20 Oct “NFT”: THE HYPE AROUND NON-FUNGIBLE TOKENS (“NFT”) AND TAX CONSEQUENCES IN LUXEMBOURG
What are NFTs and what is their significance?
NFTs, or ” Non-Fungible Tokens,” are digital assets that are part of a blockchain. Unlike “fungible” tokens, NFTs represent a unique asset and are therefore not exchangeable like cash or Bitcoin (every one-euro coin has exactly the same value and is therefore exchangeable).
Recently, NFT have made some headlines. For example, the first tweet from Twitter founder Jack Dorsey sold at auction for USD 2.9 million and the collage of 5000 images from artist Beeple, whose NFT sold for the equivalent of over USD 69 million at Christie’s auction house.  Due to extreme increases in value in a few weeks or months, NFT have aroused the interest of many people. Meanwhile, there are NFT collections for every taste and in every price range: from 0.01 Ether to several 100 Ether per single image. Memories are awakened of the early days of Bitcoin, Ethereum and other cryptocurrencies.
How do NFTs work?
The most significant NFTs currently reside on the Ethereum blockchain, but many other blockchains also offer the ability to coin NFTs. NFTs are created (or coined) by executing a smart contract (a computer protocol that runs on the blockchain and maps or verifies a transaction or contract) on the respective blockchain.
For example, if it is an NFT of an image, the metadata of the image is usually stored on the blockchain. This metadata then contains a link to a cloud database where the image is stored in full resolution. Due to the transparency of the blockchain, the respective owner of the NFT can prove at any time that he is the rightful “owner” of the respective token and thus of the art object. Creators of any kind can use NFTs to market their creations bypassing intermediaries such as gallery owners, record labels, etc.
Blockchains that function as smart contract platforms offer unimagined possibilities for shaping ownership and contractual relationships. For example, NFTs can already be programmed in such a way that royalties flow to the creator every time an NFT changes its owner.
Other examples of NFT:
- The so-called Cryptokitties were the first major application in the field of NFT in 2017 and 2018. Virtual cats could be collected and bred on the Ethereum blockchain.
- Crypto Punks / Bored Ape Yacht Club / Artblocks / Crypto Gorillas – examples of collections of digital artwork that have found appeal in the crypto community and beyond.
- Axie Infinity – An online game from Asia, based on Pokemon and Tamagotchi, with “Axies”, virtual creatures that are tradable as NFT (so-called “in-game items” or also “in-game assets”). Axie Infinity was the first “NFT game” to reach $1 billion in trading volume. Many see the greatest future for NFT in the gaming and metaverse sectors.
Trading platforms where NFT are traded are e.g.
Opensea and Rarible work like auction platforms where everyone can put his NFT for free. A fee is only charged for the purchase of an NFT.
Tax assessment of NFT
The tax authorities in Luxembourg (and in most other countries) have not yet made any precise statements about the taxation of NFT. In the following we describe how the taxation of NFT could look like, based on the taxation of Crypto and Art Objects.
Artistic activity is considered as self-employed work
In most cases, the creation of NFT should be able to be classified as a so-called self-creative achievement and thus as an artistic activity.
Self-employed artists are considered freelancers in Luxembourg from a tax perspective. Their income is generally considered as income from self-employment within the meaning of Art. 91 LEStG.
Most artists will determine their income via a revenue surplus account. Purely professional expenses, such as Ethereum gas costs (transaction fees) for coining the NFT, should be able to be claimed as expenses.
Question of commerciality
A freelance activity as an artist regularly excludes the commercial nature of the activity. Other actors involved in NFT, such as traders, may be affected by commerciality. Should the commercial nature be affirmed, all income will be taxed as income from commercial activities for income tax purposes.
The Luxembourg Direct Tax Administration Circular L.I.R. n° 14/5 – 99/3 – 99bis/3 of July 26, 2018 establishes that trading in and mining of crypto can be classified as commercial if the activity goes beyond mere private asset management. The following criteria can be used as indications for the existence of a commercial activity:
- existing facilities or an organization intended for the operative performances for virtual crypto currencies;
- Financing through debt capital;
- Frequent rotation of the stock of virtual crypto currencies;
- Trade on behalf of third parties
Expenses arising from this commercial activity, such as electricity costs or transaction fees, are only deductible as business expenses if they are incurred exclusively by the Company pursuant to Art. 45 Luxembourg Income Tax Law (“LEStG”). In addition, the Circular states that income arising from the activities of taxpayers subject to corporate income tax pursuant to Art. 159 in connection with. Art. 162 LEStG, must always be considered as commercial activity.
Although there have been no statements from the tax authorities yet, it would be reasonable to assume that the same standards would be applied to trading in NFT.
Taxation of capital gains realized by individuals
Individuals who are not self-employed or engaged in business may also be taxed on their gains from trading in NFT. Similarly to the taxation of profits from trading in crypto or art objects, capital gains should fall into the category of other income.
The taxable income category of other income is described in Art. 99 i.V.m. Art. 99bis LEStG. This tax regulation applies only if no commercial activity is carried out according to Art. 14 LEStG. This means that any gain or loss resulting from trading in NFT is considered a speculative gain or loss if the holding period does not exceed six months. These speculative gains are taxable at the personal tax rate, with an exemption limit for gains of EUR 500.
VAT on trade with NFTs
For VAT purposes, cryptocurrencies have been treated as equivalent to legal tender. Consequently, trading is not subject to VAT.
Since the payment function is not the main focus of trading in NFT and it is actually an exchange of services, it cannot be assumed that the VAT exemption also applies to NFT. However, the tax authorities have not yet commented specifically on the application of VAT.
Luxembourg artists who generate less than EUR 35,000 in sales should be able to benefit from a VAT exemption as a “small entrepreneur” under Art. 57 of the Luxembourg VAT Law.
Photo source: https://www.shutterstock.com/de/image-vector/bored-ape-nft-blockchain-non-fungible-2105074160