Non-fungible tokens (NFTs) have attracted the interest of investors and the public in the last couple of years because of their skyrocketing price and the possibility of producing revenues for the artists. The increasing price of NFTs has made it apparently also interesting enough for governments to try to levy VAT on these digital assets.
In the following, we will analyse how the VAT legislation is being extended in Spain to NFTs and the legal feasibility of this purpose. But let’s first start with an overview of the functioning of NFTs.
What are NFTs?
An NFT is a unique crypto-asset. It can be an original piece of digital art, a piece of audio, a game or something else. Ownership of an NFT is cryptographically recorded in order to give authenticity to a specific digital asset, though the enforceability of this record is often questioned and regulatory frameworks are in its infancy. Therefore we are not going to discuss the feasibility of NFTs nor their technical implementation, just tax implications.
The sale of NFTs has exponentially increased in 2021 when the total value of NFTs sales jumped 21,000% to $17.6 billion. Some of the most important sales of NFTs are the digital work of art by artist Mike Winkelmann, known as Beeple, which was sold for $69 million. Another example is the NFT of the first tweet ever published, which was sold for $2,9 million.
Due to the high value of the NFTs, several governments and tax authorities are thinking about extending the VAT system to these digital assets. This way, VAT treatment for NFTs might become similar to the one reserved for works of art. In the EU, full VAT is in general applied on artworks sold in a gallery while reduced rates are applied on artworks directly sold by the artist. For instance, Italy applies a 22% rate on art sold in art-galleries and 10% on art sold by the artist, while Germany applies a 13% rate for art sold in art-galleries and 7% by artists. How to account for the possible double taxation with VAT on the actual physical art piece and the VAT on top because of the NFT is left to the astute reader to figure out.
Applying VAT to NFTs might require a ruling from the tax authority in order to include NFTs within the framework of existing laws. We will analyse how this works in the following paragraph.
VAT on NFTs
Among the countries interested in applying VAT to NFTs is Spain. The Spanish tax authority issued a ruling analysing the VAT treatment of NFTs. In this ruling, the tax authority stated that NFTs should be identified as “electronically supplied services”. This definition opens the way to the extension of the Spanish VAT system also to NFTs, if these are supplied to users in the Spanish territory, with a standard rate of 21%.
Spain is the first country in the EU to apply VAT to NFTs, nevertheless the European Commission might soon clear out any doubt about the feasibility of this project. The EU defines electronically supplied services as: “Services which are 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”.
Nevertheless, questions arise about the determination of the place of supply, which is indispensable in order to know the applicable VAT rate and the responsible tax authority. Article 24f of the Spanish VAT ruling provides that the customer shall be presumed to be established or have his domicile or habitual residence in the place determined by the service provider based on two non-contradictory pieces of evidence. These elements include, among others, the billing address, the address of the IP used or any other commercially relevant information.
In order to do this, more and more data to determine the identity of the NFT buyer will be required. Some proposals have risen in the European Parliament aiming at extending the travel rule also to crypto assets. This will require crypto providers to store information that “travels” between payers and recipients and make it available to authorities for several years.
After Spain, Belgium and the state of Washington in the United States decided to incorporate NFTs within their tax regime. Belgium ruled in the spring of 2022 that NFTs must be considered as supply of services and are therefore subject to the local VAT rate of 21%. On the other side of the Ocean, Washington state issued an Interim Guidance Statement subjecting non-fungible tokens (NFTs) to a 6.5% sales tax and a 0.471% business & occupancy tax. Washington is the first state in the USA to extend its sales tax to NFTs. Furthermore, in Norway “The Tax Administration considers an NFT to be an asset, and the tax rules are the same as for other virtual assets.” This means that the sale of NFTs is taxed at 22%, while the creation “does not trigger taxation”.
Applying VAT to NFTs might not be an easy task because of the privacy-oriented nature of the crypto world. Already today, a remarkable amount of VAT fraud happens in relation to high value digital goods. This is because their provenance can either be (1) faked by the buyer or (2) hidden by the supplier. NFTs might add up to this and become the next focus of VAT fraudsters, of which the first signs already became apparent when the HMRC discovered a £1.4 million fraud scheme involving NFTs. Remember the VAT fraud with digital emission certificates? Anyone?
The idea of applying VAT to crypto assets like NFTs is of high interest to governments looking for more resources. Nevertheless, is it important to bear in mind the centrality of privacy in the crypto world. Requiring sensitive users’ information might be of help in applying VAT to these assets but could push users away from this sector.