Should NFT trades be taxed? A comparison of the United States, Russia and Ukraine

NFT fever continues to gain momentum. Celebrities are selling as NFTs a wide range of things — from music and photographs to quotes and tweets, famous outlets are auctioning covers, and one of the world's oldest auction houses Sotheby’s speaks of the technology's potential and announces NFT auctions.

But not all is rosy. The NFT sold for almost $70 million by digital artist Beeple described the market as a ‘bubble’ (which, however, did not stop him from selling another NFT painting), and Litecoin creator Charlie Lee believes that NFTs will depreciate over time due to the "zero cost" of their creation.

Private opinions hardly concern most NFT market participants. However what could be a real unwelcome surprise for many is the need to pay taxes.

US: “Pay up in cold, hard cash”

In the United States, where many NFT market participants are based, deals to buy and sell such tokens are subject to taxation, experts say.

Residents of the US do not need to declare crypto holdings if they follow a long-term holding strategy. However the IRS regards their sale as a taxable event [taxable event].

According to information on the IRS site, if virtual currency is part of capital assets, exchanging it for other property, including goods or another currency, you must record losses or gains.

Tax expert Shehan Chandrasekera of CoinTracker noted that this carries "serious implications for the NFT craze."

There are two tax treatment options for NFT deals, Forbes.

The first relates to the creators of such tokens. They must declare profit earned from selling an NFT, the publication notes:

«If some Sam created an NFT and sold it for 2 ETH worth $2000, he must report these $2000 as ordinary income».

For investors who merely buy and sell NFTs, taxation is similar to that applied to ordinary cryptocurrency transactions.

«Both buying an NFT with cryptocurrency and selling tokens to realise a profit create a taxable event for the investor. Capital gains tax rules apply to the profit», the publication notes.

In addition to the federal tax, investors may also face state taxes, CNBC reports.

Because many NFTs are considered collectibles, they may be taxed at a higher rate for high-income individuals at 28%.

Tax does not apply to buyers who purchased cryptocurrency and immediately used it to buy NFT, CNBC notes:

«Tax applies only to those who buy NFT with cryptocurrency whose value has risen since purchase».

The rules also do not apply to NFT investors not from the United States.

Based on this, the buyer of Beeple's NFT for $69.3 million, Metapurse founder under the pseudonym Metakovan, based in Singapore, would not have to pay tax.

Beeple himself has already converted the proceeds from selling NFT from Ethereum into U.S. dollars, paying taxes and the auction house's commissions.

A potential problem for the IRS could be the tax reporting of NFT marketplaces registered or having a presence in the United States.

Chandrasekera noted that platforms may report the sale of tokens, but not the buyer's profit from the cryptocurrency used to purchase.

Tax experts say that it is practically impossible to determine the total amount of unpaid IRS taxes. They may run into tens or even hundreds of millions of dollars.

Nevertheless, the IRS is unlikely to close its eyes to the situation. In March, agency officials announced the launch of Operation "Hidden Treasure", aimed at locating U.S. residents who evade taxes on cryptocurrency operations.

Russia in Uncertainty

In Russia, the taxation of such deals remains unclear due to the absence of a comprehensive framework for digital currencies, say ForkLog interviewees.

Tax burden applied to income from digital-currency operations is laid out in a government draft law, which has passed only the first reading in the State Duma, i.e. it has not come into force, GMT Legal managing partner Andrey Tugarin noted.

«The absence of amendments that have come into force in the Tax Code of the Russian Federation does not allow applying the concept of a taxable event to the purchase/sale of NFT», — said Tugarin.

Senior lawyer at Bryan Cave Leighton Paisner (Russia) LLP, Dmitry Kirillov, stressed that the current bill does not regulate NFT in detail.

«In any case the sale of NFT and receipt of money by a Russian resident will not go unnoticed by the tax authorities — failure to declare income and failure to pay tax will create the risk of tax claims», he says.

The lawyer noted that in each NFT sale case a content analysis is required, since “a copyright object is tied to such a token in one form or another”.

«A NFT could exist either as property (ownership of the underlying NFT) or as a proprietary right. Thus, the decisive factor for taxation, among other important characteristics, will be whether ownership of the underlying asset has transferred».

NFT in Ukraine

NFT taxation presents a similar picture in Ukraine.

According to Eterna Law attorney Kristina Tsybaluk, deciding the tax regime in the absence of regulation raises many questions.

«At the moment Ukraine has no legal regulation not only for NFT, but for the crypto market as a whole, so objects and participants in this market are outside the state's legal field», Tsybaluk said.

Recall that on 2 December the Verkhovna Rada of Ukraine, in the first reading, approved the draft law “On Virtual Assets” as a basis. It classifies virtual assets as intangible property.

Lawyers from Alcor, Oksana Petruś and Alina Zorchenko, say that given current legislation it would be most logical to classify NFT as goods, specifically as intangible assets.

In this case, taxation of NFT purchases and sales would arise only on the seller's side, they note:

«Income from selling NFTs by individuals would be taxed at 18% personal income tax and 1.5% military levy, and profits from their sale by legal entities would be 18% corporate income tax. For VAT payers, there are currently no direct restrictions on NFT sales».

According to Juscutum managing partner Artem Afian, today NFT sales under Ukrainian law fall into base income and are taxed with VAT if the transaction is between a VAT payer company.

«Sale of an intangible asset or any other form of alienation, even written off due to lack of use, by a VAT payer – all this provides grounds for VAT assessment», he says.

As NFT is often treated as art, through brokerage one might try to tax only the difference, Afian notes:

«But, unfortunately, the very definition of art as property and linking it to commodities today, without further clarifications and possibly legislative changes, does not allow applying such an interesting rate».

Lawyer Kristina Tsybaluk noted that if an NFT deal contemplates transfer or acquisition of rights to the underlying asset, such transactions are likely to be taxed as personal income tax as other incomes.

«If the NFT transaction does not entail transfer/acquisition of rights to the underlying NFT, but rather is a license of rights to the underlying asset, such operations can be taxed under licensing agreements», the expert noted.

Lawyers from Alcor also point to peculiarities when crypto and tokens, including NFTs, are bought by Ukrainian residents abroad:

«In such operations, given that their nature is not entirely clear, tax authorities may force a buyer to withhold 15% tax on non-resident income, based on the amount of the asset purchased».

This could potentially be avoided if there is a double taxation treaty between Ukraine and the seller's country and if the buyer in Ukraine obtains a residency certificate from the seller, lawyers said.

Tsybaluk stressed that it is still difficult to predict exactly how tax authorities will treat NFT transactions; the most likely path is to regulate by analogy with existing legal relationships:

«Therefore, in Ukrainian law NFT could exist either as property (ownership of the underlying NFT) or as a proprietary right. The decisive factor for taxation, among other important traits, will be whether ownership of the underlying asset has transferred».

***

Although the NFT market has existed for a long time, the hype began in 2021.

With growing public attention to NFT and multi-million-dollar deals, it would be naive to think regulators, including tax authorities, will overlook this market. That means in many countries users can expect clarifications on how to declare and pay taxes on such transactions.

For more on the NFT market potential, read ForkLog's exclusive.

Author: Alina Saganskaya.

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