Non fungible tokens- Unleashing the unknown

Biren Vyas,
Karishma Punjabi
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Non-fungible token's (NFTs), crypto-currencies, blockchain technology - some of the top spoken terms by everyone in the world, in recent times. Digitalization would be the primary backbone of the economy in the times to come. So, let's understand what do these terms essentially mean and the various intricacies involved including the ambiguity around the indirect tax related implications.

Understanding NFTs:

NFTs, as the name suggests, are non-fungible in nature & cannot be used as currency. Each NFT is a unique digital asset. NFTs are primarily linked to the ownership of unique digital or physical goods. Often, the term NFT is treated at an equal level with crypto currencies, however, there is a stark difference between the two terms and the mechanism in which they function. NFTs are digital art or modern-day collectibles that cannot be replaced. What also differentiates them from crypto currencies is the extra information they carry, as compared to crypto-currencies, which could be construed as money (though crypto currencies are not legalized tender in India currently). NFTs can be sold and purchased online and such trade primarily grants digital evidence of ownership of any item.

NFTs can be a painting, an image, a popular tweet by a celebrity, an audio clip, a video, graphic image, a sketch, etc. Any item worth an investment could be considered as a NFT, sold on a digital platform. Hence, practically, there is no limit to one's imagination as to what can be construed as a NFT.

Value of NFTs:

Recent trends in the NFT market evidences that digital ownership of an artwork, image, etc., comes with a whopping high monetary value attached to it. Yet, many still wonder how tokens on the internet could have a monetary value at all - especially when majority of them just represent digital ownership of an online image or an animation that one could, in principle, download a copy of for free.

Primarily, scarcity and craze of enthusiasts to keep up with the trends drives the demand and the monetary value attached to such NFTs.

NFTs in the Indian context:

In the Indian context, various artists, platform owners and auctioneers are hopeful that NFTs would be the next horizon of Indian art, especially in the wake of COVID-19. In India, the party has just begun, where celebrities are launching their exclusive NFTs. The primary reason why NFTs are gaining impetus amongst the Indian creators is the elimination of the middleman when it comes to monetization. Creators are required to pay a listing fee, termed as 'gas fee' to the NFT trading platforms.

Another reason why NFTs are gaining the buzz in the Indian market, is the royalty paid to the owner on each secondary sale of NFT. This gives a lot of impetus to budding artists to showcase their talent and earn revenue on primary sale of their artwork, at the same time, giving them an opportunity to earn passive income in the name of royalty on each subsequent secondary sale of their artwork.

However, NFTs are largely unregulated. One can create and sell a NFT and there is no guarantee of its value. There is a huge scope of insider trading and further losses can stack up if the hype and craze dies down. Simultaneously, taxation on NFTs is an ambiguous area, in the absence of any clarity on the tax implications.

NFTs and indirect taxation:

There are various aspects to be considered when it comes to indirect tax implications on a transaction involving NFTs - sale of NFTs, payment of 'gas fee' by the creator of NFTs to the platform owners, payment of royalty on subsequent sale.

Sale of NFT's

NFT, merely being a digital token, showcases the ownership of digital assets. It is of utmost importance to evaluate if sale of such NFTs qualifies to be a supply for the purposes of the Goods & Services Tax (GST) law. For which, it is also relevant to identify if such sale is in the course or furtherance of business. More so, if it qualifies as a supply, then, how should one classify the nature of such NFT.

Rationally speaking, the classification of NFTs would primarily depend on the underlying asset it represents. Hence, it is important to determine the nature of the underlying asset i.e., does it fall within the ambit of goods or services or securities or actionable claims.

If the underlying asset is an artwork, painting, then, in that event, the underlying assets may qualify to be 'goods', however, such goods being digital and in the form of NFT, would clearly not be tangible. Also, in sale of NFT, the ownership passes on to the buyer, however, it is a digital ownership and there is no sale of tangible goods to the buyer. Given, the above, the determination of classification of such sale and place of supply would also play an important role.

Another aspect which is required to be evaluated is whether NFTs, essentially being music, movies, digital content being supplied automatically through the internet with minimal human intervention, could also be classified as online information and database access retrieval (OIDAR) services. In which event, if the creator of the artwork, NFT, is a person located outside India, then, provision of such OIDAR services to individuals, not registered for GST, would become taxable in India. The burden of collection and payment of taxes would lie on the creator of the NFT. It is also pertinent to evaluate the concept of intermediary in the Indian GST context.

It is amply clear that the tax implications would have to be evaluated basis the nature of the NFT being sold to the buyer. Hence, each sale would have to be independently examined to assess the indirect tax implications based on the documentation, paperwork, legal aspects, etc.

Payment of gas fee to the platform operators:

Payment of gas fees by the creators to the platform operators for listing of their NFTs, being in the nature of supply of services, would likely attract GST on such payments.

Payment of royalty on subsequent sale:

Currently, there is no clarity on the mechanism for enabling royalty payments to the creators on subsequent sale of NFTs. However, royalty would be agreed as a percentage of the sale value, which would essentially give an impetus to the creators of NFT. Such royalty, being in relation to the NFT i.e., an underlying asset, would have to be evaluated to determine the tax implications on subsequent sale.

Way forward:

Though NFT is the buzzword of the town, it comes with its own basket of complications and intricacies that needs to be analyzed, evaluated and thought upon on a holistic basis.

It is time that a regulatory authority be formed to regulate and streamline the transaction in NFTs for all the parties to the transaction - creators, buyers and the platform operators. The regulatory authority should release or recommend guidelines, clarifications and circulars addressing the mechanism, issues and intricacies related to valuation, legality, tax including both from a direct and indirect tax perspective.

From an indirect tax perspective, there is a lot of ambiguity and questions around the GST implications on NFTs. Aspects such as such transactions being in the course or furtherance of business, classification into goods or services, whether such transactions would qualify as OIDAR services, valuation to be adopted for the purposes of charging GST, applicable GST rate, input tax credit on such transactions, import related implications are part of the larger bouquet of intricacies from an indirect tax perspective. Thus, it is the need of the hour to unleash such unknown aspects around the current sensation globally.

This article was originally published on Taxmann.