How will Non-Fungible Tokens (NFT) be Taxed?
So, you’ve stumbled across non-fungible tokens. With soaring popularity and increased press coverage, NFTs are without a doubt the new hot topic for 2022. With all the hype and media attention, we’re sure you’re keen to understand this phenomenon.
Read on, to find out everything you need to know about non-fungible tokens and their tax implications.
What are non-fungible tokens?
Non-fungible tokens are a distinct (and new) asset class. Bearing similarities to cryptocurrency, NFTs hold exciting possibilities for investors and collectors alike. But before we dive in with the details, let’s have a quick run-through of the terminology.
Fungible: The dictionary definition is “easy to exchange or trade for something else of the same type and value”.
Non-Fungible: In contrast, non-fungible is a unique identifier that isn’t easy to trade.
Blockchain: This is essentially a database that’s shared across a network of computers. Being a database, the blockchain stores information electronically. Blockchains are best known for their role in cryptocurrency systems, essentially making a secure and decentralised record of currency transactions.
Metadata: Metadata provides information about other data, but specifically doesn’t provide information about the content of that data.
So, now you know those terms…we can move on to say:
NFTs are assets on a blockchain with unique metadata.
But how secure are NFTs? Well, as it uses blockchain technology just like cryptocurrency, it’s generally very secure. However, a security consideration of non-fungible tokens is that access to them can be lost if the platform hosting is compromised for some reason.
Remember, digital-only assets are only as good as the infrastructure hosting them.
NFT markets are currently focused on collectables, for example, digital works of art, sports cards, and other rare items that have been digitally “tokenised”. An extreme example is a digital artwork that sold for $69.3 million. This artwork was a collection of 5000 digital images arranged into a collage and then “minted” into NFTs. Bidding for the artwork lasted two weeks and started at a modest $100. The sale was then recorded on the blockchain, giving the buyer proof of authenticity and ownership.
So, now we’ve established what these are and how they can be bought and sold as digital assets. What’s next?
We need to know how non-fungible tokens are taxed.
Taxing NFTs for individuals
At the time of writing, HMRC currently has no specific guidance for taxing NFTs. However, the published HMRC crypto-assets manual does cover how the transfer and disposal of “tokens” should be treated. In this instance, the token is assumed to be a cryptocurrency, but non-fungible tokens will likely be treated in the same way when it comes to both income tax and capital gains tax.
1. Income tax
The buying and selling of tokens, like other assets, could be subject to income tax, although currently there isn’t a formal definition of when it would be applied. Trading tokens on the blockchain might be more ‘distant’ from HMRC than say, buying a car from a dealership, however, the activities are subject to the same tests.
HMRC applies its testing and standards to financial activities, taking into account the “motive to profit”, timing and location of trading. Once applied, HMRC could conclude that transactions involving NFTs would be liable to capital gains tax, although there’s not a clear consensus on this yet.
Until HMRC catch up with the financial implications of digital assets, it would be wise to record any transactions involving crypto-assets and seek an advisor, who may suggest disclosing them and arguing that they’re non-taxable, shielding against future penalties should the rules change.
2. Capital gains tax
Cryptocurrencies are not considered to be “money” or “currency” as per the HMRC manual. However, NFTs and cryptocurrency are very similar, in that individuals holding them are seen as investors holding an asset. The buying of an NFT as an investment is similar in some ways to other alternative investments, such as wine.
An individual buys an asset (NFT/wine) and holds it for some time in the hope that its inherent value grows.
In the future, the NFT/wine is sold and the value growth is realised. Should a capital gain be made by the investor, this is taxed.
Taxing NFTs for companies
If your company’s business activity is primarily the transacting of NFTs, then unlike the case for individuals, it would be more straightforward for HMRC to consider this activity “trading”, and the profit realised be taxed accordingly using the corporation tax regime.
If your company holds an NFT as an investment, this would be declared as an intangible fixed asset for accounting purposes. This would be the same as holding another intangible asset, such as trademarks, patents, design rights etc.
Disposing of the NFT in the future may attract corporation tax, (Corporation Tax of Intangible Assets) depending on if a profit is made. While the nature and treatment of NFTs and cryptocurrencies are unsettled and not written in UK law, it would be wise to record all transactions and holding.
NFT & VAT
It’s expected that any goods or services sold in exchange for NFT would be subject to VAT in the normal way. The value of the NFT at the time being converted is £ for the transaction.
NFT tax is still a nebulous area and will remain so until HMCR catch up with these and other digital assets.
In the meantime, this guide and the expertise of professional advisors can help support you and your business. The key takeaway from all this is that it's wise to keep a clear record of all your activity using NFTs, so when HMRC do catch up, you’ll be ready for them.
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If your company is looking to take advantage of the rise of NFTs and other assets held on the blockchain, we’re here to help. At Accountancy Cloud, we offer our market-leading accounting services powered by our team of financial experts to help you meet your business goals.
Through our expert and personalised service, we can help you navigate the tax landscape and be as efficient as possible in your financial dealings with HMRC. Talk to us today to see how we can help.