Crypto Tax Considerations with NFTs (UK)

Are you a collector, an artist, a musician, or is your business coordinating a big NFT project for the gaming or collectible industries?

In a fiat world, working in a crypto environment can be challenging for your business. While it will likely be some time before NFTs reach a mature state, NFT participants may wish to seek advice now about the potential tax implications of their business activities.

At Square Mile we can discuss strategies to ensure your affairs remain tax efficient, as well as to ensure you have enough fiat to cover your UK tax obligations.

Today, NFTs are represented in many different forms

Digital Art

London-based digital artist and crypto enthusiast XCopy has sold 9,567 NFT pieces. His Super Rare piece, All Time High in the City, sold for $1,987,556.80

Collectibles

WhaleShark is a well-known British collector based in Hong Kong, and is the creator of $ Whale Vault, the digital archive that contains certified NFT video clips of the NBA’s Top Shots. According to a collector’s estimate, the entire collection is now worth up to $ 53 million.

Music

Serenade, the performance platform, entered the U.K. in 2021 to add NFTs to its inventory of must-have music collectibles, including new and unreleased performances, to music, documentary footage, and rare visuals. They are seen to be working with U.K. artists like Ash, Emeli Sande, Kaiser Chiefs and Ride.

Gaming

It is possible to earn significant profits in the gaming world through NFTs, since they allow you to transfer ownership of your in-game assets. Axie Infinity, a blockchain-based video game where players collect Pokémon-like pets, tied to NFTs, sold a rare one for $130,000 in cryptocurrency.

Film

NFTs could be a great way to finance a film or TV project and build a fanbase that will watch the film once it is released. Award-winning British indie film ‘Little White Lies’ is the first film ever to be made available to buy in its entirety including all rights as an NFT. This unique offering is an outright sale of the film and all rights associated with it. The film has been split into 15 parts in order to be put onto the blockchain.

Sports

Former Chelsea and England defender John Terry has been active in the NFT market, having sold a “John Terry Ape” for an auction that eventually attracted bids over £5,200 ($7,000). These cartoon ape NFTs – an NFT project titled Bored Ape Yacht Club (BAYC) – are particularly popular amongst celebrities and high-profile figures. Additionally, sports companies have also been reportedly investigating the metaverse and possible uses for NFT items.

Cultural artefacts and history

Certain media outlets started to express their interest towards NFTs. The Economist, the international weekly magazine, has announced a plan to auction off the front cover of its September 18 DeFi edition as an NFT.

Fashion

Burberry, the British luxury brand launched into NFTs with Blank Block Party, an NFT-based game. The digital item in the Burberry’s B-Series called Sharky B can be collected and sold among players in the game. In addition, Burberry also launched its own collection of in-game NFT accessories for Sharky B to show off. These accessories include jetpacks, pool shoes, and armbands. These accessories can be included for other in-game characters as well.

Ticketing

Any form of evidence that allows holders to access certain events, software, airplane tickets, etc., can be minted and created using unique NFTs.

Education and Research

Education, business, and the professional world all rely on the authenticity of educational achievements and degrees. A tokenised certificate can prove the authenticity of documents to third parties without the issuer having to be contacted. Through NFTs, literary property can also be protected, enhancing the value of research.

Potential NFT Tax considerations

NFT tax guidance from HMRC has yet to be released, but in summary:

• An NFT is an asset, so if it is sold for more than you paid for it, there will be a tax liability – most probably Capital Gains Tax, unless it is sold in the course of your business
• Buying an NFT with fiat currency: Not taxable
• Buying an NFT with cryptocurrency: Capital Gains Tax
• Selling an NFT for crypto or fiat currency: Capital Gains Tax
• Minting an NFT: Not taxable
• Swapping an NFT for another NFT: Capital Gains Tax
• Farming NFTs: Could be subject to Capital Gains Tax or Income Tax
• Gifting an NFT: Capital Gains Tax (unless gifting to your spouse in which case it’s tax free)
• Share pooling: because NFTs are separately identifiable you do not need to pool these assets

The Tax treatment of NFTs for companies

Profits realised from the company’s NFT activity, which is considered a trading activity, will be subject to corporation tax, just like cryptocurrencies. Businesses should calculate profits from trades involving NFTs in accordance with Generally Accepted Accounting Practices (GAAP).

Intangible assets must be reflected on a company’s balance sheet if it acquires NFTs as an investment. Upon disposal of an NFT held as an investment, it may fall under the Corporation Tax Intangible Asset Regime.

VAT rules for NFTs

Profits realised from the company’s NFT activity, which is considered a trading activity, will be subject to corporation tax, just like cryptocurrencies. Businesses should calculate profits from trades involving NFTs in accordance with Generally Accepted Accounting Practices (GAAP).

Intangible assets must be reflected on a company’s balance sheet if it acquires NFTs as an investment. Upon disposal of an NFT held as an investment, it may fall under the Corporation Tax Intangible Asset Regime.The main issue around NFTs is what is being supplied when an NFT is created or sold. Early trends are to treat NFTs as a service (not goods), meaning electronically supplied services (ESS) rules are likely to apply. There are currently no applicable VAT/GST exemptions.

Other important ESS aspects are:

• Location of the consumer, which can be more complicated to identify. The sale of NFTs to international clients requires tracking the sales that are potentially  VATable and those outside of the UK VAT regime.
• Seller’s commission and how ESS rules would apply to a given series of transactions that could involve various commissions for market, valuation, AML and due diligence checks
• Buyer’s premium which might be paid for payment collection/facilitating/arranging the transfer of NFTs.

How businesses should approach NFTs

NFT accounting and tax guidance is still scarce, with few regulatory bodies providing guidance in this area. Until NFTs reach a mature stage, it is important that NFT participants seek advice on the potential implications for their business activities. For example, those involved in the design of NFT protocols and DApps may want to take into consideration the implications of having users from particular geographies or the possible return or token distribution mechanisms on their platforms.

Business considerations are important, but accounting and tax implications may be much more significant, and may not be as obvious at first, but they are certainly challenging.

The crypto industry has taught us that these issues will always exist. As the companies in this industry have grown in size, the complexity of these issues has increased and a number of legal and regulatory issues have become a challenge for participants as they progress. The earlier these matters are addressed, and the more proactively they are dealt with, the greater the likelihood of avoiding any repercussions in the future.

We strongly urge you to keep in mind that this is just an overview of the most likely tax treatment. Hopefully, HMRC will be able to offer more clarity in the near future. Please read our disclaimer here.