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European Ecommerce, Dropshipping and VAT: The Essential Guide

europe, law, VAT, Value Added Tax, Europe, Tax

Initially published on the EternosCorp blog on the 

by B.F. Fabregue, Legal Affairs Director, Eternos Corp.

If you sell to buyers in the EU you need to know how VAT impacts your business. How do you ensure you follow the rules, and what happens if you don’t?

If you sell online, you need to understand which international tax laws will be relevant to your business. Just because you sell online, this doesn’t mean your business is not governed by the normal rules of taxation.

And if you sell to buyers within European Union (EU) countries (also known as member states), even if your business is based in another part of the world, you will need to know how Value Added Tax (VAT) impacts your business.

What do ecommerce businesses need to think about? What exactly are the different rules and regulations? What do you need to do to ensure you are compliant? What happens if you don’t comply? And finally, what upcoming changes in VAT regulations should you be aware of?

As we will see below, the VAT rules you need to consider when trading within the EU are not impossible to comply with if you ask yourself the right questions.

Additionally, the EU VAT landscape is ever changing and today this is true more than ever with new parameters such as Brexit and a focused fight against VAT fraud in ecommerce by EU tax authorities happening. In this guide, we will cover the rules you should currently follow and explain to you the new legislation coming into place in the next year that may impact the way you trade in the EU.

What is VAT, then?

The Value Added Tax (VAT) applies to most EU traded goods and services. Any business which exceeds a certain threshold of turnover usually adds VAT to the price of what they sell there. For every EU country the threshold is different.

VAT is also regarded as a general levy, because it extends to all goods and services more or less. It is a tax on sales, that is, it is charged by the consumer theoretically, not the company. But by applying VAT to the price customers pay, firms are essentially raising the tax on behalf of the EU.

Is dropshipping any different from any business ?
Short answer, no.

There are however specific elements to think about. Very often, dropshipping will happen without any storage of your products. So there is a “flash purchase and sale” when the final customer buys the product. As an example, in these scenarios the flow of events would be as follows: 1) Company A advertises a product online; 2) The final client makes a purchase of this product; 3) Company A buys the product from Company B and requests this company to ship it to the address of the final client; 4) Company A issues an invoice to the final client.

In these scenarios, you should take into account where are the goods coming from and , in case of goods are originally coming non-EU countries like China or the US, who is in charge of clearing customs on these products. In case the goods come from another EU country, you will normally require a VAT number in either a) the EU country of origin or b) the EU country of destination. Contact us to get help understanding where do you need to register in case you have this activity.

Import and export

Who pays the import VAT when importing goods into the EU? What should you do about it.

When importing goods from outside the EU and selling into EU member states, the responsibility for taxes and duties depends on who is the “importer of record”.

When using non-EU marketplaces such as AliBaba, it is usually up to the consumer to pay the import charges and VAT, via the parcel carrier, before the goods will be delivered. This is often not a pleasant customer experience, especially if it is unexpected. The additional import costs may even negate the benefits of buying abroad and can result in a high number of goods returned from disgruntled customers.

To avoid this, you may want to consider registering for VAT in the first port of entry into the EU for your goods. By keeping ownership of the goods, you will be the importer of record, and VAT will be charged on the cost price of the goods on entry.

The import VAT you pay is reclaimable on your VAT return, and the customer pays the full price at checkout – including VAT – so no nasty surprises for them. You will also benefit from a reduction in the number of returned goods.

Import One Stop Shop scheme (Import OSS)

For physical goods imported in the EU, a new import scheme will be created and accessible for both EU and non-EU businesses.

From 1 January 2021, EU and non-EU businesses selling physical goods with a value up to EUR 150 to EU consumers, will be able to declare and pay the VAT due on these imported goods in a single monthly VAT return by joining the Import One Stop Shop (OSS) Scheme.

When the new Import OSS is used, VAT will have to be charged and collected when the payment for the goods has been accepted. This means that when the goods arrive at the EU border, they will benefit from a fast release at customs with the VAT already accounted for.

The online seller will then be able to declare and pay the VAT collected to a single EU country where they decide to register for the Import OSS. The VAT returns and payments will be due on a monthly basis, and the EU country of identification will distribute the corresponding VAT amounts and information to the other EU countries.

When this special scheme is not used, for any reason, a simplified import mechanism will be introduced as well and VAT will have to be collected from the end customers by the customs broker, who will be responsible for paying the VAT amount collected to the local customs authorities on a monthly basis.

VAT

VAT on dropshipping and E-commerce: EU Companies Obligations – Treatment of E-commerce VAT (dropshipping)

Who has to pay VAT? The EU VAT Distance Selling Rules

If you are based in the European Union, or hold stock within the EU and sell to consumers within the EU, the Distance Selling Rules apply to you.

The rules apply even if:

  • You are not VAT-registered.
  • You are a sole trader.
  • You sell through marketplaces such as eBay and Amazon

Every single EU country sets its own particular VAT rate. By regulation, for specific goods and services eligible for the reduced rate, this rate must only be greater than 15 percent, or 5 per cent. Also per regulation, there are at maximum 5 class of VAT rates, except in France and Spain, which have “legacy VAT rates“. Strictly-medical supplies (which doesn’t include masks and medical gloves) and pharmaceuticals don’t have VAT per se but pay a similar levy in a different fashion, depending on countries.

The individual rates for each country can be found on the applicable website of the tax authorities in that country. The Website of the European Commission has links to each authority.

In certain cases, however, European VAT applies and is applied directly to the price, along with an indication that the price is inclusive of VAT. VAT is not applicable in other situations, and should be left off the list.

What value added tax do I pay when I sell between EU countries?

How VAT works in the EU depends on what you sell, and who you sell to. Goods and services are perceived differently, as is the disparity between the B2B and B2C transactions.

When marketing B2B products

If you sell to someone with an EU VAT number you do not charge VAT. You also subtract any VAT you’ve paid from your quarterly return to make the deal. If the customer does not have an EU VAT number, you are applying VAT on the sale to your country.

When marketing B2C products

You should register your company in the country of the customer and apply the VAT on the sale to their country. You don’t have to do that if your sales to a given country fall below a certain amount, set separately by each country in that tax year.

When marketing B2B Services

Typically you will not charge VAT. It gets charged at the rate of your country by the customer itself via the reverse charge process. Once again, however, you can subtract the VAT you paid to make a quarter of the transaction.

When marketing B2C services

For most services you apply VAT at your own country cost. The exceptions are telecommunications, television, or electronic services which are charged according to the country of the consumer.

When you are purchasing products or services for industrial use

You pay VAT at the cost of the goods in your country as if you had sold them. Usually this can be deducted when you declare VAT yourself.

The above would apply in most situations but you will need to familiarise yourself with some exceptions. For eg, does the VAT extend to EU countries’ overseas territories? Yeah and no.

VAT does not apply to:

  • The Åland Islands
  • The French Overseas Departments (which have a specific VAT tax regime)
  • The territory of Büsingen and Campione d’Italia (both exclave in Swiss territory)
  • The island of Heligoland
  • Mount Athos
  • The Italian waters of Lake Lugano
  • Livigno
  • The Canary Islands
  • Ceuta & Melilla

But VAT does apply to:

  • Monaco (same rates of France, with a few reductions)
  • UK bases in Cyprus (on the behalf of Cyprus)

The combination brings its own complications to the overseas territories straddling EU membership, as well as countries outside the EU at large.

National and intraeuro threshold

However, for small business, there are ways to not pay VAT, temporarily. For sales within the EU, if you have not exceeded the threshold in a specific country, you should apply your domestic rate of VAT to those sales – if you are VAT registered. Otherwise no VAT should be applied. Once you have exceeded the threshold in an EU country, you will have to register for VAT there, charge the country’s own rate of VAT, and file VAT returns according to the frequency and deadlines set by that country. You will stay registered as long as your sales exceed the threshold for the year. If your sales drop and you want to de-register, check the rules in that country – how soon you can de-register varies.

There are however two different kind sales regarding EU VAT threshold: national, and at distance or intraeuro

National thresholds

National thresholds indicate threshold meant for companies registered in the same territory they pay VAT to : for instance, a Polish tax-registered company paying VAT in Poland. National threshold differ by country. The selling threshold only apply to national sellers: for instance, if you have a French tax-registered company, you will NOT benefit from the threshold of Belgium or the Netherlands. In most EU member states the threshold is set at Euros 35,000 (or equivalent). For Germany, Luxembourg and The Netherlands, however, it is Euros 100,000 (or equivalent), and 85,000 euros in Ireland.

It is worthy to not that as multiple tax-registration is possible in the EU, so is the multi-VAT national threshold benefits, under very specific condition.

Infraeuro threshold

Since the 1rst January 2021, a new set of rules apply to infraeuro threshold due to the introduction of the 2021 EU VAT Ecommerce Package. The terms generally used by authorities is “Changes to the EU VAT Distance Selling thresholds”, mainly due to the old regime name. The directive is a series of measures applicable from 1st January 2021 which will aim to simplify the VAT rules for online sellers, while, in fact, mainly complicating the rules.

In 2015 VAT-MOSS (Mini-One-Stop-Shop) was introduced to facilitate the sales of digital services to private consumers within the EU. As VAT MOSS proved a real success in respect of the collection of VAT on digital services, this scheme is now being extended into a One Stop Shop (VAT-OSS) from 1st January 2021 to cover the supply of goods.

The new VAT-OSS rules stipulate that if you sell goods to private customers located in the EU, local VAT must be accounted (and paid) for based on where the customer is located, once you have exceeded a threshold of €10,000, which is now the rule. Please note that this rules DOES NOT apply to services.

For instance, if you have an Austrian company (which a threshold of 35k for VAT years), but which has a 15k turnover in Czechia, you’ll have to pay VAT through the OSS, even you don’t pay it in your own country.

Another example : The distance sales threshold in Germany is €100,000 and the German VAT rate is 19%. As long as the total value of annual sales in Germany is below €10,000, an Austrian business can avoid VAT allover. Between 10,000 and 10,000, the company will have to pay VAT through the OSS-VAT. Over 100,000 a VAT registration may be required in Germany.

To avoid multiple VAT registrations in different EU countries, the OSS (One Stop Shop), allows the seller to register for VAT in one single country and submit quarterly VAT returns. The host country collects and pays the VAT due from the seller’s EU sales in one VAT return instead of the seller having to register for VAT in every EU member state where they have customers.

The VAT-OSS is an optional scheme. You can still become (or remain) VAT registered in any EU country where you have customers through a voluntary VAT registration in that country.

It is worth specifying that VAT-OSS covers private consumer supplies only, not sales to other businesses, which means you would need to be able to identify who your customers are – businesses or private consumers – and apply the relevant VAT rules accordingly.

The rules now also applies to sellers that were previously exempt thanks to the extension of their national threshold, under the previous regime.

Why am I paying VAT on Amazon products I’m selling, even if I’m not liable for VAT?

The French and German tax authority have already introduced measures that now make the marketplaces liable for the VAT owed by the third-party sellers, instead of the sellers themselves. This has, in turn, made the marketplaces insist that a seller must have a VAT registration in place prior to being able to use a marketplace in either of those countries.

The last new rule coming into force from 1st January 2021 (effective in early March) stipulate that digital marketplaces such as Amazon and eBay will be, under certain circumstances, deemed for VAT purposes to be the supplier of the goods imported from non-EU territories and sold to EU customers.

Under the new 2021 rules the responsibility of charging, collecting, and remitting the VAT due to the national tax offices will shift in certain cases from the seller to the marketplace itself. This is a major change as for the first time, digital marketplaces are given a significant role in the fight against VAT fraud.

New selling proof – 1st January 2021

In order to understand which EU country’s VAT rate to apply, you will need to collect evidence of where your customer is based.

One piece of evidence per sales is required if your VAT sales are below €100,000 and two pieces of evidence are required if the value of your sales are over that threshold. This evidence can include the billing address, the IP address of the device used to make the purchase, and the customer’s bank details.

Which VAT rate applies to your goods or services?

It is important to know which VAT rates are relevant for the goods you are selling. Please note, these may differ between countries. The European Commission (EC) have published information relating to VAT rates and specific country rules.

Selling to non-EU customers

If you are an EU-based business and are selling to consumers outside the EU, the supply of goods is usually zero-rated provided strict rules are followed, including providing evidence of the export within three months of the sale.

It is, however, important to check the local rules and regulations of the country you are importing into.

VAT Fines : the cost of compliance: penalties and fines

In 2018, the European Commission reported that EU countries were losing €150 billion each year from undeclared VAT. To stop the hemorrhaging, special measures have been put in place across the EU in the last few years.

First, in 2012, member states set up a “mutual co-operation” initiative, with special units focused on ecommerce. The authorities in each country now communicate regularly and share data.

More recently, the formal adoption of new regulations and data-sharing tools to strengthen cooperation on VAT fraud between national tax authorities means that EU countries are becoming much more pro-active and effective in identifying and dealing with online retailers avoiding their VAT obligations.

Online retailers selling abroad need, more than ever, to be aware of their tax obligations in the countries where their customers are. Unfortunately, ignorance is no defense. The “head in the sand” approach can work for a while, but it’s not a long term solution.

Tax authorities have the power to levy penalties and interest charges, which can be as high as 120% on top of the unpaid taxes in some countries.

Other general Rules

Are your invoices compliant?

Find out if you will need to raise an invoice and what information needs to be on that invoice – again different rules apply to different countries. Also consider whether your billing system can cope with the potential variations.

Compliance tips

Here are some tips to help keep you in compliance with the practicalities of VAT in the EU:

First, make sure you have the systems in place to capture accurate sales information including which countries your customers are in, and where stock is located for onward sale to your customers.

Make sure you include shipping/delivery costs as these are included in the final sums when calculating if a threshold has been exceeded.

When charging your customers, make sure you add VAT to the shipping cost as well as the product price on your invoices.

Keep up-to-date with the current VAT registration thresholds and where relevant, monitor currency fluctuations. Know when you are about to exceed a threshold including when the local currency is not in Euros. This is important even though the rules will change in the future as tax authorities are combating VAT fraud more than ever.

Know which VAT rates apply to your goods or services. If you are based within the EU, you may be familiar with the VAT rates in your own country, but they can vary elsewhere within the EU. Children’s clothing is a good example – it is zero-rated in the UK and Ireland, but attracts VAT everywhere else in the EU.

Once registered in another country, do not charge VAT for your own country as well as the buyer’s country. VAT should only be charged once.

It can take approximately 6 – 8 weeks to obtain a VAT registration, depending on the country that you are registering in.

Once registered you need to make sure your invoices comply with local regulations

Prepare for Brexit! So far there are no changes in the way UK companies can trade in the EU. However, you need to prepare for every possible scenario after the end of the transition period which is 31st December 2020.

Finally, anticipate the upcoming VAT regulation changes we have covered in this article, whilst staying compliant in respect of your current obligations.

Pricing tips

Pricing is a big issue. Unlike the USA, where it is customary to quote prices without sales tax, VAT should always be included in the price shown to consumers. It is important to understand the impact of VAT on your profit

Other questions?

Should you charge different prices in different EU countries or does one price fit all?

How badly will your margins be affected by the different VAT rates if you don’t differentiate price in each EU location?

VAT rates vary across Europe from 17% – 27%. Can the margins you have set for your products absorb the variations?

Will you stay competitive once you have VAT registered in another EU country?

Is your ecommerce system set up for multi-currencies and multi-VAT rate application? If not, how easy is it to update?

Financial Law Law

Fraud in Crowdfunding : a synthetic legal view of risks and solutions (I)

crowdfunding estonia payment escrow europe directive

The coronavirus crisis has led to a development of participatory financing platforms which have seen an exponential increase in their revenues. But with the development of these platforms, the risk of fraud has itself increased, with more and more platforms setting up fictitious projects, often offering investors high interest rates. How can you, as an investor, build up legal guarantees to protect yourself against these fraudulent platforms? The subject is very vast, and can be divided in a few different thematics. In this paper, we will explore the different problematics that an investor can encounter when someone invest and he can answer them from a legal standpoint.

How to protect yourself from platform fraud?

Many platforms are mainly located in countries where the regulation is very legimited, thanks to the flexible regulation on the subject. This has lead in the past to some problems. For instance, at the beginning of 2020, many Estonian crowdfunding platforms were no longer able to pay back their investors, initially the Estonian police became interested in the mismanagement of these platforms. The investigations led to the discovery of evidence of fraud.

To understand how this fraud was organised, it is worth recalling how a crowdfunding platform works. When you invest in a project through a crowdfunding platform, you should be aware of the risk inherent in this type of investment: if the project fails, the investment will collapse and be lost. However, there are ways to limit this risk. The investment platforms themselves insure themselves against this risk and this means that they are not accountable to investors for the success or failure of investments. They are only subject to a duty of care which takes the form of verification of the identity of borrowers and their ability to repay. Once this obligation is fulfilled, platforms do not have to guarantee the success of the investment made by the capital providers. Crowdfunding is therefore a platform that is totally conducive to scams: there is no justification for the failure of the investor to repay. In this situation, it is necessary to know how to recognise a fraudulent platform in order to be able to turn against it if you are a victim.

Wisefund is one such Estonian crowdfunding platform suspected of fraud. It aimed to finance extremely diverse projects ranging from the manufacture of microbiological fertilisers to the purchase of car parts for export. One irregularity drew the attention of investors: the guarantee allowing the platform to redeem bonds from investors in return for a discount was unilaterally deactivated. This constitutes a unilateral modification of the contract between the platform and the investors, and this possibility is regulated in the majority of EU member states’ laws, in this case Estonian law applies: how does it regulate the unilateral modification of the contract by a crowdfunding platform?

The capital providers discovered that this guarantee was provided by a Hong Kong company, Best Treasure Limited, located in a letterbox building. Despite these irregularities, the platform continued to operate, making numerous late payments and justifying its loss of capital by the risks associated with the investments. The investors decided to file for insolvency in the Estonian civil court (equivalent to a writ of reorganisation) on the basis of alleged fraud.

In a judgment of 14 January 2021, the Estonian civil court rejected the investors’ claim, considering that once fraud is suspected, only the criminal courts have jurisdiction. In this situation, a crowdfunding platform cannot be sued in insolvency, so the creditors must initiate criminal proceedings. This decision was confirmed by the Estonian Court of Appeal on 26 March 2021.

This is a decision that applies the classic division of competences between civil and criminal matters. The civil court denies jurisdiction in all situations where fraud is suspected. This implies that investors can only be reimbursed if they initiate proceedings before the criminal courts. As in French law, the courts have held that the civil court cannot substitute itself for the criminal court in judging criminal acts.

It is likely that this ruling, handed down by the Estonian courts, will set a precedent within the European Union. Investors do not have a claim on the platform but on the final borrower, so in case of fraud, they will have to turn to the criminal courts and not to the civil courts. The investors of the Wisefund platform had to pay additional sums to bring this action, which was ultimately unsuccessful. This case shows that it is necessary to determine which type of action to take to avoid incurring additional costs and lengthy proceedings.

crowdfunding estonia payment escrow europe directive

It is possible to imagine certain hypotheses whereby investors would engage the civil liability of the participatory finance platform, in particular on the basis of its due diligence obligation, and they could then have been compensated on civil grounds. In this case with the Wisefund platform, the initiation of this procedure would have forced the platform to provide evidence of fraud or the absence of fraud. Similarly, it would be possible to hold the platform liable before the civil courts if, on reading the contract between it and the investors, it appears that certain clauses are abusive.

At present, criminal proceedings are underway and the Estonian police have contacted the local police of the investors. The investigations have led to the discovery of evidence that suggests a Ponzi scheme, a criminally punishable financial fraud. But how can you, as an investor, identify them?

A second case : the platforms Envestio and Kuetzal, which offered capital providers to invest in empty companies or in existing companies but did not seek investors on the platform in order to recover the money provided by the investors and not to reimburse them by invoking the failure of the project. At the end of 2019, investors on the crowdfunding platforms investigated the projects that Envestio and Kuetzal were offering to fund, revealing the fictitious nature of some of them. These revelations led investors to demand their money back, causing the collapse of the Kuetzal and Envestio platforms. This collapse is explained by the fact that any financial intermediary does not have enough funds to pay back all its investors at once. In June 2020, the bankruptcy of both companies was declared by the Estonian courts.

Faced with this situation, investors organised themselves to form a collective action against the 2 participatory finance platforms. A procedure has been implemented at European level to facilitate the application process for the platforms’ investors. Criminal investigations have been initiated and are still ongoing, but the Estonian police suspect the platforms of being fraudulent and organising money laundering activities.

Other platforms such as Monathera or Grupeer have also experienced difficulties in repaying their investors. Initially, this was considered to be caused by mismanagement and default by borrowers, however, it now appears that these companies are suspected of embezzlement.

Investors in the Grupee platform have come together to coordinate action against it and investigations appear to reveal a scam. The Latvian authorities, where the platform is based, have stated that Grupeer has no licence to provide financial services in Latvia. Although the platform was originally established in Latvia, it was legally transferred to Ireland and therefore falls under Irish national regulation and should have obtained a licence to operate in Latvia. The characterisation of the applicable law is fundamental here, as the rules that apply will differ between a Latvian platform and an Irish platform.

It seems that this crisis of the crowdfunding platforms has raised awareness. It has revealed the lack of supervision of equity crowdfunding platforms, for example, there is no supervisory authority for platforms in Estonia to ensure that their projects are genuine. It was noted that it is difficult to engage the civil liability of the platform, but if the bankruptcy of the platform is not due to fraudulent manoeuvres, only the civil courts can be used, and it will therefore be necessary to determine on what grounds to base oneself in order to be compensated. Similarly, no procedure was really provided for to enable collaboration between the national authorities concerned and foreign investors; this was born out of practice, in particular by drawing on existing procedures. There was no European framework for crowdfunding, leading to a disparity of rules within the Member States: but how to determine the law applicable to the platform?

To address these issues, the European Union has taken steps to create a harmonised regulation between EU countries, the regulation on this issue will be applicable from 10 November 2021. It provides a framework for crowdfunding, notably by imposing certain obligations on the investment platform, such as information obligations towards the investor. Being aware of the obligations incumbent on a crowdfunding platform is becoming a necessity, as breaches of these obligations have important legal effects.

Moreover, Estonia now wants to strengthen its legislation to regulate the activity of P2P platforms more strictly and to prevent such a situation from happening again. In addition to complying with European regulations, the Estonian legislator wishes to create a framework for P2P consumer loans, similar to the one applicable to companies. It is also intended to regulate crypto-currency services, which are currently very poorly regulated. The Estonian Ministry of Finance’s draft regulation provides that all service provision activities related to virtual currencies will be placed under the jurisdiction of the Financial Supervisory Authority, increasing the control over these institutions, which should help limit fraud.

To prevend fraud, check reliability.

But how can you be sure of the reliability of a crowdfunding platform? This is a question that is currently at the heart of the news with the discovery of numerous scams set up through participatory financing platforms.

TFGCrowd is one such crowdfunding platform suspected of fraud. A class action suit was filed by investors after the service became increasingly late in making payments. It seems that it is suspected of fraud. This raises the question: what are the elements, the clues that allow us to control the reliability of a participatory financing platform?

Initially, the TFG Crowd platform offered investment plans to its members, so it acts as an investment advisor. The idea is that investors send money to the platform, which will invest it in a diversified portfolio. This diversification of the portfolio reduces the risk of loss to the investor, but other schemes would have allowed investors to limit their risk.

The risk of investing in a project is that if it fails, you will lose the money invested in it, so you need to put safeguards in place to minimise the losses your investments may suffer.

One of these guarantees is the fact that investing in many different projects allows you to reduce losses if a project fails. However, the downside of this diversification is that it involves additional work: before investing in a project, it is essential to find out whether the project is reliable. The more projects you invest in, the more work you have to do to analyse the market and balance the gains and risks. The advantage of this type of financing platform is that it takes care of this work of analysis and of the investments while respecting the principle of due diligence, so as to balance the risks and the interests of the investments, but how can we be sure that the work provided by the platform is sufficient?

On paper, the TGF crowdfunding platform seems ideal: a minimum of work for investors, a high interest rate, guarantees put in place by the platform. However, before investing in any crowdfunding platform, it is advisable to analyse it thoroughly to ensure its reliability; and irregularities concerning the TFG Crowd platform have not been slow to emerge: what are these clues to detect fraudulent projects set up by a crowdfunding platform?

The first problem with this platform is the lack of transparency: investors have no idea how the money is invested and if it is really invested. TFG Crowd displays a multitude of projects on its website, but it is impossible to get in-depth information about them, for example, the location of the properties is not necessarily indicated, the guarantees provided are not specified, or even how investors will get their money back. This lack of transparency is reminiscent of the Envestio platform, which was investigated as a scam. However, information obligations are imposed on participatory finance services in the majority of EU Member States and the institutions have sought to standardise these obligations within the EU. Today, the absence of information for investors on the guarantees provided to them constitutes a violation of European law, which you can invoke as soon as the applicable law is that of a State that is part of the European Union. It is therefore appropriate to question the methods of application of European law within the Member States.

The second suspicious element is that the TFG Crowd funding platform provides investors with a fixed annual interest, independent of the returns on investments, which is extremely high. This interest can represent from 14 to 26% of the initial investment. The size of this income should have alerted investors: how can an investment yield so much with such low risks? This is not possible unless the platform is using reprehensible financial arrangements, which one must be aware of in order to recognise and protect oneself.

Secondly, the TFG platform claims to have a buy-back guarantee fund in the event of default by a project contributor. This sum would be used to guarantee the repayment of the face value of the loan and the accrued interest. However, when one examines the amount of this guarantee, it appears derisory in relation to the amount of projects financed. FT Crowd claims to have a special fund of €1,437,000 to be used in the event of a project failure, but the amount allocated to this fund is very small and a single failed project would be enough to wipe out this repurchase promise.

In addition to this buy-back guarantee, TFG Crowd is putting in place a corporate guarantee to secure the investments made through its platform. It guarantees the repayment of the loans issued with the movable and immovable assets it owns, which will be secured by their shares. During the period in which the loans received are active, TFG Crowd Limited undertakes not to pay dividends to its shareholders or reduce the value of these guarantees, for example by disposing of any of its property or assets. Similarly, the share capital, on which the value of this guarantee depends, must be analysed in detail. The value of this guarantee is zero because the share capital is only 1GBP, so that an action to enforce this guarantee would be of no interest to the investors. This situation illustrates that once you have an investment

Finally, the guarantees offered by the platform are illusory, and this situation shows that simply reading the contract between the platform and the investor is insufficient to know the level of protection granted to investors. As a provider of capital, it is necessary to inform you of the real issues surrounding this contract and to inform you of the reality of the guarantees it grants you. This effective information allows you, in the event of the platform’s failure, to take the most appropriate course of action to turn against the participatory financing platform.

Limit your losses

How can you protect yourself from certain unforeseen risks when investing in crowdfunding? The subject is vast and the problems multiple: one of the risks as an investor in a crowdfunding platform is that of the insolvency of the platform or the investment.

Insolvency of the platform means that the participatory financing platform, as a company, does not have sufficient cash flow to repay its debts. Since the platform is the intermediary in many cases, such as in crowdlending, this can have a significant impact on the distribution of the loan interest. On the other hand, the insolvency of the investment means that the project whose capital provider participated in the financing is no longer able to pay off its creditors, and the investment is lost. In these two cases, it is necessary to have legal guarantees in order to be able to take action against the platform in the event of damage: knowing how to protect oneself from losses in the event of insolvency becomes a necessity.

Yet solutions exist. In France, for example, any insolvency can be broken by legal action. In the event of even partial insolvency, the platform may be subject to collective proceedings, a judicial measure aimed at guaranteeing the continuation of the company’s activity and maintaining employment, while ensuring that the rights of creditors are respected.

Among the various procedures, the most widely used is that of judicial liquidation, which is opened when the debtor is in a situation of “cessation of payments and whose recovery is clearly impossible” (Article L640-1 of the Commercial Code).

Liquidation has a particularly important impact on the company because it means that the recovery of the company’s finances is impossible (Cour de Cassation, Chambre commerciale, 8 July 2003, 00-13.627), particularly when a company is in a situation of cessation of payments, meaning that it is “unable to meet its liabilities with its available assets“. In this situation, the company can no longer meet its debts and the procedure will organise the end of the debtor’s activity; it is therefore appropriate to ask: How, as an investor, can you obtain the repayment of your claim when the debtor is insolvent? As soon as the judicial liquidation is pronounced, a procedure aiming at paying off the creditors is put in place. However, this action plan will affect the creditors of the company in liquidation by limiting their power to act. The main goal is to be able to pay the creditors in the end, but liquidation is not always the best solution.

First of all, it implies the freezing of the debtor’s liabilities, i.e. the debtor is prohibited from paying creditors whose claims arose before the opening of the judgment. Similarly, as a creditor of the platform, the investor will have to declare his claim in order to hope to be paid. This means that any creditor can no longer sue his debtor individually.

During the course of these collective proceedings, a creditors’ representative is always appointed who has a monopoly on action: the liquidator; he acts on behalf of and in the interest of the creditors (Article L641-4 of the Commercial Code). The liquidator will receive the damages that will be distributed among the creditors. In principle, the distribution is carried out by respecting the order of privileges: unsecured creditors will only be paid once the privileged creditors have been paid. It is therefore necessary to ask how a creditor can provide guarantees in order to benefit from the status of preferred creditor. During the judicial liquidation procedure, creditors remain subject to their contractual obligations. Indeed, as a matter of principle, “The co-contractor must fulfil his obligations despite the debtor’s failure to perform commitments made prior to the opening judgment. Failure to perform these commitments only entitles creditors to a declaration of liabilities” (Article L641-11-1of the Commercial Code). This means that you remain subject to your obligations under the contract in the same way as if the liquidation proceedings had not been initiated, e.g. the investor must pay all the funds that he had undertaken to deliver to the platform; however, certain assumptions are allowed for the automatic termination of the contract. However, the Court of Cassation has accepted that a situation in which the contracting party expressly declares its intention not to terminate the contract and the liquidator does not oppose this has legal effects. (Court of Cassation,Civil, Commercial Chamber, 17 February 2015, 13-17.076).

In principle, “the judgment closing the judicial liquidation for lack of assets does not allow creditors to exercise their individual actions against the debtor” (Article L643-11 of the Commercial Code). However, there are exceptions to this rule and it is therefore necessary to consider how the individual action can be exercised and in what situations. This is notably the case when “the claim originates from an offence for which the debtor’s guilt has been established or when it concerns rights attached to the creditor’s person“; but the criminal chamber of the Court of Cassation specified in a decision of6 April 2016 that when the claim originates from an offence for which the debtor’s guilt has been established, the recovery of the individual action can only take place after the closure of the compulsory liquidation procedure.

When it comes to crowdfunding, platforms that go bankrupt are a common occurrence. In France in 2018, the Unilend platform was declared insolvent, meaning that it no longer had the capacity to settle its debts. This situation can happen to any professional and to any participatory finance platform, so it is necessary to take measures to limit the consequences of this.

However, no collective action has been taken and the company has undertaken to reimburse each of the investors. It can be seen that judicial proceedings are not systematic and that it may be worthwhile to consider an out-of-court procedure when the judicial procedure does not correspond to the interests of the investors. Out-of-court proceedings are a mechanism for parties to a dispute to assert their rights without going to court: knowing the interests at stake, such as financial means or the need for confidentiality, is therefore necessary to determine whether an out-of-court settlement of the dispute would be more appropriate.

In recent years, class actions against crowdfunding platforms have increased, especially at European level. In January 2020, two crowdfunding platforms, EnvestioandKuetzal, were subject to compulsory liquidation proceedings. At present, the trial is still ongoing but investigations have revealed that they were fraudulent platforms. The Kuetzal collapse is said to have affected more than 550 people and to represent €3 million in liabilities. Envestio is said to have affected more than 1,800 people who are claiming €10 million from the company.

A collective action has been implemented. The companies are established in Estonia, so they are subject to Estonian law. In addition to being subject to a law that is not that of their country of origin, investors must contact the Estonian authorities and join a collective action based in Estonia, thus in a language that is not their mother tongue. In order to address these issues, a European regulation of 2017 has been put in place to regulate the insolvency of a company. It facilitates access to proceedings for litigants by setting up a form allowing them to contact directly the authorities in charge of the procedure as well as to have all the necessary information concerning the insolvency proceedings in progress. Moreover, it provides that the courts opening insolvency proceedings must contact the creditors concerned by the insolvency proceedings.

However, it does not standardise the law of the Member States of the Union on the question of collective proceedings, for example, the time limits and procedures to be followed differ from one State to another. It provides that the competent court is the one that opens the proceedings, which is a fundamental concept because the applicable law will be that of the place where the proceedings are opened. Similarly, this regulation provides for the possibility of opening one main procedure for all the injured creditors or several territorial secondary procedures. It will therefore be necessary to determine which procedure is the most suitable for your situation.

Financial Law Law

The 2020 EU Crowdfunding directive, quid novo sub solem?

Ühisrahastus Crowdfunding

Article published originally during the summer 2020.

Crowdfunding is experiencing an increasing momentum in the global economic landscape. Although it represents a unique category of fundraising, with different vehicles, processes and goals, its underlying concept is neither so revolutionary nor so different from a traditional whip round . Anyway, the coming of several disruptive events such as the Web 2.0 revolution, translated Crowdfunding into an innovative financing mechanism which is gaining always more attention from fundseeking ventures. Many different notions have been proposed with the aim of defining Crowdfunding, essentially developing a common conception that labels it as an internet-based open call for the provision of financial resources in order to support initiatives for specific purposes. It is really challenging to assess what would have happened if no one started to recognize in crowds a potential source both of finance and innovation; what is acknowledged though, is that nowadays companies are giving external individuals always more importance in several core functions, contributing to the rapid spread of the crowd phenomenon in all its derivations. Basically, Crowdfunding allows a large number of parties from different contexts to finance a project or a business by making a personal contribution, thus giving proponents the possibility to exploit their personal networks to raise funds. The innovation it provides could be found in its linkage to the crowd, implemented through dedicated platforms, that open new rooms for bridging investors’ and fundraisers’ communities. From a broad perspective, it is part of the recent wake of new forms of economic exchange which share common rationales including disintermediation through technological platforms, centrality of trust and reputation and connective dynamics. Provided that Crowdfunding encompasses different application models, this thesis focuses on the equity-based one; essentially, when a company wants to attract investments from individuals instead of credit institutes or private equity firms, this is called Equity Crowdfunding or Crowdinvesting . After the coming of 2008 crisis, traditional financing sources for startups and SMEs such as business angels, venture capitalists and banks, have become more risk averse; in this sense, some literatures have argued that Equity Crowdfunding could successfully fill in the financing gap which originated after the hardening of funders’ selection processes. Actually, despite its recent birth, Equity Crowdfunding currently forms a consistent part of the whole Alternative Finance segment for several countries, acting as a new disintermediated source of financing , which seems able to impact funding processes of young businesses in a relevant way, especially in this “digital era”.

Why Crowdfunding

The European market for crowdfunding has grown rapidly in recent years and is likely that it will grow further as investors look for yield-generating opportunities and people, organizations and businesses, notably start-ups can raise financing through websites (also known as portals or crowdfunding platforms) that acts as service providers or intermediaries between those wanting to invest and those wanting investment.

Improving the regulation of European crowdfunding service providers (ECSPs) and how investors as well as how small-to-medium sized enterprises (SMEs) can make use of crowdfunding as an alternative to bank intermediated funding has been a longstanding priority of the European Commission including as part of tis FinTech Action Plan. Rulemaking in this area was first proposed as part of the first launch of the EU’s Capital Markets Union (CMU) in September 2015 and has now become legislative reality as part of the 2020 relaunch as CMU 2.0. The European Commission is of the view that crowdfunding, in addition to being an important source of non-bank financing, can help spur job creation, economic growth and competitiveness – areas which the European Crowdfunding Stakeholders Forum,  as an expert group of representatives of associations of concerned stakeholder groups as well as national competent authorities (NCAs).

Last October,  the European Parliament has adopted the latest text for the European Crowdfunding Service Provider (ESCP) for Business Regulation. as well as related changes to Markets in Financial Instruments Directive (MiFid). The EU’s Regulation (ECSP Regulation) and a Directive (ECSP Directive) on Crowdfunding Service Providers were published in the EU’s Official Journal on October 20, 2020, entering into force on November 9, 2020 with its scheduled date of application beginning November 10, 2021. Both the ECSP Regulation and ECSP Directive have direct effect across the EU-27 and while the ECSP Regulation has direct effect, Member States have six months’ time to implement the ECSP Directive into national law. The original proposal for a regulation on crowdfunding, adopted by the European Commission in March 2018, has already enable crowdfunding platforms to easily provide their services across the EU.

Platforms have now to comply with only one set of rules, both when operating in their home market and in other EU countries. For investors, the proposal will provide legal certainty as regards the applicable protection rules. However, the rules do not stop there. The ECSP Regulation states that in the interests of legal certainty and in view of replacing national rules, a transitional switchover period applies. This means that a person carrying out activity that is covered by the ECSP Regulation and ECSP Directive may continue to conduct such business until November 10, 2022 under the existing national regimes (where these exist). During the transitional period, Member States can put in place special procedures enabling legal persons, which have been authorized under national law to convert such authorizations into ECSP compliant authorizations provided that such firms meet the requirements set out in the regime. Where crowdfunding service providers have failed to obtain an authorization as an ECSP by November 10, 2022 they should not issue any new crowdfunding offers after that date but may continue, in accordance with applicable national law, to service existing contracts, including collecting and transferring of receivables, providing asset-safekeeping services or processing corporate actions.

New rules a

  • a single set of requirements that will apply to all ECSPs for offers up to EUR 5 million, calculated over a period of 12 months for each crowdfunding project owner. Larger fund raisings will fall into the scope of MiFID II/MiFIR and the Prospectus Regulation. Reward and donation-based crowdfunding are explicitly excluded from the scope of the new rules;
  • a harmonized investor disclosure regime whereby crowdfunding project owners provide investors with a key investment information sheet (KIIS) for each crowdfunding offer or at platform level, in addition to a comprehensive set of disclaimers and recommendations on ECSP websites and communications;
  • a suitability and appropriateness testing requirement for investors prior to being able to invest assessing their understanding of financial products and their ability to bear financial losses;
  • a uniform authorization and passporting process for ECSPs across the EU-27 whereby the European Securities and Markets Authority (ESMA) has a central role in facilitating coordination and cooperation amongst national competent authorities (NCAs) or otherwise has supervisory powers including developing further technical standards and a binding dispute resolution mechanism; and
  • detailed conduct of business obligations for ECSPs including duty to avoid and prevent conflicts of interest, restrictions on inducements to clients and on a ECSP participating in crowdfunding offers hosted on their crowdfunding platform.

Ühisrahastus Crowdfunding


THE REGULATION SHOULD BRING LEGAL CLARITY TO THE PROVISION OF THE SERVICES

In the case of crowdfunding services, it has become evident that although on the one hand, companies are looking for solutions to finance their projects through crowdfunding, the unregulated market of crowdfunding services has also led to negative examples of investors losing money. The establishment of common rules for crowdfunding platforms has been underway at the European level for several years. What improvements will the new regulation bring along?

First, the new regulation determines the crowdfunding service – matching of business funding interests of investors and project owners through a crowdfunding platform, which includes either the facilitation of granting of loans or the offering of transferable securities and instruments accepted for crowdfunding without a specific obligation and the provision of the reception and transmission of related client orders. In case a crowdfunding platform wishes to safe keep investors’ assets or provide payment services in the course of its activities, the platform must have a separate authorisation for the respective financial service. Nor can a crowdfunding platform operate as a multilateral trading facility or an organised trading facility without the relevant authorisation of an investment firm or receive deposits from the public without the authorisation of a credit institution.

One of the problems in the area of crowdfunding is that under the name of crowdfunding, there are financial services offered which would require separate authorisation. The new regulation creates legal clarity for companies and investors and makes it possible to define more clearly, which services the crowdfunding platform may provide in the course of its activities and when additional authorisation is required. The preamble to the regulation also points out, as a problem, that the fragmented legal framework in the Member States creates substantial legal costs for retail investors, especially in the case of cross-border crowdfunding services.


AUTHORISATION OBLIGATION FOR CROWDFUNDING PLATFORMS

The new regulation establishes an authorisation obligation for crowdfunding platforms. The information required to apply for authorisation is essentially similar to that required for other financial services authorisation, such as a description of the programme of operations, governance arrangements and internal control mechanisms, description of operational risks, information and evidence on prudential safeguards, description of the business continuity programme, and the documents providing proof of the management’s competence and reputation, etc.

The new regulation applies to crowdfunding offers with a total value of up to EUR 5 million over a 12-month period. As the Prospectus Regulation allows Member States to derogate from the obligation to publish a prospectus in a public offer of securities until the raising of funds up to EUR 8 million, Estonia has a limit that obligation to publish a prospectus is not applicable when raising funds up to EUR 2.5 million. Projects offered through crowdfunding will unequivocally be subject to a limit of EUR 5 million, which means that under this regulation, securities of up to EUR 5 million can be offered to the public through authorised crowdfunding platforms without the obligation to draw up a prospectus. Member States such as Estonia, where the obligation to draw up a prospectus has so far applied at a lower threshold, will have a transitional period to make the necessary changes at the national level.

Minimum prudential requirements are also set for crowdfunding service providers. Namely, the service provider must have own funds or an insurance policy, which at any time is at least EUR 25 000 or one-quarter of the fixed overheads of the previous year.


THE RULES ESTABLISHED TO PROTECT INVESTORS ARE SIMILAR TO THOSE ESTABLISHED FOR OTHER INVESTMENT SERVICE PROVIDERS

Under the new regulation, a number of rules have been established to protect investors, imposing similar requirements on the activities of crowdfunding service providers as on other investment service providers. Crowdfunding platforms must distinguish between sophisticated and non-sophisticated investors, just as MiFID II distinguishes between professional and retail clients. When defining an investor as a sophisticated investor, the platform should take into account the limits set out in the regulation on the income, volume of assets, or other criteria of natural and legal persons. The service provider must assess its knowledge and ability to bear losses before granting the customer access to the platform’s services, and the assessment must be carried out periodically in the future.

Minimum due diligence measures that shall be taken by the crowdfunding service provider for project owners who offer their projects through their platform are also defined. The service provider must verify that the project owner does not have a criminal penalty for various infringements and that it is not a legal person established in a high-risk third country or non-cooperating region.

The crowdfunding service provider must allow for non-sophisticated investors a reflection period of 4 calendar days, during which the potential investor may withdraw the investment offer or interest related to his crowdfunding offer without giving a reason and without incurring a penalty.
A KEY INVESTMENT INFORMATION SHEET MUST BE PREPARED FOR EACH CROWDFUNDING OFFER

The crowdfunding service provider is obliged to provide investors with a key investment in-formation sheet prepared by the project owner for each proposed project. The Regulation lays down a mandatory minimum content of a key information sheet, which in many areas is similar to the main content of a prospectus. Although the document is prepared by the project owner, the service provider must have procedures in place to verify the completeness, accuracy, and clarity of the key information sheet.

The service provider must inform the project owner when identifying that key information sheet contains misleading or missing information that is important for the return of the expected investment and, if necessary, suspend the crowdfunding offer for up to 30 days until the project owner corrects the information. At least the project owner or its administrative, management, or supervisory bodies shall be responsible for the information provided in the key investment information sheet.
RESPONSIBILITY FOR THE INFORMATION PROVIDED IN THE KEY INFORMATION SHEET

As in the provisions on prospectus liability, the Member State undertakes to ensure that the laws, regulations, and administrative provisions on civil liability apply to the natural and legal persons responsible for the information contained in the key investment information document and its translations, at least where the information is misleading or inaccurate and the key information, necessary for investors when deciding on the financing of a crowdfunding project, has been omitted from the key information sheet.