With all the recent innovation and real-world adoption we’ve seen in crypto, NFTs have arguably stolen the show in 2021 and taken crypto mainstream. British auction house, Christie’s, founded in 1766, auctioned off its first purely digital art piece in March of this year with the NFT produced by well-known digital artist Beeple selling for $69,346,250 USD. Over the course of 2021 we have seen many celebrities and notable brands all taking part in the action as blockchain technology has provided a way in which to verify ownership of digital assets. NFTs have gained more adoption than what many could have anticipated, and it was perhaps the moment VISA purchased their first NFT (pictured) last month for $150,000 USD that gave NFTs the stamp of legitimacy. Whether you’re a NFT investor, trader or creator it is also important to be aware of the potential tax implications when dealing with NFTs.
Visa's NFT acquisition: CryptoPunk #7610
NFT is an acronym for Non-Fungible Token. The ‘non-fungible’ nature of an NFT means that each NFT is unique, which is in contrast to fungible tokens like Bitcoin and Ethereum, where one token is indistinguishable from another. Ownership of an NFT can be verified with a unique code on a blockchain. The vast majority of NFTs live on the Ethereum blockchain and can come in many forms such as digital art, collectibles, media and virtual gaming items just to name a few. Although NFTs have largely centred around digital art there are many use cases for their deployment into traditional business models. Notably, the Dallas Mavericks NBA team will issue NFT-based tickets for the upcoming 2021-22 season.
Common types of NFTs
CryptoPunks are an example of NFTs as a digital collectible. They are one of the oldest NFTs that exist on the Ethereum blockchain and have become a large part of Ethereum’s culture. There is a capped supply of 10,000 unique collectible CryptoPunks, each with unique attributes that rank from rarest to common. CryptoPunks may have been free to claim in 2017 when they launched, however, now they are only available to those that can afford to spare around a minimum of $100K USD worth of Ethereum. Ownership of a CryptoPunk has become a way in which investors can display their social status online as they join an elite community of wealthy investors. The mentality behind purchasing a CryptoPunk is not dissimilar to why people choose to buy and wear expensive branded clothing and accessories.
For the first time, digital artists have been able to make their digital artwork available for sale through NFTs as ownership of digital art pieces can finally be verified thanks to blockchain technology. Earlier this year Australian artist, Jonathan Zawada, collaborated with Australian music producer, Flume, to release a series of NFTs called Tiddalik. The release of Tiddalik by the two Australians highlighted the programmability that can be built into the smart contracts that govern the terms of an NFT. One of the NFTs that sold for $24,680 USD represents a ticket that grants the owner a lifetime pass to all of Flume’s concerts while all future secondary sales of the NFTs will automatically pay a royalty fee to the artists. These smart contracts allow artists to attach additional utility to the art they produce which can ultimately increase the value of their artwork to both the owners of the art and the artists themselves.
NFTs have started to revolutionise the sports trading card industry. The launch of NBA TopShots on the Flow blockchain quickly proved to be a success amongst NBA fans who can now buy, sell and trade their favourite NBA moments. The unique token address verifying the NFT on the blockchain is comparable to an authenticity certificate one would receive if they bought a physical NBA trading card.
It wouldn’t be fair writing about NFTs without at least mentioning the metaverse – the digital world where NFTs really come to life. The gaming sector is set to be one of the biggest beneficiaries of the development of NFTs as the technology now allows gamers to take full control of their in-game items and attach true monetary value to such items. Digital scarcity and verifiable ownership are concepts that are becoming increasingly valuable to younger generations that spend a large percent of their lives immersed in digital worlds.
Tax implications of NFTs
The tax implications that apply to you may depend on whether you are an investor/collector, trader, or creator of NFTs.
From the Australian Taxation Office’s (“ATO”) perspective, NFTs are treated the same as all other cryptocurrencies for tax purposes. As an investor/collector your NFTs will be subject to the Capital Gains Tax (“CGT”) rules, meaning when you buy and sell an NFT, you must convert the consideration paid and received for the NFT into its AUD value to calculate the ultimate gain or loss on sale. The CGT discount rules also apply to NFTs that are owned by individuals, trusts or super funds, meaning if you hold an NFT for longer than 12 months, a 50% discount can be applied to capital gains derived by an individual or trust and a 1/3 (33%) discount for super funds.
It is also important to understand that as the price of most NFTs are usually denominated in a cryptocurrency like ETH, the purchase of an NFT using cryptocurrency will also trigger a taxable event for the disposal of your cryptocurrency. For example, if you were to buy an NFT for 5 ETH you would need to calculate the AUD value of your ETH at the time you purchased the NFT and a capital gain or loss will be realised on your ETH depending on whether it has increased or decreased in value since you acquired it.
If you are an NFT trader who is engaging in activities that resembles business-like behaviour, then the trading stock rules will apply to the digital assets used in your activities and as these assets are not subject to the CGT rules, the 50% discount cannot be applied. The trading stock rules can be complicated but broadly speaking, the tax consequences of an NFT trader are:
NFTs held will form your trading stock;
Any increase/decrease in the AUD value of the trading stock held at year-end will realise income/loss according to their change in value since acquisition;
Profits will be taxed as ordinary income (as opposed to capital gains in the case of an investor)
NFT creators trigger a taxable event at the time they receive sale proceeds from their NFTs. NFT sales and royalties received by the creator are treated as ordinary income. Gas costs to mint NFTs are a deductible expense and can be offset against any NFT sales revenue.
Personal Use Assets
An NFT may also be deemed as a personal use asset by the ATO, which would exempt any taxable gain on disposal. For an NFT to be a personal use asset it must be acquired for the less than $10,000 and used for personal use or consumption. An example of this would be where an NFT represents a ticket to access an event either in the metaverse or the real-world. In-game item NFTs are also likely to be viewed as personal use assets so long as they are purchased with the intention to use in a game.
As cryptocurrency accountants, we feel that the ATOs approach to NFTs is somewhat flawed as their current stance is that NFTs are treated the same as all other cryptocurrencies for tax purposes. Although NFTs are tokens built on a blockchain, their characteristics are often vastly different when compared to other cryptocurrencies such as Bitcoin. A blockchain simply allows NFTs to verify ownership of digital assets as described above.
The ATO allows physical collectibles to be tax exempt if they are acquired for $500 or less. This rule, however, unfortunately does not apply to NFTs even if they possess the characteristics of a digital collectible. In addition, despite the ATO providing some leniency to physical card collectors who can be deemed as hobbyists, this classification for tax purposes does not apply to NFT collectors, at time of writing.
We believe the ATO needs to reconsider their position on NFTs and should reclassify them so they do not fall under the same rules as all other cryptocurrencies for tax purposes. NFTs can serve many different use cases and simply throwing them in with all cryptocurrencies could leave users in unfortunate positions. As crypto accountants, Tax On Chain aims to collaborate with accounting bodies such as Chartered Accountants Australia and New Zealand (CAANZ) to work with the ATO in delivering fair and logical crypto tax legislation.
It takes a crypto accountant with specialist knowledge in blockchain and cryptocurrency to ensure you are meeting your crypto tax reporting obligations. If you are unclear as to what your obligations are, get in touch with our team of expert crypto accountants today.
Written by Australian Crypto Tax Accountants: Rafael Franco & Oliver Woodbridge
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