NFT Tax Guide
With the boom of cryptocurrency, there are now numerous crypto networks, each with their own tokens of varying popularity. Where some currencies, such as Bitcoin, and even fiat money are "fungible", that is, their tokens are interchangeable and indistinguishable. Non-Fungible Tokens (NFTs) are unique assets with differing values. For example, where a single $5 note could be easily replaced with any other $5 note within the same currency, since NFTs are each uniquely valued, one NFT could not be arbitrarily replaced by another.
NFTs are units of data stored on a digital ledger which often take the form of assets such as digital paintings, photos, audio or other digital files, and represent ownership of a particular asset. Given their high security, uniqueness and their public nature, NFTs are often used to represent digital signatures of real objects, with the art market having taken readily to this system.
To see more examples of NFTs you can visit digital marketplaces like OpenSea (https://opensea.io/) or Mintable (https://mintable.app/).
How NFTs are Taxed
The Australian Taxation Office (ATO) recently released guidelines for the Tax treatment of NFT's. The ATO has stated that the tax treatment of NFTs follows the same principles as cryptocurrency. This means that NFTs are treated as Capital Gains Tax (CGT) Assets, and so the following activities will trigger a taxable event:
- Selling NFT's in exchange for cryptocurrency
- Exchanging one NFT for another NFT or fungible cryptocurrency
- Giving a NFT as a gift (unless it is to a tax deductible gift recipient such as an Australian charity)
It is important to note that creating (minting) an NFT is not in and of itself a taxable event, but disposing of the NFT by selling or trading it will trigger a capital gains tax event. However, if you mint the NFT with an asset that has appreciated since first purchased, this may trigger a CGT event on the value of the mint cost. Similar to cryptocurrency taxation, investors that make a loss by disposing of an NFT will trigger a capital loss that can be used to offset capital gains.
NFTs as Part of a Business
NFTs can be used to represent a smart contract between a business and another party where sale of the NFT represents sale of a smart contract. If the sale of the NFT results in an income to the business, such as through an initial sale price or a commission paid to the business when the NFT is traded to a new party, the proceeds of the trade to the business will be assessed as a business income.
If the business closes and yet some party continues to receive revenue on transfer of the NFT, the party's income will be assessed as ordinary income.
NFTs for Other Uses (Personal or as a Capital Asset)
Treatment of NFTs with respect to their owners depends on how the NFT is used. If the rights of an NFT, such as a smart contract, are exploited for personal use, such as spending time with family or friends, the NFT may be considered to be a personal use asset. If the rights of an NFT are used as part of a business, the NFT would more likely be considered a capital asset of the business.
Bridging lets users move their NFT assets between different blockchains, such as Ethereum and Solana. Ethereum is currently the most popular chain for NFT's, with marketplaces like OpenSea, and the MetaMask wallet. However, there exist tools such as Wormhole which allow users to bridge NFT assets from another chain to Ethereum, basically allowing a wrapped version of the NFT to exist on Ethereum marketplaces.
The act of bridging your NFT from one chain to another can constitute as a CGT event depending on your personal circumstances. The ATO has indicated that if you are changing the rights of the NFT by bridging from one chain to another, then it is hard to argue that this is not a CGT event. The same is true for value extraction. If you are bridging to extract more value from the NFT, then this is also a case for this being a CGT event. Wrapping an NFT to create an income generating asset does change the bundle of rights that is associated with your NFT, which may result in a CGT event. The revenue from this new asset would also have tax implications as discussed below. Ultimately, the tax implications of bridging does depend on your personal situation and the underlying reason for bridging that asset.
Staking involves users locking up a particular cryptocurrency to support the operation and security of a blockchain network (similar to a bank deposit used to gain interest). The ATO has deemed that any gains made from cryptocurrency staking activities do not constitute a CGT event; rather, these gains are treated in the same way as normal income, and so are taxed according to an individual's tax bracket.
Say you hold 1 BTC, and receive an additional 0.1 BTC from staking rewards. Suppose this additional 0.1 BTC is worth 5000 AUD. The 5000 AUD would be considered income for tax purposes. In the future, if you were to exchange the coins gained from your staking, the CGT you pay would be calculated with the base value being 5000 AUD.
In the context of NFT's, this is a relatively new space that does not have specific guidelines and so it is best to seek advice from your accountant, especially for high-valued staking rewards. However, the fact that these tokenized patents are capable of generating income (e.g royalties) indicates that the ATO is likely to treat NFT's in the same way as staking rewards from cryptocurrencies.
Unlike with traditional games, in which great time and effort is required to earn points, level up or complete quests in each and every game a user plays, NFTs allow for cross-game and cross-platform persistence, potentially allowing for improved player experience. Some popular NFT games include AxieInfinity, Gods Unchained and Alien Worlds.
A key benefit provided by NFT gaming is the transfer of virtual assets and items such as skins, characters, weapons and/or virtual land between games. NFTs will enable the creation of unique in-game items in place of developer-designed objects. Item authenticity, ownership and transferability will be certified by player licenses. If a player creates, earns, trades or by some other means obtains an NFT item in one game, it could be transferred to another game played by the same user, even if the game is created by another company.
In addition to unification of assets, NFTs allow for the publication of player records, enabling cross-game player improvement. As with items, player records can be publicised and accessed by various game developers, enabling the transfer of player history, scoreboards, achievements, experience points and more.
Through the use of public keys, NFTs generally create the ability for players to create single, unified identities which can be maintained across various games or platforms.This leads to the key benefit of easing of log-in process and all aforementioned advantages, but it also allows for the maintenance of a unified identity which allows for players to be easily recognised by others across different games and platforms.
NFTs bypass traditional gaming concerns by allowing for cross-game and cross-platform continuity. Traditional game developers prohibit the sale of in-game assets and accounts; their heavy control creates consumer hesitance. In contrast, NFT gaming will allow for the development of an immersive virtual economy via the trading and selling of NFT items. It will also open up opportunities for play-to-earn abilities.
In saying this, much like other NFT usage scenarios, tax laws around NFT games are highly ambiguous. It is best to ask your accountant for guidance, particularly if you are engaging in high-value transactions. It is also recommended that you remain conservative, as you may be required to pay back any tax in future, as was the case for early cryptocurrency investors.
NFT gaming has the potential to trigger multiple tax events:
- Creators of any NFT items may be required to pay income tax on any digital sales or transactions
- Buyers of NFT items may owe capital gains tax on cryptocurrency that is exchanged for the items
- If NFT items are traded for a profit, a tax event could be triggered
- Additional implications may occur if a recurring revenue stream results from NFT gaming or if NFT trade becomes a regular income source
NFT users should be cautious as misplacement of NFT items may not qualify you for a tax claim under investment or gambling loss.
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