Currently, the world of crypto tokens is experiencing the next hype. It has triggered tremendous enthusiasm among crypto asset followers and high proceeds are being generated on crypto exchanges: We are talking about non-fungible tokens, or NFTs for short. However, the expanding field of blockchain technology and its applications always bring new tax issues that investors, tax advisors and also the tax authorities need to work through and should keep an eye on.
Principles of NFTs
Nowadays, it is impossible to imagine the world of alternative asset investments without crypto tokens. The principles of this technology become familiar to an increasingly broad audience. NFTs represent a new manifestation of this technology. Compared to the crypto tokens known so far, the special feature of NFTs is their uniqueness. Whereas with widespread examples such as Bitcoin or Ether, the tokens each have the same content and are therefore “fungible” and can be exchanged for each other, with NFTs each token is individual due to certain digital characteristics.
The idea behind this uniqueness is that each token should represent a concrete right or a specific object in the sense of a bearer certificate. Real estate, works of art or wine bottles should be able to be “tokenised” in this way and the ownership of the respective NFT should be synchronised with the ownership of the respective object. Digital works of art are already tokenised by NFTs and traded on crypto exchanges for considerable prices.
Legal classification of NFTs
The legal processing of NFTs under German law is still in the starting blocks. It should be clear that the tokenisation of object ownership under German property law is not as easy as the crypto pioneers like to claim. While constructs under the law of obligations allow a certain synchronisation of the possibility to dispose of an object with the token ownership, a discrepancy with property law ownership cannot be avoided under the current legal situation.
The legal link could be somewhat easier in the case of digital objects under German copyright law. For example, in the case of digital works of art, the authenticity and authorship of the specific work of art can be verified through the technical link with an NFT. This should not protect against digital copies; however, the copies should be recognisable as such, since only the digital original is linked to the NFT.
Finally, the global perspective should be pointed out. While the ownership link between NFT and token is hardly possible under German law, it could be conceivable under the law of other countries that are not bound by the property law numerus clausus.
Tax classification of NFTs
The treatment of NFTs under German tax law should be based on (the lack of) these legal findings. However, due to the “economic approach” required in tax law, tax law cannot stop there, but has to take beneficial ownership into account, even if no legal ownership can be established.
For income tax law, the tax authorities (e.g. Tax Authorities of North Rhine-Westphalia, decree dated 20 April 2018) as well as case law (e.g. Tax Court Berlin-Brandenburg, decision dated 20 June 2019) assume that “conventional” crypto tokens are taxable assets and that the crypto holder is the beneficial owner of these tokens. Capital gains from private trading in these items are thus subject to taxation under Sec. 23 (1) no. 2 Income Tax Act, for example.
While this view is perceived critically in some tax literature, it is to be expected that the tax authorities will repeat the classification as taxable assets also for NFTs and consequently assume that capital gains are taxable. This is because NFTs are supposed to be linked to a concrete object, which in turn is valuable and which is supposed to be disposed of with the help of the NFT. In this respect, the NFT could share the tax fate of the asset it represents. At the same time, however, this raises the question of whether the NFT and the represented asset are a single asset or whether there are two separate assets. The assessment of this question will largely depend on the legal connection of both objects. If the “tokenisation” of an object succeeds as intended, the assessment as only one economic good is conceivable.
NFTs also present the legal practitioner with classification difficulties for VAT purposes. While the ECJ (ruling of 22 October 2015) and, following it, the Federal Ministry of Finance (letter of 22 October 2015) have regarded the transfer of cryptocurrencies, i.e. tokens with a pure means of payment function, as irrelevant for VAT purposes, the transfer of NFTs for consideration could be regarded as a service subject to VAT. It must be examined whether the NFT legally or factually provides another person with the power of disposal over an object in such a way that this is equivalent to a VAT-taxable supply of this object.
In the case of the assumption of a (domestically) VAT-taxable transfer of NFTs, follow-up questions arise: It would be conceivable, for example, in the case of the transfer of a work of art via NFT, to assume only a reduced VAT rate of 7% instead of 19% pursuant to Sec. 12 para. 2 VAT-Act in conjunction with Annex 2 no. 53. Annex 2 No. 53. Such questions will have to be answered by the tax authorities and the courts in the near future and tax law will have to be further developed for digital phenomena such as NFTs.
This article was first published in: Handelsblatt online, Tax Board, 20 May 2021 (in German)