NFTs have taken the world by storm, and regulators are taking notice. In February 2023, the Value Added Tax (VAT) Committee of the European Commission released a Working Paper to address the legal ambiguity of the VAT treatment of NFTs (non-fungible tokens). While this Working Paper is not a legal document, the European Commission’s opinion on the VAT treatment of NFTs bears weight as VAT law is harmonized in the European Union and the Commission holds a right of proposal for legislation.
Since there is no uniform EU-legislation that regulates the VAT treatment of NFTs, it is necessary to look at the supplies linked to NFTs: the underlying activities and transactions. In the Working Paper, the Committee looked at the supplies linked to NFTs to determine the assessment of NFTs for VAT.
In this article we summarized the main points from the Working Paper and added commentary where this helps to clarify and improve understanding.
Just like how not all pizzas are created equal, not all NFTs are cut from the same digital dough. While the majority view considers NFTs to be electronic services, a case-by-case assessment will be needed.
Such a case-by-case assessment determines whether a transaction is a taxable supply and within the scope of VAT and if so, whether the transaction is taxable or tax-exempt.
Let’s dive into the details and the elements to consider in an assessment.
Building the VAT framework
The three taxable activities (supplies) to consider in connection with NFTs and VAT taxation are:
Minting: making and uploading NFTs onto a digital ledger.
Trading: buying and selling NFTs.
Earning: receiving NFTs as a reward for another activity.
Each transaction linked to an NFT can be subject to a different VAT treatment.
The first question to answer is whether a transaction is within the scope of VAT:
Is the supply a taxable supply?
For this, we want to determine the following:
Is the supply for goods or services?
Is the supply made for consideration?
Is the supply made by a taxable person acting as such?
The assessment needs to answer all three questions positively. In that case, the supply is within the scope of VAT and leads to the next step in the assessment:
To determine whether the supply within scope of VAT is
Are supplies of NFTs transactions in goods and services?
Remember that this is the first hurdle to pass: if an NFT supply passes the test, we carry on to the next step in the assessment. If it doesn’t, you can stop reading here, take a break and have a cup of coffee.
To determine whether we are dealing with a transaction in goods and services, let’s take a step back to answer whether the digital token is the object of the transaction or the underlying asset.In the Committee’s Working Paper, this is answered by assessing NFT supply in comparison with property titles, vouchers, composite supplies and electronic services.
NFTs and property titles
To purchase real estate, you must complete an act at a notary and receive a property title that represents ownership of the real estate, depending on the rules of the jurisdiction. Although the property title serves as a certificate of ownership, it is not the actual real estate acquired. This raises the question whether an NFT can be compared to a property title.
An NFT is a digital record of provenance that serves as proof of ownership of an asset, just like a property title. If an NFT is considered a means of transferring the owner’s right to dispose of the asset, similar to a notary certificate, then the VAT treatment of the transaction would depend on the nature of the asset in question. The asset could be classified as either a good or a service, and the VAT rules applicable to the transfer of that good or service would apply.
Next, let us consider whether NFTs could be treated as vouchers.
NFTs and vouchers
A voucher is an instrument that obliges the redeemer to accept it as consideration for goods or services supplied in return, according to the VAT Directive. There are two types of vouchers: single-purpose and multipurpose vouchers. The aim of both types is to ensure that the VAT due is similar to what would have been applied without the use of a voucher, but the timing of taxation may differ under certain circumstances:
An NFT can be considered a voucher for VAT purposes if it is possible to redeem it for a specific good or service and is permanently removed from circulation upon redemption (single purpose voucher). In such cases, the transfer of the NFT is seen as a supply of the related goods or services and the relevant moment of taxation, while the actual handing out of the good or supply of the service is not considered a supply. An example is the right to redeem an NFT for a designer purse.
If the NFT enables the holder to choose among different goods or services, it can be seen as a multipurpose voucher, and the goods or services supplied in return would be taxed upon redemption.
“Gift card NFTs” can also be considered vouchers. Whether they are classified as a single-purpose or multipurpose voucher depends on whether the information related to the place of supply and the VAT due is known or unknown.
In all cases, the VAT treatment of an NFT should follow that of a voucher.
NFTs and composite suppliesA composite supply for VAT purposes is a supply of two or more taxable supplies of goods or services or both, or any combination thereof, which are naturally bundled and supplied in conjunction with each other in the ordinary course of business. An example says a thousand words: purchasing a product at an online store + delivery.
The VAT Directive doesn’t provide specific guidance for composite supplies, but the Court of Justice of the European Union (CJEU) indicates that a supply consisting of multiple goods or services is subject to VAT on its own merits.
Composite supplies can have a principal element, form a single supply, or have the NFT token as the principal element for VAT taxation. If one element can be considered the principal element and the others are ancillary, the VAT treatment of the ancillary supply follows that of the principal supply. Alternatively, if two or more supplies are so closely linked that they form a single, indivisible economic supply, they are uniformly taxed. When it comes to NFTs, the acquisition of the related asset is likely to be considered the principal element, but if the value lies in the uniqueness provided by the NFT medium, the token could be the principal element and the VAT treatment would follow that of the token. If the token and asset are closely intertwined, they could be considered a single, indivisible economic supply and taxed uniformly as an electronic service.
NFTs and electronic services
NFTs also correspond to the definition of electronic assets:
According to Article 7(1) of the VAT Implementing Regulation, “electronically supplied services” include services that are delivered over the Internet and involve minimal human intervention. Examples of such services include images, text, and information.
Clear as mud what NFTs are for VAT purposes? Time for a brief summary.
In a nutshell:
NFT transactions can fall under the four categories of property titles, vouchers, composite supplies and electronic services and thus be considered supplies for goods and services for VAT. While the current majority view considers NFTs to be electronic assets, a generalization is not possible and determining NFTs for VAT purposes needs to be done on a case-by-case basis.
Let’s consider the taxable activities next: minting, trading and earning.
NFT Minting and VAT
Minting involves recording metadata and implementing a smart contract. The process includes several steps, such as generating new blocks, recording information, and paying the necessary gas fee.
To assess whether minting is subject to VAT, we determine:
Is the supply made for consideration?Qualification of the transaction
For a transaction to qualify for VAT, the transaction has to be for goods or services. Minting an NFT requires no human intervention and is dependent upon information technology for its supply. This would qualify as an electronic service in line with the definition of electronically supplied services in Article 7(1) of the VAT Implementing Regulation and qualify the transaction for VAT.
Existence of considerationTo be within the scope of VAT, a transaction has to be made for consideration. A supply is made for consideration if there is a direct link between the goods and services provided and the consideration received. Pre-requisite for a direct link is the legal relationship between the supplier and the purchaser, entailing reciprocal performance: a balance of the value of the consideration actually given in return for the goods or services supplied.
How can we apply this to NFT minting?
The remuneration given for minting services are typically gas fees paid in the native currency of the digital ledger on which an NFT is minted, exchangeable for FIAT currency, and thus qualify as consideration from this perspective.
Establishing whether a legal relationship exists between the person requesting the minting service and the network validators is more complex. It likely requires – you may have guessed it – a case-by-case analysis.
Attention should be given to the parts of the gas fee that are base fees and the so-called tip part of the fees.
Base gas-fees that are burnt and not paid to the network validators, should not be considers for VAT.
Tip gas-fees that are mandatory, on the other hand, should fall within the scope of VAT.
For now, whether gas-fees paid for minting are within the scope of VAT, hinges on establishing the legal relationship between the parties because of the anonymity of the transaction involved. However, with the development of legislation regulating the automated exchange of information (CARF, MiCA), we expect the legal relationships between involved parties to be established more easily and the argument to exclude a minting transaction from VAT based on a lack of an established relationship to lose importance in the future.
In the next step, to assess whether mining is within or out of the scope for VAT, we need to consider the person acting.
Is the supply made by a taxable person acting as such?
You are not a taxable person by default, you actually need to get active and earn your stripes! In other words: the Committee does not automatically consider everyone a taxable person. Your status as a taxable person is determined by fulfilling certain requirements.
Taxable status of the network validatorsThe Working Paper states that network validators cannot automatically be assumed to be taxable persons. Compared to mining (in a proof of work consent mechanism) that requires active participation, minting only requires staking crypto-assets as a collateral. Staking is seen as a passive activity, similar to holding shares to derive dividend income, which is not VAT taxable either.
Although minting involves holding crypto-assets, it also requires running programs to validate transactions and earning gas fees. As a result, minters may meet the criteria to be classified as taxable persons.
The last aspect to determine whether a transaction is within the scope of VAT is whether the supply is taxable or tax-exempt.
Is the supply taxable or tax-exempt?
With regard to gas-fees for NFT minting, the Committee finds no reason for the supply to be VAT exempt.
A final remark on minting:
In their Working Paper, the Committee points out that the legal relationship between the participants in the minting process is difficult to establish. VAT is meant as a large based tax, and establishing the relationship between the parties does not seem in line with the purpose of VAT as a large based tax. The Committee recommends rethinking the definition of consideration.
Let’s examine NFT trading next.
NFT Trading and VAT
NFT trading is broadly categorized in the Working Paper. It encompasses the classic trading activities of primary and secondary market exchange of NFTs for cryptocurrencies, fiat money or a transfer for free. It also includes the related supplies: the recording of the transaction and update of the distributed ledger by miners and the services provided by marketplaces.
Let’s go through the assessment step by step again.
Are the supplies made for consideration?Qualification of the transactionsAs discussed earlier, NFT sales may qualify as supplies of goods and services and
the supplies from miners and from marketplaces may qualify as services.
Existence of consideration
Consideration is typically given, where an NFT is exchanged for a payment that corresponds to the subjective value agreed by the parties. The anonymity of the transaction may jeopardize the recognition of a legal relationship, and a further analysis is recommended in the Working Paper.
A free transfer of an NFT is in principle out of the scope of VAT.FeesGas fees are payable for services rendered by the network validators.
The Working Paper suggests that the analysis made in relation to minting fees also applies to gas fees connected to trading. Please refer to the relevant section above.
Marketplace fees can be charged to the seller of the purchaser. Whether they fall within the scope of VAT hinges on the existence of a legal relationship between the marketplace and the seller or the purchaser who pays the fees.
Are the supplies made by a taxable person acting as such?Taxable status of the NFT sellersTo qualify as a taxable person, you have to act independently and with the intention of making a profit. Marketplaces and individuals selling NFTs on a regular basis should typically qualify as taxable persons.
Individuals selling NFTs occasionally requires closer analysis for VAT purposes. A single sale of an NFT could be considered within the scope of VAT, if it entitles the seller to ongoing royalties every time the NFT is resold. Determining the VAT status in this case needs to be considered on a case-by-case basis.
In particular, it is important to consider whether the royalties received correspond to rights of successive use and exploitation or resale rights.Right of successive use and exploitation are consideration for an economic activity and subject to VAT, while resale rights are not a consideration for an economic activity and out of the scope of VAT.
The Committee further suggest in the Working Paper: As NFTs are unique, one may consider that the rights of use and exploitation attached to them are exhausted when they are first placed on the market, which would then entail that the remuneration gained from the resale is deemed to be a resale right outside the scope of VAT.
Taxable status of the network validatorsDepending on the individual case from an economic point of view, validator activities are commercial activities. If they are commercial activities, they are taxable.
Are the supplies taxed or exempt?The Committee finds no basis for exemption of NFT trades for VAT purposes.
And last but not least:
NFTs earned and VAT
Additional to NFTs obtained through purchase or for free, NFTs can also be earned. For example, in games. Only play-to-earn models are discussed in the Working Paper.
You know how it works: let’s walk through the stages.
Qualification of the supplyReceiving NFTs through online gaming meets the criteria for electronically supplied services.
Existence of considerationThere is no direct link between the NFT earned by a player and the amount paid by the player. This is because participation in a game can either be payable by players or free for players, if the game is sponsored by other means. This link should be established on a case-by-case basis.
The paper indicates, that NFTs obtained through online gaming are likely out of the scope for VAT:
Moreover, the possibility of a direct link seems rather remote, considering that there is (probably) no relationship between the value of the earned NFT which a player can gain and the amount he or she has to pay to play the game.
In the absence of consideration, earned NFTs would in principle be out of the scope of VAT.
Place of taxation
The place of supply of an earned NFT depends on its VAT qualification and on the taxable status of the parties.
Note: In connection with NFT trades and NFT fees, the place of taxation is not discussed in the Working Paper. In this context, it should be discussed whether protocol and validating services are economic activities at all.
Are the supplies made by a taxable person acting as such?Taxable status of the playersIf the purpose of the player and the factual circumstances that surround their gaming activity indicate that they are being remunerated by the earned NFTs, then such activity may be classified as an economic activity. In this scenario, the player would be regarded as a taxable person.
In summary, the Working Paper provides some guidance on the VAT treatment of NFTs.
Our aim in this article was to provide you with a summary of the most important points from the Committee’s Working Paper. We will delve deeper into the technical aspects in a subsequent article with DAAA.