The tax treatment of Non-Fungible Tokens

A relatively new class of cryptocurrency which has made headlines recently are Non-Fungible Tokens - or NFT's for short. Given their current popularity it seems appropriate to discuss the tax treatment of Non-Fungible Tokens.

tax treatment of Non-Fungible Tokens

What are Non-Fungible Tokens?

A Non-Fungible Token or NFT, is a unit of data stored on the blockchain which certifies a digital asset to be unique and not interchangeable. They are mostly run on the Ethereum blockchain. Each token is evidence of ownership of an asset. This is usually a digital asset, although they are marketed as capable of granting ownership of real life assets too. 

An NFT functions like cryptocurrency though unlike other cryptocurrencies like Bitcoin it is not mutually interchangeable. Therefore it is is not fungible. Ownership of an NFT also does not inherently grant copyright to whatever digital asset the token represents. So if someone sells an NFT representing their work, this does not guarantee the purchaser copyright privileges. This enables the original owner to create more NFT's of the same work.

Perhaps one crude analogy of an NFT is the digital equivalent of an autographed item. These digital tokens have been represented in many different forms:

  • Digital Art - Some of the first NFT'S were digital works of art. Beeple by Mike Winkleman sold for a staggering $69.3 million
  • Collectibles - NFT's can represent cards albeit in digital format. The legendary William Shatner (Captain Kirk for the uninitiated), managed to sell 125,000 collectibles in a matter of minutes.
  • Games - They can be used to control in game assets such as digital plots of land. These are controlled by the user rather than the game developer.  Axie Infinity recorded a sale of $1.5 million for digital land titles in a single sale  
  • Music  - Many musicians saw an opportunity to recoup income lost during the height of the Covid-19 pandemic. The US rock band Kings of Leon were one of the first bands to announce an NFT album release. As a result, they generated $2 million in sales from this venture.
  • Film - This sector has been slower to react to the NFT market partly because of the technical challenges of storing movies. However we understand there is an exclusive Godzilla v Kong NFT collection available if anyone's interested?
  • Sports - A rather intriguing example of an NFT for sports is pro tennis player Oleksandra Oliynykova. She has  offered prospective NFT buyers the lifetime rights to part of her right arm(!).
  • Fashion - Nike have been one of the first fashion brands to jump on the NFT bandwagon by attaching NFT's to physical products with their 'CryptoKicks' range.
  • Pornography - The hostility of the marketplace has, ahem, provided significant drawbacks for the creators of these NFT's  

The Tax treatment of Non-Fungible Tokens for individuals

Now we've described what NFT's are, we can now go on to discuss the most likely tax treatment of Non-Fungible Tokens. Whilst there is currently no published guidance from HMRC on NFT's, it is most likely that HMRC will seek to tax them in a similar way to cryptocurrencies. We've covered the tax treatment for cryptocurrency and individuals previously here. 

Income tax

A transaction involving an NFT is likely to be subject to income tax where it can be attributed to a trading activity. HMRC will apply a series of tests known as ‘The Badges of Trade’ to determine whether an activity involving NFT's is a trade

It follows that if enough 'badges' can be metaphorically 'pinned' to an activity then HMRC will consider this to be a trade. So for example an artist/musician selling their work as NFT's would most likely be subject to income tax on their profits.

Capital Gains Tax

HMRC regard cryptocurrency as an intangible asset and NFT's also fall squarely into this category of asset.

Therefore, if an NFT is bought as an investment and subsequently sold, any gain realised 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.

Conversely a loss realised that involves a transaction with an NFT (perhaps Godzilla v Kong collectibles?) can only be relieved against other capital gains which are subject to Capital Gains Tax.

The Tax treatment of Non-fungible tokens for companies

If the company's activity involves NFT's and is considered a trading activity then any profits realised will be subject to corporation tax in a similar way that cryptocurrencies are. Generally speaking for a business, any profits from a trade involving NFT's should be calculated in accordance with the Generally Accepted Accounting Practice (GAAP).

If a company acquires NFT's as an investment then their value will need to be reflected on the company's balance sheet as an intangible asset. Any subsequent disposal of an NFT held as an investment may potentially fall within the Corporation Tax Intangible Asset Regime.

The tax treatment of Non-fungible tokens - VAT rules

We would expect VAT to be due in the normal way on any goods or services sold in exchange for NFT's. Similarly the value of the supply of goods or services on which VAT is due will be the £ sterling value of the NFT's when the transaction takes place.

Where the sale of NFT's involves an international client base it will be important to track those sales that are potentially VATable and those outside the scope of UK VAT. 

We would stress this is just an overview of the most likely tax treatment and hopefully we'll receive more clarity from HMRC in the near future. 

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