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.
"So in-game land is exchanged against in-game currency, for example, is out of scope for VAT," Luther explains.
According to Luther, the court's decision appears to be in violation of international tax conventions. Its conclusion that the transfer of in-game currency from one player to another was not an electronically supplied service, despite the fact that it took place entirely online, appears strange.
According to Anton Appel, the Federal Fiscal Court's decision is difficult to understand, and the Cologne Court's decision is more accurate in my opinion.
According to him, the Federal Tax Court did not want to make everyone who transacted in online games taxable. The ruling also appears to be more concerned with the outcomes than with the legal realities of transactions.
"The best thing they [Federal Tax Court] could have done here is to define the difference between playing a game for private fun, and conducting a business," Visser says.
Making a distinction between business activity and recreational gaming, he claims, would have allowed for the establishment of a threshold for when someone becomes a taxable person.
According to Friedberg, the Federal Court also believed that in-game transactions should not be subject to VAT because they were merely intended to shape the players' experience.
"But what about, for example, Nike selling a sneaker NFT in the metaverse….is this just shaping the digital experience for customer or is there any connection to real life… You just don’t know where it starts and ends ," Friedberg says.
The world is fragmenting into parallel worlds, which is becoming increasingly obvious. Tax authorities are quickly catching up to the consequences of actions in virtual worlds, despite the fact that they cannot yet affect them directly through tax obligations.
The cost of VAT compliance is a frequent source of disagreement among businesses. Any expansion into the online world will be viewed as a threat to virtual commerce's growth.
According to Blaccard, when businesses in the virtual world receive money through payment providers such as Paypal or Skrill, they are already subject to income tax obligations. Adding more tax obligations would only add to the compliance burden for businesses in their early stages.
“The money that becomes a processed credit is considered income when the credit processing company Paypal or Skrill files your 1099-K form [stating your income] or whatever forms they file for specific countries,” says Blaccard.
Friedberg believes the court will bridge the gap between what is considered business in the digital world and what is considered business in the real world.
According to Friedberg, "the [Federal] Tax Court said in one of the Cum-Ex tax fraud rulings that business activities in the digital world are also business activities of the real world because the digital and real world are not to be distinguished." as stated in one of the Cum-Ex tax fraud rulings.
He believes the court will close the gap in interpretation and move toward enforcing VAT obligations regardless of where transactions occur.
Some tax professionals believe that this case will serve as a precedent for future cases. This could include asking the European Court of Justice of the EU (CJEU) for clarification on the tax treatment of digital services.
According to Appel, German VAT experts are also discussing possible legislation to counter the Federal Tax Court's decision and the resulting confusion.
The metaverse will be a key area of the future economy as the virtual world develops. More clarity and certainty about tax obligations from both tax authorities and courts will be needed by businesses.
This decision could mark the beginning of a metaverse-specific legal and tax framework. However, there are still many unanswered questions regarding taxation and the metaverse.
By fLEXI tEAM