Taxation of Non-Fungible Tokens in Germany

Non-fungible tokens (NFTs) are enjoying great popularity around the world. What NFTs are exactly, we have described here. In this article, we explore the question of how NFTs should be classified for tax purposes.

NFTs, on the other hand, are characterized by the fact that they are digital goods that are not interchangeable at will (non-fungible). In the case of artwork NFTs, the tokens depict an artistic image of which there is only one in existence. While it is technically possible to replicate the digital asset an infinite number of times, a certificate of authenticity stored on the blockchain ensures the singularity of the NFT.

But how are NFTs treated from a tax perspective? Due to the novelty of the topic, binding tax law guidelines are still lacking. Nevertheless, the following initial considerations can be made:

According to the tax assessment, there are two different ways to produce NFTs (minting), each of which entails distinct tax consequences.

• In the case of the production of digital works of art, income from an artistic activity is obvious. The prerequisite here is that the taxpayer performs a creative activity that involves a certain level of design.
• In addition, however, a commercial classification as a type of income is also conceivable. Among other things, the tax office assumes a commercial activity in the case of self-distribution of art in online trade. However, such a classification entails several disadvantages for the taxpayer, one of which is that trade tax must also be paid.

The specific individual case must be considered to determine which of the two types of income is present. Since neither the courts have issued a ruling nor has the German Federal Ministry of Finance (BMF) released a clarifying letter on this, there is a great deal of legal uncertainty for manufacturers of NFTs in many cases. In order to eliminate this, it is advisable to have experienced experts in the field of crypto tax law assess the specific facts.

The same considerations apply to manufactured NFT characters in the context of NFT computer games. If there is creative activity and the figure embodies a certain level of design, income from an artistic activity may accrue when such NFT characters are sold.

The boundaries of commercial activity are, however, quickly exceeded here as well. Depending on the individual case, commercial income may exist. To be on the safe side, a tax audit from a lawyer is advisable.

While many private crypto investors do not make NFTs themselves, they do buy and sell NFTs and make profits. The question of taxation also arises for this group of persons.

The taxation of trading in NFTs has still yet to be clarified either by the tax authorities or by case law. In particular, it is unclear when trading in NFTs should be classified as commercial for the purposes of income tax law. The distinction as a commercial activity is of paramount relevance for the degree of tax liability:

• As a benchmark for a commercial classification of NFT trading, it seems plausible to use the delimitation criteria defined for securities and foreign exchange trading developed thus far by the German Federal Fiscal Court (Bundesfinanzhof, BFH) and to apply the principles on which the German Federal Ministry of Finance (Bundesfinanzministerium, BMF) also relies in its draft letter on the taxation of cryptocurrencies published in 2021.
• However, it is not certain that the above principles can actually be applied to this form of NFTs. This is because, in its considerations, the German Federal Ministry of Finance only refers to fungible tokens, i.e. exchangeable cryptocurrencies, such as ETH and bitcoins. NFTs could also be treated similar to classic works of art, so that NFT investors could quite quickly be affixed with the stamp of commerciality for tax purposes, similar to eBay sellers. However, there is much to be said for treating NFTs in the same manner as conventional cryptocurrencies with regard to the question of the commercial nature of trading, i.e. applying the BMF draft to NFTs accordingly.
• Based on these principles, high requirements are placed on the existence of commercial activity. This requires activity as a trader or proceedings in a manner typical of a bank.
• According to the principles developed by the highest courts, merely a high number of NFTs sold is not sufficient for an affirmation of commercial activity on a regular basis.
• It is true that the aspect of the extent to which NFTs were bought and sold must be included. However, other points are also included in the overall picture. Specific indications of commercial trading, in addition to the scope of business, include, for example, maintaining an office or a professional organization to conduct business, exploiting a market by using specialized professional experience or knowledge, professional distribution or offering NFTs to a broad public.

The assessment of whether the sale of NFTs qualifies as commercial under these criteria is determined on a case-by-case basis.

If crypto investors are classified as commercial NFT traders by the tax authorities, this will have far-reaching tax consequences.

• On one hand, additional trade tax is then incurred. This is usually falls between 7 and approx. 15 percent.
• Secondly, any profit is taxed regardless of a holding period. Commercial NFT sellers thus have no opportunity to make tax-free profits. In return, they can offset losses more easily.

As a rule, you do not have to worry about value added tax when trading fungible tokens such as Ether, Polygon, ETC or BTC, as, fundamentally, no tax must be paid.

Due to the uniqueness of NFTs, however, using them as a means of payment has so far not been an option. Therefore, there are good reasons for subjecting trade in NFTs to VAT.

Read more about NFTs and VAT here.

Commercial NFT traders should also be aware of the Money Laundering Act and the due diligence, risk management and other obligations contained therein. This is because such crypto traders could fall within the scope of the MLA as "traders in goods." Even the most frivolous violations of the provisions of the Money Laundering Act are subject to heavy fines.