Earlier this month, Washington released an Interim Guidance Statement on the taxability of non-fungible tokens (NFTs). In short, the Washington Department of Revenue (DOR) suggested that certain types of NFTs would be subject to sales and use tax under existing rules applicable to digital goods and would also be subject to their business and occupancy (B&O) tax.
In its guidance, Washington did a decent job of explaining the underlying technology. Like most, it jumbles together the concept of an NFT and the digital asset the NFT represents. It’s the token that allows the asset to be traded on blockchain, but it’s the asset itself that stands behind the token (the good or service it represents) that has perceived value.
But what does Washington’s guidance potentially mean for the NFT industry? Here are some key things to keep in mind as NFT marketplaces consider their next steps.
- It’s clear that Washington is moving deliberately and obtaining insight from experts and other stakeholders along the way. This approach seems to stand in contrast to territories/states like Puerto Rico and Pennsylvania; both of which revised existing guidance to indicate that NFTs were taxable, with hardly any context at all. Additional published guidance from Washington is likely in the offing.
- At least to start, Washington has carved out some straight-forward scenarios, addressing digital assets that have the look and feel of “traditional” digital equivalents to tangible personal property. NFT sellers should know that many states have laws on the books that expressly tax digital equivalents to tangible property and that it’s possible that a good chunk of those states will look to apply those rules to similar NFTs.
- Washington didn’t fully articulate the role “smart contracts” play in transaction. Smart contracts are scripts of code that contain all sorts of details of what the NFT represents. It essentially creates the NFT by spelling out what it represents, what it might eventually unlock and whether the creator participates in the proceeds of any future transactions. Recognizing the role of smart contracts is important as Washington and other states move forward with additional guidance.
- The DOR suggests that “in some cases” consideration for NFTs is paid in cryptocurrency. Truth be told, it’s essentially all cases. NFTs are traded using the Ethereum cryptocurrency and states should recognize this in any new rules.
- The DOR specifies that payments to NFT creators earned in any subsequent transfers are characterized as “royalties,” meaning they are subject to B&O tax but not sales tax. While characterizing these payments as royalties is by no means illogical, it’s interesting to note that they are not considered royalties for federal tax purposes.
- Washington makes clear that its existing sourcing rules for digital products will apply to NFTs. Under those rules, tax is applied based on the location of their customer/purchaser if known to the seller at the time of sale, contained in their existing business records or provided by the buyer at the time of sale. If the location of the buyer is not known, then the tax applies based on where the item was first made available by the seller. This last-ditch “origin sourcing” possibility may come into play often given the anonymity permitted by blockchain.
- The guidance talks a lot about marketplaces and marketplace facilitator rules. Across the country, most states (including Washington) have rules on the books that hold marketplace facilitators responsible for collecting and remitting sales tax for transactions taking place over their platform. While the document says that NFT marketplaces may be responsible for registering to collect Washington tax, and while one of the examples talks about an NFT marketplace, it did not fully articulate an example showing exactly where and when the marketplace would be liable. For example, it would have been helpful to understand how the sourcing rules might apply when the marketplace does not know the identity and location of the buyer. Is tax based on the location of the marketplace seller or the marketplace facilitator?
There is a lot of public awareness around blockchain, cryptocurrency and NFTs these days, and now that Washington has opened the floodgates by issuing direct guidance, it’s likely that other states will follow. It likewise seems probable other states with existing laws on the books taxing digital products will say that those laws equally apply to NFTs and will hold NFT marketplaces responsible for the requisite tax collection and remittance. Whether these new states take the time to understand the technology and work with impacted industry players to create thoughtful, comprehensive and most importantly manageable compliance requirements remains an open question. Either way, the industry needs to be ready.
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