Global indirect tax considerations for the sale of NFTs

The rise in popularity of non-fungible tokens (NFTs) has raised a number of important questions as to how these should be taxed, particularly when considering this from a global indirect tax perspective (i.e., VAT, GST, and U.S. sales tax). At the time of publication, there is very little official guidance from tax authorities as to the indirect tax treatment of the sale of NFTs. This presents a number of important questions for both the creators and sellers of NFTs, as well as marketplaces facilitating the auction and sale of NFTs in the secondary market.

What are NFTs?

NFTs are unique and non-interchangeable units of data stored on a digital ledger. These can be used to represent items such as digital artwork, photos, videos, audio, or other types of digital files. The blockchain allows a verified and public proof of ownership of the NFT. In essence, NFTs are simply a digital wrapper that leverages the security of a blockchain to create a certificate of authenticity.

Popular types of NFTs include digital art, music, trading cards, event tickets, and club memberships. In some cases, NFTs may be backed by an underlying physical asset, which may or may not involve the owner taking possession of the physical asset. Apparel companies have used NFTs to presell limited-edition lines of clothing, those in possession of the NFT can redeem it for the physical item.

NFTs can be sold on either a primary or a secondary market. The primary market is between the creator of the NFT and the collector, whereas the secondary market is where NFTs are traded amongst collectors, typically on third-party marketplaces. A unique feature of the NFT is that the creator of the NFT typically can receive a royalty, generally between 5 and 10%, each time their NFT is sold on a secondary market.

Global VAT and GST considerations

VAT and GST (hereafter just referred to as VAT) are transactional consumption taxes that currently exist in approximately 170 countries around the world. When considering the VAT implications of selling NFTs, it is important to understand exactly what the NFT is, for example

• Is the NFT a form of digital art or a similar product;
• Is it some sort of financial instrument or security; or
• Is it linked to an underlying physical asset?

Is the NFT a form of digital art or a similar product?

There are currently 100 countries that have implemented specific VAT rules regarding cross-border supplies of digital services, under the principles of economic nexus. Broadly speaking, this means if a company established in Country A sells a digital service to a private individual customer located in Country B, the company may be required to register and remit VAT in Country B, subject to items such as VAT registration thresholds.

The definition of a digital service does vary across jurisdictions, but they often follow a similar definition within the European Union (EU). For EU VAT purposes, a digital service is a service that is “delivered over the Internet or an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention, and impossible to ensure in the absence of information technology”.

A specific non-exhaustive list of examples are included in the EU VAT Directive, which covers:

• Website supply, web-hosting, distance maintenance of programs and equipment.
• Supply of software and updating thereof.
• Supply of images, text, and information and making available of databases.
• Supply of music, films, and games, including games of chance and gambling games, and of political, cultural, artistic, sporting, scientific, and entertainment broadcasts and events.
• Supply of distance teaching.

As a result of these rules, the current thinking is that most NFTs are likely to be qualified as a digital service for VAT purposes and therefore taxed in the same way as the supply of a digital image, text, or video clip. This would potentially result in sellers of NFTs in primary markets being liable to collect and remit VAT in jurisdictions where they exceed the economic nexus thresholds, which in many countries are ‘nil’. The considerations for sales via secondary marketplaces is a little more complex, and we have considered these further below.

Finally, note the VAT rules outlined above typically only apply in a business-to-consumer (B2C) context, and not in a business-to-business (B2B) scenario. As such, understanding the VAT status of the purchaser may be a critical consideration when determining VAT implications of such supplies.

Is the NFT some fort of financial instrument or security?

What remains to be seen is whether any tax authorities take a position that NFTs are not digital services for VAT purposes – specifically, whether NFTs could be considered as some form of financial instrument, where they are being held as financial speculation.

In the EU VAT case of Hedqvist (C-264/14), the Court of Justice held that for VAT purposes bitcoin was a currency, and exchange fees relating to trading bitcoin (and by extension, similar cryptocurrencies that have the characteristics as a means of stored value) for fiat currencies constituted a VAT exempt financial service. Since then, other countries have implemented similar VAT reliefs for fees associated with the exchange of cryptocurrencies.

While this position would obviously be beneficial for suppliers of NFTs located in non-VAT jurisdictions (such as the United States or the Cayman Islands), a VAT exemption typically means that the supplier cannot recover any VAT incurred on their business costs – so could increase the cost of doing business. However, this potential VAT cost is likely to be small given the nature of companies in the NFT space – and would not impact U.S. sellers.

Given the specific nature of most VAT financial exemptions, we consider that NFTs are unlikely to fall into this category unless they have very specific features that could lead them to being classified as financial securities.

Is the NFT linked to an underlying physical asset?

The final potential position is where the NFT is linked to an underlying physical asset. This situation presents several complexities, including determining whether the supply is the underlying physical asset, or some type of service.

If the purchase of the NFT does lead to the delivery of a physical asset, it is likely the VAT rules for the supply of goods would need to be considered. This would involve understanding where the goods are being shipped from, and shipped to, as well as the “VAT status” of the purchaser. There may also be customs duty considerations for such transactions.

NFT Marketplaces

If NFTs are considered to fall under the digital services rules for VAT purposes, NFT marketplaces should consider whether they could be liable for the VAT due on gross sales under “marketplace facilitator” rules.

Most VAT jurisdictions that have implemented some form of digital services rules include provisions that deem the marketplace to be the supplier of the digital service for VAT purposes. There are often conditions around the scenario in which the NFT could be liable for the VAT due, and this includes the situation where the marketplace does one of the following:

• Authorizes the charge to the customer
• Sets terms and conditions for the supply
• Authorizes the delivery of the digital service

These terms are designed to be overly broad to bring most marketplaces within the scope of these rules, and so are likely to apply to NFT marketplaces. Given that marketplaces are liable for VAT on the gross amount due, potential VAT exposures given average rates in the EU of 21% could be higher than the revenue earned by the marketplace. It is therefore very important that NFT marketplaces consider the VAT treatment of sales occurring on their platform.

NFTs and U.S. Sales Tax

Like VAT, sales tax is a consumption tax imposed by state and local governments in the U.S. on sales of goods and services. Also referred to as a “trust tax,” it is collected by the retailer (seller) at the point of sale and remitted to the tax authority. For the most part, retailers collect the sales tax based on the rate in the jurisdiction where their customer consumes the good or service. If the retailer is not engaged in business (or does not have nexus) in the state/jurisdiction where the customer consumes the good/service, the customer (purchaser) is generally required to self-pay the compensating use tax directly to the applicable tax authority.

After the U.S. Supreme Court decision in South Dakota v. Wayfair (2018), state tax authorities now require many out-of-state (remote) retailers to collect and remit sales tax, despite not having a physical presence in their state. To determine whether remote retailers (including foreign businesses outside of the U.S.) have “economic nexus” based on their sales, states have enacted sales dollar and/or transaction thresholds. For example, $100,000 or 200 transactions in a calendar year. States have also passed laws imposing sales tax collection responsibility on Marketplace Facilitators. These are online marketplaces that enable third parties to sell on their platforms and facilitate the transactions. The Marketplace Facilitator is responsible for collecting/remitting sales tax on taxable items sold by third parties on the marketplace.

Many states currently have laws in place to apply sales/use tax to digital goods (movies, art, music, ringtones, etc.). Much like global VAT authorities, U.S. sales tax laws have yet to provide specific guidance on NFTs. The consensus at this time among sales tax advisors is that many NFTs are considered digital goods and would likely be subject to sales and use tax in states who already tax such items.

Other considerations

In addition to the above, there are a couple of other key items to consider from a VAT perspective:

• Determining the location of the customer: it is crucial for VAT purposes to be able to identify where the customer is located. This is typically based on having two pieces of non-contradictory evidence (e.g. customer address, credit card address, IP address, etc.) and determines which jurisdiction the sale may be taxable in.
• Value of the supply: as most NFT transactions take place in cryptocurrency, the date and value of the sale should be monitored to allow this to be converted into fiat currency based on the relevant exchange rules in the taxing jurisdiction.