We are living in a world with an exponential rate of change in how it operates and functions, with a small few driving the curve or keeping ahead of it, and most trying to keep up. From using physical fiat currency in brick-and-mortar stores and receiving in-person services, we have rapidly transitioned our way through on-line payments for digital goods/services and have arrived in a world where cryptocurrencies, avatars in simulated environments and non-fungible tokens are becoming the most valued assets.

As we have seen from such rapid changes in business operating models in the past, it can take quite some time for the global and local tax frameworks to become “fit for purpose” for the new norm. Businesses, advisors and tax authorities alike are therefore left to seek to interpret how the current tax rules can or should be applied to new technologies, concepts and economies, with differences inevitably arising between jurisdictions. In parallel, over time, the real challenges in seeking to apply law (which never envisaged the current realities at the time of its drafting) seep their way into the local and European courts and eventually into European Commission VAT Committee Working Papers and / or proposed amendments to the EU VAT Directive. While this cycle of the tax framework playing catch up on the new economic realities inevitably continues, businesses and individuals still need to be compliant and tax authorities still need to enforce the law and collect taxes, while seeking to minimise fraud and evasion.

Commerciality of the new reality

Certain businesses and individuals will be intrinsically involved in this new simulated mixed reality world of digital assets such as those engineering alternative realities, mining blockchain, trading tokens and so on, while others will seek to engage primarily to avoid falling behind the curve or out of personal interest to gain.

Regardless of your drivers to engage or your industry sector, geography or size, the commercial aspects of operating in or with these new technologies will trigger interesting VAT challenges and care should be taken, especially given the limited and slow release of tax authority guidance.

VAT Considerations

What we have experienced to date is that assessing the VAT treatment is much more difficult than with historic supply chains and traditional product/service offerings, and businesses may often find themselves being the first to ask what the VAT treatment is of a particular supply, with its underlying contractual and commercial characteristics being crucial. With this complexity and the frequent need to “operate in the grey”, it is more important than ever to keep in mind some of the basic VAT principles including fiscal neutrality, the limited scope of exemptions and that VAT is intended to be a burden for the end consumer.
We have dealt with a few specific types of supplies and digital environments below to demonstrate the commercial practicalities faced by many businesses and tax authorities in this space for VAT.

Digital Assets

In addition to Cryptocurrencies, a wide range of other digital assets now exist in the digital world with new ones continuing to emerge; the NFT market alone is already substantial. For each type of digital asset, it is important to understand both the unique characteristics of the specific digital asset and the individual transactions involved in the supply chain, in order to properly determine the indirect tax treatment.

In this respect, common asset types we have encountered include:

Financial Services Exemption

It is clear from the above that the digital asset market has expanded significantly since the advent of blockchain and Bitcoin. In the EU, it is accepted that some transactions involving Bitcoin (and by extension, similar cryptocurrencies) can fall to be VAT exempt as financial services transactions. However, given the wide variety of digital asset types and attributes, it is unlikely that VAT exemption can be assumed, with our experience already showing that the VAT treatment needs to be considered on an asset-by-asset basis.

Although many digital assets were intended by their creators to be used as a means of payment, the reality is that most are currently functioning as an investment asset due to potential increases in value. Generally, currency tokens whose value is not derived from or dependent on anything else and do not give an entitlement or privileges to receive something else should likely be able to rely on the Hedqvist decision (C-264/14), 22 October 2015, which stated that

“Transactions involving non-traditional currencies (i.e., currencies other than those that are legal tender in one or more countries), in so far as those currencies have been accepted by the parties to a transaction as an alternative to legal tender and have no purpose other than to be a means of payment, are financial transactions”.

However, the position is less clear in respect of other digital assets which are arguably comparable with Bitcoin in that they may also be used, or be intended to be used, as a medium of exchange or investment asset. For example, the most topical digital assets at the moment concern DeFi tokens, such as Governance Tokens, and whether they can be treated as alternatives to VAT exempt instruments as outlined in Article 135 of the EU VAT Directive or should such assets instead be seen as ‘a right’ to access certain benefits – namely the right to stake the asset and vote on protocol decisions.

An EU VAT Committee was set up in February 2022 to review the current guidance in respect of digital asset transactions as clearly the Hedqvist decision is not applicable to the newer generation digital assets.

Non-Financial Digital Assets & Tokens

For many categories of digital assets, unlike cryptocurrencies, the main function of the token is not merely as a means of payment, but the value is in the underlying crypto assets (or physical assets) to which the owner is entitled or in the access to a specific application or service that the crypto asset gives. Why buy a new handbag when you could give one to your avatar? Why hang artwork at home when you could buy rights to digital images or go to a live concert, when you could do it virtually? You can even buy a very special bottle of whiskey (a real one!) via an NFT!

Assessing the VAT Treatment

From a VAT perspective, it is critically important to understand the characteristics of each individual type of token or crypto asset commercially and legally, in order to assess its true nature including whether:

1. it has a financial services or securities element to it and so exemption needs to be considered,
2. it is a voucher and as such the VAT voucher rules need to be applied, o
3. it is an electronically supplied services (“ESS”) and so the well-established ESS rules need to be considered. From an ESS perspective, you need to determine:
   • the status of the customer,
   • the location of the customer using evidence obtained,
   • the interaction of the marketplace rules if supplied via a platform, and
   • the associated compliance obligations and reliefs such as the One-Stop-Shop (“OSS”) regimes in the EU.
4. it is a supply of rights, or something else.

Even where you determine that a crypto asset falls into one of the above, the world of buying and selling digital assets is not quite as ‘straight forward’ as normal sales of financial services, vouchers/rights or ESS on digital platforms. The dynamics surrounding and technology underpinning each transaction within the crypto world result in complex financial structures to transactions.
We often see a range of charges and fees becoming due, such as gas fees to the underlying blockchain, listing/account fees to the platform and fixed percentage royalty fees to underlying creators (via smart contracts), posing new questions on what each payment is for (i.e., determining our “direct link” to a supply) and how the payments should be assessed for VAT purposes.
While the basics for determining the correct VAT treatment of any transaction continue to apply in terms of (1) what is being supplied, (2) to whom, (3) where is it taxable, (4) who is accountable for the VAT due and (5) at what rate/exemption, inevitably, a business or individual who never previously fell within the remit of ESS or financial services or even VAT, may find themselves needing to understand these rules and the impact on their compliance obligations, as a result of transitioning their business or personal endeavours to participate in these new realities.

These complexities have already led to different VAT analyses and interpretations of the correct application of law, from one asset to another, or one jurisdiction to another, with differing indirect tax consequences/reporting requirements and costs.

Digital Communities

With the expanding digital economy, businesses are increasingly seeking to establish online spaces where they can interact with their customer base. To encourage engagement and loyalty, some platforms are introducing their own virtual currencies which can be purchased to access products, gifted/donated or traded between users. From a VAT perspective, this creates challenges concerning both the issue, exchange, and redemption of any in-platform currencies, and the treatment of on-platform transactions between users. Similar questions arise as mentioned above, in terms of whether these platform currency transactions have financial traits, are the equivalent of a multi-purpose voucher, are additional/enhanced ESS content and whether marketplace rules apply for transactions between users. 

Virtual Events

Many businesses will, and have already, started moving internal business meetings, client meetings and events to an on-line and virtual “avatar friendly” forum. There are two main VAT rules which need to be considered in the context of virtual events where a charge is made for attendance or participation, whether they are events simply held on-line, in an augmented reality or in a new virtual reality type setting –

1. Electronically supplied services, and
2. (Admission to) events

An “electronically supplied service” (ESS), per A.7 of the Implementing Regulations (“IR”), is a service which is delivered over the Internet or an electronic network and the nature of which renders the supply essentially automated and involving minimal human intervention, and impossible to ensure in the absence of information technology. Generally, the place of supply (“POS”) of ESS is where the end customer is located (A. 34 VATCA 2010) regardless of whether the customer is in business (“B2B”) or not (“B2C”).

The characteristics of any virtual event will be critical in determining whether it is an ESS or not for VAT purposes – is the event live or on-demand, is it predominantly automated (like a virtual reality experience that you can join at any time and get the same experience) or is there reasonable human involvement in its delivery (like a conference or training session), etc.
Other than determining the correct POS rule, another important reason to determine whether a virtual event is ESS or not, is that the deemed buy-sell marketplace rules for “taking part in the supply” per A.9a of the Implementing Regulations only apply for ESS purposes. This could be important for example where there are multiple parties involved in the supply and one is “hosting” the event via its virtual world or platform on behalf of the event organiser.

Where it is determined that the supply of the virtual event is not an ESS for VAT purposes (e.g., due to the level of human intervention), then A.53 of the EU VAT Directive states that the place of supply (“POS”) of the admission to “cultural, artistic, sporting, scientific, educational, entertainment or similar events…” supplied B2B is the place where the event takes place. Any other supplies B2B relating to the event which do not qualify as and are not ancillary to “admission” fall within the general B2B place of supply rules under A.44 and are taxable where the B customer is established.

We can apply these rules also in the context of digital/virtual events i.e., taxable where they take place if it is admission to an event, and taxable where the B customer is located if it is not related to admission. The challenge is in determining what “admission” and an “event” means in the virtual worlds and how to determine where the event “takes place” when it is held fully on-line or in an interactive virtual reality environment.

These challenges have been looked at to some extent already by the courts, for example CJEU C-647/17 which underlines that the notion of “admission” covers both the right of entry and the “right to participate” in a course. It also states that advanced registration and payment are irrelevant in determining whether it is an “event”, and the AG Opinion (as emphasised in EC VAT Committee WP 982) goes on to say that it must “be planned in advance” and that it is “an indivisible whole in terms of content, place and time”. These interpretations are imported as digital/virtual events may not be as structured as physical events in terms of having pre-determined content, perhaps not having fixed start / end times but being more of open forums, admission may be my means of logging in your avatar, etc.

C-568/17 considered that where the person delivering the event and the attendee are not physically in the same place, the POS should be where the supplier is established. However, EC VAT Committee WP 1013 went on to detail how this ruling was prior to more recent EU VAT developments and that taxation in the customer’s location (i.e., where services are consumed) would be more appropriate for virtual events.

With effect from 1 January 2025, A.53 now additionally states that “This Article shall not apply to admission to the events referred to in the first paragraph where the attendance is virtual.” Therefore, in the future, all B2B supplies relating to such events will fall under the general B2B services rule.

A.54(1) which deals with similar B2C supplies, does not ringfence the POS rule to “admissions” to an “event” but instead covers all “services and ancillary services, relating to cultural, artistic, sporting, scientific, educational, entertainment or similar activities” supplied B2C, deeming that they shall be taxed where those activities actually take place. Again, with effect from 1 January 2025, this wording is then extended to include “Where the services and ancillary services relate to activities which are streamed or otherwise made virtually available, the place of supply shall, however, be the place where the non-taxable person is established, has his permanent address or usually resides.”

The rules which come into effect on 1 January 2025 align all virtual events or services relating to cultural / educational and other similar activities as being taxable where the customer is located, regardless of whether its B2B or B2C. However, it is expected that alternative treatments may apply in the interim across the Member States subject to their transposition of current EU law and interpretation of associated EU case law, and so businesses should tread carefully.

With respect to virtual events being taxable where the customer is located, this poses additional challenges in the new “reality worlds” where many participants may settle payments using cryptocurrency or tokens, which by their nature are anonymous to the underlying owner (see below) and so do not automatically disclose a physical location (such as address for credit card), or through regulated crypto exchanges.

The option is available for Member States to apply reduced rates to events of this nature, which will be extended to the “live streaming” of such events also with effect from 1 January 2025. Therefore, the categorisation of the virtual event or forum as an ESS or not, and determining its correct place of supply, could also impact the overall VAT rate due and the business’ ability to minimise any potential VAT exposure by applying lower rates where available.

Transactions and activities by individuals, and the role of marketplaces

Many of the concepts mentioned above have developed and been used already for many years by individuals, such as the use of virtual reality in the gaming world and the acquisition of cryptocurrencies as personal investments.

From a VAT perspective, we therefore also need to consider the normal challenges of individuals undertaking activities in a personal capacity versus a business capacity, thresholds for registration or the lack of threshold where transactions cross territories, and a business’ role when engaging in digital or crypto transactions either directly with a “C” counterparty as the “vendor” or as a platform / intermediary in such a supply (e.g., a C2C or C2B transaction).

While it appears likely that a marketplace would need to follow the same steps in assessing whether it is “taking part” in the supply of an ESS, regardless of the fact that the vendor is a C, the impact of the resulting deemed buy-sell would see no VAT being charged on the deemed “buy” by the marketplace and yet VAT becoming due on the onward deemed “sell” (either by being charged by the marketplace or under reverse-charge mechanism procedures by the purchasing B).

Care needs to be taken in assessing the status of parties, as this will often drive the place of supply rules mentioned above, and therefore the VAT regime within which the transaction falls. Similar to the challenges faced in the supply of ESS in the past, businesses may also need to consider their own VAT governance approach where other parties in the supply chain are non-compliant, given that many will still be adapting to these new concepts and their treatment for VAT purposes.

Tax Fraud Risks

It is hard to deny that NFTs represent a tempting prize for missing trader fraud, they are often high value, easy to store and transfer, and relatively hard for law enforcement agencies to trace, allowing the fraudsters to generate significant indirect tax amounts by levying VAT at the applicable rate, disappearing without reporting it and then resurfacing in another jurisdiction to repeat the process on a never-ending carousel!

Therefore, it is crucial that businesses engaging in the purchasing or selling of digital assets, like any other goods or services, take steps to ensure they have in place suitably robust and proportionate measures to detect and deter fraud. The ability to “know your customer” or “know your supplier” could prove more challenging than in traditional goods-based or regulated financial supply chains, especially where they are relying on steps taken by third parties such as online marketplaces and exchanges. Businesses should understand the steps those parties take to mitigate the risks posed by indirect tax fraud and other forms of tax evasion. The extended application of reverse-charge (even domestic) and withholding taxes have assisted in other industry sectors and supply chains to mitigate the risk of fraud and may be considered further in the space of digital assets.

Reflection

While the VAT assessment of transactions in virtual reality and blockchain will not always be a path well-trodden, it is a space which is continuously being analysed in terms of tax authority guidance on the correct application of current VAT legislation and the development of VAT laws at an EU level.
That being said, businesses should ensure to undertake sufficient due diligence and care when operating in this space and are strongly recommended to take tax expert advice before implementing any new commercial arrangements as many other VAT technical challenges can be faced, in addition to the examples highlighted above within this article. Auditors will also seek comfort on any risk levels associated with these types of activities which may pose challenging for any business which has not yet given these transactions sufficient thought from a VAT perspective.