The OECD is in the early stages of examining the tax policy implications of non-fungible tokens (NFTs), following up on its work so far on the tax treatment of virtual currencies, an OECD adviser said.
Preliminary analysis suggests that governments should consider whether the regulation of NFTs, including their tax treatment, should be similar or different to that of virtual currency, Julien Jarrige, adviser to the director and deputy director of the OECD Centre for Tax Policy and Administration, said November 10. He was speaking during a virtual conference organized by Hansuke Consulting.
The OECD published a report in October 2020 about taxing virtual currencies and emerging tax policy issues, and NFTs are clearly a major area for further consideration, according to Jarrige, who coauthored the report.
The G-20-mandated report had described the approaches and policies that more than 50 jurisdictions have adopted to address the tax implications of virtual currencies, such as Bitcoin and Ethereum. The OECD had touted it as the first broad analysis of the policy gaps in several areas — income taxes, consumption taxes, and property taxes — and included several considerations for policymakers tackling those cryptoassets. The OECD also expects to produce an implementation package for a new tax transparency framework for cryptoassets in 2022.
The three main challenges with taxing virtual currencies are characterization, timing, and valuation, Jarrige said. Policymakers face similar difficulties with NFTs, which can take many different forms and are used in different ways, he added.
An NFT is a one-of-a-kind token that can’t be exchanged for another NFT because its value is tied to its unique properties, according to Wendy Walker of Sovos Compliance, who added that an NFT’s ownership is recorded in a blockchain. NFTs can take the form of artwork, GIFs, video clips, memes, digital trading cards, music, and other forms of digital representation, she said. In addition to purchasing NFTs from marketplaces using Ethereum cryptocurrency, individuals can also have the right to sell them, which could give rise to a profit, which in turn gives rise to potential tax issues, Walker said.
If a buyer purchases an NFT with Ethereum in the United States, that means a gain-loss event will occur when he later sells the NFT, Walker explained. Once he uses the Ethereum to buy the NFT, then he would calculate the gain or loss on the disposal of the Ethereum, she said.
Sellers receive Ethereum as payment for the NFT and will have to first recognize a gain-loss event on the NFT they sold, according to Walker. “But then they need to start to track basis for the Ethereum tokens that they received so that they can recognize gain or loss when they dispose of the Ethereum later on,” she said.
What’s different about NFTs is that transactions don’t just involve buyers and sellers but also artists, who can sell NFTs for Ethereum or cash, Walker explained. “This feels like ordinary income — in the United States, anyway — that could be subject to self-employment taxes because the artist has created and sold something rather than being a trader of property that’s producing a gain or loss,” she added.
Moreover, some artists are able to collect income every time their NFTs are sold, which may resemble royalty income in the United States, according to Walker. “You’d have to investigate that a little further to see if that’s the case,” she said. “That’s not something we have guidance on yet.”
NFTs have been around for a while, with CryptoKitties — a 2017 Ethereum blockchain game that allows players to breed, collect, buy and sell digital cats — among the first on the scene, according to Walker. NFTs are unlikely to go away anytime soon, she added, pointing to the March sale of an NFT by an artist named Beeple for more than $60 million at auction.
“Over the next several years, I think we’re going to see governments really investigate NFTs and perhaps, hopefully, categorize them,” Walker said. Governments are also likely to produce guidance on collectible NFTs, she added.
To that end, HM Revenue & Customs is working on guidance not only on NFTs but also on decentralized finance, also known as DeFi, according to Dion Seymour, policy and technical adviser at HMRC. DeFi is a blockchain-based type of finance that doesn’t depend on traditional financial institutions such as banks.
The challenge is that the term “NFT” is an umbrella term that encompasses much more than just a singular item, according to Seymour. “You can't just say, ‘This is an NFT.’ You have to look at the rights and obligations that have to be provided,” he said. Tax authorities must determine what the NFT is meant to do before they can determine what the tax treatment should be, he added.
OECD analysis suggests that it is not likely to be appropriate for governments to tax all NFTs in the same way, but the main features of NFTs already give some indication of what the treatment should be, Jarrige said.
One fundamental difference between NFTs and payment tokens is that NFTs may not be a means of exchanging or storing value, according to Jarrige. Because NFTs could represent the rights to equity, like an investment, then they may be closer to a security or utility tokens. Questions also arise if NFTs are to be taxed as property subject to capital gains or property taxes, he added.
The tax treatment of NFTs may differ depending on the use case and the nature of their ownership, Jarrige said. “Overall, these are questions, of course, that we need to clarify with countries, with their ministries of finances, [and] with their tax administrations,” he said, adding that the OECD is still in the early stages of initiating those questions.
“We hope that this will lead to common understanding before turning to any possible coordination on the tax treatment [of NFTs],” Jarrige said.