Introduction

Real estate investment has long been considered a lucrative venture for individuals seeking to diversify their portfolios and generate passive income. Traditionally, investing in real estate required significant capital, making it inaccessible to many. However, the advent of crowdfunding has revolutionized the real estate industry, enabling investors to participate in lucrative opportunities with smaller investment amounts. In this article, we will explore the concept of crowdfunding in real estate investment, with a particular focus on UK investment opportunities.

 

The applicable law

Although crowdfunding has existed in various forms since the late 1990s, the global financial crisis in 2008 accelerated the trend of channelling consumer and business lending through crowdfunding platforms. This mode of nonbank financing experienced significant growth in the period since the financial crisis, particularly for start-ups and early stage companies. Investment and financing through crowdfunding platforms has been subject to very different levels of regulation in the EU and the U.K., which divergent treatment has inhibited cross-border activity and allowed the concentration of crowdfunding businesses in a small number of jurisdictions.

Some jurisdictions applied their existing regimes for alternative investment fund management, payment services or investment business to crowdfunding platforms, while others settled on the absence of any regulation, and some jurisdictions, such as the U.K., expanded the coverage of their existing licensing regimes to address gaps in consumer protection rather than develop an entirely new regulatory framework.

The EU has now belatedly implemented a bespoke regime in Regulation 2020/1503 on European crowdfunding services providers (the Regulation) to govern investment- and lending-based peer-to-peer or crowdfunding platforms. In the U.K., where the majority of crowdfunding platforms in Europe are established, the U.K. government has resolved to continue with the U.K. regime instituted in 2013 to cover electronic lending without making any amendment in response to the Regulation.1

This is notwithstanding the replication and onshoring in the U.K. of the vast bulk of EU financial services regulation following Brexit. U.K. regulators have determined the existing regime to be adequate compared to the new EU regime, which position aligns with the post-Brexit trend for the U.K. to steer its own course in the regulation of fintech companies rather than mirror regulatory efforts in the EU.

The U.K. government has confirmed that the Regulation will not be transposed into U.K. law. In a November 3, 2020, letter, the U.K. economic secretary to the Treasury stated that the reason for not replicating the legislation in the U.K. is that “there is no evidence to suggest that [implementing the Regulation] would result in material benefit to the U.K. Crowdfunding sector” and that sufficient protections for users of crowdfunding services are already set out in U.K. legislation.

But, crowdfunding was mostly unregulated. From 1 April 2014, the Financial Conduct Authority (FCA) started to regulate some forms of crowdfunding in the UK. Before that, the main legal provision that was the most similar with the crowdfunding scheme was Article 36H from Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, wich was about operating an electronic system in relation to lending. I will not present its provisions here, in regard to its wast amount on informations.

 

The main Insitution that has the main supervising and endorsing duties regarding the crowfunding platforms (CFP) its the Financial Conduct Authority, name hereinafter FCA.

But, in spite of being regulated by several insitutions, the Financial Conduct Authority leads the role with its regulations about it named FCA Policy Statement PS14/4, and FCS Policy Statement 19/14.

The conclusion so far is that there is no specific reference to real-estate area in the above mentioned regulations, but in absence of the special provisions regarding to this area, I consider that it is going to be applied the general, wich means general provisions in the United Kingdom`s law about property, shared property, etc.

Authorizations

There are many forms of CFP and the exact format being considered and products offered/Ventures promoted will need to be assessed against the terms of the Financial Services and Markets Act 2000 (FSMA). Under the terms of section 19 of FSMA, anyone carrying on investment business in the UK needs to be authorised to do so, or fall within the terms of a relevant exemption. The consequences of carrying on investment business illegally can be severe.

 

There are a few forms that CFP cand took, for example Choice, Partnership, Limited Company and Limited Liability Partnership.

As example, for Limited Company, there are required:

• Memorandum of association
• Articles of association
• Form 10, setting out details of registered office, directors and secretary
• Form 12, a statutory declaration of compliance with the Companies Act 2006 In addition, the application for registration must state:
  • the proposed name of the company
  • the proposed location of the registered office;
  • any limitation on liability, either by shares or guarantee; and
  • whether the company is to be public or private

For a Limited Liability Partnership, there are documents needed as like:

• name of the LLP
• statement about intended location of registered office
• names and addresses of those who are to be members. This information should be provided with the signature of two or more persons associated with the business.

As with a company, an LLP must file:

• annual accounts
• annual returns
• notifications of appointments
• notifications of any termination of membership; and
• notifications of any change in members or registered address.

Crowdfunding Model Options

A. Reward based

In this scenario, the investor makes a pledge and receives a reward which may have no or little intrinsic value. The backer does not anticipate any serious return on his “investment” and in many ways this might best be viewed as a donation rather than an investment. Typically an investment level target is set and individual pledges towards that target are made via an online payment channel such as Paypal. Generally speaking, if the fundraising target is reached, the pledged sums are debited directly to the investor’s bank account with the CFP taking its commission, which is typically in the region of 5%. Some CFP are set up so that pledges are transmitted directly to the Venture’s bank account.

This means that the CFP does not get involved in holding investor monies. However, other CFP do accept the funds directly, take their commission and then distribute the balance to the Venture. In some cases, the Venture does not have a specific funding target and the transmission of the pledged sums to the Venture is not deferred. In the “reward-based” model, the backer is not really making an investment and the so-called reward is generally known at the time of donation.

Accounting: From the perspective of the Venture, funds raised are income, and should be accounted for on a receivables basis, typically this is the date on which the funds hit the company’s bank account. In terms of accounting for the cost of rewards given to the investors, this should be recorded at the cost incurred by the business. So if the reward given is a signed photograph, this might simply be the cost of developing the photograph.

Corporation Tax: If the Venture is a company, it is liable to corporation tax if the investment provided is to fund a commercial activity, and this will apply in many cases of reward based crowd funding. At the time of writing, tax is paid in the UK at 20% on profits up to £300,000, and at 23% over £1.5m. An effective rate of 23.75% applies between these two limits. Therefore if the net of funds received minus costs incurred means a profit has been made at the end of the year, corporation tax will be due, and some of the funds raised should be retained to meet those liabilities after the year end.

Income Tax: If it is an individual rather than a corporate Venture, the investment is a donation and not liable to income tax, unless he or she is considered to be involved in a taxable activity in which case the funds are likely to become chargeable to income tax, although of course everyone has a personal allowance which, at the time of writing is set at £8,105. Should the funds raised be a genuine gift, and the purpose is not to fund a taxable commercial activity, then they will usually be treated as a donation or gift for tax purposes.

VAT: A business is required to register for VAT once it expects annual turnover to exceed £79,000. The primary reason for the donation should be established, and whether this was done for the 8 purpose of obtaining the reward, or for social reasons. In most instances if what the funder has received is of intrinsic value in return for its investment, HMRC will look to argue that there is a taxable supply for VAT purposes, even if the rewards in question are worth less than the sum invested.

However, for those investments which might be described as broadly philanthropic, it might be possible to argue that rewards of limited value, like signed programmes or photographs are no more than a simple “thank you” and as such not subject to VAT.

B. Loan Based

CFPs adopting this model are highly varied in nature and constitute the majority of “alternative finance” activity in the UK when measured by turnover. The actual structure of the repayable finance terms vary from platform to platform. Two of the more common types are those based on revenue participation or interest. In the case of revenue participation, the investor receives a percentage of sales for a given period of time from the Venture. There is no repayment of the loan principal. In the case of those based on interest, the investor receives a fixed interest payment for a given period of time from the Venture and at the end of the loan period, the loan is to be repaid in full.

Accounting: For the Venture receiving the loan, it should recognise a liability on its balance sheet within creditors, analysing the loan into amounts due before and after one year. It must also disclose the principal terms of the loan, such as rate of interest and loan period. Arrangement fees payable to the CFP should be deducted from the cash received and accounted for over the period of the loan as part of the finance cost.

For the CFP, given the principal activity is that of the provision of finance, all arrangement fees and commissions earned will be its principal source of revenue, and should be shown as revenue. The timing of the recognition of revenue from the arrangement fees will depend on whether or not there are ongoing obligations for the CFP; if they do not exist, this would suggest the revenues can be recognised immediately. From a balance sheet perspective, since the actual loans bypass the CPF itself, these will not be shown.

Taxation: For the Venture, the interest payable is deductible against corporation tax as a trading expense. The CFP is liable to corporation tax on its revenues earned in the year. For the individual investor, he or she should receive interest net of basic rate tax, and is liable to further tax if a higher rate tax payer.

3. Equity Based

The investor is looking to share in the success of the Venture but may of course end up participating in its failure. The terms of participation in the equity of the Venture are set by the CFP. This is generally the riskiest form of CFP participation from the investor’s point of view and, wherever possible, the potential investor should seek to do due diligence not only on the Venture but also the CFP itself.

EIS and SEIS: Often the key driver for UK investors via this model of CFP is tax relief. Typically, this is dependent on the company being registered for EIS, where income tax relief is 30% or SEIS where it is 50% and in the case of the latter this can mean up to 72% total relief. This is a complex area with companies engaged in certain “financial activities” excluded from offering SEIS/EIS relief.

Companies need to ensure they do not act in such a way as to make their investors unable to benefit from the tax relief. Investors must not receive anything of “significant” value from the company in which they have invested, otherwise EIS and SEIS benefits may disappear. “Significant” can be subjective, and HMRC might not share the view of the investor.

VAT: For VAT purposes, shares, and other forms of equity are treated as an exempt supply, so there will be no need to charge VAT to the individual investor. However, the Venture will generally be unable to recover VAT on any associated costs.

Of course, these ar not all the business options. There are a lot more, but those above are regulated.

Special mentions concernig the service provider

Today, the FCA regulates equity and loan-based crowdfunding (peer-to-peer lending). Donation and reward-based crowdfunding platforms are spared from the regulation as they don’t offer equity stakes or return.

Only platforms that facilitate credit agreements where either (i) the lender is an individual (including within a partnership or unincorporated body) or (ii) the borrower is such an individual and the amount of credit is below £25,000 or otherwise is intended for a nonbusiness purpose fall within the scope of authorisation.

The ambit of what is regulated in the U.K. is therefore more limited than what is covered by the EU Regulation — the Regulation is not confined to participation by an individual either as a lender or borrower, and it covers investment beyond the mere granting of loans.

Given the narrower scope of the U.K. regime, many U.K.-based platforms are either unregulated (although some have obtained consumer credit licenses) or have business models that only partially fall within the scope of regulation.

Those that do fall within the regime have the option of operating as an “appointed representative,” which does not require obtaining a license since another firm acts as the principal with the requisite license and assumes the regulatory responsibility over the platform.

The U.K. regime is also much less onerous than the one set out by the EU Regulation, as the U.K. regime does not provide for any rules on due diligence, disclosure akin to a KIIS (Key Investment Information sheet), a reflection period or an investor appropriateness test.

Conclusions

 

The applicable law uppon crowdfunfing business are Financial Services and Markets Act 2000 (Regulated Activities) Order 2001, FCA Policy Statement PS19/14, FCA Policy Statement PS14/4, Unfair Contract Terms Act (“UCTA”) 1977 and Unfair Terms in Consumer Contracts Regulations 1999.

The main authority in this area is the Financial Conduct Authority, for entering into crowdfunding business being needed to fulfil a special condition of receiving a authorization from the ASF for the most usable and serioius type of CPF, besides the documents required for enlist a new commercial legal entity,

The Regulation (EU) 2020/1503 states provisions that now are not in force and imposed in the internal UK`s law, follwing the Brexit.