FAQ; Non-Fungible Tokens (NFTs)

March 1, 2022

What is a Non-Fungible Token?

Non-Fungible Tokens (NFTs), are cryptographically secured units of data that confirm the authenticity and ownership of a digital asset. A fundamental characteristic of an NFT is its non- fungibility i.e., absence of interchangeability. Another important characteristic is that the data pertaining to the asset and its ownership is recorded on a distributed ledger. Recording is done on a database that is synchronized across many nodes with each transaction witnessed by all the concerned participants. Therefore, any change in ownership of the NFT is verified by multiple systems.

How are NFTs produced?

To create Non-Fungible Tokens (NFTs), one must decide which digital media asset has to be represented in an NFT. Once that is decided the NFT has to be minted by using a cryptographic key to secure the token which is created on a blockchain. The most popular blockchain for NFT is ‘Ethereum’.

How are NFTs bought and sold?

Once the NFTs are minted, the creator can list them on the NFT marketplace for auction. The creator normally runs a marketing campaign for the promotion of the auction. Interested buyers of the NFT will come to the marketplace when the auction is live and place the bids. The successful bidder will get the NFT transferred to the bidder. NFTs can be sold in the secondary market or directly to an interested buyer. All the purchase and sale transactions are recorded on the blockchain and due to this being a distributed ledger each transaction is witnessed by all the participants.

What can NFTs be used for?

Due to their protection from non-fungibility, coupled with the guarantee of authenticity and ownership NFTs are quite popular and have a wide range of uses. Some of the uses include:

a) In arts, entertainment and creative industries as memorabilia and collectables.

b) Smart tickets for events.

c) Video games.

d) Digitized meta media.

e) Contract verification

What do I own in an NFT?

When you buy an NFT, you probably own the agreed rights attached to the cast NFT work and not those attached to the original work. Normally a buyer of an NFT does not acquire any rights to the original work, on which the NFT is minted, unless the contract specifically agrees otherwise.

Are NFTs currency or property for tax purposes?

Many jurisdictions around the world tend to tax NFT as property and not currency. It is a well-recognized tax principle that convertible cryptocurrencies like Bitcoin and Ether are considered as property and not currency under tax laws. Although many jurisdictions are silent on whether non-convertible cryptocurrencies or NFTs or digital tokens are property or currency, it stands to reason that if convertible cryptocurrency itself is taxed as property, then definitely NFTs will not be treated as currency.

Is NFT an ordinary asset or capital asset?

For a creator, the NFT is a capital asset, because it is in the nature of a patent, model or copyright, literary composition, musical composition, artistic composition, created through the creator’s personal efforts. In the hands of a dealer, the NFT is considered an ordinary asset because the dealer holds it as inventory. For a taxpayer who is neither a creator nor the dealer, the NFT is used in the taxpayer’s business and therefore assumes the nature of a capital asset.

What is method of taxation of personal use NFTs?

Personal use assets are those which are neither held in a trade or business nor held for investment. Such assets are used by taxpayers as part of their hobbies and recreational use. Under tax laws in different jurisdictions, the taxpayer cannot deduct expenses incurred for such personal assets and also cannot claim any amortizations benefits on such personal use assets.

What is the taxability on sale or exchange of NFT?

Sellers have ordinary income or losses or even capital gains or capital losses depending on whether an NFT is a capital or ordinary asset in the taxpayers’ hands. If it is a capital asset, then capital gains or capital losses would apply, whereas if the NFT is an ordinary asset then ordinary business profit or loss would be applicable.

Is NFT sale subject to VAT or under any indirect tax regime?

If NFT is considered as trading assets, the revenue earned on the sale of such NFTs would be subjected to VAT and other indirect tax regimes in some countries, unless explicitly exempted.

Written by Ganesh Ramaswamy, Kreston Global Regional Tax Director Asia Pacific, Kreston Rangamani, India. If you would like to speak to a member firm about NFTs, please fill in the form below and we will be in touch.