an investment has generated losses in year one but begins making gains in year two after dividends were reinvested. In that case, those gains can’t be offset by taxable income from those early losses. However, unlike equity investments (when you buy stock), angel investing isn’t subject to capital gains tax in Australia.
Is Venture Investment Taxable?
The USA – If you are a US-based individual with a taxable income, then venture capital investments will be taxed.
You’ll need to know your total up-front investment, the year of the investment, and your total return on investments before an accurate determination can be made.
The company that funded your venture may also have provided you with stock grants or options that need to be considered as well.
Depending on how long it has been since your initial investment was made in this venture work, you should speak with a tax professional who works with these investments specifically to review and file all appropriate forms.
The U.K. – Venture investment is taxable in the U.K., but there are a few exemptions that you may be eligible to claim and should talk about with your accountant. Visit https://www.gov.uk/guidance/venture-capital-schemes-tax-relief-for-investors to find more information on income tax for investments like venture capital, or speak with an accountant who specializes in taxes and investment strategies!
The taxability of investment returns for British investors is based on your circumstances. Some funds are registered offshore, or some are not registered at all.
Capital Gains Tax relief may be available depending on the situation. It is always best to consult your tax advisor when you want to diversify away from stocks and shares into other assets.
Canada – All Canadian venture investing income is taxable in Canada, and the amount of tax to be paid is based on income, not profits.
The tax rate has gone up significantly in recent years and could go even higher as the government looks for revenue to pay down its debt, so investors beware!
Australia – If you’re living in Australia, then yes, venture investment is taxable.
It’s taxable in Australia because Venture Capital Investment Income is also considered capital gains.
For example, if you bought a share for $10 and sold it for $50, then this would be considered income and taxed accordingly at the time of sale.
When you invest in V.C. funds outside of Australia, these are deemed investments rather than capital gains, so they may not be subject to Australian tax laws. The provisions vary from country to country, but they’re generally based on where the investor is domiciled or residing at the time of investment.
Is Money Raised Through Investors Taxed?
The USA – In the United States, all money that is earned will be taxed. If you receive cash from an outside investor, then the government will see it as taxable income.
On top of that, they’ll take a cut for taxes taken out automatically (usually at around 30% with some variables) without consulting you on this or allowing for any other negotiation.
The citizen is responsible for figuring out how much tax has been paid into their account and claiming refunds when appropriate to cover gaps in taxes owed.
It could be complicated and time-consuming because you’re dealing with different currencies and individual problems if the original investors transferred money back into a U.S. dollar bank account which later reverted to its original currency.
The U.K. – Several factors determine whether or not an investment is treated as income and, therefore, subject to taxation.
If the government has a right of pre-emption, this effectively means they can reinvest in a project rather than take money out of it. This right applies to certain types of loans (e.g., those created under new companies’ articles) that always have the option over the future profits if this prevents tax liability from building up.
To be classified as income, there must be a transaction between two financial parties where one party is receiving a cash payment from another person or organization.
Canada – Investing in Canada is subject to the Canadian Income Tax Act, which does not typically provide for the deduction of amounts paid or payable by an individual in respect of private investment in a qualifying small business corporation (QSBC) that they control as a shareholder.
Australia – The Australian Taxation Office currently does not impose any tax on unearned income from investments.
It’s true that if you had invested $100 over the last year and received a 10% return on your investment, you would be required to pay taxes on that $10 of profit ($1,000*0.10 =$100).
However, if one were to invest through an Australian company with more than $20 million in revenue in the past year, they are eligible for the new exemption. These types of investments will not be subject to capital gains tax.
Conclusion
If you’re not sure about your company’s tax situation, it may be a good idea to consult with an accountant. Taxes are complex and can differ drastically depending on the type of business that is being run.
For example, if someone invests money in a startup that has never been profitable before, they will receive taxable income for their investment. Still, they won’t have any deductions against those earnings because they haven’t paid taxes yet.
Whereas if someone invested after the first year of profitability, then there would likely be some deductions taken out by the government because this investor had already paid taxes at least once during that period.
Glossary
An angel investor invests their own money explicitly rather than managing a large pool of investments for others. They are typically retired wealthy individuals who invest their savings into private high-risk ventures for profit.
Restricted stock is when the company gives you the right to buy or sell shares of their stores at some point in the future. To do this, a company must agree that it won’t release or sell all shares at once for a certain period. These restrictions may last weeks, months, years and so forth depending on how far out into the future they extend.
A capital contribution is money invested in a company, of which 10% is required to be from equity (owned or bought by the investor) and 90% from debt.
Angel tax is a new rule proposed by the U.S. government that would charge venture capitalists for investing in early-stage startups to help with their startup costs and startup expenses.
A sole proprietor is when an individual owns and operates a business, aka the “sole” person, as they’re the only factor in the industry. This means that this type of company is not composed of more than just one person.
Ordinary income, for tax purposes, is any gain or income that’s not considered capital gains (from an investment).
Employment tax is the U.S. federal and sometimes state government tax on an employee’s gross pay.
Organizational costs are expenditures to build and maintain an organization. They include salaries, payroll taxes, workers’ compensation premiums, health insurance premiums, office space rental expenses (including any real estate taxes), administrative costs such as supplies expenditure, etc.
Long-term capital gain is the profits derived from the sale of assets that have been held for at least a year.
Self-employment tax is a Social Security and Medicare tax paid by those who work for themselves.
Ordinary income tax (or just “income tax” in some cases) is levied on earned income and investment income.
A tax return is a document you receive from the government showing how much money they took from your salary and what you expect from them.
An accredited investor typically has a net worth of more than $1 million excluding primary residences or an income over $200,000 with an acceptable amount of risk. Alternatively, they can have more than $5 million in allowable assets, which do not include a primary residence. The rules are stricter for private equity and hedge funds.
Equity compensation is a powerful long-term motivator. For example, IBM pays out about 70% of its earnings as dividends to shareholders – until recently, no other large company has paid such a high percentage.
A tax year is an annual period in which an individual or business pays taxes. Tax years vary by country regarding what calendars they use and how many fiscal years they have. For example, Canada typically has a tax year of April 1-March 31, and the U.K. has one from April 6th to April 5th.
A sole proprietorship is a form of business that only has one owner. They are the most common type of small business within the United States.
A tax consequence can be rather complicated and vary by individual case. Still, generally speaking, it is an assessment of an individual or entity concerning earning income or taking on certain deductions that could influence their tax liability.
A business entity is a company or corporation that has been legally registered with the state, and it’s an official and legal person that engages in commerce.
Business expenses are costs that a company incurs to keep its enterprise running.
A foreign investor is any investor who invests their money in an economy other than their own. For example, a British or American citizen who supports the Chinese economy may be considered a foreign investor.
A business structure comes in many different configurations, but there are two main types: sole proprietorship and corporations.
A fair market value is the amount of money that a buyer and seller would agree to for a given property in an open market transaction. It can also be defined as the price paid or received for most varieties of both real estate and personal property transactions.
Tax treatment is how taxes are applied to a person or entity.
Preferred stock is a security, which means it’s just like any other investment. It has monetary value and exists in little physical pieces of paper that can be transferred from one person to the next.
Outside investors are individuals or groups who contribute money for a company, not themselves owning part of the company but believing in the company.
Personal assets are anything that you and not anyone else legally or physically own.
Double taxation occurs when a country tries to impose taxes on income, capital gain, or some other form of assets that have already been taxed in another country.
