FinTechs: Understanding the Tax Implications of Various Pricing Models

In the rapidly evolving world of financial technology, selecting the right and flexible business model is a crucial decision that can significantly impact profitability and sustainability. A company’s business model outlines how it creates, delivers, and captures value. A pricing model is an integral part of a business model, focusing on how a company sets prices for its products or services to generate revenue.

The right pricing model not only ensures profitability but also must align with the company's strategic goals and the needs of its customers. However, one aspect that is often overlooked in this

process is the importance of tax considerations. Taxes can significantly impact a business's overall financial health, influencing decisions related to pricing strategy.

This article explores several popular pricing models and their tax implications.

Fees per Transaction

One of the most common and straightforward pricing models for fintechs is charging fees per

transaction. This model involves taking a small percentage of the transaction amount, a fixed fee, or both from each transaction processed through the FinTech platform. The variations include interest charges, late payment fees, and usage-based pricing, where customers are charged based on their

actual usage, such as the number of API calls or the volume of data processed. It is widely used by B2B fintechs, payment processors, lending and financing companies, and money transfer services.

Advantages:

·       Revenue grows with transaction volume

·       Transparent and easy to understand for customers

The drawback of this model is that it encourages customers to minimize their transaction volume. This could be addressed with a regressive sliding scale, where customers pay progressively less with each transaction they complete.

Tax Implications:

Revenue from transaction fees is generally considered ordinary income and is subject to corporate tax. Fintechs must ensure proper documentation and reporting to comply with tax regulations of the relevant jurisdiction.

Margin-Based Model

In a margin-based model, fintechs generate revenue by exploiting the price differential between the buying and selling prices of financial products. This model is prevalent in trading platforms, investment firms, and foreign exchange and cryptocurrency services. Since the customer sees only one side of the

transaction, the size of the transaction cost is effectively concealed from them. This often creates an impression of “commission-free” trading. This is particularly appealing for cost-conscious individual consumers.

Advantages:

·       Potential for high profitability

·       Encourages volume trading and liquidity

Tax Implications:

Gains from margin-based transactions are typically subject to capital gains tax. The specific tax rate can vary depending on the transaction type and jurisdiction.

Fintechs engaging in international transactions may be subject to withholding tax on cross-border payments.

The VAT treatment of revenue from processing FX and/or cryptocurrency payments depends on the nature of the service provided. In certain jurisdictions, services that directly result in the transfer of funds may qualify as Exempt Financial Services and be exempt from the VAT. Executing brokerage

services related to buying or selling securities on behalf of clients are generally exempt from the VAT.

Revenue from processing payments without directly facilitating the exchange of cryptocurrencies and fiat currencies may be subject to VAT.

Subscription Model

The subscription model entails charging customers a recurring fee at regular intervals, typically monthly or annually, for access to a range of services. This model is popular among fintechs that offer financial planning tools, automated investment management, accounting tools, credit monitoring, payment processing platforms, and payroll services.

The variations of the model include

·       Freemium - offering basic services for free while charging for premium features

·       Tiered pricing - offering different pricing levels based on the features and services included

Advantages:

·       Predictable and stable revenue stream

·       Encourages long-term customer relationships

While benefiting from a predictable revenue stream, fintechs can’t ignore the cost associated with subscription management. Subscription management is a tedious and expensive process that can either be outsourced or managed in-house, both options involving associated costs.

Tax Implications:

Subscription fees are considered ordinary income and are subject to corporation tax. Fintechs must carefully manage revenue recognition, as subscription pricing involves recurring revenue, which can complicate tax reporting. Businesses must account for how subscription income is taxed and plan for any potential changes in tax laws that may impact recurring revenue streams.

Software as a Service (SaaS)

SaaS involves delivering software applications over the Internet, with customers typically paying a subscription fee. Arguably a variation of the subscription model, it shares its advantages and

disadvantages. This model is widely used in various fintech applications, including accounting, investment management, and banking solutions.

Advantages:

·       Scalable and flexible

·       Encourages continuous innovation and updates

Tax Implications:

SaaS revenue is subject to corporation tax. Additionally, there may be VAT/sales tax implications depending on the jurisdiction and nature of the software provided.

Inactivity Fees

The inactivity fee is a supplementary model that charges customers for not using their accounts or services over a specified period. This may be combined with minimum balance or other account

requirements. Brokerage firms, cryptocurrency companies, and prepaid card providers commonly use this model.

Advantages:

·       Encourages active use of services

·       Generates revenue from dormant accounts

Tax Implications:

Inactivity fees are considered ordinary income and subject to corporation tax. Proper disclosure and transparency with customers are essential to avoid regulatory issues.

Penetration Pricing Model

The penetration pricing or minimal fee model sets low initial prices to attract customers and increase market share. This model relies on high volume to generate significant revenue and is often employed by budget-friendly financial services.

Advantages:

·       Attractive to cost-conscious customers

·       Can lead to rapid user acquisition

Tax Implications:

Revenue from minimal fees is ordinary income and subject to corporation tax. The penetration pricing model often involves initial losses or lower margins to build market share. These losses can have tax benefits, such as write-offs, but businesses must ensure they can sustain long-term tax

obligations once prices increase.

Revenue from Advertising, Referrals, and Affiliate Commissions

Some fintechs generate additional revenue through advertising and affiliate commissions. This involves partnering with other companies to promote their products or services and earning a commission for each successful referral or sale.

Advantages:

·       Diversifies revenue streams

·       Can be highly lucrative with the right partnerships

Tax Implications:

Advertising and affiliate commission income is subject to corporation tax. Fintechs must track and report these revenues accurately to comply with tax regulations.

Other Revenue Streams

There are several other revenue streams that appropriate fintechs may consider, including:

·       Interest on balance - investing customer balances

·       Lending customers shares to short sellers

·       Revenue share - partnering with other companies and sharing the revenue generated from joint offerings

Tax Implications:

Depending on the type of investment and the jurisdiction, the tax implication may vary. Breakage revenue may require compliance with accounting standards, such as GAAP or IFRS.

Seeking Professional Advice

Tax consideration is an integral part of choosing a pricing model for a business. The tax implications of using various pricing models can vary significantly based on the revenue streams and geographical

locations. Failing to consider tax implications can lead to unforeseen financial challenges and negatively impact the overall success of the business.

Fintechs must consider the following:

·        Corporation Tax: All revenue generated by fintechs is subject to corporation tax. The tax rate can vary based on jurisdiction and business structure

·        VAT/Sales Tax: Depending on the nature of the services and the jurisdiction, fintechs may need to collect and remit VAT/sales tax on specific transactions

·        Capital Gains Tax: For margin-based models, gains from financial transactions can be subject to capital gains tax

·        Withholding Tax: Fintechs engaging in international transactions may encounter withholding tax on cross-border payments

·        Value-Added Tax: For services, VAT rules differ for B2B and B2C transactions

Understanding and implementing the correct business model is vital for fintechs to thrive in a competitive market. Startups and scale-ups are advised to seek professional assistance.

LEXeFISCAL 

offer comprehensive advice on the tax implications of various pricing models and the implementation of effective tax planning strategies. This enables businesses to make informed decisions that boost profitability, adapt to evolving customer needs and regulatory

landscapes, and secure their long-term success and sustainability.

Contact us!  fintech@lexefiscal.com

Tel: +44 (0)208 092 2111

FinTechs: Understanding the Tax Implications of Various Pricing Models.

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