NFTs: A Deep Dive into the Revolutionary World of Digital Assets
NFTs: A Deep Dive into the Revolutionary World of Digital Assets
The world is always changing, and we once again find the world asking - is this art? And accountants asking - what the hell do we do with this? Often the world moves faster than accounting law so we have to do our best to keep up and apply current laws to new events, transactions and assets.
NFTs are a great example of this.
In the digital realm, Non-Fungible Tokens (NFTs) have emerged as a groundbreaking concept. These unique digital assets, stored on blockchain technology like Ethereum, have captured widespread attention for their potential to transform the art market, digital collectibles, and the concept of ownership itself. This blog explores the world of NFTs, discussing their characteristics, examples, potential value, and examines how NFTs compare to shares and cryptocurrencies in terms of tax implications.
Understanding NFTs:
These bad boys are unique digital assets that reside on the mystical blockchain, particularly Ethereum. Unlike cryptocurrencies like Bitcoin or Ethereum, which are pretty interchangeable, each NFT carries its own enchanting value, making it absolutely one-of-a-kind. Think of it as a personalized stamp of authenticity and rarity that gives digital creators a sense of ownership in the virtual realm.
NFTs as Investments
Note: this is presented for education and is not intended to be investment or financial advice in any way.
Guccighost Sticker By Trouble Andrew via GIPHY
What NFTs offer:
- Unique Ownership: NFTs offer undeniable proof of ownership, providing a digital certificate of authenticity and exclusivity. This characteristic can be especially valuable in the art world, where provenance is crucial.
- Value Appreciation: If an NFT gains popularity, demand can surge, leading to significant increases in value. NFTs with limited editions, high-profile artists, or historical significance may attract substantial interest, potentially resulting in attractive returns on investment.
- Direct Support to Artists: NFTs enable artists to earn directly from their work without relying solely on traditional intermediaries, such as galleries or auction houses. By purchasing an artist's NFT, you can directly support their career and creative endeavors.
Buyer beware:
- Volatility and Market Speculation: The value of NFTs can be highly volatile, subject to rapid price fluctuations. The market for NFTs is still evolving, and while some NFTs have experienced significant value appreciation, others have seen sharp declines. Investors should be prepared for the possibility of substantial price swings and should speak to financial advisors.
- Environmental Impact: Many NFTs are built on blockchain platforms, such as Ethereum, which currently rely on energy-intensive mining. This energy consumption raises concerns about the environmental sustainability of NFTs. Investors interested in NFTs may consider platforms with more eco-friendly approaches or explore the potential for the industry to adopt greener solutions
- Market Saturation and Quality: With the increasing popularity of NFTs, the market has become more crowded. The abundance of NFTs raises concerns about oversaturation and potential dilution of value. Investors need to carefully assess the quality, uniqueness, and scarcity of NFTs to identify those with long-term potential
- Lack of Regulation and Standards: The NFT market currently lacks standardised regulations and guidelines. This absence of clear rules can lead to uncertainty, challenges in valuing NFTs accurately, and potential risks for investors. Due diligence and careful research are necessary to navigate this dynamic and evolving landscape. Again, speak to the pros.
Determining whether NFTs are a good investment requires careful consideration of the potential benefits and risks involved. While NFTs offer unique ownership experiences, the potential for value appreciation, and direct artist support, they also come with risks, including market volatility, market saturation, and the lack of regulations. It is essential to conduct thorough research, assess the quality and potential of NFTs, and stay informed about market trends and developments. Ultimately, investors should approach NFTs with caution, diversify their investment portfolio, and consult with financial professionals to make well-informed decisions aligned with their investment goals and risk tolerance.
Tax Implications of NFTs
Ah, tax... the ever-present buzzkill!!
The tax treatment of an NFT depends on:
- your circumstances
- the way you use the NFT
- your reasons for holding and transacting with the NFT.
You may pay income tax on the NFT:
- as a CGT asset under the capital gains tax (CGT) regime
- on revenue account as trading stock
- as part of a business
- as a profit-making scheme
Speak to your accountant if you are not sure!
As with other types of crypto asset, in rare circumstances you could hold an NFT as a personal use asset. If your crypto asset is a traditional cryptocurrency (such as Bitcoin), see Crypto as a personal use asset.
Example: personal use NFT
Billy, a professional artist, paints a portrait of a famous Australian and decides to create 10 NFTs, each of which provides the right to one, 4-hour, private viewing of the portrait in his gallery each year for up to 20 people.
Ming is a relative of the portrait's subject. She buys the NFT and uses the private viewing to celebrate the subject's birthday with close family and friends every year.
For Ming the NFT is a personal use asset.
Example: NFT as part of a business
Billy, a professional artist, paints a portrait of a famous Australian and decides to create 10 NFTs, each of which provides the right to one, 4-hour, private viewing of the portrait in his gallery each year for up to 20 people. On subsequent transfers of the NFTs to new owners, the digital contract allocates part of the proceeds to Billy as a commission.
Billy retains all other rights associated with the painting.
The proceeds of the initial sale of the NFTs is assessable as business income to Billy. While they remain in business, any commissions received would also be business income. If Billy ceased carrying on the business, the commissions would still be assessable as ordinary income.
The treatment in the hands of the owners depends on how they make use of the NFT.
Example: NFT as a capital asset of a business
Billy, a professional artist, paints a portrait of a famous Australian and decides to create 10 NFTs, each of which provides the right to one, 4-hour, private viewing of the portrait in his gallery each year for up to 20 people.
Ming buys one of Billy’s NFTs. In running a tour business, he plans to use the private viewing of the portrait as part of an annual art tour of the region.
The NFT is a capital gains tax asset of the business.
— Goat lord (@deadmau5) January 12, 2021
Here are some other tax considerations…
Capital Gains Tax (CGT):
- Selling NFTs: When you sell an NFT, it may trigger a capital gains tax event if you make a profit. The capital gain is calculated by subtracting the cost base (acquisition cost) from the sale price. The resulting gain is added to your assessable income for the tax year. This is just like for other assets.
- Holding Period: The length of time you hold an NFT can impact the capital gains tax. If you hold an NFT for longer than 12 months, you may be eligible for a CGT discount. This means only 50% of the capital gain will be included in your assessable income. This is just like for other assets.
- Record-Keeping: It is crucial to maintain detailed records of NFT transactions, including purchase receipts, sale receipts, and any associated costs. These records will be essential for accurate tax reporting and calculating your capital gains. We suggest keeping the data in Google Drive folder so it is easily found later down the track or if ever audited
GST Considerations:
- GST on NFT Sales: The sale of an NFT may attract Goods and Services Tax (GST) in certain circumstances. If you are registered for GST and conducting business activities related to NFTs, you may need to include GST in the sale price and remit it to the Australian Taxation Office (ATO).
- Personal Use Exemption: If you purchase an NFT for personal use and not for business or investment purposes, you are generally exempt from GST obligations. However, if you later sell the NFT at a profit, it may trigger capital gains tax implications.
Income Tax Considerations:
- NFT Trading as Business: If you actively trade NFTs as a business or profession, the proceeds from NFT sales may be considered ordinary income. In such cases, you will be required to report the income and deduct any associated expenses, subject to the usual income tax rates.
- Deductible Expenses: If you are engaged in NFT trading as a business, you may be eligible to claim deductions for expenses related to your activities, such as transaction fees, storage costs, and marketing expenses. It is important to keep proper records and consult with a tax professional to determine eligible deductions.
NFTs represent an exciting intersection of art, technology, and finance, offering unique opportunities for creators, collectors, and investors. However, the NFT market is still evolving, and inherent risks and uncertainties exist. Understanding the pros and cons, conducting thorough research, and seeking professional advice are crucial steps when considering NFTs as an investment. Additionally, staying updated on tax regulations specific to NFTs is essential to ensure compliance with relevant laws.
I hope this has changed the feeling from NFI (no f*cking idea) to NFT (with a bit more of an idea). If you want to continue the discussion or have any questions let me know!
Sources
Crypto Asset investments and tax
