The Australian Taxation Office (ATO) has released guidance on the tax treatment of non-fungible tokens, or NFTs.
An NFT is a unit of data stored on a digital ledger which demonstrates the ownership of an asset. The NFT can demonstrate ownership of a tangible asset or an intangible asset such as a digital painting, audio or other digital file. The NFT is ‘non-fungible’ as it is unique and cannot be replaced or exchanged for the same thing. For example, if you compose and record a song and use an NFT to register your ownership then you become the official owner of that asset. Where stored on an appropriate blockchain no one can modify or change the NFT and thus the ownership of the related asset.
The most well-known NFT to date is the body of work known as “EVERYDAYS: THE FIRST 5000 DAYS” by digital artist Mike Winklemann otherwise known as Beeple. Auction house Christie’s brokered the sale of the digital work in March 2021 for a staggering US$69.3million. Whilst anyone can view the digital art created by Beeple the ownership, according to the NFT, remains with the buyer.
How are NFTs treated for Tax Purposes?
NFTs store additional information which make them work differently from standard coins. However, in terms of tax treatment the ATO has stated that NFTs follow the same principles as cryptocurrencies. This means that the default position will be that the asset is a capital gains tax (CGT) asset and the disposal will be subject to CGT.
This default position may change depending on your use of the asset and your intention for holding or disposing the asset. As a result, the asset may be:
held and subsequently taxed as trading stock; or
deemed to form part of a business or commercial transaction with an intention of profit.
We have discussed this treatment of cryptocurrency in further detail here and here.
What if your NFT forms part of a Smart Contract?
Where NFTs form part of a smart contract the rights provided under that contract may result in the asset having both revenue and capital elements. The Commissioner provides a helpful example of this:
Kim, a professional artist, paints a portrait of a famous Australian and decides to create ten NFTs each of which provides the right to one, four-hour, exclusive viewing of the portrait in a private viewing room in Kim’s gallery each year for up to 20 people. On subsequent transfers of the NFTs to new owners, the smart contract allocates part of the proceeds to Kim as a commission.
Kim retains all other rights associated with the painting.
The proceeds of the initial sale would be assessable as business income to Kim. While Kim remained in business any commissions received would also be business income. If Kim ceased carrying on the business the commissions would still be assessable as ordinary income to Kim.
The treatment in the hands of the owners would depend on how they made use of the NFT.
Where a smart contract is used in relation to the NFT careful review of the contract terms should be undertaken to ensure the correct tax treatment is applied.
Does the Personal Use Exemption Apply?
“Personal use assets” are CGT assets acquired for less than $10,000 that are used or kept for personal use or enjoyment. The disposal of these assets may be exempt from CGT.
The Commissioner acknowledged in Tax Determination 2014/26 that where Bitcoin is kept or used for personal use and consumption, such as online purchases of clothing or music, then it may fall within this exemption. However, a number of private binding rulings issued by the Commissioner in relation to specific taxpayers (available to view on the ATO’s public register) show that proving the intention of personal use in recent years has become problematic.
In the context of NFTs the same exemption may apply. If we revisit the ATO’s example above and imagine that one of the NFTs is acquired by Jo for $5,000. Jo is the relative of the subject of the portrait and uses the private viewing to celebrate her birthday with her close family and friends. For Jo the NFT would be a personal use asset.
By contrast, Osman acquires one of the NFTs also for $5,000. Osman runs an art tour business and uses the private viewing as part of a tour. Attendees pay Osman to participate in the tour, which includes the viewing of the painting by Kim. Whilst it was acquired for less than $10,000 the asset would not be a personal use asset as it is used for business purposes.
Careful consideration should be given to ensure that the asset is truly acquired and held for personal use and this will involve a case by case analysis rather than a blanket application of the rule. Contemporaneous evidence to substantiate the position taken should be documented.
What should you do?
Holders of and investors in NFTs and their advisors need to ascertain how such NFTs will be treated for tax purposes. Whilst NFT specific guidance is limited, taxpayers should look to the tax treatment of cryptocurrency for direction. Where uncertainty arises guidance from a specialist in this area is recommended.
For more information on the taxation of NFTs or for general tax advice, please contact:
Laura Spencer
Senior Associate
M 0436 436 718 | T +61 3 9611 0110
E: lspencer@sladen.com.au
Daniel Smedley
Principal | Accredited Specialist in Tax Law
M +61 411 319 327| T +61 3 9611 0105
E: dsmedley@sladen.com.au
