Editorial: Real taxation of the virtual world
Another turbulent year is behind us and we’re slowly looking ahead to the tax return filing deadline. Most have resigned themselves to the need to tax, for example, Airbnb income. Although, again, it won’t be a huge amount of money in the last year. The less successful some areas of the real world are, the more explosive the virtual market for various crypto-assets (cryptocurrencies, ICOs, NFTs, etc.) and the volume of transactions taking place there.
The loyal reader of our regular Tax and Legal News shouldn’t be surprised to learn that many of these transactions are likely to be taxable. Although we don’t have any specific legislation or binding tax administration interpretation, at least among the professional public there’s a prevailing view that any exchange of cryptocurrency constitutes taxable income. This is based primarily on the classification of cryptocurrency as any other asset. This includes the exchange of cryptocurrency for a fiat currency (CZK, USD, EUR...), but also the exchange of one cryptocurrency for another. And watch out for the purchase of goods or services with cryptocurrencies (including payment for online content downloaded via the internet) – while this might seem like an expense at first glance, tax-wise it’s very likely the realisation of income from the “sale” of cryptocurrency and subsequent purchase. Again, nothing new and illogical, because according to Czech tax law we tax the exchange by default (apples for pears = two sales and a “settlement”).
Anyone wanting to start blaming our tax administration in the Czech Republic should be reminded that a similar approach (also without robust local legislation) is applied in most foreign jurisdictions, e.g. see the OECD report. The US IRS has also long warned about the obligation to tax cryptocurrency transactions. Even the individual tax return form (1040) has a box right after the taxpayer’s name and address asking “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency? Yes/No”.
The world is even more colourful for so-called “miners”, for whom, in many cases, due to the consistency of this activity carried out for profit, it can be business income, which, in addition to tax, will also be subject to not insignificant insurance contributions.
But it didn’t just stop at cryptocurrencies. The year 2021 was, among other things, marked by the boom in non-fungible tokens (NFTs). In short, unlike cryptocurrencies (where one bitcoin can be generically exchanged for another), it is a unique digital asset based on a public blockchain with confirmation of asset ownership (e.g. a digital image, a collector’s card or an item from a game). According to the first published estimates, this market grew to $44 billion last year. And right at the beginning of the year, optimistic tax headlines began to appear “NFT – investors owe billions in taxes…”.
How's that? It all stems from the standard exchange taxation outlined above. Buying an NFT for cryptocurrency = taxable transaction, exchanging an NFT for an NFT = taxable transaction, selling an NFT for anything = taxable transaction. In addition to the relatively simple answer to the question of whether to tax (yes), a number of related questions arise, such as how to determine the acquisition price of “sold” cryptocurrency (FIFO?), the (im)possibility of offsetting gains and losses from various crypto-transactions, withholding tax paid by the “author” of the NFT for payments for its use, how to tax the “rental of (virtual) real estate” in the metaverse, VAT implications, and many others.
But to end on a positive note, it all fits in very nicely with the government’s stated concept of not raising taxes. There is no need to raise or reintroduce anything, just impose tax.
Final note: In the Czech Republic, the tax liability cannot be paid in cryptocurrency yet, but only in CZK (so don’t forget to tax the necessary exchange from cryptocurrency or NFT sales next year).