In depth

The EU VAT Committee is aware of the recent exponential increase in volume of NFTs and other blockchain transactions, which has triggered a strong interest among local tax and regulatory authorities.

In October 2022, the EU Council published the text of the Regulation on Markets in Cryptoassets (MiCA), which will establish the first comprehensive, pan-EU regulatory regime for the regulation of crypto-assets. This was followed, in December 2022, by the EU Commission's publication of the long-awaited DAC 8 proposal, a crypto-asset reporting framework that introduces the possibility of advanced cross-border rulings for high-net-worth individuals, and a crypto-asset reporting framework for the competent EU authorities.

It is, therefore, no surprise that the EU VAT Committee has now published a working paper on NFTs. The working paper sets out the landscape of the current NFT ecosystem by providing qualifying definitions of NFTs and other concepts related to the NFT ecosystem that are currently not defined in any existing EU regulation. It also qualifies standard transactions and the VAT treatment thereof.

Should the sale of NFTs be considered a supply of goods or services?

A case-by-case analysis must be performed in advance to determine the VAT treatment of each transaction. The EU VAT Committee points out that NFTs are most commonly used for assets that can be supplied (either exclusively or not) in a digital format, such as GIFs, music, collectibles, art, tweets and virtual real estate. Yet, beyond these use cases, NFTs are also extending to real-world use cases. For example, ownership of physical items such as real estate or a fashion item can be represented on a blockchain through an NFT.

The working paper provides key aspects for determining the qualification of the supply, such as the following:

Property title

In these transactions, NFTs act as a digital record of provenance or as proof of ownership of an asset, i.e., title of property. Therefore, NFTs are considered a mere means, or proof of, the transfer of the underlying asset. As a result, the VAT treatment of the transaction involving the NFTs should follow the underlying transaction.

The common VAT rules applicable to the underlying goods/services would then normally apply.

Voucher

When the sale of an NFT entails an owner's intent to dispose of an asset at a later date at a token value, the holder can redeem a voucher for a specific good or service. Upon redemption, the NFT is permanently removed from circulation. This is referred to as "burning" an NFT.

1. If the transfer qualifies as a single-purpose voucher (SPV), it must be regarded as a supply of the underlying goods or services. Thus, if a the NFT functions as an SPV, VAT would be due on the sale of the NFT, if VAT would be applicable to the underlying goods or services.
2. If the transfer qualifies as a multi-purpose voucher (MPV), its holder has the right to choose to redeem the NFT against different goods or services. An MPV would be a voucher that could be redeemed for many different goods or services and to which different VAT rates would apply. The goods or services supplied in return for the NFT would be subject to VAT, and VAT should be due upon redemption of the NFT by the holder.

Composite supply

The VAT Directive does not offer specific guidance on composite supplies, which are made up of multiple goods or services. The Court of Justice of the European Union clarifies that if one element is the principal and the rest are ancillary, the ancillary supply should follow the same VAT treatment as the principal supply. If the supplies form a single, indivisible economic supply, it is artificial to split them, and the VAT treatment would be uniform. In terms of NFTs, if the related asset is the principal element, the NFT would follow that VAT treatment. However, if the digital token is the principal, it would follow that VAT treatment. This can especially be the case when NFTs are combined with physical goods, e.g., a digital representation of a shoe design for use in the metaverse when a physical shoe is sold.

Electronically supplied service

As NFTs are based on digital ledger technology and can only be transferred over the internet, which requires minimal human intervention, transactions regarding them may fall under the definition of electronically supplied services (ESS). This is the general rule and, in practice, most transactions related to NFTs may qualify as such. However, this conclusion does not apply by default. The object of the underlying transaction must still be analyzed to provide the corresponding VAT treatment.

NFT-related supplies and VAT

It is important to note that, as well as primary markets on which NFTs are sold by their creators, secondary markets on which traders and collectors resell NFTs also exist. Working Paper No. 1060 does not only focus on the (initial) transfer of NFTs, but also on these related transactions that may occur within the NFT ecosystem. These also have a potentially significant impact from a VAT perspective and, therefore, should receive common treatment among all EU member states.

The NFT launch, also known as "minting" 

Minting is defined as the process of uploading an NFT to the digital ledger (i.e., blockchain) and is called "minting" through the Proof of Stake or Proof of Work methods (PoF and PoW). To mint an NFT, the creator needs to select, name and describe the file in the chosen platform, and hit the "mint" button. After this, no human intervention is necessary, as the subsequent transactions and checks are completed automatically. Minting can therefore qualify as an electronic service.

As minting can be an expensive operation, some creators do not upload the NFT to the blockchain until it is sold. This procedure is called "lazy minting". This minting procedure does not rely on a significant amount of computing power, since it does not involve the whole process of uploading the NFT to the digital ledger and no gas (transaction) fee is due for granting lazy minting authorization. The buyer of an NFT covers the cost of minting, but generally does not cover the cost of lazy minting. Therefore, lazy minting would fall out of scope of VAT.

Taxable status of NFT traders

The guidance provided by the working paper on this point is not straightforward enough, as, when identifying whether the sellers are taxable persons, it only refers to the common VAT rules that apply to "occasional sellers" unless the corresponding EU member state enforces the presumption established in Articles 9 and 12 of the EU VAT Directive.

The EU VAT Committee foresees different scenarios to determine whether the marketplaces or individuals may be treated as taxable persons. These are as follows:

1. When an individual sells multiple NFTs over time, they should be considered a taxable person.
2. When an individual sells NFTs occasionally, they should not be considered a taxable person.
3. When an individual sells NFTs that accrue royalties every time the NFT is resold:
   1. If royalties correspond to rights of successive use and exploitation, they should be considered a taxable person.
   2. If royalties correspond to resale rights, they should not be considered a taxable person.

Other fees

The working paper also considers the gas (i.e., transaction) fee payable to the network validators, stating that the analysis in relation to the existence of a consideration for minting may equally apply to gas fees for NFT supplies.

Next, the fee that marketplaces charge for their services is analyzed. Marketplaces can charge fees for transactions in NFTs to either the buyer or seller, or charge a separate fee to list an NFT. The working paper states that these supplies should qualify as services if there is a legal relationship between the marketplace and the seller or purchaser of the NFT.

Sometimes the purchaser of an NFT pays a single fee comprising the NFT price, the gas fee and the marketplace fee. The EU VAT Committee, following European Court of Justice criteria, understands that these transactions should qualify as a unique composite supply. Therefore, all the transactions should follow the VAT treatment of the main supply, which is the sale of the NFT.

NFTs earned

Occasionally, NFTs are obtained for free as a "reward" when users play games or use digital ledger technologies.

In this case, it is necessary to analyze the nature of the transactions in which a user can receive the reward on a case-by-case basis.

1. If the gamer/user can play the game for free or access the digital ledgers without paying any consideration, there is no consideration for the NFT. Therefore, the NFTs earned should be out of scope for VAT.
2. If the gamer/user pays to play the game or pays any consideration to access the digital ledgers, the NFTs earned are not automatically in scope for VAT, but further analysis would be needed to determine whether there is a direct link between the NFTs earned and the total/qualifying amount paid by the user.

Taxable basis

The EU VAT Committee also provides its views on how to determine the taxable basis in situations where the sellers receive cryptocurrency in exchange for an NFT transaction. In this regard, the value of the cryptocurrency must be converted to the currency of the member state where the supply takes place, in accordance with the general place of supply rules at the time of the sale. However, some issues may arise due to the decentralized and global nature of cryptocurrencies, which triggers uncertainty around the exchange market and the reference rate to use references.

To circumvent the issues mentioned above, the EU VAT Committee proposes agreeing that the reference rate to be used to convert the price paid in cryptocurrency into fiat money is that of the platform hosting the seller's wallet used to receive the NFT's payment. Once again, the EU VAT Committee seems to reinforce the need for intermediaries — in this case, the platform hosting the seller's wallet used to receive the payment for the NFT — to play a key role in the sale of NFTs and to duly collect VAT. We appreciate the EU VAT Committee's effort to reach a solution, but note that, for some of these platforms, payment is only received in crypto into a wallet key, and they do not necessarily have more information about the underlying seller. In addition, these platforms that host the sellers' wallets will, in a lot of cases, be a different party than the platform that operates the NFT marketplace (and thus facilitates the sale). This solution therefore seems to diverge from, for example, VAT deemed reseller rules we have seen with respect to ESS. Considering that, based on the working paper, a lot of NFTs will qualify as ESS, this does not seem in line with current legislation.

In addition, the working paper mentions the potential application of a "margin scheme", which would make sense, as secondary markets exist in which NFTs are being sold between creators and collectors repeatedly, as previously stated. If VAT is charged over the entire value of the NFT sale, this would result in unprecedented accumulation of VAT. However, the EU VAT Committee remains silent on when and how to apply such a margin scheme.

VAT position of different EU jurisdictions

The EU VAT Committee also provides some of the criteria adopted by different EU jurisdictions in relation to the VAT treatment of NFTs.

In this regard, some member states have already taken the position that NFT sales are considered ESS and have established local guidance on how to tax such services.

However, after the publication of this working paper and those yet to come, it seems that all EU tax authorities will need to further review their respective VAT positions adopted so far and perform a more in-depth analysis of all services related to NFTs.

Key takeaways

The conclusions in this working paper are not definitive, and the EU VAT Committee refers various open questions to the delegations of each respective member state. More likely than not, the VAT Expert Group will share its thoughts on this matter.

We are of the view that the VAT Expert Group's further comments will be aligned with the guidelines provided by the EU VAT Committee. Furthermore, it appears that the EU's legislative bodies are taking a growing interest in online marketplaces. The competent EU authorities are receiving additional tools to use these platforms to collect an increasing amount of data on both transactions and platform users, as well as to ensure that the right amount of VAT is collected. It seems that it will be increasingly necessary to implement a system that allows such platforms to do the following:

• Determine whether the sellers of NFTs are taxable persons.
• Determine the nature of the NFTs and the corresponding VAT treatment (which not only includes the compensation paid for the NFT, but should also include the related services, such as marketplace fees, gas fees, royalties or any other fees and charges that might apply).
• Determine the place of supply (according to the VAT treatment of the underlying transaction or according to the general place of supply rules) and the VAT qualification of the parties involved.
• Ensure the correct taxable base is determined and the correct VAT amount is applied and collected.

Please reach out to your local Baker McKenzie contact for assistance with this.