VAT and non-fungible tokens: crypto or cryptic?

While cryptocurrencies such as Bitcoin and Ethereum are now well-known alternatives to traditional currencies and investments, the market in other cryptoassets - such as non-fungible tokens (NFTs) - has also grown significantly in recent years, both as an alternative to tangible artwork and as a business or investment opportunity.

Despite the rapid growth in popularity of NFTs, there is currently very little guidance on the tax treatment of cryptoassets from HMRC or other tax authorities. Until this changes, individuals and businesses buying and selling NFTs have no alternative but to identify the potential tax issues for themselves. 

What is an NFT?

NFTs are a type of cryptoasset that have become an established form of digital artwork and collectables; particularly with brands, artists and sports stars using them as an opportunity to engage with customers and fans, and further monetise their intellectual property.

NFTs are a unique representation of an asset, which is stored on a blockchain, a means of recording and storing transaction data and tracking assets securely without a centralised data manager. The inherent security afforded by blockchains allows NFTs to be more than just digital artwork - they can effectively be used to represent ownership of any unique digital or, in some cases, physical asset.

Current VAT treatment

At present, there is, in particular, very little official information available on the VAT treatment of NFTs. Despite issuing some guidance on their direct tax implications, so far there is no specific HMRC guidance on the VAT liability or place of supply of NFTs and, to date, there has only been one notable court case on the topic, which was heard in Spain.

Both the HMRC guidance (for direct taxes) and Spanish court decision stress the electronic or digital nature of NFTs, with the latter concluding that the supply of an NFT is an ‘electronically supplied service’. As UK VAT law has not substantially diverged from EU VAT law in this area since the UK left the European Union, we may expect UK courts to come to similar conclusions if the same questions were asked in the UK.

Treating supplies of NFTs as an electronically supplied service for VAT purposes leaves suppliers with a whole host of questions and issues to deal with.

• Am I in business? - For many individuals occasionally buying and selling NFTs, it is unlikely that they will be considered to be ‘in business’ for VAT purposes, and as a result should not fall within the scope of VAT. However, those that begin to regularly trade in NFTs and make significant amounts of money must consider at what point this becomes a business which might require a VAT registration. There is a real risk of incurring significant penalties and liabilities if individuals fail to recognise that their hobby has now become a business.

• What if I am a business trading in NFTs? - If you are in business and making sales to private individuals (ie non-business customers), you need to be aware of the electronically supplied services rules. In the UK and EU, these require the supplier to register for VAT in the country where the customer belongs. Many other countries have adopted similar rules, so a business trading in NFTs could potentially have to register for VAT in multiple countries.
  
  Whilst electronically supplied services to business customers are also usually subject to VAT where the customer belongs, some countries allow the business customer to account for the VAT due, thereby relieving the obligation from the seller. However, other jurisdictions still require the seller to register, even where the NFT is sold to a business customer.

• How do I identify the location of my customers? - To determine where VAT should be accounted for, and where they may need to register for VAT, NFT traders must ensure their systems are able to capture the location of private individual customers - something that can be a difficult proposition for any online trader. Allowing customers using cryptocurrencies to pay for NFTs will present additional VAT challenges for the seller because they will not be able to use information from the traditional banking system as evidence of the customer’s location.
  
  To apply the correct VAT treatment, businesses will also need to determine whether or not a customer is in business. This often involves collecting a customer’s VAT number, but different countries have different rules on what is acceptable evidence.

• Are all my NFT sales subject to VAT? - To date, NFTs have largely been viewed as digital artwork with little importance placed on the underlying asset stored on the blockchain. However, NFTs can effectively be used to represent ownership of any digital asset or, in some cases, physical assets.
  
  While supplies of digital artwork may be taxable at the standard rate of VAT, what would the VAT position be if an NFT represents proof of ownership of an exempt financial security, or where an NFT is linked to underlying zero-rated printed matter? Would it need to be considered whether real estate linked to an NFT is taxable or exempt to determine the VAT treatment of the NFT itself?
  
  As mentioned above, NFTs will usually be supplied in the country where the customer belongs, so for cross-border supplies it will be necessary to check whether any reliefs or reduced rates apply in the customer’s country to understand the correct VAT rate to apply.

• What if I operate a platform selling NFTs? - Sellers will need to be careful if they provide an online NFT marketplace or platform on which other businesses can make sales as, in some circumstances, they may themselves be required to account for VAT on the sales made by other businesses using the platform. 

• Volatility of cryptoassets and cryptocurrency - As we have seen in recent times, crypto markets are volatile, so the value of cryptocurrency and other cryptoassets can fluctuate quickly. For UK VAT purposes, the value of a supply has to be expressed in sterling at the time of supply. There is a real concern, therefore, that for some businesses, the exchange rate may materially change between the time of supply and the point that VAT needs to be paid to HMRC - for a business on quarterly VAT returns, there may be a four-month gap between these dates. Businesses may therefore need to consider how they will meet their VAT liabilities if the value of the cryptoassets they hold falls dramatically.

The future

While there are already significant VAT challenges for suppliers of NFTs, especially against the backdrop of recent market volatility, the inherently evolving nature of NFTs suggests the picture could become even more complex in the future. 

To navigate the current VAT obstacles without clear guidance from HMRC or the UK courts, suppliers of NFTs will need to make sure they have considered the above questions.

For more information, please get in touch with Simon Atkins, Jack Thompson or your usual RSM contact.