Metaverse & Taxation

Featured UK | Fernando R. Lopez | Mar 09, 2022


The metaverse refers to a highly immersive virtual world where individuals will be able to come together to socialize, play, work, and trade in virtual (and non-virtual) goods and services.  Some call it a parallel universe, populated by avatars and all forms of digital items (in the form of NFTs) found in our daily world. The key facilitator of the metaverse is the underlying blockchain technology and smart contracts that drive the operation of cryptocurrencies and decentralized autonomous organizations (DAOs).  Some claim that the metaverse will be the next chapter for the internet.

The metaverse’s array of 3-D spaces will include residential and office structures, music and sports venues, education/learning venues, and social venues like social clubs and bars.  It may include virtual infrastructure found in our real world – like, roads, bridges, tunnels, and all sorts of public and private transport infrastructure and vehicles.

Individual metaverse participants will create or buy avatars and outfit them out in an array of NFT clothing, shoes, and accessories.   They will purchase virtual homes and furnishings, including art and music so that they can invite friends to socialize and entertain.  Away from their virtual homes, they can attend 3-D music venues, art shows, conferences, etc.

For recreation and games, the metaverse will offer a variety of 3-D games.  It will also have available virtual recreational vehicles, including cars, boats, and motorcycles, not to mention bicycles, skis, skates, skateboards, and all manner of sports equipment and clothing.

For professional services, rather than traveling to see their service providers (bankers, lawyers, accountants, doctors, etc.), clients and prospects may choose to connect with their service providers via offices in the metaverse.

For travel experiences, individuals will be able to take immersive 3-D mini-vacations to scenic locations around the globe where avatars can stroll, shop, and engage in activities like hiking, swimming, snorkeling and golfing, etc.

Whether it’s land, infrastructure, buildings, furniture, art or clothing, games, entertainment, services, or virtual travel, many of the assets and services available for purchase in the metaverse will be in the form of NFTs that people create, sell, buy and lease.  And as individuals deepen their participation in the metaverse, they will make more and more purchases of virtual NFT assets from metaverse vendors.


A retailer like Nike may set up shop in the Metaverse to sell shoes and athletic clothing.  Other real-world companies may set up shop in the metaverse to sell virtual cars, boats, furniture, clothing, accessories, etc.

Real-world musical artists and promoters may put on virtual shows, private parties, and other events in the metaverse with payment occurring via cryptocurrency and the entry ticket being in the form of an NFT which may also provide fans with physical merchandise related to a concert or show.

Similarly, a real-world hospitality company may decide to set up a virtual resort with all manner of recreation and games. Entertainment companies may set up bars in the universe where people can meet and socialize in a relaxing environment with an attractive ambiance.

And there will be a wide array of service providers who will find it compelling to do business in the metaverse, including consulting firms, financial advisory firms, professional firms, and gaming and entertainment organizations.  Such real-world firms will set up a vibrant, inviting presence in the metaverse – perhaps a virtual office building with vibrant, inviting spaces, including lobby, workspaces, and meeting rooms that enhance the quality of shared work experience and our connection with clients.


Can Tax Authorities Have Jurisdiction Over Transactions in The Metaverse?

As noted above, the metaverse will effectively be a centrally located, virtual marketplace and social forum where persons and entities from across the globe can come together to socialize, play, learn, access entertainment, and trade goods and services.  Although metaverse economic transactions will take place in virtual spaces between virtual persons, they will generate real world revenue in the form of cryptocurrency.

A key tax question is whether local and national tax authorities across the globe will be able to assert tax authority over transactions occurring in a virtual arena that lacks the type of provincial, state, and national boundaries that provide the framework for real-world tax administration?

Who Will Have Tax Liability Over Metaverse Transactions and How Will They Be Taxed?

Although the sales and service transactions described at the outset of this article will occur in the metaverse, such transactions will generate real-world revenue (in the form of cryptocurrency) that is in most cases linked to real-world persons and entities.  Once tax authorities can link metaverse transactions undertaken by avatars and virtual entities with persons or entities in the real world, the next issue is who should be taxed?  Should it be Nike’s virtual presence in the metaverse that is subject to tax on the sale of virtual products or Nike’s real-world headquarters in Beaverton, Oregon?  In the service context, if Prager Metis’ virtual office in the Metaverse is engaged by a virtual advisory client, who should be taxed? Should it be Prager Metis’ virtual office in Decentraland or Prager Metis’ real-world office in New York?

The analysis of who should be taxed is further complicated by the fact that, in some cases, metaverse patrons may be able to make payments outside the metaverse for products or services to be used in the metaverse.  Alternatively, they may be able to make payments in the Metaverse for products and services that are delivered and used in real life outside the metaverse.  The variations are likely numerous.

Until tax authorities around the world develop a virtual presence, they are likely to impose tax liability on the real-world legal entity or natural person with a proximate, meaningful connection to the metaverse transaction. Such entity or person may be the legal or beneficial owner of the metaverse vendor or a person or entity exercising management authority over the transactions carried out by the metaverse vendor. It’s worth noting that vendors will not be the only ones subject to tax liability.   In the U.S. and several other jurisdictions, cryptocurrency is viewed as property (rather than money) for tax purposes.  Therefore, when virtual buyers purchase assets in the metaverse using cryptocurrency, the exchange of cryptocurrency for other property will be subject to U.S. taxation and reporting.

Metaverse participants should not be deluded into believing that tax authorities cannot track transactions that occur in the metaverse on the theory that it is an autonomous virtual space over which no country or tax authority has jurisdiction.  Tax authorities have (or will have) the ability to get information about wallet addresses, cryptocurrency transactions, and cryptocurrency holdings of their citizens and tax residents, so metaverse participants should keep in mind the tax consequences of their metaverse activities and should not operate on the assumption that the 3-D world is a space beyond the reach of tax authorities.

Determination of Tax Consequences of Metaverse Transactions  

Whether and how metaverse transactions are taxed by relevant tax authorities will largely depend on the usual tax analysis, including (i) determination of the location of the real-world person or entity behind the virtual transaction; (ii) determination of the type of property or service involved; (iii) determination of whether it involves virtual property or services or real-world property or services and the related location where relevant; (iv) the character and source of the income.  In cases where buyers and vendors are in the same country, domestic law can be applied to determine who is taxed and how they are taxed.  Where relevant parties are in different countries, tax treaties should generally apply in the same manner that they apply to real-world transactions.

Proactive Tax Planning

Although taxpayers may be disappointed that economic transactions in the metaverse are not galactic enough to evade the reach of tax authorities, the good news is that proactive planning should permit metaverse vendors and buyers to arrange their virtual economic activities in a manner that minimizes tax uncertainty, while at the same time maximizing tax efficiency.

As an initial tax planning diagnostic, tax practitioners should first consider and evaluate the tax consequences of metaverse economic activity as if it were carried out in the physical world (or online) rather than in the metaverse.  Whether it be the sale or licensing of NFTs or the provision of services, metaverse transactions should generally have determinable tax consequences if they are considered to take place in the real world.

In some cases, a favorable tax result may arise when attributing metaverse revenue to relevant real-world persons or entities. In other cases, such attribution to existing persons or entities may result in highly inefficient tax results. When the diagnostic analysis results in tax consequences that are unexpected and unpalatable, taxpayers should strongly consider proactive tax planning.

Such planning may involve setting up a legal entity or subsidiary in a tax favorable province, or state within a country.  For example, a handful of U.S. states, have attractively low-income tax rates so that income related to carrying out metaverse activities may be arranged so that related income is exempt or subject to low rates.  In addition, certain states (like Florida) don’t tax individual income at all such that carrying out metaverse activities in such state as an individual or via a passthrough structure (e.g., LLC, sole proprietorships, or S corporations) will exempt the metaverse income from state income taxation.

Depending on investors’ objectives and longer-term plans, an attractive choice of a legal entity may be a corporation that permits deferral of most, if not all, shareholder-level taxation.  In other cases, where a metaverse entrepreneur seeks capital from outside investors, pass-through entity investors prefer to avoid the double taxation of corporate structures.

It will not be unusual for decentralized autonomous organizations (DAOs) to participate in the metaverse.  A DAO is a digital organizational form based on blockchain technology and the use of smart contracts.  Mature DAOs typically have no shareholders, no central authority, and are led by a community of users who can be located across the globe.

Since a DAO is not established as a formal legal entity, the entity status of the DAO and the determination of beneficial owners may be ambiguous from a tax compliance standpoint. In some cases, a DAO might be determined to be like a partnership and will be treated as one.  In other cases, the relevant facts may point to treating the DAO as something else for tax purposes.  Since most tax authorities around the world have not issued detailed guidance on the taxation of DAOs, there is a risk that tax authorities could assess tax on persons or entities that would be unexpected and onerous.  In such a case, taxpayers should consider proactively planning for their preferred tax outcome.

This can be achieved, for example, by proactively wrapping the DAO or its management activity within a legal entity (corporation or partnership).  In other cases, where any revenue is intended for charity, securing non-profit tax treatment may be best achieved by setting up a real-world non-profit entity to carry out the metaverse activity.  Documentation, including intercompany agreements, will be important in securing the intended tax consequences and reducing the risk of unfavorable recharacterization by tax authorities.

Finally, VAT or sales tax will also need to be considered with respect to metaverse transactions.  The real-world location of buyers and service recipients will be relevant in this regard. It will be highly unlikely that tax authorities will accept a vendor’s position that their buyers are virtual avatars in a virtual digital space and that their physical identity and location do not exist or is unknown. Metaverse vendors need to develop a customer ID and data system that will permit them to gather the requisite real-world information of clients to meet their payment and reporting requirements related to VAT and sales tax.

In conclusion, the metaverse will permit persons and entities across the globe to connect in a virtual environment to socialize, play and engage in economic transactions.  Such transactions will occur in 3-D digital space, but they will generate real-world revenue.  Tax authorities should be able to leverage the fact that the metaverse has innumerable digital spokes that reach out to real-life persons and entities who access the metaverse via the internet and connect to it economically using virtual wallets.  Until tax authorities establish virtual tax administrative presence in the metaverse, taxpayers should expect tax consequences of their metaverse activities will be real-world tax consequences and should proactively plan to avoid onerous tax results.


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