The most relevant tax issues to consider will depend largely on the growth stage, profitability and nature of your business.

For loss-making or early-stage businesses, we tend to find the focus is on cash preservation. From a tax perspective that often means R&D tax claims, VAT and payroll taxes are priority areas as these either represent opportunities to generate positive cash flows or real cash/tax leakage.

For larger, profitable fintechs, the focus shifts towards tax risk management and tax governance. As the business grows and teams expand, it becomes more and more important to have strong controls and processes in place to manage tax risk. Often this is a challenging transition as fintech culture often promotes flexibility, innovation and empowerment of all staff to make decisions on for example new products, services or markets. Making sure the tax or finance teams have an early awareness of these plans is key to managing the business’ tax risk, both in the UK and internationally.

Key tax considerations may include:

• R&D tax relief – ensuring claims are maximised but robust, minimising risk of HMRC enquiry which can be costly and delay repayment of any tax credits.
• VAT recovery – ensuring an appropriate VAT recovery method is agreed with HMRC (if necessary) and applied correctly.
• International tax – managing the business tax residence and international presence, along with ensuring compliance with local tax rules and reporting requirements.
• Transfer pricing and profit fragmentation - ensuring appropriate policies and documentation are in place to justify an arm’s length price for any related party transactions.

We help fintechs at all stages of growth to identify and maximise tax opportunities, as well as manage and mitigate tax risks across all areas of tax. Find out more about our Business tax services.

Fintechs are often incurring significant expenditure on research and development, most commonly software development activities to either improve processes or develop new innovative ways of doing business with a view to disrupting the market.

Making an R&D tax relief claim can be vitally important for fintechs, particularly in the early stages of growth where cash is so important.

R&D tax relief is claimed through a Company Tax return (assuming the company pays UK corporation tax). A claim can be made up to two years after the end of the accounting period in which qualifying expenditure was incurred, so for example a company with a year end of 31 December 2020 has until 31 December 2022 to make an R&D claim in the tax return. However, we find that preparing an R&D claim on a real-time basis not only tends to increase the value of the claim (because engineers or developers are more engaged in the process) but also ensures a robust claim is made to HMRC as access to supporting data is more easily available.

The first step is generally to determine what qualifying R&D projects your fintech has been involved with in the relevant accounting period, and then identify the qualifying expenditure that was incurred on relevant projects. It is important to use the Department for Business Energy and Industrial Strategy guidelines when considering this.

Our R&D team includes developers who fully understand the projects undertaken by clients at a technical level and so help prepare a technical narrative to accompany your R&D claim. The amount of supporting explanation required depends on the size and risk of the claim. Our expertise has allowed us to deliver a very high success rate of R&D claims with HMRC.

If your company is paying UK corporation tax as well as working on an R&D project that qualifies for tax relief, then you may end up incurring some qualifying costs that are linked to overseas activities. In order to qualify for the relief, the company must be paying UK corporation tax, but the expenditures that qualify may be occurring overseas – for example with subcontracted work.

Note: there are benefits and different treatments depending on whether your fintech is considered a Small and Medium Sized Enterprise (SME) or a large corporation.

If R&D activity is carried out by a division of a UK-based company, but this division is based overseas, it could still be eligible for R&D tax relief. This assumes that your overseas branch is a permanent establishment, whose activities are within the scope of UK Corporation Tax.

The most important thing to remember is that there is no geographical restriction on R&D tax credits. The validity of your claim is based on your qualifying R&D activities and the level of qualifying expenditure – not where the R&D work was conducted.

Fintech businesses are generally only permitted to recover a proportion of the VAT they incur. This is because they commonly make a mix of ‘taxable’ and ‘exempt’ supplies for VAT purposes. We assist many clients in this area from the outset as it can get complex quickly but here is a flavour of the general rules around input VAT recovery to get you started.

Where a fintech is carrying on ‘taxable supplies’ for VAT purposes, VAT on directly attributable business costs can be recovered. Where a fintech is carrying on VAT exempt activities for VAT purposes (e.g. including certain insurance, credit and finance services), no VAT recovery is allowed on directly attributable business costs. For costs that are consumed by the business as a whole, VAT recovery will depend on what proportion of your total supplies (sales) are considered to be ‘taxable supplies’ for VAT purposes, as well as whether you have agreed a specific VAT recovery approach with HMRC.

If your fintech is partially exempt, the ‘standard method’ is often the starting point for calculating how much input tax on costs is recoverable – this must be used unless you have agreed a ‘special method’ with HMRC. A special method should be agreed if the standard method does not provide a fair and reasonable result for your fintech.

We often help fintechs to determine whether the standard method is providing a fair result and if not, to approach HMRC to agree the best special method for them.

Please note VAT recovery is never allowed on client entertainment or non-business costs.

Typically businesses set up an employee share ownership plan (ESOP) sometime between pre-seed and early VC stage. When possible, it’s best to communicate options packages as a £ based value on the current valuation (rather than as a percentage of ownership in the company).

Options can have material tax consequences for employees – which need to be understood by both the new employees and also the company itself.

Several tax treatments of the options granted include: taxable event upon grant, taxable event upon leaving company, taxable event upon exercise, or no effective tax event.

Companies focused on social impact goals and/or in developing markets may have unique ESOP considerations

1. Financial Inclusion Goals: Employee-friendly hiring practices and ESOPs can help build local financial inclusion. If this is part of your corporate mandate, consider the added social impact value of offering your options program to all levels of employees.

2. Local Ownership Culture: Conversely, in certain regions stock options may have negligible value to employees, either because of risk aversion, lack of liquidity, or lack of understanding. If this is the case, it is not worth extensively offering options to employees who would rather be paid in cash. ESOP size is a board-level decision. Given the legal and administrative overheads, you won’t want to revisit it between rounds of funding. The size of your ESOP should aim to cover all your potential talent needs through to your next round - make sure your ESOP allocation is sufficient, but if you over- allocate, you risk diluting your stake, and your existing investors’ stake. ESOP size can be created using a bottom up or top down approach (typically a mixture of the two).

Further information on ESOP size is available on the link below: 

https://www.indexventures.com/rewardingtalent/handbook/esop-size

Traditionally, ESOPs are set to 10% at seed.

We help businesses identify whether and when an employee share ownership scheme may be beneficial. If so, we support businesses in designing a scheme that is fully aligned to their commercial objectives.

Every founder and business has a different view on how they would like to set up share schemes for their teams. In this area fintech businesses generally are no different to other fast-growth firms.

The most popular of the share schemes to set-up for employees is the Enterprise Management Incentive (EMI) share scheme. Many fintech’s introduce an EMI in the early stages of growth as a tax efficient way to incentivise key team members and retain their top talent.

Key tax benefits of an EMI scheme include:

1. Generally, no income tax or national insurance contributions on grant or exercise if share options are issued at market value.

2. Capital gains tax payable on sale of the shares, potentially at a reduced rate of 10% if Entrepreneur’s Relief applies.

3. Corporation tax deduction on exercise based on market value of the shares at exercise less exercise price.

Fast-growth fintechs often out-grow EMI relatively quickly however, as the rules specify that there must be fewer than 250 full time equivalent employees and gross assets must be £30m or less.

If your fintech does not qualify under the EMI scheme, then we recommend considering the Company Share Option Plan (CSOP). This is another tax-advantaged HMRC approved share option scheme, but with no limit on company size or number of employees, meaning that larger businesses can benefit.

More well-established fintechs also often use bespoke share schemes to incentivise or retain talent, for example growth or flowering shares.

We advise businesses on all types of share scheme, including design, set-up and ongoing compliance.

Market and company considerations need to be made. Three common approaches to determining business value: asset approach, income approach and market approach.

The key value drivers for business are: technology development, proving the business model, borrow pipeline and investor appetite, building scale and branding, moving into the ‘black’/ profitability, trust and resilience.

A multiple method approach is usually considered more accurate.

In addition to those mentioned above, other possible methods to use include: discounted cash flow, revenue or book value, replacement cost, price to earnings ratio, strategic/competitive value.

We help fintechs assess the best approach to valuing their business as well as providing support and advice around potential exit events.