An explosion in nonfungible token sales this year has tax authorities scrambling to account for high-dollar cryptocurrency and blockchain technology transactions, and to craft rules that work both for national coffers and creators.
“There is huge value at stake,” said Julien Jarrige, a tax policy adviser at the Organization for Economic Cooperation and Development, which is asking countries to consider how to regulate and tax NFTs, and whether those policies should be similar or different from virtual currency.
NFTs are blockchain-backed digital assets that serve as a certificate of authenticity for both tangible goods (like a painting) and intangible goods (like a digital soccer trading card). The first one was created in 2014, three years before the term NFT was even in use, and their sales have generally been treated and taxed under traditional laws.
But there can be differences, and NFT sales are quickly becoming mainstream. NFTs generated about $10.7 billion in trading volume in the third quarter of 2021—a 700% increase from the previous quarter and 38,000% increase year-over-year, according to data from DappRadar, which tracks NFT sales across multiple blockchains.
Sales this year included the $4 million Doge meme and the $2.9 million digital image of the first Tweet.
“It’s a gold mine,” said Shaun Hunley, a U.S.-based tax attorney and senior specialist editor for Thomson Reuters Tax and Accounting. “Governments should really look into it.”
Recording Value and Creating Value
Most of the OECD’s 38 member countries apply existing classifications to emerging financial tools like cryptocurrency, according to a report last year co-written by Jarrige.
On the whole, this has worked well without requiring new categories or specific treatments, he said.
But the rapid expansion of the NFT market and the fact that NFTs can take on so many different forms—recording a transaction of tangible goods, creating value for a digital-only good, providing a license for services—create “novel challenges” for tax policy officials, said Michelle Harding, senior economist and head of the OECD tax data and statistical analysis unit, and the report’s other co-author.
And the people and companies creating, selling, investing in, and exchanging NFTs are looking for certainty that, first of all, what they are doing is legal, Jarrige said. Once that’s clear, the question becomes how countries treat and tax the industry.
NFTs can trigger multiple taxation events, Hunley explained. There’s a tax on the creator side and on the investor side. Investors would likely trigger two taxable events: when you buy it because you’re using cryptocurrency, which is a taxable event, and then when you sell the NFT later, that’s a taxable event.
Nations Take Notice
A few countries have already issued guidance on how their tax authorities will approach NFTs.
Australia is taking the approach described by the report—applying existing tax regimes to new technology. However, the guidance does not address digital-only goods, rather provides examples of NFTs that originate from a tangible work of art.
The U.K. was “a little bit behind the curve” in responding to the emergence of cryptocurrency, but there is now a full manual on taxation of cryptocurrency, said John McCaffery, a tax partner and head of tax at Alexander & Co in the U.K . That manual mentions NFTs just once and does not lay out explicit guidance on how they’d be taxed. But McCaffrey says Her Majesty’s Revenue and Customs’ approach to tokens is inclusive of NFTs.
The U.K. finds that by default a token is an asset that will be subject to capital gains tax. But if you trade in those assets, it would be taxed as a trade. If you engage in the crypto market personally, it would be subject to income tax, and if you do it through a company, it would be subject to corporate tax, McCaffery said. This approach also does not address a purely digital NFT asset.
South Korean lawmakers want to delay taxes on virtual asset transactions until 2023, but the status of NFTs is unclear. The government is reviewing whether NFTs should be taxed, the country’s Minister of Economy and Finance Hong Nam-ki told the National Assembly Oct. 6.
In the U.S., the Internal Revenue Service hasn’t issued guidance on the issue, Hunley said. The agency confirmed that it has “not opined specifically on NFTs.”
“We are aware of and closely monitor developments in the area of digital assets,” Bruce Friedland, a spokesman for the IRS, said in an email.
U.S. tax practitioners have to apply general tax principles in the absence of anything more specific, Hunley said. Tax professionals are relying on the IRS guidance on virtual currency, which is a digital asset, to infer some things from the general tax treatment of cryptocurrency and apply it to an NFT, also a digital asset, he said.
“The question then on tax pros mind is, ‘Does that really work? Is that realistic in our day and age with this new technology?,’” Hunley said.
A lack of guidance specifically on NFT’s doesn’t mean they aren’t taxable, but the nature of NFTs with the varying uses and characteristics may blur lines for taxpayers and tax authorities as to which type of NFT is which type of property, said Harding.
“The tax system needs to consider how to differentiate between NFT’s that merely record transactions or value in the real world to those that create it from nothing,” Harding said. To read more click here.
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