Under the laws of most jurisdictions, NFTs will be regarded as intellectual property assets, similar to trademarks, patents, and copyrighted materials. Therefore, the sale of NFTs is usually an event leading to taxation with capital gains taxes. For example, if you purchase an NFT for EUR 1000 and sell it for EUR 1500, your net gain of EUR 500 may be subject to capital gains taxes in the jurisdiction where you are based. It is worth mentioning that the so-called gas fees (fees paid by buyers of NFTs in order to process their purchase transactions) constitute a business expense for capital gains tax purposes.
The purchase of NFTs may also lead to the imposition of capital gains taxes. This will be the case when NFTs are purchased by using cryptocurrencies. Since cryptocurrencies are normally considered assets, the purchase of NFTs by using cryptocurrencies will be deemed to be a sale of the cryptocurrencies for capital gains tax purposes. As a result, capital gains tax may be levied on the difference between the purchase price of the cryptocurrencies used for buying the NFTs and the value of the cryptocurrencies at the time of buying the NFTs.
NFT businesses willing to reduce or completely eliminate their tax burden may consider the relocation to jurisdictions having no or low capital gains taxes. Otherwise, they may need to give a big chunk of their profits to the taxman. This is particularly true for countries with high capital gains taxes, such as Denmark (42%), Finland (34%), France (34%), Norway (31,7%), the Netherlands (31%), Sweden (30%), Germany (26%), Spain (26%), Italy (26%), and the United Kingdom (20%). Due to the large value of some NFTs, the applicable capital gains tax may amount to millions of euros. By way of illustration, the NFT “the Merge” is valued at more than EUR 80,000,000. If your NFT business purchases that token and sells it for EUR 160,000,000 in Denmark, you will need to pay capital gains taxes amounting to EUR 33,600,000. This is just for one NFTs.
Relocation to low or no tax jurisdictions..?
To ensure that your NFT business falls within the scope of a low or no tax jurisdiction, the management team of the business needs to actually relocate to that jurisdiction. This is because the effective place of the management of a company is usually one of the important criteria for establishing tax residency. If you are an owner and a director of an NFT business, but you do not wish to relocate to a country with a better taxation regime, you can incorporate a new company in such a country and appoint a director who resides there. Please note that, if you continue informally managing the new company, the company may, for tax purposes, still be regarded as residing in the jurisdiction of your residence.
After you make sure that the management team of your company is based in a low or no tax jurisdiction, you may wish to establish a real office there which will prove to the tax authorities that your business is not merely a shell company, i.e., a company that exists merely on paper and has no office and no employees. Although shell companies can be used for legitimate business purposes, it may be difficult to prove that such companies are actual tax residents of the countries where they are registered. The establishment of corporate tax residence generally requires proving economic substance, i.e., the presence of assets, employees, offices, and managers in the relevant jurisdiction.
How to avoid taxes?
If you would like to establish your NFT business in a country that is not known for being a shelter for shell companies, you can consider registering it in low tax jurisdictions. These jurisdictions charge low taxes, but may have better locations than no tax jurisdictions which are usually on remote islands or far from large population centers. Furthermore, low tax countries often offer qualified workforce and excellent business and transport infrastructure.
For example: Bulgaria, Hong Kong, Singapore or Dubai are good options!
The strategies for tax optimization of capital gains tax for NFT businesses vary depending on the jurisdiction concerned. Nevertheless, we will provide some general advice which applies to most jurisdictions.
First, if you decide to purchase NFTs by using cryptocurrencies, you may wish to use cryptocurrencies which do not fluctuate much. You can, for instance, use cryptocurrencies (also known as stable coins) which are designed to be pegged to the fiat money of your jurisdiction. This will ensure that there is not going to be fluctuation of the cryptocurrencies used for buying NFTs. As mentioned in the beginning of this article, such fluctuations may lead to capital gains taxes as cryptocurrencies are considered assets and the purchase of NFTs with cryptocurrencies is deemed to be a taxable event.
Second, if the rate of capital gains tax in your jurisdiction is not fixed, but progressive (i.e., it includes different tax brackets), you can sell your NFTs in a tax year in which the sale will be subject to the lowest tax bracket. For example, (i) if the rate of the capital gains tax in your country varies between 15% and 45% and (ii) you see that the sale of the NFTs in 2022 will fall within the 45% bracket because you generated a high amount of capital gains during that year, you may wish to sell the NFTs in 2023 for which you expect the proceeds of the sale to fall within the scope of the lowest tax bracket of 15%. This will save you 30% of capital gains tax.
Third, if the laws of your jurisdiction permit it, you may wish to donate some of your NFTs to charities. For example, if you purchase an NFT for EUR 1,000 and its price later raises to EUR 5,000, you may need to pay capital gains tax on the difference (EUR 4,000). Instead of paying capital gains tax, you may donate the NFT to a qualifying charity and get a deduction to your tax return. In some cases, such deduction may amount to 100% of the donated amount (i.e., EUR 5,000). The tax deduction may put you in a better financial position than if you pay the capital gains tax and get the remaining capital gains.
Fourth, if you plan to sell an NFT that has generated substantial capital gains in a given year, you may decrease the capital gains that you need to pay during that year by also selling an NFT that has generated substantial capital losses. The losses will offset your gains and, as a result, you will not need to pay capital gains taxes.
Fifth, if you expect to sell one or more of your NFTs in a few years at a high price, you may before that regularly sell your NFTs that generate losses. Afterwards, you can carry forward the losses to the year in which you will sell the highly priced NFTs. The losses will offset the gains and will lead to zero capital gains taxation. This approach is also known as “tax-loss harvesting.”
NFTs may generate tremendous profits. The governments, of course, try to take their fair share of those profits. The taxation of NFTs is primarily in the form of capital gains tax. The tax optimization strategies which NFT businesses may use can be broadly divided into two categories, namely, (i) relocation for tax purposes and (ii) other tax optimization strategies. The first category is the most effective way to eliminate or substantially reduce your capital gains taxes. However, it requires the relocation of your business and its management. The second category includes various well-known legal methods which allow taxpayers, if certain conditions are met, to optimize their capital gains taxes.
BUT each case is different, contact your crypto tax lawyer at: info@dehoon-dhp.com !!!
