How should states tax NFT sales?
On July 1, 2022, the Washington State Department of Revenue published an interim statement on how sales tax applies to non-fungible tokens, or NFTs. Washington is one of the few states that tackles the tax liability of NFTs, and it is starting to stand out as a leader in the field.
That’s pretty much uncharted territory.
What is an NFT?
NFTs grew out of blockchain, a decentralized, “peer-to-peer network that sits on top of the internet.” Blockchain emerged in October 2008 during the Great Recession, when confidence in traditional financial processes was shaky. Bitcoin, a virtual currency that represents “the first application of blockchain technology,” was introduced in 2009.
The first topic the Washington State Department of Revenue (DOR) addresses in its interim statement is providing what it calls “functional descriptions” for the terms non-fungible, tokenand non-fungible token. These terms and the technologies they represent are so new that they do not yet have definitions codified by the government.
Per DOR:
Non-fungible means non-fungible, so something that is non-fungible cannot be copied, subdivided or replaced. In contrast, something “fungible” is a commodity, money or other things that is is reimbursed as much as payment to settle a debt or account.
ONE token is a digital device backed by a blockchain.
ONE non-fungible token is a unique digital identifier that cannot be copied, subdivided or substituted; it is recorded in a blockchain and is used to verify authenticity and ownership. An NFT is not a cryptocurrency, which is fungible; similarly, cryptocurrency is not an NFT.
An NFT can be bought and sold as a stand-alone commodity, for lack of a better term. Or the sale of an NFT may entitle the buyer to receive products or services such as:
- Digital products (artwork, music, video games or video works)
- Access to events (tickets to concerts, clubs or sporting events)
- Prepared food or drink in a restaurant or club
- Tangible personal possessions (clothing, collectibles)
For example, there is a company that sells golf club and country club memberships via NFT to allow more fractional usage and heritability. A private dining club in New York sells membership via NFT. And in the world of fashion, NFTs are increasingly linked to physical objects.
It is worth highlighting that the part statement functionally describes NFTs as digital code. Most states have yet to do so, leaving the taxability of NFTs in doubt. Senior Director of North America Tax Content at Avalara David Lingerfelt wants the states to define NFTs clearly as Washington now does. “If you don’t, you invite tax controversy that is costly and time-consuming,” he says.
Is the sale of an NFT subject to tax?
There is no one answer to this question because the tax liability depends on several factors: what is included in the transaction, the tax liability of each component and the identity of the buyer and seller.
DOR has identified four basic types of NFT transactions and provided guidance on sales tax:
- 1. The object of the purchase is a stand-alone digital product (the NFT itself), such as artwork, an autograph or video clip. Sales tax generally applies to retail sales of digital products in Washington, so sales of a stand-alone NFT will be taxable.
- one. Retail and business tax (B&O) also applies.
- 2. The object of the purchase is an independent product or service, not the NFT itself. Retail sales of goods or services are generally subject to sales tax in Washington, so this transaction will generally be taxable.
- one. Retail and business tax (B&O) also applies.
- 3. The object of the purchase is an independent good or service that is not classified as retail, not the NFT itself. Washington sales tax generally does not apply to sales of goods or services that are not defined as retail, so the transaction will not be taxable.
- one. B&O tax, use tax or other special tax may apply.
- 4. The sale of an NFT includes a royalty payment to the NFT creator, or to another party selling the right to royalties for the future sale or distribution of the NFT. Royalty payments are not subject to sales tax in Washington.
- one. Royalties B&O tax applies to gross income from royalties.
How to tax packaged transactions that include an NFT
While some are undoubtedly happy with the purchase of a stand-alone NFT, DOR expects that many NFT sales will be mixed or packaged transactions. And determining the tax liability for any kind of bundled transaction can be like untying a knot: you have to follow different threads to get to the end.
First, the seller must determine whether the sale is in fact a unified transaction (ie, it is a retail sale of two or more products, the products are otherwise distinct and identifiable, and the products are sold for one unspecified price).
Secondly, the seller must decide whether sales tax applies to each good or service included in the sale. Aggregate transactions are generally subject to both Washington sales tax and B&O tax, but there may be exceptions to this rule.
How do you collect the sale of an NFT?
To determine the sales tax rate that will apply to the sale of an NFT, you need to know how the sale is coming from. The rules for destination purchasing base the sales tax on the place where the consumer takes possession of a good or benefits from a service. The origin purchase rules base the sales tax on the place where the sale is made (ie the location of the seller). Learn more about destination and origin purchases.
It can be difficult to find the sale of tangible property, but that has nothing to say for the sale of a digital product such as an NFT. As a Streamlined Sales Tax (SST) member, Washington State is obligated to follow the SST sourcing hierarchy. But the SST has yet to specify how to source NFTs, and until it does, SST member states like Washington are on their own. “It has happened in the past that the first state has to step back if another SST member state develops a different policy, and the SST, as an arbitrator, determines that the second state’s position is more accurate. when the SST takes a position,” says Scott Peterson, VP of Government Relations at Avalara and the first Executive Director of the SST Governing Board.
For now, Washington applies SST’s digital product procurement rules to NFTs:
- Origin sourcing is used when the digital product is received by the buyer at the seller’s place of business.
- Destination collection is used when reception does not take place at the seller’s place of business.
- If not 1 or 2, the sale to the address of the buyer is retrieved from the seller’s business register.
- If not 1-3, the sale is brought to the place indicated by an address for the buyer “obtained during the completion of the sale, including the address of a buyer’s primary payment instrument.”
- If not 1-4, or if the seller does not have sufficient information to apply one of these provisions, the location of the address from which the digital code was first available for transmission by the seller, or from which the digital automated service (or other service that is a retail sales) was delivered. In other words, original sourcing is used.
It is necessary to explain all the options due to the intangible nature of digital products. A seller does not need a physical address to complete the sale and delivery, and therefore the address may not be obtainable.
“Proper purchasing of a sale to a state requires at least the five-digit zip code, which is often all the credit card requires,” explains Peterson. “That then results in the credit card rules determining exactly how merchants collect local sales tax. It’s not an ideal situation.”
Washington’s interim statement on the tax liability of non-fungible tokens is a good read. The department clearly identifies the relevant issues and provides excellent examples to bring each scenario to life. Businesses are encouraged to contact the department for guidance in the event that the facts and circumstances surrounding their business activities are not addressed in the statement.
Pennsylvania and Puerto Rico are also working to clarify how sales tax applies to NFTs. In February 2022, the Treasury Department of Puerto Rico proposed adding NFTs to the list of taxable digital products. A few months later, the Pennsylvania Department of Revenue updated Rev-717 to specify that non-fungible tokens are taxable. The Multistate Tax Commission and the Streamlined Sales Tax Governing Board are also working to determine how best to classify NFTs for sales tax purposes.
To date, Washington’s guidance is the most robust. NFT sales that are described as taxable in the partial statement should be assumed to be taxable from 1 July 2022.
Learn more about the mysterious nature of NFTs and the metaverse:
Tax on the Metaverse: The Basics
Selling goods in a virtual world can have real tax consequences
Will there be a VAT holiday in the metaverse?
