Blockchain: Advice for Regulators to Tackle the Digital Asset Dilemma

With a few jurisdictions already on the record, including Belgium, Spain and Switzerland, and with Puerto Rico and Washington poised to issue official guidance, it seems extraordinarily likely that within a few months a substantial number of states will have issued opinions on the application of sales tax on digital assets transferred on blockchain. With this new technology, states have a unique opportunity to issue thoughtful and comprehensive tax rules that can apply (almost) from its inception. In this blog, we offer some helpful advice to legislators and regulators as they look to create effective tax policies.

Blockchain and sales tax

In the absence of official guidance, the possibility of abuse unquestionably exists. The flexibility offered by blockchain and smart contracts could be used by tax-savvy bad actors to circumvent traditional sales tax requirements as they clearly exist and apply today. For example, the transfer of a token representing the right to obtain a kitchen appliance, should (ultimately) be taxed identically to the sale a kitchen appliance. Given the possibility of abuse, when combined with the notoriety generated by the sale of high-priced assets, legislation and regulation in the digital space is inevitable.

However, before states start writing statutes and rules into this new blank slate, we offer the following words of wisdom.

1. Know what you are regulating. If the topics of blockchain, smart contracts and NFTs feel daunting, consult with the experts. Understand the technology before you start articulating new rules. Tax rules always work best when they reflect business reality as opposed to a regulator’s conception about how businesses operate.
2. Apply all new rules and requirements prospectively. Remember, in the seminal Wayfair decision, states were given the authority to depart from standard physical presence nexus restrictions and apply their sales tax requirements on remote sellers, but only if their tax compliance obligations do not represent an undue burden on interstate commerce. In fact, in the Wayfair decision, the Supreme Court specifically noted that South Dakota was not seeking to apply its economic nexus standard retrospectively. Any state opting to retroactively apply the tax to this new industry is arguably creating an unfair and undue burden on the taxpaying public. Asking a seller or a marketplace to have known they are responsible for sales tax compliance seems facially unjust.
3. Don’t try to shoehorn. Some states have laws on the books as it relates to digital products. Many of the 24 member states of the Streamlined Sales Tax Agreement have definitions for specific digital products and other products transferred electronically, including digital audio works, digital audio-visual works, digital books and digital codes. As explained above, digital assets transferred on the blockchain are not necessarily analogous to “traditional” digital products as we know them today and they are worthy of their own clear rules and requirements.
4. This is likely not a passing fad. It’s possible, if not tempting, to dismiss digital assets as the latest trend. Thinking they are destined to go the way of the Beanie Baby or to analogize the current market for certain digital art as the newest incarnation of the Dutch “Tulip Mania” of the 17th century. However, the flexibility of blockchain and the certainty of smart contracts means that we are likely at the beginning of a new sales channel that doesn’t necessarily replace, but stands alongside traditional brick and mortar and ecommerce channels.

For the most part, sellers and marketplaces stand ready to comply with reasonable and well-articulated sales tax compliance requirements. The key to writing such requirements is rooted in a thoughtful and comprehensive understanding of the industry. Here’s hoping states take a moment and adopt this best practice, before diving headfirst into blockchain, sales tax and digital assets.