Recognizing the significant macroeconomic implications of the growing crypto assets59 market, tax policy makers across the world have attempted to monitor and understand developments in crypto assets and their implications for taxation. For income tax purposes, many tax authorities view crypto assets as a form of property, similar to stocks or bonds, to enable them to determine when taxable income has been generated (e.g., in the US60 and Australia61 with respect to cryptocurrency). However, VAT considerations have been largely unexplored due to the difficulty in establishing the substance of the transactions or the linkage to a taxable event. Tax policymakers are also struggling to formulate tax policies for crypto assets because the nature of crypto assets and their trading activities is constantly evolving.
Crypto assets are purely digital assets that use public ledgers housed on the internet to prove ownership. They use cryptography, peer-to-peer networks, and a distributed ledger technology, such as blockchain, to create, verify, and secure transactions62. One of the challenges for applying the correct VAT treatment to crypto assets is that most crypto asset transactions are pseudonymous, meaning users operate through private keys and do not provide their contact details during the transaction. Consequently, determining user locations in most crypto asset transactions is almost impossible as businesses do not collect and store geolocation markers usually collected for VAT purposes (e.g., IP address, billing address, bank details, etc.). Even disregarding the pseudonymous element of crypto asset transactions, challenges remain with determining the appropriate VAT treatment, including difficulties in characterizing a transaction as either a transfer of goods, a service, or an intangible, as well as the parties to the transaction, and the consideration involved.
The central point we wish to make here is that the desire by taxpayers and tax authorities to have a singular, simple, and consistent VAT position for crypto assets is an illusory quest. The essential nature of a VAT is as a tax on consumption expenditure. Thinking you can attribute a single VAT treatment to crypto assets ignores the diversity of legal forms they take, the rights and entitlements they convey, and the transactions which may occur.
In this section, we will discuss the VAT implications of three types of crypto assets.
There are numerous activities involving cryptocurrencies — from the exchange of traditional currency to cryptocurrency, mining cryptocurrency (the activity to verify a transaction in a blockchain), selling and making a payment with cryptocurrency, etc. To determine the relevant VAT implications, it is crucial to identify what activity is being performed and the substance of the transaction taking place.
The baseline cryptocurrency activity people commonly would refer to is when such a cryptocurrency is being exchanged for traditional currency. The nature of the transaction is economically akin to a method of exchange. Naturally, therefore, it should not be subject to a VAT, as tax authorities around the world increasingly recognize and follow the ECJ decision’s approach that buying and selling bitcoin should be considered an exempt financial service.63 (See, for example, Singapore, Ireland, and the UK.) Other countries were slow to follow, with the Australia Taxation Office first taking a position that transactions involving cryptocurrencies were subject to GST. (The authors believe this was driven primarily by a motivation to use tax as an instrument to drive out money laundering and tax evasion.) The Australian legislature later amended the GST Act effective 1 July 2017 to apply the same treatment as fiat currency.64 Most jurisdictions appear to have taken interest in the VAT treatment of cryptocurrencies only in the last 12 to 18 months, with an increasing number adopting or proposing new (and disparate) VAT rules for crypto assets, including Costa Rica, which considers all transactions involving crypto assets as taxable,65 Indonesia, which imposes a special VAT treatment on crypto assets,66 and Thailand, which has introduced a temporary VAT exemption for qualifying digital asset transactions.67 Given that not all countries have adopted clear rules on cryptocurrencies and that the VAT treatment can vary greatly across jurisdictions, cryptocurrency businesses face an even greater challenge than “traditional” digital services providers to understand and determine their VAT obligations.
But even this baseline activity is merely scratching the surface.
The VAT treatment of mining activities is in its early stages of being addressed by tax authorities. Here again, they seem to be adopting inconsistent positions. According to the Irish Revenue, income received from cryptocurrency mining activities will generally be outside the scope of VAT on the basis that the activity does not constitute an economic activity for VAT purposes.68 This position seems also to be the preferred approach by the EU VAT Committee in its latest Working Paper on crypto assets.69 By contrast, the Dutch Court of the Hague ruled on 15 October 2021 that bitcoin mining does constitute an economic activity. The validation, verification, and mining were regarded as being inseparably intertwined and indispensable to bitcoin trading. This characterization qualified mining activities as a VAT-exempt transaction, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments under Article 135(1)(d) of the EU VAT Directive. The Inland Revenue Authority of Singapore (IRAS) also recently introduced guidance material to similar effect.70 Canada recently enacted specific legislation to treat crypto mining activities as being outside the scope for GST purposes.71 Canada’s approach, unlike most other jurisdictions, provides a clear rule for the treatment of mining activities, as it clearly states that if a person receives any form of remuneration (including money or property or a service), the mining activity is not going to be considered a supply. This position has the advantage of addressing barter transactions such as the contribution of a hash rate (i.e., computing power) to a mining pool in exchange for cryptocurrency.
Its presently unclear whether the purpose of excluding mining activities from the VAT net is a function of its highly speculative nature, or it is designed to exclude loss-making miners (or zero rating exporters) from claiming refunds.
Similar to the position with cryptocurrency, there are numerous activities and applications involving NFTs. For instance, NFTs can be used to sell collectible digital content. One of the best-known examples is NBA Top Shot Moments (video highlight clips sold as NFTs on NBA Top Shot, a blockchain-based platform). In this respect, NFTs fulfil a similar function to traditional sports trading cards, with the value of NFTs being based on the rarity of the collection itself. (For example, a LeBron James slam dunk video was sold at USD$230,000).72
Aside from providing ownership of digital collectibles, some NFTs provide tangible benefits to the owners and these benefits can be referenced to an “NFT roadmap”, which shows what an NFT project intends to achieve. A few casinos have launched NFTs, and the NFT owners become VIP members of the casino and may even own part of a casino’s profits or receive monetary benefits such as additional rakeback guarantees.73 Some NFTs can also act as an effective source of funding — for example, the World Wildlife Fund created their NFT collection, Non-Fungible Animals (NFAs), to raise awareness and funds for the conservation of endangered animals.
As there are multiple applications, forms and uses of NFTs, the VAT consequences will differ depending on the bundle of rights conveyed in the transaction — some of them are tokens which give access to underlying intangibles, some of them are akin to membership interests, some of them may be economically akin to shares in a company, and some actually convey ownership of a physical or digital asset. It is clear that NFTs are not just a series of unique identification codes on a blockchain. Without understanding the underlying assets and the accompanying rights associated with NFTs, it is almost impossible for tax policymakers to address their VAT implications.
At this early stage, there is very little guidance issued by tax authorities on the treatment of NFTs. Having said this, the Spanish authorities are among the first, having published a ruling on 10 March 2022 clarifying that the sale of NFTs granting the right to digital pictures is a digital service for VAT purposes.74
The central issue in our view is whether tax policymakers will determine the VAT implications by reference to the legal form of NFTs, as a digital token or right, or by reference to the underlying nature of the assets and benefits conveyed by NFTs. The answer to this question will likely vary from jurisdiction to jurisdiction, with some tax authorities being more willing to engage in rights-based analyses, whereas others will tend to look through and focus on their underlying use and enjoyment.
In many respects, this debate is akin to the line of cases that have arisen over the years in the context of golf clubs which provide the right to play golf attached to a subscription for securities. In the New Zealand Court of Appeal case of CIR v Gulf Harbour Development Ltd,75 the court held there was an exempt supply of securities by focusing on the “true nature” of a transaction, which required an analysis of the legal arrangements actually entered into and carried out — not by an assessment of the broad substance of the transaction, measured by the results intended and achieved, or of the overall economic consequences. Similarly, in the ECJ decision in Bridport & West Dorset Golf Club (Case C-495/12), green fees charged by non-profit golf clubs were held to be exempt from VAT in the same way as member subscriptions.
The key point from each of these cases in terms of NFTs is that it is necessary to analyze the substance and underlying effect of the rights conferred by the NFTs (e.g., an ownership right to a tangible property), and not merely by reference to the form of their delivery (e.g., the transfer of a digital code). There are, of course, cases going the other way and delineating the boundaries will be where the real challenge lies.
With the rapid development of the metaverse, it will be fascinating to see whether tax authorities seek to equate "real" market activities with those market activities occurring in a virtual space from a VAT and economic perspective.
The metaverse, which, according to its proponent, is “a quasi-successor state to the mobile internet”,76 will provide the next big challenge to the application of the VAT rules aimed at the digital economy as the world will live, work, and consume in the metaverse. Examples of these challenges can already be seen today in the narrower framework of massive multiplayer online games in which, depending on the game, participants can buy in-game tokens or properties, exchange goods, exchange fiat currencies for in-game currencies, or even get married (to name a few). These in-game (or in-metaverse transactions) trigger different sets of rules, such as the application of vouchers or e-wallets. Indeed, depending on when the exchange of “real world” currency is made for “virtual assets and or currencies” the transaction could qualify as a multi-purpose voucher, a single purpose voucher, or simply an infusion of in-game cash in an e-wallet. This classification may trigger different place and time of supply rules for the transaction. However, as the metaverse does not recognize current real-life borders, meaning users can be in any given jurisdiction while accessing the metaverse, businesses dealing in the metaverse will have to consider complex multi-country VAT rules that are not yet ready for virtual reality entering the real economy.
As noted earlier, in May 2022, the German Federal Tax Court held77 that the rental of virtual land in Second Life was irrelevant for tax purposes on the basis that the activity took place in a virtual environment and the value of the virtual land was limited to a specific virtual space. The court did rule, however, that a taxable transaction took place when virtual currencies earned from renting the virtual land were exchanged for US dollars. But, since the exchange took place over the taxpayer’s currency exchange platform, which is established in the US, the court decided the transaction was not subject to German tax.
The least difficult part of the case is the idea that an ordinary participant in the virtual world is, generally speaking, unlikely to be engaging in an economic activity in participating or transacting in the metaverse. However, the case raises many other challenging questions.
To that end, the transaction involved here (renting virtual land in exchange for virtual currency (known as Linden dollars) was in Germany, the court determined that was irrelevant and focused instead the exchange of virtual currency for real currency, which occurred elsewhere. It seems less clear to the authors that this is the “right” approach.
Some commentators have observed that “[f]rom a tax compliance perspective, it makes sense to leave the metaverse to itself and only invoke tax rules when virtual world activities lead to a real-world event.”78 We disagree. The fundamental nature of a VAT is to tax the consumption of goods and services, and while it may lead to complex compliance issues, we believe the “right” result is to tax the rental of virtual land carried out as an economic activity in exchange for virtual currency. The fact that virtual currency is being used is, with all due respect, irrelevant. In our view, what matters is the transferability or value of that virtual currency.
Whenever we encounter issues in the virtual world, it is helpful to remain grounded by reference to two examples:
- If you play a game of Monopoly (whether online or offline), plainly your “winnings” of monopoly money do not trigger VAT consequences (assuming you were professional Monopolists). What triggers VAT consequences is if the Monopoly money is convertible to cash; and
- If you go to a casino and gamble, the first thing you typically do upon entering the casino is to exchange your cash for gambling chips. At that point, there is no VAT consequence because the gambling chips are merely the medium of exchange. You could (in theory) go straight back to the cashier and you’d get precisely the same funds in return. Consumption expenditure in gambling and other games of chance occurs when you participate in the casino games using your gambling chips and derive a win or a loss. This is not to suggest that the consumption activity ordinarily occuring in the virtual world is therefore the same as gambling - in particular, in games of chance, it is the net amount (e.g. winnings less losses) that may be regarded as the consideration for gambling supply.79
In short, the mere fact these transactions happen in a “virtual” world really just creates challenges around the place of supply/consumption. We must be wary not to confuse, in our respectful opinion, issues of using crypto as the medium of exchange with the fact that there may be consumption taking place pursuant to economic activities in renting virtual land. While we acknowledge that this position creates serious practical and policy complexities,80 it is consistent with applying VAT at each point of the transaction. Delaying the application of the consumption tax later to a more convenient point in time (e.g., when the virtual currency is potentially converted into fiat currency) would potentially transform the VAT system into a form of retail sales tax, thus requiring a far broader review of the current VAT systems than policymakers appear to be ready to do.65
Where to next with crypto?
Cryptocurrencies continue to disrupt the financial industry; NFTs are revolutionizing the art and creative content world; and the metaverse is combining the physical and virtual world. So, how will tax regulators respond to these changes in a new digital economy?
In each case, the quest for a single, simple, and consistent VAT treatment is a fool’s errand — both the form of the transactions and activities taking place, as well as the rights, entitlements and benefits conferred, are likely to be as diverse as those occurring in the 'real' world. Instead, what tax policymakers should be striving for is a consistent set of principles to apply.
There are three principles which spring to mind here — the first is to recognize that VAT is a tax on private consumption in one country in which the consumption occurs and therefore taxing something merely because there is an exchange of currencies is not the appropriate yardstick. Second, tax rules should be designed to achieve economic equivalence — that is, of taxing transactions which are economically similar in a similar way. Third, there is a need to apply consistency in determining whether to tax the legal form of the transaction, versus the economic benefits being conveyed.
It is only when we develop and then adhere to certain basic principles can the multiplicity of products and transaction types be suitably applied in a VAT context. Policymakers will thus sooner or later have to address the taxation of these virtual businesses in a holistic and global way to avoid the metaverse becoming the VAT multiverse of madness if countries take unilateral approaches.
Explore more propositions on the future of indirect taxation:
59 In this paper we will use the term crypto assets. It is taken to include cryptocurrencies, NFTs, and virtual objects in the Metaverse.
60 In the US, virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency. See: https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions.
61 In Australia, in most situations cryptocurrency is not a personal use asset and is subject to capital gains. However, some exceptions apply. See: https://www.ato.gov.au/General/Other-languages/In-detail/Information-in-other-languages/Cryptocurrency-and-tax/#:~:text=In%20most%20situations%2C%20cryptocurrency%20is,for%20capital%20gains%20tax%20purposes
62 See e.g., Canada Financial and Consumer Services Commission, Crypto Assets and Cryptocurrency.
63 ECJ, Hedqvist, Case C‑264/14 (22 October 2015).
64 ATO, GST and digital currency (16 March 2018).
65 Costa Rica - Tax Authority Launches Public Consultation on Taxation of Virtual Assets (24 March 2022), News IBFD.
66 Indonesia - Indonesia To Impose Income Tax and VAT on Cryptoassets (11 April 2022), News IBFD.
67 Thailand - Thailand Gazettes VAT Exemption for Qualifying Digital Asset Transactions (25 May 2022), News IBFD.
68 Tax & Duty Manual, “Taxation of crypto-asset transactions”, April 2022, Irish tax authorities.
69 EU VAT Committee, Working paper No 1037 - VAT treatment of crypto-assets (24 February 2022).
70 See IRAS e-Tax Guide, “GST: Digital Payment Tokens” published on 19 November 2019.
71 See e.g., Government of Canada, Legislative and Regulatory Proposals Relating to the Excise Tax Act, the Air Travellers Security Charge Act, the Excise Act, 2001 and the Greenhouse Gas Pollution Pricing Act and Explanatory Notes (February 2022).
72 See https://www.bhfs.com/insights/alerts-articles/2022/nfts-the-next-crowdfunding
73 See https://www.cryptowisser.com/top-3-gambling-nfts-to-keep-an-eye-on/
74 Spain - Tax Authorities Classify NFT Sales as Electronically Supplied Services for VAT Purposes (31 May 2022), News IBFD.
75 See https://iknow.cch.co.nz/document/iknzUio894839sl44367684/court-of-appeal-nz-05-november-2004-commissioner-of-inland-revenue-v-gulf-harbour-development-limited
76 See e.g., Matthew Ball, Framework for the Metaverse (29 June 2021).
77 BFH, V R 38/19 (18 November 2021).
78 See https://news.bloombergtax.com/daily-tax-report-international/german-tax-court-rules-renting-virtual-land-is-vat-free
79 See for example, Glawe Spiel, Case 38/93, ECJ 1994.
80 E.g., How do economic operators value the transaction in the Metaverse? Do governments accept payment in Metaverse currency? Is it of any value to them? Could they convert also?
81 Ultimately a perfectly designed sales tax system should arrive at the same revenue as a VAT system with the only differences being the time when the revenue is collected by the government. While new technological advances should be able to ensure such an outcome, so far, no jurisdiction has implemented a such a system and existing sales taxes often result in a higher taxation of business inputs than their VAT counterparts.