How VAT should be charged on trading in NFTs is of interest to taxpayers and tax authorities in various European Union countries, which sometimes take different approaches. On 21 March 2023, the EU VAT Committee published Working Paper no. 1060, entitled “Initial VAT reflections on non-fungible tokens,” touching on a number of issues concerning the VAT treatment of NFTs. As NFT transactions, including high-value ones, become more common, the tax treatment of these tokens and operations involving them, including on VAT grounds, should be fairly assessed, and the working paper may have a significant impact on this assessment.
What are NFTs?
NFTs are generally cryptographic, non-fungible tokens. They are one-of-a-kind digital assets with a virtual certificate created in blockchain technology, constituting verifiable proof of validity of creation and ownership by a specific holder. As NFTs are non-fungible, they offer a rarity in the digital world—confirmation of their uniqueness. NFTs are used for identification of works of art, but also a number of other assets, including real estate.
The working paper focuses on the metadata (data providing basic information about other data) contained in the NFT as an asset. The metadata can include multiple elements, such as the NFT name, description and URL (if necessary). The working paper presents as an example a digital portrait by NFT, whose metadata may include the URL of the image and rare image features, such as identification of the person portrayed, hair and eye colour, or type of clothing. The paper notes that through their metadata, NFTs are a digital representation of related assets.
NFTs: services for VAT purposes
Generally, the working paper regards NFTs as services (rather than goods), with a possible exception regarding NFTs that can be exchanged for specific goods. The working paper focuses on what is the object of the trade: a digital token (NFT) or the underlying asset (represented by the NFT). If NFTs are understood as contracts, for example transferring title to a physical good, transfer of NFTs should qualify as delivery of a good.
NFTs: overview of possible classifications
The working paper notes that although currently NFTs are often treated as digital services, such a classification is not certain, and it is not justifiable to apply it generally to all cases. On the contrary, an individual assessment of each case is necessary. In doing so, the working paper provides an overview of NFTs, as well as how they are created and traded. For this purpose, NFTs are compared with several categories:
An NFT can be compared to a property title, as it is a digital record of provenance and proof of ownership of the underlying asset. In this case, VAT on the transaction would be based on the taxation of the underlying asset, which may be a good or a service.
An NFT can be compared to a single-purpose voucher, if upon purchase the holder may exchange it for a specific good or service and upon redemption the NFT is permanently removed from circulation. Alternatively, NFTs can be considered multi-purpose vouchers if the holder can modify the metadata (i.e. choose among different goods or services). In this case, the VAT effects of the transaction would be analogous to those of vouchers—single-use or multiple-use, respectively.
An NFT can be considered a composite sale, consisting of a digital token and a related asset with a principal and an ancillary element or two closely linked elements. If acquisition of the underlying asset is considered the main element of the transaction, the VAT effects of the redemption of the NFT should be determined by reference to the underlying asset. If the main item is a token, taxation of sale of the NFT would follow the token-specific rules. If the sale of the NFT and the asset were considered indivisible, or their division would be artificial, the transaction should be subject to VAT in a manner appropriate to such a composite supply.
NFTs can be considered electronic services, as they are a technology related to digital ledgers and as such can be executed exclusively online and require only minimal human intervention. NFTs should qualify as electronic services especially when the NFT assets are digital in nature and their sale provides the recipient with access and some right to that digital asset.
The working paper discusses the potential VAT implications of key NFT transactions, including NFT minting, trading, and earning.
As the working paper points out, in the case of minting remunerated with “gas fees” (fees paid for computation and storage on a distributed ledger), it is not easy to establish a direct link, required for the transaction to be subject to VAT, between the gas fee and publication in the digital ledger, as it is difficult to establish the existence of a legal relationship between the person requesting minting and the network validators involved in the publication. As a result, it is not clear whether gas fees qualify as consideration for VAT purposes (which would determine the chargeable nature of the services and VAT liability). However, the working paper points out that this may be only a temporary state.
In principle, the sale of NFTs is subject to VAT (under the rules for the specific NFT, as indicated above), but if the parties to the transaction are anonymous, it is unclear whether the payments received by the creator for sale of NFTs should be treated as mutual consideration (their absence would exclude the pecuniary nature of the sale and remove it from the category of VAT-able consideration). Additionally, when an individual sells NFTs occasionally, it is not clear whether he or she should be considered a VAT payer (lack of VAT status excludes a transaction from being subject to VAT, as only activities carried out by a VAT payer acting as such are subject to VAT). At the same time, according to the working paper, if the terms of the NFTs stipulate that the seller will receive remuneration each time the NFT is resold, that seller can be treated as a VAT payer. Additionally, the working paper recognises the problems in a situation where a NFT vendor is paid in cryptocurrency. These problems are particularly related to determining the value of remuneration and the VAT base.
The working paper states that in the case of play-to-earn games, when a player receives NFTs as a reward for playing, no direct relationship automatically arises between the NFTs earned and the amount paid by players to enter the game. Thus there is probably no relationship between the value of the NFTs earned and the amount paid for the game.
Although the working paper does not set forth a definitive position on the VAT treatment of NFTs, it will certainly stimulate a discussion on this subject and is likely to become a touchstone for assessing the VAT implications of NFT operations, including for the Polish tax authorities.
The working paper presents a range of possible approaches, depending on the characteristics and functions performed by the given NFT. Despite the lack of clarity, it can undoubtedly help overcome the common attitude in Poland that NFTs are not subject to VAT (or by analogy with bitcoin, are exempt from VAT).This confirms that the VAT rules for NFTs depend primarily on the intended purpose of the token.
Since VAT is levied on activities carried out by a VAT payer acting in such capacity, it is also relevant who issues the NFTs and in what capacity.
Therefore, interested parties should make an appropriate analysis of their situation, as well as monitor the trends and legislation in this area.
Joanna Prokurat, tax adviser, Tax practice, Wardyński & Partners