Home Blockchain Digital assets and blockchain will force sales tax to evolve

Digital assets and blockchain will force sales tax to evolve

Digital assets and blockchain will force sales tax to evolve

The sales tax challenge facing state legislators and regulators regarding the application of sales tax to digital assets traded on the blockchain is new, but by no means unprecedented. There have been many occasions where sales tax regulators have been challenged to understand changing technologies. It’s fair to say that sales tax rules have lately lagged behind technology.

With the growing popularity of non-fungible tokens and more states considering implementing a sales tax on blockchain transactions, lawmakers should take up the challenge of providing clear and comprehensive guidance that reflects reality and offers businesses a reasonable path to compliance.

Get the right terminology

In common parlance, the term NFT is often used to describe the potentially taxed digital asset, but this is not entirely correct. A token is simply a representation of one thing residing on blockchain technology, and there are all kinds of tokens that represent all kinds of things beyond NFTs. Cryptocurrencies such as bitcoin are a type of token. However, cryptocurrency tokens are intended to be used as a store of value and a medium of exchange, and are in fact fully fungible – one bitcoin is interchangeable with another.

In contrast, NFTs represent a single item, more accurately called a digital asset. It is the digital asset behind the token, not the token itself, that has perceived value and is potentially subject to sales tax when bought and sold.

Digital assets are minted on the blockchain; the form and function of these assets are limited only by the imagination of their creators. When most people think of NFTs, they think of digital art. However, almost anything can be represented by an NFT, including photos, videos, audio clips, GIFs, memes, experiences, and even interests in real tangible personal property.

The role of marketplaces

Although there is no single, all-encompassing selling approach, digital assets are often sold through online marketplaces. Much like their e-commerce cousins, NFT marketplaces are platforms where digital assets can be viewed and traded. The marketplace provides advertising services to the creator. When the item is sold, the marketplace facilitates payment between buyer and creator, possibly including subsequent royalty payments on subsequent transfers.

For example, suppose a buyer using a marketplace creates a digital wallet and funds it with the Ethereum cryptocurrency. Ethereum can be purchased on most mainstream cryptocurrency exchanges and then transferred to the market wallet address. Most marketplaces offer NFTs through an auction system.

Today, every state with a sales tax comes with rules that impose e-commerce collection and remittance obligations. market facilitators, which perform a payment processing and marketing function for marketplace sellers. These rules could be extended to cover at least some NFT marketplaces.

The supply challenge

Transacting via the blockchain means that the buyer’s identity or location is not necessarily known. Once the NFT is created, the smart contract addresses indicate the location of the NFT on the blockchain, but the assets are stored on the internet via a file sharing system. Wallet addresses do not identify physical owners of assets, which makes blockchain technology so secure.

From a sales tax perspective, this creates a unique procurement challenge. Which jurisdiction is entitled to apply the tax to a particular transaction? Is it based on the location of the server where the digital asset is stored? Probably not. In many states, taxable digital property is taxed based on the buyer’s address as shown on the seller’s books and records that are kept in the ordinary course of business or obtained upon confirmation of the sale.

Today, some sellers of digital goods collect address information from their customers to confirm that the buyer is using a valid payment method. However, many only collect the five-digit postcodes of their customers. While by no means perfect, knowing a buyer’s zip code does at least provide some clarity on applicable sales tax. A nine-digit ZIP code, on the other hand, provides even more relevant information, and a full address basically gives you everything you need to know.

Even so, it remains far from clear whether NFT marketplaces facilitating anonymous customer payments using cryptocurrency will be able or inclined to collect their customer’s location data, as it is not necessary to conclude. the sale. The buyer may also not want to provide it. After all, people are becoming more and more protective of their personally identifiable information.

When is the tax due?

Current sales tax requirements suggest that tax becomes due and payable upon transfer of title or possession, whichever comes first. But there are nuances to determining when someone owns a digital asset. For some assets, the answer will be simple: the tax will be due when the asset is acquired for the buyer. For others, the answer could be much more complex.

How will states value digital assets that can be exchanged for tangible goods or services? Take a digital asset that can be redeemed for an overnight stay at a major global hotel chain, for example. At the time the asset is purchased, no one knows which hotel the stay will be at or what room rates are in effect there. In this case, is it better to defer the tax until the redemption of the asset? When it comes time to issue guidance, states need to address this complexity head-on.

When digital assets are purchased, the value is usually paid in cryptocurrency, which means states must clearly state where to find the applicable exchange rate for the most common forms of crypto. Whereas Ohio briefly experimented with the idea of ​​allowing tax payments directly in crypto, most states are still expecting US dollar payments. States rely on tax revenue to fund their government and likely have no interest in the wild swings that can be felt in the cryptocurrency market.

Additionally, it is possible for creators to earn additional revenue if the digital asset is resold by the initial buyer or subsequent buyer. Since most of these sales take place in a marketplace, the market facilitator’s tax compliance obligations, if any, will need to be detailed.

What happens afterwards?

States will inevitably start issuing guidelines on the sales tax treatment of digital assets and blockchain transactions. The industry – and the money involved – is just too big to ignore. Hopefully they will first take the time and effort to understand the industry and its practicesproviding thoughtful and comprehensive advice that will enable sellers and marketplaces to achieve compliance in an efficient and affordable way.

This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Charles Maniace is Vice President of Regulatory Analysis and Design at Sovos.

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