VAT treatment of NFT tokens in the opinion of the European Commission

On March 21, 2023, the European Commission published a working paper (Working Paper no. 1060 of the EU Value Added Tax (VAT) Committee regarding an EC question on non-fungible tokens (NFTs)[1]), which aims to consider the tax consequences of NFT-related transactions and to generate a discussion with the intention of reaching a common position among representatives of the VAT Committee[2].

The concerns presented in the paper highlight the complexity of the issues related to digital assets and outline the directions that the Commission is most likely to take in seeking to regulate the VAT treatment of NFT tokens in the future.

NFT – goods or services?

The authors of the paper notice that there is a commonly prevailing view of treating an NFT token transaction as an electronic service, while at the same time stipulating that such a view should not be generalised and applied to all NFT transactions.

The need for a case-by-case analysis, emphasised in the paper, is illustrated in the examples of possible ways of treating NFT-related transactions for VAT purposes, i.e., applying the rules such as these for:

• transfers of property titles – thus taxing a transaction according to the object to which the token would transfer ownership;
• vouchers – whenever a token, once purchased, can be used to redeem a specified (such as an SPV voucher) or unspecified (such as an MPV voucher) good or service, as a result of which it is subsequently removed from circulation;
• composite supplies – when another asset (which may also have a real, non-digital form) is associated with the NFT token. In this case, it will be crucial to determine which elements of the transaction constitute the principal element and which are auxiliary.

Minting vs. trading – differentiation of tax consequences

The paper reasonably distinguishes between the events as a result of which an entity may acquire an NFT token.  Potential consequences of events such as so-called minting (the process by which the token is created) and the subsequent trading of NFTs may vary on the grounds of VAT.

The paper addresses, inter alia, the difficulties in finding a direct link between a remuneration in the form of a so-called gas fee and the minting of an NFT token, due to the problematic nature of establishing a legal relationship between the entity commissioning the minting of the token and the validators involved in its creation. It was pointed out that in order to assess whether a transaction subject to VAT takes place, a detailed analysis of the terms and conditions under which such services are provided and remunerated is necessary, including a thorough analysis of the components of the amounts that could be considered as remuneration.

In terms of the tax qualification of the NFT token minting event, the potential status of validators as VAT taxpayers also becomes the subject of the paper’s consideration. This is dependent on whether the service provider (i.e., the validator) can be perceived as an entity conducting business activity

In contrast to the cryptocurrency mining process (with the use of the proof-of-work, known as PoW, consensus mechanism) where the mining activity has been characterized as an economic activity, due to the connection between the “miner’s” hardware capacity to find solutions to complex calculations and transaction verification (i.e. mining) , the activities of the validators involved in the NFT token minting process are limited only to the staking  a certain amount of tokens as a sort of collateral, for which the validator may derive a revenue (proof-of-stake PoS consensus mechanism). Therefore, the document compares staking to another type of passive income-generating activity, i.e., holding shares in order to receive dividends, arguing by this example that the validator is not a taxable person.

At the same time, however, arguments were brought in favour of considering the validator a taxable person, e.g. the fact that, in this case, obtaining a benefit is not related to the very possession of an asset, but requires an action to be taken on the part of the validator – the crypto-asset is staked, which is equivalent to exploiting it to obtain a benefit.

The third event discussed in the paper is the receipt of NFT tokens as part of play-to-earn games, in which the player receives NFT as a reward for playing. It was assumed that, in principle, in such a case there would be no taxable transaction due to the lack of a direct link between the NFT received and the amount paid by the player to enter the game.

When does a creator become a taxable person?

The paper also addresses the issue of qualifying an entity that occasionally sells tokens as a VAT taxpayer, raising the issue of receiving royalties by the token creator for each subsequent sale of a given NFT that is important for such an assessment.

The consequences of recognizing such an entity as a taxable person should depend on whether royalties bound to subsequent NFT sale transactions can be considered as a consideration for:

• the right to successive use and exploitation of works, and thus it should be considered that the entity conducts economic activity subject to VAT;
• the right to resale, which does not involve an economic activity for VAT purposes.

The role of platforms in determining a taxable base

A recurring issue in considering the VAT treatment of all types of crypto-assets is the difficulty in determining taxable base.

In this regard, it was indicated that, in principle, the NFT value expressed in cryptocurrency should be converted into the currency of the Member State in which supply takes place (in accordance with the rules for determining the place of supply of goods or services applicable to a given transaction). However, noting the problems related to the decentralized and global nature of cryptocurrencies, i.e. uncertainty about the exchange market and the reference rate, a solution was proposed, whereby the reference rate used to convert the price paid in cryptocurrency into fiat money would be the rate of the platform hosting the seller’s wallet used for the receipt of the payment for NFT.

Such a solution would stay in line with the current trend in the scope of solutions applied in the field of taxation of other aspects of the digital economy, consisting in the active role of intermediary platforms in the taxation of transactions that are hosted by them.

Significance of the paper

On 16 May, the Economic and Financial Affairs Council of the EU voted in favour of the regulation on Cryptocurrency Markets (the so-called MiCA[3]), which aims to establish a comprehensive, EU-wide regulatory regime for crypto-assets.

The MiCA regulation is also linked to amendments to two other EU legal acts aimed at regulating the crypto-asset market, i.e., the regulation on information accompanying transfers of funds and certain cryptographic assets (so-called TFR), and the Directive on Administrative Cooperation in taxation (DAC 8), thanks to which tax authorities will be able to exchange information provided by crypto-assets service providers, who are obliged to report certain activities..

The document published is one of the expressions of the increased interest of the EU authorities in regulating the market of crypto-assets. The interest of the European Commission and the VAT Committee in the subject of NFT taxation should therefore not come as a surprise, considering the volumes of transactions involving digital assets of this type.

The fact that the paper notes a wide range of tokens applications and token-related events pointing to their potentially different consequences in VAT let us hope that possible future regulations in this respect will be adjusted to the market and not stand in the way of its development.

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[1] Working Paper 1060 of the EU Value Added Tax (VAT) Committee regarding an EC question on non-fungible tokens (NFTs), https://circabc.europa.eu/ui/group/cb1eaff7-eedd-413d-ab88-94f761f9773b/library/7d1ef2eb-b820-4866-a155-785e2373fb80/details

[2] The VAT Committee is an advisory body to the European Commission, composed of representatives of the Member States and the Commission itself

[3] https://data.consilium.europa.eu/doc/document/PE-54-2022-INIT/pl/pdf