By Aleksandra Bal
Aleksandra Bal of Stripe looks at the value-added tax treatment of non-fungible tokens and hopes for some much-needed clarity from legislators and tax authorities.
Non-fungible tokens, or NFTs, have taken the world by storm. These unique digital assets have been embraced by celebrities, digital artists, and investors. Although they may feel like a fad, NFTs have been around much longer than most people realize.
The idea of NFTs emerged from “colored coins,” a method for representing real-world assets on top of the Bitcoin blockchain proposed in 2012. Even though the concept of colored coins was never fully realized due to the limitations of the bitcoin blockchain, it laid the groundwork for further NFT experimentation. In 2014, digital artist Kevin McCoy minted the first known NFT, “Quantum,” a pixelated octagon filled with different shapes that pulse hypnotically.
But NFTs really crashed into the public consciousness in March 2021, when the digital artist Beeple sold the NFT “Everydays: The First 5000 Days” for $69.3 million in a Christie’s online auction—the most expensive NFT sale ever. Overall, the NFT market has been growing exponentially; the trade volume of NFTs rose to $24.9 billion in 2021 from $95 million in 2020.
While NFTs are exploding in popularity, tax and legal rules have been slow to keep up. Although most countries provide some guidance on the VAT treatment of virtual currency, these clarifications are not easily applied to NFTs given their distinct nature and purpose. Before diving into the VAT implications of NFTs, it is important to understand what exactly NFTs are and how they differ from other cryptoassets.
“Cryptoassets” is an umbrella term that describes digital assets that are transferred and stored on a distributed ledger (blockchain) and secured by cryptography. Although cryptoassets come in different varieties and flavors, they are commonly divided into three broad categories based on their purpose: payment tokens (also known as virtual currencies), security tokens, and utility tokens.
Payment tokens act like money and are designed to be used as a means of exchange for goods and services. Utility tokens facilitate access to specific goods or services and operate in a similar way to vouchers or prepayments, giving their owners the right to use a particular service or purchase a particular product in the future. Security tokens are similar to equity shares or short-term loans, as they permit the investors to earn “dividends’’ or embody the right to variable or fixed interest during a specified time period.
NFTs are also digital assets built on a blockchain, but they have a distinct character from the three traditional categories of cryptoassets described above. Most cryptoassets are fungible tokens, meaning that each unit is the same as any other. In contrast, with non-fungible tokens, each unit is distinctly identifiable and defined by its own unique metadata. NFTs derive their value from uniqueness. Their rise in popularity can be explained by the fact that people have always been willing to pay large amounts of money for rare assets that are difficult to obtain due to their scarcity.
Just like other cryptoassets, NFTs may be purchased for investment reasons. However, their common use case is to create a verifiable digital record of ownership title to a unique underlying digital asset. When someone “mints’’ an NFT, they create a unique digital token on an existing blockchain (e.g., ethereum). Subsequent transfers of the NFT are recorded and publicly verifiable on the same distributed ledger.
An NFT is a blockchain-based record containing metadata about the unique digital object it represents (e.g., digital artwork) and a pointer to the location where this digital object resides. It does not contain the object that it points to—the underlying digital assets themselves are not included in the blockchain. An NFT is just a cryptographically signed receipt that you own an object. Moreover, there is no guarantee that an NFT will point to the right object or file. There have been several situations in which NFT buyers ended up with a broken link pointing to nothing.
Without other contractual arrangements, owning a token confers no ownership or other exclusive rights in the represented item. An owner of an NFT owns only the token itself. To acquire rights over the digital object represented by the NFT, you need to have a traditional written contract, valid under the applicable national law, stipulating the rights being granted.
Contractual terms are generally not included in the NFT itself but are built into the terms of service of the online marketplace through which an NFT is purchased. They often stipulate that the buyer gets some basic usage rights over the digital object, such as the right to post the image online.
In most EU countries, there is no official guidance on the VAT treatment of NFTs. This means that you need to interpret the general tax rules and try to apply them to NFT sales. This gives rise to significant legal uncertainty, as the interpretation of the tax rules has always been speculative.
The EU VAT law divides supplies into two categories: goods and services. As NFTs do not constitute tangible assets, they are treated as services for VAT purposes. To determine whether VAT should be charged on a sale of a service, you need to identify the country in which the sale is taxable (the so-called place of supply) and check whether a VAT exemption may apply.
If the seller and the buyer are both located in the same country, it is relatively easy to determine the country of sale for VAT purposes, as only one country is involved in the transaction. If the seller and the buyer are located in different countries, you need to designate one of these countries as the place of taxation. If the incorrect country is designated, counterparties run the risk of double taxation on the sales price.
Which country should be selected depends on the nature of the service. For example, digital services are generally always taxed in the country of the customer, but services consisting of a transfer of intellectual property (IP) rights are taxable in the country of the customer unless they are provided to a private individual residing in the EU. If the recipient is an EU private individual, they are taxable in the country of the seller.
Are sales of NFTs digital services or transfers of IP rights? The EU VAT legislation defines digital services as services delivered over the internet or an electronic network the nature of which renders their supply essentially automated, involving minimum human intervention and impossible in the absence of information technology. NFTs seem to meet this definition: An NFT transfer does not require much human involvement and relies on the blockchain technology.
As contractual arrangements governing NFT sales typically give the buyer only the minimum rights needed to use the digital object (e.g., the right to display it for personal purposes but not the right to charge another person a license fee to display it), they are similar to those applicable to sales of common digital products such as e-books or software. The latter are not treated as transfers of intellectual property rights but as sales of digital services. As a rule of thumb, the more rights are transferred to the buyer, the more the sale is likely to be treated as a transfer of IP rights. The right view is to treat NFTs as electronically supplied services. This view was confirmed by the Spanish tax administration, which is the first tax authority in the EU to comment on NFT sales.
Once you determine in which country a sale is taxable, you need to investigate whether it may be covered by a VAT exemption, in which case no tax should be charged at all. Although there are no VAT exemptions for digital services, sales of cryptoassests may be covered by VAT exemptions for: transactions involving coins and banknotes used as legal tender; transactions in financial instruments (shares, bonds and other securities); and transactions concerning deposits, current accounts payments, and other negotiable instruments.
The application of the first exemption to virtual currency transactions was confirmed by the Court of Justice of the European Union (CJEU) in Skatteverket v. David Hedqvist (C-264/14). The CJEU observed that bitcoin has no other purpose than to be a means of payment. As it serves the same purpose as national currencies, the principle of fiscal neutrality requires it be treated in the same way.
Although the CJEU judgment explicitly referred to bitcoin transactions, it also applies to sales of other types of virtual currency (payment tokens) with the same characteristics. In contrast, NFTs are fundamentally different from virtual currency—given their non-fungible nature, they are not able to serve as a means of payment. Therefore, the VAT exemption applicable to virtual currency sales is unlikely to apply to NFTs.
The application of the second exemption is tricky. At first glance, NFTs do not appear to be securities. To qualify as a security under the EU laws, an object must be highly standardized and thus be fungible. As NFTs are non-fungible, they seem to fall outside the definition of security. However, NFTs may show some characteristics of securities in certain circumstances. For example, securities law could be triggered if an NFT representing virtual land in the metaverse is fractionalized and sold to investors.
Based on its judicial interpretation in the case Granton Advertising (C-461/12), the third exemption for transactions involving payments, and other negotiable instruments should apply to instruments that “operate as a way of transferring money” or “confer an entitlement to a particular sum of money.” NFTs do not give their holders an unconditional right to be paid in legal currency. They can be exchanged for legal currency (i.e., sold on secondary markets) only to the extent that another party is willing to buy them. Thus, this exemption is unlikely be applied to NFT sales.
To sum up, it is rather unlikely that a general VAT exemption would apply to all NFT sales. The previously mentioned ruling by the Spanish tax administration did not discuss the application of VAT exemptions. This may imply that the Spanish tax authorities did not consider this topic to be relevant in the context of NFTs at all.
Unlike many other cryptoassets, NFTs are not likely to benefit from VAT exemptions under the currently applicable laws. This means that NFT traders should familiarize themselves with the VAT obligations that may apply to their transactions in the applicable jurisdiction—which in the EU is likely to be country of the purchaser.
If the NFT boom of 2021 continues, let’s hope that legislators and tax administrations will provide much needed clarity in respect of NFT sales. Otherwise, there is a risk that this booming market may be subject to double taxation, tax leakage, and expensive litigation.
In the meantime, taxpayers are advised to ask their tax authorities for an interpretative ruling on the tax consequences of NFT sales to reduce the legal uncertainty surrounding their business operations. The Spanish example shows that at least some tax authorities are willing to help by clarifying the applicable law.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organizations with which the author is affiliated.
Aleksandra Bal is indirect tax technology & operation lead at Stripe.
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By Aleksandra Bal