The metaverse and non-fungible tokens are the two hottest terms in the emerging Web 3.0 landscape. Both present multimillion-dollar business opportunities. And where there is money, sooner or later, there will be taxes. Very few jurisdictions have published official guidance on how sales tax applies to metaverse transactions. Does this mean that the metaverse is a tax-free space until new regulations are enacted?
What Are the Metaverse and NFTs?
The metaverse is an online space where anyone can create a virtual representation of themselves (an avatar) to socialize with others, do business, visit events, and do most of the activities that we do in everyday life. The idea of an immersive virtual world is not new. Virtual worlds such as Second Life have existed for many years. Just like the internet has transitioned to Web 3.0 from Web 1.0, so did the metaverse. Impacted by new technologies such as blockchain and nonfungible tokens, it evolved from a virtual world governed by a single organization to a collection of decentralized online environments where the decision-making power belongs to the users.
Given this evolution, it’s not surprising that metaverses come in many different flavors. Some are governed by a central organization that determines what’s possible within the virtual world. This organization issues virtual currency that can be used for in-world transactions.
On the other side of the spectrum are decentralized blockchain-based metaverses that have a fully autonomous virtual economy that users control. They integrate crypto payments and rely on NFTs to represent asset ownership within the virtual world. The ultimate objective of decentralized metaverses is to achieve interoperability and permit users to transfer their avatars and virtual assets from one virtual space to another.
NFTs are the backbone of the new metaverse economy. An NFT is a unique piece of data stored on a blockchain that provides a way to establish ownership or the right to use digital assets. However, it is distinct from the digital asset itself. When you purchase an NFT, you typically acquire a token on the blockchain comprising a non-exclusive right to use a unique copy of the digital object, but you don’t obtain the ownership of the object.
The terms of the contact may grant the purchaser more extensive rights regarding the underlying asset. Within the metaverse, NFTs can also be used for other purposes: for example, to represent the right to access to virtual events.
Does Tax Apply to Metaverse Transactions?
In 2021, the German Federal Tax Court ruled that a sale of virtual land for Linden dollars did not attract value-added tax as it didn’t constitute any economic activity. While many people criticized this conclusion, claiming that a general consumption tax such as VAT should apply to sales in the metaverse, we must keep in mind that the court judgment wasn’t a general statement on the taxability of metaverse transactions—it merely commented on an individual case involving a centralized virtual world.
If this virtual world was closed by its operator, all virtual land would cease to exist. All “landowners” would lose their virtual wealth and wouldn’t be able to claim any property rights because the virtual land was never their property. Why should fictitious transactions made within a fictitious universe and paid with fictitious money be subject to real VAT? A fictitious tax collected by a fictitious tax office would seem more appropriate.
While the German court reached the right conclusion regarding sales in centralized metaverses controlled by a single entity, this reasoning can’t be transposed to sales of NFTs in decentralized blockchain-based metaverses with a fully autonomous economy controlled by its users. These metaverses can’t be closed by a single entity.
As the UK’s High Court recognized NFTs as private property protected by law, metaverse participants may invoke their property rights if their NFTs are taken away without their permission. Therefore, it seems reasonable to assume that transactions taking place in decentralized blockchain-based metaverses are within the scope of tax and are not fictitious.
If we believe that tax should generally apply to decentralized blockchain-based metaverses, the question of which transactions will actually be subject to tax depends on the design of a particular indirect tax system. In countries with a broad-based VAT, sales of NFTs for virtual currency are unlikely to escape taxation. Such sales are generally treated as supplies of digital services.
If an NFT grants the user access to a virtual event, the transaction may be viewed as the provision of admission services, as it is the service standing behind the token that has perceived value for the user. Consequently, VAT should be paid on the supply of the service according to the general rules. No tax will be collected on the transfer of the virtual currency itself, as it’s generally regarded as a tax-exempt means of payment.
Things get more complicated in jurisdictions such as US states, where not every product delivered electronically is included in the taxable base. States such as California, Florida, and Georgia generally exempt digital goods and services because of their intangible nature. In these states, metaverse transactions are likely to be tax-free.
There are also states that apply sales tax to nearly all or some specifically enumerated digital products, and the rules on what’s taxable and what isn’t may be quite complex. For example, states can treat digital products as taxable only if their physical equivalent is taxable or make the tax treatment dependent on whether a product is downloaded or accessed online.
This makes it necessary to examine on a case-by-case basis whether the sale of a particular NFT will be covered by the existing definitions. Even though the existing statutes don’t explicitly mention them, NFTs could fall under the definitions of digital products or digital code. States have often interpreted their sales tax laws extensively to ensure that the scope of sales tax keeps up with technological developments.
Very few states have issued official guidance explaining whether NFT sales are subject to sales and use tax. Pennsylvania clarified that NFTs are taxable as its sales and use tax applies to any transfer of a digital product. Minnesota, Wisconsin, and Washington explained that the sale or purchase of an NFT is taxable if the underlying product or service is taxable.
As NFTs are usually purchased with virtual currency, it’s necessary to investigate whether the sale may qualify as a barter transaction in states that treat virtual currency as some form of property. The qualification as a barter transaction would mean that sales tax must be collected on the transfer of both the NFT and the virtual currency if both are taxable. However, most states that have some guidance on the taxability of virtual currency treat it as non-taxable intangible property, such as New York, Wisconsin, and Missouri.
This usually means that no sales tax is due on the transfer of the virtual currency itself. Therefore, a business that makes a taxable NFT sale and receives virtual currency as payment must collect sales tax only on the transfer of the NFT (if it’s taxable) based on the fair-market value of the virtual currency in US dollars as of the date of sale.
Tax Collection Challenges and Opportunities
A common problem with taxing metaverse transactions is to identify which jurisdiction has the right to tax the sale. In the US, sales of digital products are generally sourced to the destination jurisdiction, which is either the location where the buyer first makes use of a product or the buyer’s billing address.
But states such as Pennsylvania, Arizona, and Ohio apply origin-based taxation and source intrastate sales to the location of the seller. Because NFT platforms often don’t collect any location data from their customers, it may not be clear which state has jurisdiction over a transaction.
Some states resolved this sourcing problem by allowing sellers to source the sale to their own location if they are unable to collect any customer location data. The guidance on the taxability of NFTs issued by Washington explicitly says that “where the seller is without sufficient information about the purchaser’s location, then the location shall be determined by the address from which the digital code was first available for transmission by the seller.”
In the EU, sales of digital products are always taxable at their destination, and the seller must use two items of non-contradictory evidence to determine the place where the customer belongs. If this doesn’t seem possible, the European Commission advises sellers to “continue to seek further evidence such as relevant commercial information.” There is no possibility to apply origin-based sourcing. From the perspective of NFT and crypto sales, US regulations are more forward-looking, as they acknowledge the possibility of anonymous transactions.
Tax collection on metaverse transactions could be improved by relying on intermediaries. All US states that levy a sales tax have enacted marketplace facilitator laws that make the marketplace operator liable to remit sales tax for transactions conducted by marketplace sellers provided sufficient transaction frequency, value thresholds, or other nexus requirements are met. The scope of the marketplace facilitator laws varies per state.
For example, under Washington’s laws, a marketplace facilitator is a business that
- Facilitates the sale of a marketplace seller’s products for consideration;
- Engages in communicating the offer or acceptance between the buyer and seller; and
- Performs any of the following activities: payment processing services, fulfillment or storage services, setting prices, listing products for sale, branding sales, taking orders, providing customer service, or accepting or assisting with returns and exchanges.
NFT platforms are likely to meet this definition because they operate technology that facilitates transactions between buyers and sellers, provide a technical interface to list products for sale, and communicate offer and acceptance between the transaction parties. Some states, such as New York, limit the definition of a marketplace facilitator to persons facilitating sales of tangible personal property. This makes it necessary to examine whether an NFT would qualify as tangible personal property under the laws of a particular state. In the absence of any official guidance, the outcome of this examination may be affected by subjective perceptions of those who interpret the law.
Marketplace operators in the EU that facilitate sales of digital products and either authorize the charge to the customer, authorize the delivery of the product, or set the general terms and conditions of the sale must collect VAT on the sale and remit it to the tax administration. Considering that most NFTs will meet the definition of a digital product, and the platform will typically perform at least one of the activities listed above, the tax collection obligation will be shifted to the platform operator.
As there are several types of metaverses, the question “how to tax metaverse sales” can’t be answered in a one-fits-all manner—it requires a case-by-case analysis. While metaverses controlled by a single entity should remain outside the scope of tax, this conclusion can’t be applied to decentralized metaverses, as NFTs are subject to legal protection as a form of property.
Official guidance is still scarce but would be very much welcomed, especially in jurisdictions with a narrowly defined tax base where a wrong decision about the non-taxability of metaverse sales may have the largest financial impact. The biggest obstacle to taxing transactions in the metaverse is that many tax administrations and legislators don’t know what a metaverse is or how it operates. And if you don’t know what something is, you don’t know how to tax it.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Aleksandra Bal is indirect tax technology & operation lead at Stripe. 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.
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