NFT Taxation

With the recent spike in sales at record-breaking prices, the term ‘NFT’ has managed to gather attention worldwide. It has been a subject of discussion over social media for the past year with people debating whether it’s a game-changing technology or an internet fad that will die in due course. We have seen the sale of NFT digital assets at astronomical values in the past year from arts like 3D models of real estate selling for more than a million dollars or just images of famous internet memes like ‘Disaster girl’ for almost half a million dollars.

What is NFT?

An NFT or non-fungible token is a digital certificate that shows the uniqueness of a digital asset. It is information stored in a blockchain ledger that can provide proof of ownership of a digital asset like photo, video, audio or other digital file.

It uses the same blockchain technology that cryptocurrencies uses, however all units of any crypto currency are similar. For example, 1 bitcoin is similar to another bitcoin and can be exchanged with the other. In contrast to that, each NFT is unique and non-fungible with unique value and cannot be recreated.

Musicians and other digital art creators are recording their art as NFTs to record their ownership of their art and selling it to make money. The ownership and transfer of NFTs can be verified universally in the blockchain ledger similar to cryptocurrencies.

However, NFTs aren’t like copyrights and selling a token doesn’t mean the creator cannot produce another copy of the art. In a practical sense, an NFT is like an autographed copy of art in which the token serves as the proof of authenticity. Anyone else can still download a copy of the art from the internet, which is why a lot of people are still speculating about the worth of NFTs.

But considering the huge gains people have made in creation and trade of NFTs, a lot of people are jumping into the game. Thus, it is important to take note of tax consequences of NFTs.

Tax Treatment of NFTs

Tax authorities around the world are yet to give proper guidance notes on tax treatments of digital assets like NFTs, which has kept creators and traders in confusion. Questions like what will be considered a taxable event, how income tax and/or capital gains tax will be applied are baffling investors and tax practitioners alike.

However, we can still apply the general taxation principles to NFTs in a similar way that it applies to other cryptocurrencies. Generally, the same tax treatments of cryptocurrency will be applicable to NFTs too.

NFTs are likely to be considered as a property for taxation purposes like cryptocurrency, making purchase and sale of them a taxable event. Thus, in trading of NFTs, depending upon its use for business/profession or not, it will either be taxed as business income or trigger personal income or capital gains tax.

Taxation for NFT Creators

Creation of NFT itself is not a taxable event just as the case with any work of art. But when the artist sells the NFT on trading platforms or auctions, he/she will be liable to pay tax on the profit generated on it.

If the artist is in the business of creating and selling NFTs then it is likely that the creator of NFTs will be considered self-employed in the business of creating and selling NFT tokens, they will be taxed at normal income tax slab rate, depending on their total income unless they form a business entity.

NFT creators will be taxed in the same manner as the people who mine crypto currencies. You can get deductions of expenses incurred for creating the token from your sale value. For NFT creators, there might not be any differential tax treatments than small business owners. You will have to pay self-employment taxes and social security contributions as per your country just like any other business.

NFTs also come with contracts that allow the creator a portion from the future earnings of NFTs like licensing. Such contracts can be embedded in the blockchain ledger of the token. The creator might also put in an embedded condition to provide him a part of future sale of the token. These will also form a part of the taxable income of the creator as his ordinary business income.

Taxation for Investors in NFT

NFTs are generally traded using crypto currencies, hence a lot of time the exchange takes place between two digital assets and no real money is involved. But they are taxable events, similar to how buying a crypto currency for another crypto currency is.

These may include

1. Purchase/ sale of NFT using cryptocurrency

• Suppose you bought a baseball NFT worth $1000 by exchanging 1 ETH you bought a few years ago for $100. Thus, now you have earned a capital gain of $900 ($1000 – $100) on your 1 ETH as this will be considered as a sale of ETH. This is because cryptocurrency is not actual currency for the tax department but an asset that you are disposing of in exchange for another asset. It might also attract long-term capital gain tax rates as you bought the ETH more than a year ago (depends on where you’re living).
• The $1000 will be the cost price for the NFT for considering future gains. Now if you sold an NFT on the marketplace at a higher value than you bought it, then you will again incur capital gains on that transaction. A lot of basketball videos have been selling at a good price on NFT marketplaces and people are earning huge gains. Suppose you sold the NFT at $2000, you will have a capital gain of $1000 ($2000 – $1000). In other words, both buyers and sellers of NFT may have to pay taxes.

2. Exchanging one NFT with another NFT

• Trading one NFT for another will also be a taxable event. Suppose you exchanged the above NFT of $1000 for an NFT valued at $1500 after sometime, you will incur a capital gains tax of $500 in this transaction.

3. Earning royalties etc. in cryptocurrencies.

• If you are earning royalties or licensing fees on usage or subsequent sale of NFT as discussed above and get paid in cryptocurrencies, you will still have to pay tax on that income when it occurs on regular income tax rates.

It is not necessary to earn fiat or receive the gains in real currency to pay taxes on them. A lot of people who are not aware of this, will get delayed in payment of their taxes and might be charged huge penalties for it. If you have earned substantial gains from NFT trading, you might also have an obligation to pay advance taxes, failure of which will also attract penalties.

There has not been any clarification as to whether NFTs will be taxed as collectible arts like stamps, antiques, trading cards etc. In such cases, NFT might attract higher tax rates for long-term capital gains. For short term capital gains, they will still be taxed according to your income level.

Calculation of NFT Taxes

As shown above, there are many situations where taxes will be applicable in NFT trade. If you are regularly trading in NFTs especially using cryptocurrency, it will be difficult to keep a track of your trades. Unlike crypto exchanges, where the software allows you to reconcile your purchase and sales and determine costs and gains for taxation, NFT marketplaces do not provide such facilities.

NFT marketplaces can only show the sale value of the NFT, but not the price of the crypto currency at which the buyer has bought them. When you purchase an NFT, it will not be possible for the marketplace to ascertain your gains. If you bought crypto to purchase NFT instantly, then there will not be any gains but if the value of crypto has increased from previous purchases, then you will have to pay tax.

It will be your responsibility to track each purchase and sale and figure out the correct cost and sale value. Each NFT being unique, it wouldn’t be necessary to use cost valuation methods as in case of crypto currencies. But determining the fair value of NFTs can be problematic. You cannot check their value on exchanges, thus a proper appraisal will be needed to determine their value. If the transaction value is huge, the appraisal can be of significant issue.

Tax Savings in NFT for Digital Nomads

Digital nomad can have a severe advantage for saving capital gain taxes. If you are based in a country with low or no capital gain taxes, your entire gains from the NFT trades may not attract any tax. A lot of higher value NFTs have been bought and sold from Singapore based traders. These traders are avoiding tax on both purchase and sale of NFT using cryptocurrencies as there are no capital gains taxes in Singapore.

So, if you are creating or investing in NFTs or planning to do so, it is important to keep in mind the tax considerations from these traders. As NFT platforms are not able to provide details of your gains from NFT trades, you have to keep track of both the NFTs and the cryptocurrencies used in their trade, to calculate your taxes.

COMMENTS

In the US When you sell NFTs, it Is considered a disposal of assets held for investment purposes, so the transaction will generate capital gain or loss. If it is short-term capital gain, it is taxed at your marginal ordinary income tax rate. If it is long-term capital gain, the gain may be subject to a higher 28% maximum rate.

In the UK if an NFT is bought as an investment and subsequently sold, any gain realized following conversion of the purchase and sale prices into the Pound/Sterling exchange rate (on the relevant dates of sale and purchase) will be subject to Capital Gains Tax. Same thing is true in Canada.

However, keep in mind that if you’re in the business of creating and selling an NFT taxes work exactly like creating and selling anything else, and therefore this income qualifies as business income. If you were a store owner selling widgets, you’d pay taxes on the income from those sales (either self-employment taxes or business taxes if you’ve formed an entity), minus any applicable business expenses.