An NFT, or non-fungible token, is a unique unit of data stored using distributed ledger technology that represents ownership of a specific item. We discussed NFTs in a previous article, in which we expressed our legal opinion according to which entities trading in NFTs are not obligated parties within the meaning of Act No. 297/2008 Coll. on the Prevention of Money Laundering and Terrorist Financing and on Amendments to Certain Acts. In this article, we will explain how and whether it is necessary to tax income from NFTs, what other obligations exist for NFT owners, and what the penalties are for non-compliance.
As the popularity of NFTs grows, so does the number of entities trading in them, whether by issuing their own NFTs or by buying and selling existing ones. When purchasing an NFT with the intention of reselling it, it is important to know that such a sale is considered income that must be taxed in accordance with applicable tax regulations. In our legal opinion, such income can be classified as income from other independent gainful activities—that is, not income derived from business or employment—and the individual is required to report it in the tax return they file annually. Specifically, we believe that the aforementioned income obtained from the sale of NFTs could be classified as income arising from the transfer of rights to intellectual property under Section 6(2)(a) of Act No. 595/2003 Coll. on Income Tax, since intellectual property is, in many cases, the essence of NFTs.
It is therefore necessary to state in the tax return what income was earned from the sale of NFTs during the relevant tax period, from which the tax itself can then be determined relatively easily. In this case, we are referring to income tax, which is currently set at 19% or 25% for individuals, with these rates representing progressive taxation, where the lower rate applies to the portion of the tax base not exceeding 176.8 times the subsistence minimum (the subsistence minimum is set at €218.06 per adult individual until June 30, 2022; this means that if an individual’s total income does not exceed €40,768.00, their income will be taxed at the lower rate. Conversely, income from the portion of the tax base exceeding this amount is taxed at a higher rate).
A different tax rate applies to corporate income tax, which is set at 15% or 21%, again depending on the amount of income earned during the relevant tax period. For reference, we note that legal entities pay a 15% income tax rate if their income for the relevant tax period does not exceed €49,790.00—if a legal entity earns a higher income, it must tax such income at a higher rate.
Taxation at these rates may seem relatively high, as it does not in any way take into account the specific nature, uniqueness, and technological advancements related to NFTs, treating such income as any other “ordinary” income, which in many cases may even lead, just as with cryptocurrencies, to various attempts at tax optimization that may not always be legal. Failure to pay or declare taxes in the correct amount is a criminal offense, and it is important to remember that the current Criminal Code does not distinguish between the sources of income in any way; that is, it does not matter whether you fail to declare income from business activities or income from the sale of NFTs. In both cases, you may commit an act that will be classified as a criminal offense.
However, just as with cryptocurrencies, the legislation in this area is still in its infancy, and we expect that certain legislative changes will be adopted in the future—whether at the European Union or national level—that will regulate not only the taxation of NFTs.
A more complex situation arises, however, if you decide to issue your own NFTs. The actual issuance of NFTs is currently a relatively complex process under Slovak law, and there are not enough entities on the market providing comprehensive advisory services in this area; therefore, you may encounter several issues during this process, not just related to taxation. It is important to note, however, that when a business issues new NFTs, it is crucial to examine the total revenue not only from an income tax perspective but also from a value-added tax (VAT) perspective. Not every entrepreneur is required to register for value-added tax; however, this registration obligation arises when revenue (turnover) reaches €49,790.00 over the last 12 consecutive calendar months. However, this does not preclude an entrepreneur from voluntarily registering for VAT even before reaching this amount, for example, if such revenue is anticipated in advance. Once this amount is reached, however, VAT registration is mandatory. For entities that decide to issue new NFTs, it would therefore be important to also take into account the total revenue generated from this activity so that VAT can subsequently be correctly calculated and paid. Incorrect calculation or failure to pay would expose such an entity to the risk that its actions could be classified as a criminal offense.
Under current Slovak law (de lege lata), no legal regulation contains a definition of NFTs. The absence of such a definition can cause several significant problems in practice, including in relation to proper taxation. It is therefore important to address whether NFTs can be considered virtual currency or not. If we were to determine that an NFT is a virtual currency, the above interpretation regarding taxation would be incorrect, as we would then have to address the taxation of virtual currencies.
To assess whether an NFT is a virtual currency, it is necessary to establish what is actually meant by “virtual currency.” The 5th AML Directive defines virtual currency as a digital store of value that is not issued or guaranteed by a central bank or public authority, is not necessarily linked to a currency established in accordance with the law, and does not have the legal status of currency or money, but is accepted by natural or legal persons as a medium of exchange that can be electronically transferred, stored, and traded.
A similar definition is also contained in Act No. 297/2008 Coll. on the Prevention of Money Laundering and the Financing of Terrorism and on Amendments to Certain Acts. In this context, we also refer to our previous article, in which we discussed in more detail whether entities operating in the NFT sector can be considered obligated persons within the meaning of the aforementioned Act.
However, the Income Tax Act does not contain a specific definition of virtual currency; it merely defines what constitutes the sale of virtual currency. According to Section 2(ai) of the Income Tax Act, the sale of virtual currency means the exchange of virtual currency for property, the exchange of virtual currency for another virtual currency, the exchange of virtual currency for the provision of a service, or the transfer of virtual currency for consideration.
The absence of a legal definition causes significant problems in practice. However, the Methodological Guideline of the Ministry of Finance of the Slovak Republic No. MF/10386/2018-721 on the taxation of virtual currencies can serve as a guide. According to the aforementioned guidance, virtual currency is understood to be a digital store of value that is neither issued nor guaranteed by a central bank or public authority, nor is it necessarily linked to legal tender; it does not have the legal status of currency or money, but is accepted by certain natural or legal persons as a means of payment and which may be transferred, stored, or traded electronically.
It is necessary to examine this definition in greater detail and assess whether NFTs can also be subsumed under it. Regarding the first part of the definition, it can be stated that this applies to NFTs as well, since NFTs are neither issued nor guaranteed by a central bank or public authority, nor are they necessarily linked to legal tender. At the same time, NFTs do not have the legal status of currency or money. However, we do not agree with the part of the definition that states that it is accepted by certain natural or legal persons as a means of payment and that it can be transferred, stored, or traded electronically. We believe that NFTs can never be considered a means of payment for several reasons. An NFT merely represents a form of authentication of ownership of a specific item, which is the very essence of the NFT itself. This means that, unlike cryptocurrencies, an NFT does not enable direct payment for the provision of services or the delivery of goods.
This can be explained with a simple example. Let’s imagine that we own 1 bitcoin and, at the same time, an NFT—such as a digital image—also worth 1 bitcoin. While we could “pay” with the bitcoin itself—using it as a means of payment in various situations (for example, in various e-shops that accept bitcoin payments)— payment via an NFT may not be possible (in practice, one could only consider so-called barter, i.e., exchanging the item that is the subject of the NFT for another item, whereby the NFT would be transferred, i.e., a specific change of ownership of the NFT would occur).
At the same time, means of payment must be standardized in a certain way; that is, they must be something that is recognized as a means of payment by at least a certain group of people. In practice, in addition to standard currencies, cryptocurrencies or, for example, gold can be considered means of payment (payment with gold is rare in practice but not impossible). However, NFTs do not possess this characteristic, which we again justify by the very nature of NFTs, namely that they serve to authenticate ownership of a specific item. At the same time, means of payment are considered to be items designated by type. Items designated by type are fungible. Money is a typical example of such items. If you lend someone 100 euros, it will suffice for that person to return 100 euros to you. You will not check whether they returned the exact same 100-euro bill that you lent them. Similarly, if they transfer the amount to your bank account instead of giving you cash, you will still consider the obligation fulfilled even though you did not receive back the specific bill you lent. With NFTs, however, we are talking about items that are individually designated, meaning they are irreplaceable and unique. For this reason, they do not meet the above condition and therefore cannot be considered a standardized means of payment.
In our legal opinion, therefore, an NFT does not constitute a virtual currency for tax purposes, and consequently, income derived from the sale of NFTs will not fall under income derived from the sale of virtual currency. However, it is reasonable to expect that in the future, further legislation—whether national or European—will be adopted, providing a specific definition of NFTs and specific methods for taxing income derived from NFTs and their sale.
The fact that NFTs enjoy considerable popularity and represent an opportunity for many to get rich is also evidenced by the fact that, according to the Chainanalysis portal, transactions totaling $44 billion took place in 2021, with the most expensive single transaction reaching as high as 69 million US dollars. While transactions of such magnitude have not yet taken place in Slovakia, and we believe this “record” will not be surpassed in the Slovak market, this in no way diminishes the overall potential that lies behind NFTs. The lack of adequate legal regulation in this area is not just a problem for Slovakia or the European Union as a whole. The United States, for example, also feels the absence of quality legal regulation. As a point of interest, we note that in the U.S., income tax on NFTs can reach up to 37%.
The law firm Hronček & Partners, s. r. o. provides legal advice across a wide range of legal fields, including blockchain, cryptoassets, and NFTs.
