Regardless of how they are generated, it is clear that revenues from metaverse transactions will be substantial. Recent research suggests that the market opportunity in the metaverse may be worth over $1 trillion in annual revenue. Tax authorities will need the right tools to effectively levy and collect tax arising from these transactions, or risk significant amounts falling into this virtual tax gap.
In the seventh article of our series, we explore how ‘real world’ international tax rules may be applied and adapted to effectively tax revenue and profits generated in these virtual worlds.
Are transactions in the metaverse subject to tax?
Even when transactions take place in the metaverse, they generate value for real world natural persons or legal entities connected to the relevant transaction. Existing international tax rules can (and should) be applied to those real world individuals and entities. However, the following tax challenges need to be properly addressed:
1. How do you identify a taxable transaction in the metaverse?
In some cases, identifying that a transaction has occurred in the metaverse will be straightforward, particularly when the transaction is effectively just an online purchase of ‘real world’ goods or services. The tax treatment will follow established rules that apply to everyday online transactions, subject to any future adjustments arising from the implementation of the OECD’s proposals to address the taxation of the digital economy (referred to as ‘pillar 1’ and ‘pillar 2’).
In scenarios that involve the exchange of one virtual asset for another (e.g. a non-fungible token (NFT) acquired with cryptocurrency or another token), it may be less obvious to the parties involved that (a) a ‘transaction’ has occurred on which tax may arise and (b) the value of that transaction for tax purposes.
Many jurisdictions are grappling with this issue as part of their efforts to implement tax rules tailored to crypto assets. Although this issue is not unique to the metaverse, having clear rules that specify the tax treatment that applies to crypto transactions (including when and how the charges are calculated) will be key to developing an effective tax policy that can be applied in the metaverse.
Compared to other jurisdictions, the UK’s position on the ‘direct’ tax treatment is relatively clear: the capital gains rules should (generally) be applied to crypto-asset transactions. A ‘disposal’ of a crypto-asset (potentially triggering capital gains charges) will occur whenever the asset is sold, gifted, exchanged for another token, or used to pay for goods or services. When anything other than cash is received following the disposal, that receipt (e.g. the exchanged token or services) will need to be valued in order to calculate the resulting capital gain. Applying these principles to a hypothetical transaction in the metaverse in which a UK consumer uses cryptocurrency to acquire a limited edition NFT accessory from the metaverse store of a UK company, the following ‘direct’ tax charges could arise:
- capital gains tax (CGT) for the individual on the disposal of their cryptocurrency when buying the NFT (assuming the value of the cryptocurrency has increased since they acquired it and the individual has no CGT reliefs available);
- corporation tax for the UK corporate on the profit generated from the sale of the NFT; and
- CGT for the individual on any future sale of the NFT (again, assuming the value of the NFT has increased since its acquisition and the individual has no CGT reliefs available).
The ‘indirect’ tax treatment (i.e. the sales tax/VAT position) is much less clear. Currently, Spain is the only European jurisdiction with a clear tax ruling specifying that NFTs should attract VAT.
2. Where should metaverse transactions be taxed?
The assumption held by some that transactions occurring in the metaverse are protected from tax on the basis that no country or tax authority has jurisdiction over the virtual space is incorrect. The key to identifying the tax authority with primary taxing rights over a metaverse transaction (applying current tax rules) is identifying the tax residency of the ‘real world’ parties to the transaction.
Identifying the tax residency should be relatively straightforward for sales by established brands with real world companies incorporated in a particular jurisdiction. It is much more difficult to accurately determine the tax residency position of an individual consumer in the metaverse and arguably impossible to determine when a metaverse sale is made by a decentralised autonomous organisation (DAO) (a member-owned and controlled organisation governed by computer software in the form of blockchain-powered smart contracts). In order to identify the appropriate tax jurisdiction (and police and collect tax from participants in the metaverse), the legal status and tax residence of DAOs will need to be clarified.
3. How can tax authorities police transactions in the metaverse and collect the resulting tax?
The starting point for any tax authority will be reporting. The OECD is consulting on a framework for the automatic exchange of information on crypto-assets. The technical proposals would require a crypto-asset service provider (such as coin platform operators) to provide key identifying information on their users together with a list of crypto-asset transactions. In order to provide tax authorities with the information needed to tax transactions in the metaverse, this exchange of information framework may need to be extended to capture metaverse platform hosts too.
In the same way that online sales platforms have been forced to act as ‘VAT collectors’ in respect of transactions facilitated by their platforms in many jurisdictions, metaverse platform hosts may need to accept a degree of policing responsibility in the worlds they have created.
Still have questions? Be sure to read our metaverse articles below:
- Welcome to the metaverse: part one (definitions for a digital world)
- Welcome to the metaverse: part two (the metaverse’s past, present and future)
- NFTs in the metaverse
- Brand protection in the metaverse
- Advertising in the metaverse
- Copyright in the metaverse
- Competition/antitrust in the metaverse
- Jurisdiction and torts in the metaverse
- Reputation in the metaverse
- Online harms and safety in the metaverse
- Data protection in the metaverse
- Working in the metaverse – what employers need to know
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