Transactions worth billions of dollars are flowing through the metaverse, creating complex conundrums around how taxation should work in virtual reality.
The metaverse, for some, is a frivolous escape – a place to play games, socialise with friends or attend a virtual concert.
But make no mistake, for many the metaverse is serious business, with serious amounts of money at stake.
The value of transactions taking place throughout the metaverse continues to grow exponentially.
Active monthly users on the metaverse are estimated to be more than 400 million, while In the first five months of 2022, more than $US120 billion was invested, more than doubling the $57 billion spent last year in the 3D network of virtual worlds.
That included $US500 million spent on virtual real estate in 2021 alone, a big proportion of which was purchased by businesses looking to increase their brand exposure.
While some scoff at the utility of Facebook founder Mark Zuckerberg refocusing his company towards the metaverse – and point to his company Meta’s plummeting value since he announced his virtual reality investments – he knows that it is no small coin and he wants a piece.
The value of some of the individual transactions has been eye-popping. Earlier this year, financial publishing company Curzio Research set a record after it splashed $US5 million on 19 commercial real estate properties in a corner of the metaverse known as TCG World.
And the impressive investments aren’t restricted to virtual real estate. In May 2021, a virtual Gucci handbag sold for more than $US4,000, a price tag surpassing its real-life version.
But how do you apply Value Added Tax (VAT) to a transaction for a place or product that only exists in the virtual world? That is the puzzle vexing governments across the EU and in the United Kingdom.
Tax laws can’t keep up with virtual world
Marc van Weert, VAT consultant at Baker Tilly Netherlands, explains that VAT is a complex issue when it comes to the digital realms.
“The current VAT legislation is not up to date and are not suitable to tax current transactions in the metaverse ,” Mr van Weert says.
“The European Commission has already developed a set of rules to streamline VAT levies for e-commerce retailers and as of 2025 new rules for digital events are applicable. Therefore, the European Commission is clearly moving on taxing the digital economy, but the metaverse is currently not covered and also still not part of the new set of rules recently announced”.
“There is a lot of money going through there, so it’s a great opportunity to tax it, and that of course is a great incentive for authorities to create legislation”.
To illustrate the complexity for virtual real estate, a precedent may have been established after a German court ruled that renting virtual land should be VAT free.
If such a transaction would qualify as relevant for VAT, it would raise several questions. If the real estate transaction takes place in exchange for cryptocurrency, in which country is the transaction taxable and what is the value of the transaction? The value of crypto currency heavily fluctuates.
Mr van Weert says that if cryptocurrency is not recognized as official currency, there could be a mismatch in value between the moment of the transaction and the conversion. In light of official exchange rates, the legislation is not equipped for this at the moment.
VAT rules for other products selling in the metaverse are similarly unclear.
Mr van Weert says the European Commission is preparing legislation to formalise the application of VAT for virtual events such as webinars and training, where those that attend would be subject to VAT in the country in which they are resident.
But applying that principle in an environment where most transactions take place using cryptocurrencies raises a particular challenge.
“It is very hard to determine where your customers are located and whether these transactions in the metaverse are even in the scope of these new rules,” Mr van Weert says.
“For the last half year, the major wallet providers for Bitcoin have required users to provide identification and an indication of where they are established – the exchanges have to gather that information for governments”.
“But there has already been a lot of fraud in this space because cryptocurrency is known for its decentralized character and often used specifically in view of its anonymity.”
A physical product or a digital service?
Applying VAT to virtual products such as a digital Gucci handbag is similarly challenging, according to Julie Green, VAT manager at Baker Tilly network firm MHA UK.
Retail brands such as Gucci are generally taxed on the supply of physical goods. But for digital products such as avatar accessories, different VAT rules around the provision of digital services could apply.
Ms Green says governments will have to determine whether the sale of a product in the metaverse constitutes the supply of a good or a service.
“The question is – if there was a supply, what was it?” Ms Green says.
“The seller would need to establish what it is they are supplying – is it an electronic service, or does what you’re buying also give you real-world benefits which would have their normal taxation?
“There is the additional consideration of where the customer is and how governments are going to get that data, and there is also a question of how you value a supply.”
Ms Green says that the value question is particularly pertinent due to the proliferation of different cryptocurrencies being used for metaverse transactions.
For transactions using Bitcoin, Ms Green referenced a European Court decision that recognised the world’s most popular cryptocurrency as a currency for tax purposes.
But for other coins or tokens, Ms Green says a lack of recognition of their validity of a currency makes applying VAT a tricky proposition.
“The European Court decision was made on the basis that the only purpose of Bitcoin is as a currency,” she says.
“With Ethereum and other cryptocurrencies, I understand it can be used for other things as well as currency.
“If any of them have other uses apart from just being a means of payment, it’s not clear that they are recognised currencies.
“The question then is almost, if it’s not a currency, then what is it?”
Ms Green says regulatory bodies will also soon have to grapple with an unsavoury reality of transactions that occur virtually using cryptocurrencies – the potential for fraudulent transactions.
“We have had cases in the UK where fraudsters will set up a chain of transactions and then someone in the chain will disappear and not pay the VAT.
“The customer then claims the VAT back, and it is effectively supply chain fraud, where you set up a series of fraudulent transactions and then someone goes missing without paying the VAT to the relevant authority.
“This market is a potential breeding ground for fraud and hacking,” she says. “In the real world, when there is a sector that’s subject to fraud and it’s a business-to-business transaction, governments have responded by making the customer responsible for paying the VAT and claiming it back.
“That’s something that needs to be considered going forward.”
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