The advent of the digital era requires lawyers to update themselves in order to understand and adapt legal rules to the new reality. With the digital era have come cryptocurrencies and, recently, NFTs. NFT’s can be understood as digital certificates of authenticity over units of value or assets stored on the blockchain, linked -attached or linked- to a digital file that commonly consists of a JPEG file (a file containing an image). The very name of the NFT’s gives us an idea of their peculiarities.
First of all, as already mentioned, an NFT is a digital certificate of authenticity on a non-fungible digital asset, i.e., it cannot be replaced by another of the same species, quality and quantity, as defined in Article 763 of the Federal Civil Code. The technology that allows a digital asset to be non-fungible is the blockchain. The blockchain is a decentralized public database that is characterized by allowing the creation of unique and non-replicable digital files, as it encrypts them in a data chain; anyone can enter this database to verify who owns the file and monitor the transactions carried out with and by the file. The value of an NFT can come from the rights that its author or creator attaches to it or by its speculated value in the market, since, in reality, an NFT does not have value because it is useful; since, through it, it cannot produce goods or provide services, it only has an aesthetic value.
It is important to distinguish between the author or creator of the NFT and its owner. The author or creator is the person who owns the copyright on the digital asset, as he/she is the one who designs the JPEG file, links it to a unit of value, and may or may not link it to certain rights and incorporates it into the blockchain. Instead, the owner is the person who acquires the digital certificate of authenticity over the digital asset that was integrated into the blockchain. Thus, we can understand that an NFT is a kind of digital certificate of authenticity on a digital asset.
The NFT market has grown exponentially, almost keeping pace with the technological advances that humanity has experienced in the 21st century. It is estimated that by the end of 2021 the value of the market for the creation, purchase and sale of NFT’s was close to USD$41,000,000.00 (Forty-one billion US dollars, 00/100). The purchase and sale of NFT’s has generated more money than conventional works of art during 2021. The largest purchase of an NFT occurred on March 11, 2021, the day on which Christie’s auction house executed the auction of an NFT entitled “Everydays: The First 5,000 Days” created and designed by Mike Winkelmann, for the amount of USD$69,340,250.00 (Sixty-nine million three hundred and forty thousand two hundred and fifty U.S. dollars, 00/100). The growth of the market demands that we turn our attention to it in order to determine the taxation scheme for these transactions.
There is room for debate as to whether an NFT can be conceived as art or as a simple good. Because an NFT is a digital asset whose value depends on the supply and demand for it, which to a large extent depends on its aesthetic perception, it could be conceived as a work of art. Although in the same way, it can be conceived simply and simply as an intangible good lacking an aesthetic perception. Depending on the way in which an NFT is conceived, whether as an artistic work or as a simple intangible good, the regime under which individuals who dispose of one may be taxed may vary. Likewise, we cannot overlook the fact that these transactions are carried out through intermediaries, consisting of technological platforms that function as a Marketplace, in terms of article 18-B, section II of the Value Added Tax Law (“LIVA”). The most well-known technology platforms are OpenSea, Axie, Larva Labs, Rarible, SuperRare, Foundation, Nifty Gateway, Mintable, Theta Drop, among others. These platforms are free of charge, although they charge and retain to the creator and/or seller a quantified commission on the total amount of the sale, at the time the sale of an NFT is executed.
There are several legal acts that may have one or more FTNs as their object. A person can: (A) create, design and register an NFT, (B) purchase NFT’s or (C) sell NFT’s. In this article we will focus on the tax treatment of the last act. At present, countless transactions of this type have been executed, although we cannot state with certainty how many have been carried out in national territory, however, it is important to ask ourselves if these transactions cause taxes in national territory in case they are carried out by individuals with residence in national territory through technological platforms? The tax treatment of these transactions is still not so clear to the authorities or to individuals; however, the purpose of this article is to reverse this situation.
What taxes would a natural person with residence in national territory who disposes of an NFT through a technological platform have to pay? First, in the case of individuals residing in Mexican territory, we must refer to Title IV of the Income Tax Law (Ley del Impuesto Sobre la Renta or “LISR”). Said title includes the regime “Income from the sale of goods or rendering of services through the Internet, by means of technological platforms, computer applications and the like”, contained in Section III. With respect to the LIVA, we must refer to Chapter III BIS, Section I and II of the title “On the rendering of digital services by residents abroad without an establishment in Mexico”.
Now, let us assume a hypothetical situation to be clearer in the explanation: a subject A (transferor) and a subject B (acquirer) carry out a transaction in which subject A is obliged to transfer an FTN to subject B. In turn, subject B undertakes to pay a consideration to subject A at the time the FTN is delivered to him. Subject A paid the equivalent of $100.00 (One hundred pesos, 00/100 M.N.) for the NFT and is selling it to subject B for the equivalent of $200.00 (Two hundred pesos, 00/100 M.N.). The transaction will be executed through OpenSea, which charges a commission of two point five percent (2.5%) on the total amount of the consideration. Therefore, OpenSea will charge and retain from Subject A a commission of $5.00 (Five pesos, 00/100 M.N.). Thus, the income effectively received by subject A will be $195.00 (One hundred and ninety-five pesos, 00/100 M.N.).
A. Income tax. In terms of Article 113-A of the Income Tax Law, the transferor is obligated to pay income tax (“ISR”) on the income received through the technological platform. The form in which the tax would be paid would be through a withholding by the technological platform, in terms of Article 113-A, second paragraph of the Income Tax Law. The withholding shall be calculated on the income effectively received by subject A, that is to say on the $195.00 (One hundred and ninety five pesos, 00/100 M.N.) of the previous example. In accordance with section III of the third paragraph of Article 113-A of the Income Tax Law, the withholding rate would be one percent (1%), since it is the disposal of a good/work of art (NFT). Therefore, the amount of ISR to be paid by way of withholding would be $1.95 (One peso, 95/100 M.N.). Such amount shall be reported by OpenSea to the Tax Administration Service (“SAT”) and will be considered as a provisional payment for purposes of the annual income tax of Subject A.
A final payment can only be considered as a final payment when (i) Subject A receives part or all of the $195.00 (One hundred and ninety-five pesos, 00/100 M.N.) directly from Subject B – not through OpenSea – and (ii) Subject A’s total annual income does not exceed $300,000.00 (Three hundred thousand pesos, 00/100 M.N.). In such situation, Subject A may choose to pay income tax also by applying the withholding rate of one percent (1%) on the total income received through OpenSea and may credit the tax that would have been withheld. That is to say, supposing that subject A makes alienations of additional NFT’s for the amount of $300.00 (Three hundred pesos, 00/100 M.N.), whose payment is not made directly by subject B, but through OpenSea, then subject A will be able to apply the rate of one percent (1%) to the $495. 00 (Four hundred ninety-five pesos, 00/100 M.N.) corresponding to the total income received and credit the $1.95 (One peso, 95/100 M.N.) that was previously withheld. In this way, subject A would have to pay $3.00 (Three pesos, 00/100 M.N.) directly to SAT.
B. Value added tax. With respect to value added tax (“IVA”), the payments to be made in the transaction must be itemized. On the one hand, subject B is going to pay subject A $195.00 (One hundred and ninety five pesos, 00/100 M.N.) for the sale of the NFT, on the other hand, subject A is going to pay OpenSea $5.00 (Five pesos, 00/100 M.N.) as a commission for the rendering of a service, are both activities subject to IVA?
In terms of article 18-B, section II and 18-D, section II of the LIVA, OpenSea must transfer the IVA to subject A for the rendering of the service, therefore the sixteen percent (16%) rate must be applied to the $5.00 (Five pesos, 00/100 M.N.), which implies that subject A will pay a total of $5.80 (Five pesos, 80/100 M.N.) for the commission, including the corresponding IVA. Likewise, according to Article 18-D, Section V, OpenSea shall issue the Digital Tax Receipt via Internet (“CFDI”) to Subject A, in accordance with the requirements established in Article 29 and 29-A of the Federal Fiscal Code (“CFF”).
In the case of the payment of $195.00 (One hundred and ninety-five pesos, 00/100 M.N.) for the disposal of the NFT, the picture is a little vague, because depending on whether the disposal is made through OpenSea or not, the tax treatment of the operation will be different. In this case, the transaction was carried out through OpenSea, therefore, articles 18-K and 18-J of the LIVA are applicable. Therefore, the rate of sixteen percent (16%) shall be applied to the $200.00 (Two hundred pesos, 00/100 M.N.) in which the NFT was offered and sold, that is to say, $36.00 (Thirty-six pesos, 00/100 M.N.) shall be paid for VAT, therefore, the total amount to be paid by subject B shall be $236.00 (Two hundred and thirty-six pesos, 00/100 M.N.). In the collection, OpenSea must withhold fifty percent (50%) of the VAT caused, in terms of article 18-J, section II, paragraph a) of the LIVA and pay it to the SAT. Subject A shall issue the CFDI to subject B in which the $200.00 (Two hundred pesos, 00/100 M.N.) for the alienation and the $36.00 (Thirty-six pesos, 00/100 M.N.) for the transferred VAT; and, on the other hand, OpenSea shall issue a Digital Tax Receipt by Internet of Withholdings and Payment Information in which the $18.00 (Eighteen pesos, 00/100 M.N.) that it withheld to subject A is stated.
As the reader may notice, to a great extent, the effectiveness of the tax regulation described above depends on the intermediaries operating the technological platforms being registered in the Federal Taxpayers Registry (“RFC”). Of special relevance is the case of non-compliance by foreign residents without a permanent establishment in the country, how do we oblige a foreign resident without a permanent establishment in the country to register in the RFC? Article 18-H Bis of the LIVA imposes the sanction of blocking access to the digital service of the digital service provider. However, this measure is easy to evade, since it is enough for the recipient of the service in national territory to change the IP address of his equipment to be able to access the service. Would it be worthwhile to reconsider the way in which foreign residents without permanent establishment in national territory could be obliged to comply with tax obligations?
José Eduardo Martínez Torres
Law Clerk
Author’s note: the foregoing does not represent the interpretation or opinion of the firm Acedo Santamarina, S.C. with respect to the detailed subject matter, it is prepared and published in a personal capacity by the author.
José Eduardo Martínez Torres
Law Clerk
Author’s note: the foregoing does not represent the interpretation or opinion of the firm Acedo Santamarina, S.C. with respect to the detailed subject matter, it is prepared and published in a personal capacity by the author.
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