Financial Technology, or FinTech is a terminology used to describe digital innovation in the financial sector. FinTech was first believed to be limited to creative ways of enabling payments and transactions. However, it has experienced tremendous growth in the recent years, fuelled by dramatic shifts in the internet and mobile technology.
Presently, it encompasses a wide range of technical, financial services including crowdfunding, online client acquisition, mobile wallets, peer-to-peer lending, MPOS, MSME services, personal financial management, personal financial planning, Blockchain, and cryptocurrencies.
It is pertinent to note that the most challenging aspect of operating a FinTech company is handling the complicated regulatory landscape along with its tax implications. Understanding the global implications of tax on such companies and their services from the inception will aid in ensuring compliance with all the tax laws applicable.
This blog will discuss and elaborate upon the implications of tax on FinTech companies from a global perspective, analyzing the various taxes imposed and incentives provided in the UK, Ireland and USA to the FinTech companies.
I. UNITED KINGDOM
The United Kingdom (UK) is known for providing a supportive regulatory environment for digital and FinTech companies. It has been at the forefront of supporting competition and innovation in FinTech.
Corporate Tax Regime
The corporate tax regime, in force, in UK imposes a corporation tax at the rate of 19%. Corporate tax in the UK is applicable on worldwide profits of UK incorporated FinTech companies; and, in the case of non-UK FinTech companies, to the profits attributable to its UK branches. Additionally, companies are exempted from corporate tax for certain equity disposals and upon receiving different forms of dividends.
For corporate tax purposes, the UK does not have a group consolidation scheme, but a group relief system. This allows for losses to be transferred between sub-group members of UK-incorporated company, so that each of such members can achieve a similar outcome.
UK-based FinTech companies are not subject to domestic withholding of tax on dividends. Interest and royalty payments are subject to a 20% withholding tax. However, domestic laws and the UK’s double-tax treaty network, provides for eliminating or lowering such withholding tax, or imposes no withholding tax if paid to certain European Union (EU) affiliates.
The tax regime also offers various commercially attractive schemes to avoid the domestic withholding of tax on interest payments. Interest paid by a FinTech company incorporated in the UK may be deducted from corporate tax under certain conditions. However, such deductions shall not be more 30% of the company and its group’s earnings in the UK, excluding interest, tax, depreciation and amortization.
Value Added Tax
Value Added Tax (VAT) is usually imposed on the supply of goods and services, on a standard rate of 20%, and credit for VAT incurred may be provided. However, most financial services provided by FinTech companies are exempt from VAT, although such companies are also restricted in their capacity to claim VAT credits.
Tax Regime for Start-Ups and Tech Business
Several stand-alone benefits which support smaller enterprises are offered to FinTech Start-Ups. They provide tax benefits to the founders of such Start-Ups, or assist them in incentivizing staff or obtaining critical early-stage funding. Where certain conditions are satisfied, the entrepreneurs’ relief can decrease the rate of capital gains tax payable from 20% to 10%, on the ultimate sale of their FinTech Start-Up.
The UK’s Research and Development (R&D) Regime provides certain benefits to companies which intend to innovate in science or technology irrespective of their success or failure, including FinTech companies, by granting them enhanced deductions against profits for corporation tax in respect of certain qualifying expenditures.
Also, where the FinTech company incur losses, it can surrender those losses in exchange for a cash credit. This may prove to be beneficial for businesses in their early stages of operation.
FinTech companies can take advantage of several tax benefits offered in Ireland. The Irish tax structure provides substantial reliefs to FinTech enterprises in addition to the country’s physical position, availability of the relevant skills and knowledge, and track record.
The Irish Government is a strong supporter of FinTech and has declared its commitment to develop Ireland as a global leader in the financial services sector in its recently revised Strategy for the International Financial Services Sector, Ireland for Finance 2025. This includes creating an environment where domestic and multinational firms benefit from key Government incentives and supports to grow their businesses.
Corporate Tax Regime
The tax regime of Ireland imposes a corporation tax at the rate of 12.5%. However, several noteworthy Irish tax provisions encourage innovation and investment in FinTech in Ireland, including:
- Tax credit is granted at the rate of 25% on eligible R&D spending conducted within the European Economic Area. This tax credit is in addition to the standard company deduction of 12.5% for such R&D expenditure, offering relief for R&D spending at an effective rate of 37.5%. These credits can also be surrendered by the FinTech company to essential personnel who are actively engaged in R&D operations, effectively lowering the rate of corporation tax.
- A top-of-the-line Knowledge Development Box is established, which satisfies the Organization for Economic Co-operation and Development’s (OECD) modified nexus requirement. When qualified R&D activity is carried out by FinTech establishments in Ireland, the rate of corporation tax for the entity reduces to 6.25% for profits obtained from certain Intellectual Property (IP) assets. This relief can be sought in addition to the R&D tax credit.
- Individual investors in FinTech companies are eligible to receive Income Tax relief of up to 41% on investments made in qualified, certified FinTech enterprises each tax year under the Employment and Investment Incentive (EII) and Start-up Refunds for Entrepreneurs (SURE) program.
- The entrepreneur’s relief reduces the rate of capital gains to 10% on the sale of qualified FinTech business assets up to a lifetime value of €1 million.
III. UNITED STATES OF AMERICA
The United States (US) Government does not offer any Federal income tax benefits to FinTech companies. The rate of corporation tax in the US is 21%, which was decreased from 35% as amended by the 2018 Amendments to the Federal Tax Law.
The Government has also levied an incentive tax at 13.125% on intangible asset-based company profits earned outside the US. They also provide a federal R&D Tax Credit which can be utilized to offset payroll taxes and encourage entrepreneurship in technology start-ups in general.
FinTech Firms & Banking Status
Many FinTech firms in the US have applied to state banking authorities or the Office of the Comptroller of the Currency (OCC) to obtain the status of bank or trust charters, or have acquired an existing bank for the charter.
Banks are taxed in the US in a similar manner as other corporations. However, one of the most significant advantages of being a bank for Federal Income Tax purposes is that profits and losses from the sale or exchange of bonds, debentures, notes, certificates, or other evidence of indebtedness are taxed as ordinary gains and losses under IRC Section 582(c)(1).
The capital gain or loss treatment under Income Tax maybe detrimental for unsuspecting FinTech businesses which do not fulfil the criteria of a bank for federal income tax purposes. Such businesses must be aware of the possible tax consequences of selling debt instruments at a capital loss, which capital gains can only compensate. This scenario might be a problem for a FinTech business if it does not earn enough, offsetting capital gains.
FinTech firms may not fulfil the definition of a bank for federal or state income tax purposes under the US Laws in many circumstances, which might result in unanticipated tax implications.
A Bank is defined as an institution which satisfies three unique characteristics under IRC Section 581:
- It must be a federal or state-chartered bank or trust corporation incorporated and doing business;
- A “significant portion” of its operation comprises of “accepting deposits, issuing loans, and providing discounts”; and
- It must be “subject to lawful monitoring and scrutiny” by federal or state authorities with oversight of financial institutions.
In the United States, Supreme Court ruling in MoneyGram International Inc. v. Commissioner of Internal Revenue No. 20-60146 (5th Cir. 2021), the 5th Circuit Court of Appeals upheld the Tax Court’s decision that MoneyGram is not a bank for Federal Income Tax purposes as its consumers do not provide it money for safekeeping. Hence, it failed to fulfil the second element of the definition of ‘bank’ under IRC Section 581.
Many organizations seeking a bank or trust charter in the FinTech industry do not collect deposits to support their operations but seek outside financing. Hence, these businesses are unlikely to fulfil the “significant portion” criteria and, as a result, cannot utilize the tax benefits granted to banks under the US Tax Regime.
FinTech businesses have recently risen to popularity as the preferred method for acquiring financial services quickly and efficiently. The growing reliance on internet activities exacerbates this due to the COVID-19 pandemic.
The tax regimes of both UK and Ireland provide optimistic benefits to FinTech companies to reduce their tax liability, while granting reliefs for R&D in technological and digital spaces. However, the tax regime of US has not accorded any special relief or benefit for FinTech companies, as they are taxed similar to ordinary companies within the country.
The Governments of various countries have either implemented or proposed to implement taxing measures and beneficial provisions for companies involved in FinTech Industries. However, the need of the hour is for the countries active in the digital and technological landscape to introduce and implement express laws within their countries spelling out the consequences of tax on the FinTech sector. This would further push other countries across the world to frame the taxation structure for FinTech companies within their jurisdiction.
-TEAM AMLEGALS, assisted by Mr. Hraday Jaiswal (Intern)
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