According to tax experts, the German VAT exemption for the metaverse is unclear.

Companies applaud the German Tax Court's decision to exempt virtual land rentals from VAT, but they are concerned about the lack of clarity in the ruling.

The Tax Court's decision to exempt land rentals in the metaverse from VAT is viewed positively by tax professionals and businesses, but they are concerned that the decision lacks clarity for businesses.

The comments came in response to a decision by the German Federal Tax Court in November 2021, which found that virtual land rentals in the metaverse were VAT-free.

Paul Blaccard, chief executive officer and owner of RentMainland.com, a virtual property rental firm in Second Life but based in the US, says he welcomes the decision by German tax authorities not to impose VAT on rentals.

He claims that "sometimes governments have nothing better to do than create more bureaucracy."

The decision overturned a case from August 2019 by the Tax Court of Cologne, which held that landlords in Second Life, a virtual world in the metaverse, were liable for VAT because land was rented in exchange for payment in Linden dollars, Second Life's currency.

This decision is significant because it establishes the principle that virtual land or property rentals are exempt from VAT because the transaction took place in a virtual environment. The existence of the online space determines the value of assets in Second Life.

This also means that in the real world, transactions made in an online game are not subject to VAT.

"It [the ruling] appears positive, at first, because the Cologne Tax Court said before that renting virtual land is subject to VAT," says Martin Friedberg, a partner at the Dusseldorf law firm CMS. "But I think the decisive point is that it doesn’t really provide clarity," he says.

Most people and German VAT experts, according to Anton Appel, director and VAT lawyer at WTS Global, an international tax firm in Germany, "cannot really understand the decision of the Federal Tax Court."

The court's key distinction is that operating in a virtual world provides landlords with important protections from real-world tax obligations. The entire legal basis for VAT exemption hinges on this point.

With the support of companies like Facebook, the metaverse may be set to dominate the future. The company has even changed its name to Meta because of its belief in the metaverse's potential.

The metaverse is a vast virtual universe containing numerous self-contained worlds. Second Life, Somnium Space, The Sandbox, Cryptovoxels, and Decentraland are some of the most popular metaverses. Participants can settle, rent, or buy property in these worlds.

A virtual landlord rented a parcel of his land in Second Life for a monthly rental in Linden dollars, according to the case before the German Federal Tax Court.

Because virtual land rentals are digital services provided to a customer in Germany, tax authorities believe they are subject to VAT. However, the plaintiff argued that because his only relationship was with the Second Life operator in the United States, he should not be liable for VAT in Germany.

The landlord was liable for German VAT on virtual land rentals in the first case, according to the Cologne Court, because he had entered rental contracts. These were initially paid in Linden dollars and then converted to US dollars.

According to Appel, the Cologne Court's position was persuasive because it determined that a legal currency is not required for a remuneration for a service to be subject to VAT.

The Federal Tax Court overturned the decision, ruling that transactions in the metaverse were not subject to VAT because they took place in a virtual world.

The key distinction, according to Johan Visser, partner and global indirect tax and customs at WTS Global in Amsterdam, is that money spent in a virtual environment is not considered payment for a service and thus is not eligible for VAT.

Others believe it is merely a diversion for tax authorities. "Having a government try and extract tax from transactions within Second Life is a stupid waste of time and energy," Blaccard says.

The Federal Tax Court ruled that if transactions remained in the metaverse, they would not be subject to German VAT until they were converted to fiat currency and entered the real-world monetary system.

The court ruling, according to Matthias Luther, associate partner for indirect tax at EY in Hamburg, applies to every transaction that occurs in-game.