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NFTs explained; what are the tax implications of buying and selling crypto assets?

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NFTs are fast becoming the latest phenomenon in the world of crypto assets and are rarely out of the news these days. In the wake of his infamous civil suit this year, it was reported that Johnny Depp donated his NFT earnings to charities his ex-wife, Amber Heard had previously promised the proceeds of her divorce settlement to. Apart from being a genius PR move, what was interesting to note was that the actor’s NFT had raised a total of £666,530 making it one of the most philanthropic NFT sales to date, demonstrating the increasing popularity of digital assets.

With some NFTs now changing hands for millions of pounds, and more and more people becoming interested in owning them, it is easy to overlook the potential tax implications surrounding NFT ownership, donorship or inheritance.

What are NFTs?
An NFT is a ‘Non-fungible Token’ linked to a unique and non-interchangeable digital asset; most commonly artwork or other collectibles but can be almost anything which is capable of being stored digitally and has value.

As with physical collectibles such as paintings or stamps, NFTs have their own intrinsic value based on the underlying digital asset. However, rather than a tangible physical item, you own the token which proves your possession of the original digital asset.

How do they differ from bitcoin?
Bitcoin and similar cryptocurrencies work as a decentralised digital currency that you can buy, sell and exchange directly, without an intermediary like a bank. Similarly, to bitcoin or other cryptocurrencies, NFTs use blockchain technology to securely store data of who owns the digital asset. Where NFTs differ however, is they relate to unique items and so the digital ledger also serves to prove the uniqueness, i.e. NFTs are non-fungible, whereas cryptocurrencies are fungible in that you can exchange one bitcoin for another as they are the same.

How does the UK tax NFTs?
The UK currently has no legislation regarding NFTs specifically, and guidance related to the tax treatment from HMRC extends only to crypto assets in general, despite HMRC acknowledging that NFTs are classified as a separate entity to cryptocurrency.

As an NFT is an asset, if it is sold for more than you paid for it, there will be a tax liability. In the absence of any official legislation or guidance on NFTs, by considering them as akin to physical artworks or collectibles, it seems reasonable to expect that profits and losses relating to NFTs would be subject to capital gains tax when sold or given away. NFTs would therefore also be considered assets for the purposes of other tax, such as Inheritance tax.

Income tax may instead be applicable if you are trading NFTs, generally where a large number of NFTs are bought and sold in order to make a profit. HMRC has stated previously that, for tax purposes, cryptocurrencies are considered to be situated in the jurisdiction in which the owner is resident; and although they are yet to comment specifically on NFTs, we would expect the treatment to be similar.

Philanthropy
Many charities have already benefited from the popularity of NFTs, most recently in Johnny Depp’s much publicised example. NFTs can also enable charities to raise money in a transparent way through auctioning them off and engaging with NFT creators. Again, understanding any tax implications for all parties, is important as NFTs represent new ground both for benefactors and charitable organizations themselves.

Environmental Impact
NFTs themselves are not harmful to the environment. However, there is an impact on the environment in how they are produced. Most are produced (minted) using an extremely high energy process, which is of course detrimental to the environment. However, it is not all bad news for NFTs as there are other ways to process them which have a lower impact on climate change.

How Mercer & Hole can help
We understand that HMRC are in the process of consulting and preparing specific guidance for NFTs which would provide welcome clarity of the tax position. Please watch this space for future updates.

Additionally, we can offer support and advice if you currently own or have previously disposed of NFTs. If this may impact you, or you have any concerns regarding other crypto assets, please don’t hesitate to contact Henry.

Henry lowe private client partner

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