Aleksandra Bal of Stripe discusses a recent German case which considered whether the renting out of land in a virtual space to users’ avatars constituted a taxable digital service and was therefore subject to VAT.
The “metaverse,” an immersive virtual space allowing users to interact via avatars, is growing in popularity. If you spend a lot of time in the metaverse, you’ll probably want a digital home. And, just like in the real world, there are different ways to find one.
If you know what you want and have the money, you can spend a few hundred dollars straight away to buy a place. Many people have already taken this route, pouring millions of dollars into metaverse real estate. The virtual land market in the four largest metaverses—Decentraland, Somnium Space, Cryptovoxels and The Sandbox—reached 440 million euros ($465 million) in 2021, and that figure is projected to double in 2022.
But if you’re not quite ready to commit, there are more affordable options out there: You can rent a parcel or a dwelling on the metaverse’s active secondary market. The metaverse also has its own real estate industry, with real estate advisers and agents who specialize in this space.
Before you sign that rental contract, however, there are some tax issues to consider. And they’re confusing. So confusing, in fact, that a pair of German courts recently struggled to sort them out, in a case involving a virtual world entrepreneur. The case concerned the virtual world Second Life, which is an example of a metaverse with centralized authority, sometimes also called “proto-metaverse”.
The German Case
The dispute involved a German landlord (the plaintiff) who bought land in the virtual world Second Life, which he then subdivided and rented out to other Second Life users. Those users’ avatars signed rental contracts with the plaintiff’s avatar in the virtual world and paid monthly rental fees in Linden dollars, Second Life’s virtual currency. The plaintiff subsequently took those Linden dollars and exchanged them for US dollars, generating a profit for himself—and triggering the notice of the German tax authorities.
The German tax office claimed that the renting out of virtual land constituted a taxable digital service and asked the plaintiff to send in the value-added tax, or VAT, that the tax office claimed he should have charged his tenants.
The plaintiff disagreed, arguing that he did not provide the tenants with any actual services because he had not in fact entered into direct contractual relationships with them. He argued that the only contractual relationship he had was with the virtual world operator that runs Second Life: And as that operator was established in the US, the rental services could not be subject to tax in Germany because, under the German place of taxation rules, services provided to other businesses are generally taxed in the country of the customer.
The case first went before the Tax Court of Cologne, which ruled against the landlord. As the Court understood it, the situation was fairly straightforward: The plaintiff had allowed Second Life participants to use his plots in exchange for Linden dollars after signing rental agreements.
The fact that the “rental contracts” were signed by avatars in the virtual world did not matter from a tax perspective: the plaintiff provided taxable services to other Second Life users, meaning that his rental income was subject to German VAT, as a purely domestic transaction, as long as the customers were private individuals residing in Germany.
The landlord appealed the ruling to the German Federal Tax Court, which overturned the lower court ruling. The Court ruled that the renting of virtual assets was irrelevant for tax purposes as it took place entirely in a virtual world. Although virtual land had significant value, this value was limited to a particular online environment. If the virtual world closed down, the virtual land would cease to exist.
Therefore, “in-game” activities undertaken for hobby purposes should not have real tax consequences.
However, the Federal Tax Court noted that activities beyond the boundaries of a virtual world may have real tax consequences. The Court ruled that the plaintiff performed a taxable transaction when he exchanged Linden dollars for US dollars. But because that exchange took place over Second Life’s currency exchange platform, which is established in the US, the Court ruled that the transaction was not subject to tax in Germany.
The decision of the German Federal Tax Court is final and cannot be appealed
Effects of the Ruling
So, what does this all mean for landlords and tenants, and other players in the emerging metaverse real estate scene? Well, in short—it’s good news.
Participation in virtual worlds enables people to act without consequences in their offline lives. That is a large part of the appeal—Las Vegas commercialized this idea long ago with its “what happens in Vegas, stays in Vegas” tagline. Similarly, virtual worlds allow large numbers of people to engage in role-playing that many do not expect to carry over into the real world.
From a tax compliance perspective, it makes sense to leave the metaverse to itself and only invoke tax rules when virtual world activities lead to a real-world event. If every rental payment made in virtual currency for the use of virtual land were subject to VAT, virtual landlords would suddenly have to deal with a thicket of regulatory and compliance requirements: Who do they owe tax to, and where, and when, and in what currency?
It does not seem right to impose all these burdensome obligations on people who have a virtual second life. What happens in the metaverse should stay in the metaverse.
However, we need to keep in mind that the German court decision was based on the facts of the individual case. It might have been different if, for example, the transactions took place in an open decentralized metaverse that was not run by one company. Also, it cannot be excluded that courts in other countries would reach a different conclusion on the taxability of transactions taking place in a virtual world.
There is still no tax certainty in the metaverse: When nothing is sure, everything is possible.
The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organizations with which the author is affiliated.
Source: https://news.bloombergtax.com/
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