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Tax Tasks: Mitigating Liability in a Potential Metaverse Tax

The metaverse continues to be one of the hottest topics in the tech world, with projections that it could become an $800 billion market by 2024. As virtual worlds and experiences powered by the metaverse grow in popularity and economic significance, governments will grow eager to tax the purchases and income derived from metaverse business activities.

Technological bottlenecks, outdated regulations, and the esoteric nature of the metaverse combine to create confusion and a lack of clear guidance on whether, which, when, and how much metaverse transactions will be taxed. The Organization for Economic Cooperation and Development (OECD) has already begun exploring the feasibility of creating a common crypto tax framework that could generate consensus among jurisdictions. Such international accord seems destined for a protracted process. In the meantime, individual countries continue to take divergent tax positions, classifying assets in different ways and applying different tax treatments to transactions. While it is widely expected the US’s Internal Revenue Service and its counterparts in other countries will claim their share of the profits this new technology enables. They just need to determine if existing tax frameworks can be properly applied to the metaverse’s unique digital ecosystems or whether this new economic activity must be formulated.

The metaverse already promises tremendous economic opportunities across industries like gaming, social media, retail, and more. Major players like Meta are investing billions to build out their metaverse offerings. With so much revenue at stake, it’s no surprise that tax planners, CFOs, and legal experts are exploring strategies for companies to potentially minimize their tax obligations related to the metaverse.

Businesses aiming to commercialize the metaverse and their advisors should explore creative and legally compliant tax strategies to maximize the benefits and minimize the tax liabilities that come with operating in the metaverse’s decentralized digital environment.

The Bumpy Road to Taxing Digital Transactions

Metaverse developers and platforms allow users to purchase virtual plots of land. So, should the new owner expect to pay property taxes? Other metaverse businesses allow us to dress our avatars in designer fashions, so will be charged sales taxes? If gamers buy a flying mansion to explore the metaverse, will a luxury tax be tacked on? All these digital assets have the potential to bring real-world value, but who gets to tax them?

How do you even value a virtual item like a dragon mount or a pair of digital Faragamos? Do taxes get assessed when you earn revenue from selling your high-end kicks and your trusty, fire-breathing steed, or only once you cash out the proceeds? And where does jurisdiction come in? If the metaverse transcends borders, who gets to tax that virtual concert ticket you just bought? These are just some of the taxation vexations facing policymakers:

Jurisdiction – The metaverse raises fundamental questions related to geographical authority. Consider pop singer Ariana Grande’s multi-day virtual “tour” in October 2021. This show was broadcast on the Fortnite platform and watched by 78 million fee-paying customers around the world. It is estimated that Grande grossed more than 20 million from the performance, including merchandise sales. There is confusion pertaining to which authority had the right to tax Grande – the location where she performed, the country in which she is a tax resident, the location of the majority of the audience, or some combination of these jurisdictions.
Tax Structure – The type of tax that should apply to different virtual transactions and activities presents an additional challenge. For instance, when someone purchases a piece of NFT real estate in the metaverse using cryptocurrency, should this be treated as a value-added sale or a barter transaction? Should it trigger income or capital gains tax? There are already clear indications that capital gains tax will apply when metaverse assets like virtual land are sold for a profit or rented out to generate income, similar to traditional real estate transactions.

Deductions and Exemptions – Carving out exceptions, exemptions, and deductions for metaverse taxes would be a tightrope walk as the US would have to define virtual goods. Unlike the gas fees associated with real-world cryptocurrency transactions, the value of virtual items and experiences can be subjective and fluid. Is a virtual Gucci bag a luxury item or just a line of code? Should a user creating art in the metaverse be taxed like a professional artist? If a metaverse platform itself sells or rents items, should it, its customers, or both be taxed?

Metaverse Tax Mitigation

The metaverse’s evolution into business, leisure, and social activities presents a new frontier for tactical, legal, and ethical tax mitigation that companies should explore carefully. An experienced Web3 and transactional attorney can help metaverse companies plan for potential US taxation of these platforms by leveraging their expertise in tax, digital asset, and international law.

One way attorneys can help is by advising on the strategic structuring of NFT transactions across various jurisdictions. Given the immaturity of metaverse-specific tax regulations, companies have an opportunity to exploit favorable tax treatments. For instance, conducting the sale or transfer of NFTs in jurisdictions with no capital gains tax or reduced rates can significantly minimize tax liability. This involves identifying and taking advantage of regions that offer generous exemptions or specific tax incentives for digital transactions.

An attorney knowledgeable in the space can advise on strategically locating digital assets, intellectual property, or revenue-generating activities in jurisdictions that allow the greatest leverage of tax credits, exemptions, or preferential regimes that may apply to certain metaverse-related transactions or business models. They can ensure proper tax compliance and reporting for metaverse activities. By accurately characterizing various transactions and acting as custodians for robust documentation and recordkeeping processes attorneys can support tax positions and successfully defend against potential audits and regulatory challenges.

Finally, a Web3 attorney can minimize the risk association with operating in an industry lacking a defined regulatory framework. They will stay abreast of evolving regulations and advise on how to align business operations with current laws. This includes monitoring developments in tax legislation, engaging with policymakers, and participating in industry forums to anticipate changes that could impact taxation.

Responsible gaming lawyers keep ethical considerations at the forefront. They ensure that companies do not exploit regulatory gaps to the detriment of vulnerable users. By promoting ethical business practices, attorneys help companies build trust with their customers and stakeholders, demonstrating that player well-being is a priority.

In summary, a Web3 and transactional attorney plays a pivotal role in helping companies navigate the complex and evolving landscape of metaverse taxation. By advising on strategic transaction structuring, exploiting jurisdictional benefits, ensuring compliance, and promoting ethical practices, these legal experts enable companies to thrive in the digital realm while minimizing tax liabilities. As the metaverse continues to grow, partnering with knowledgeable attorneys will be crucial for any company looking to succeed in this innovative space.

Gamma Law is a premier specialty law firm supporting select clients in complex and cutting-edge business sectors. We provide our clients with the legal counsel and representation they need to succeed in dynamic business environments, push the boundaries of innovation, and achieve their business objectives, both in the U.S. and internationally. Contact us today to discuss your business needs.