A non-fungible token (NFT) is a special digital record stored on a blockchain. It typically represents ownership rights in digital or real assets, such as digital art or reward items like alcohol or vacations. NFTs serve as a way to confirm who owns or has the rights to that asset. The proof of ownership is secure because information stored on blockchains is extremely difficult to alter or delete.
NFTs stand out from other tokens like Bitcoin and Ether. Bitcoin and Ether tokens are very similar and can be exchanged directly, making them fungible, like serial-numbered banknotes. In contrast, NFTs have unique metadata that points to various digital or real-world assets, making them non-fungible. So, what about NFT regulations in Europe?
Why are European legislators Interested in NFTs?
NFTs have become a major trend in the cryptocurrency market over the past 12-18 months. Individual NFTs have sold for hundreds of thousands of dollars, with one record-breaking sale reaching $69 million.
NFT marketplaces have reported transaction volumes reaching nearly $25 billion in 2021, a substantial increase from less than $100 million the previous year. The profit potential has attracted financial institutions and non-financial businesses to issue, promote, and facilitate NFT transactions.
For instance, Diageo-owned Johnnie Walker recently partnered with Blockbar to launch an NFT that offers owners various rewards, including bottles of 48-year-old whiskey. JP Morgan made history by becoming the first bank to enter the “metaverse,” where users can buy, sell, and use NFTs and other crypto-related services.
Although the NFT market may be cooling down, as evidenced by OpenSea’s recent layoffs, NFTs continue to generate significant attention. Despite price fluctuations and transaction volumes, there is still substantial money and interest in NFTs. Additionally, NFTs are closely connected to the broader world of cryptocurrencies, ensuring lawmakers will continue monitoring them closely.
Lawmakers in the European Parliament suggest modifications to the upcoming EU anti-money laundering legislation to ensure that NFT platforms and companies offering NFT-related services fall under its regulatory purview.
This proposed alteration addresses a significant gap in the EU’s influential Markets in Crypto-Assets (MiCA) regulation, which presently excludes non-fungible tokens (NFTs) from its scope.
According to a leaked draft of the anti-money laundering (AML) proposal, which has reportedly been confirmed by sources familiar with the negotiations, the current definition of crypto-assets service providers under the MiCA Regulation does not cover NFT platforms unless they offer services related to fungible and non-unique crypto-assets.
To address this gap and mitigate the associated risks of money laundering and terrorist financing, the proposal suggests including NFT platforms as a separate category of obligated entities within the broader anti-money laundering and counter-terrorism financing (AML/CFT) framework.
This updated draft aligns with earlier reports from September, indicating that the European Parliament intended to incorporate decentralized finance, decentralized autonomous organizations (DAOs), and NFTs into anti-money laundering regulations, areas previously not covered by the EU’s initial proposals for the upcoming AML/CFT legislative package.
This development follows January’s news that French regulators were advocating for stricter regulations to prevent a recurrence of the crises and collapses seen in the digital asset space in 2022. The language in the leaked AML proposal underscores the EU’s determination to regulate digital assets with its extensive regulatory reforms comprehensively.
AML and MiCA: Strengthening Anti-Money Laundering Rules in the EU
In July 2021, the European Commission unveiled an ambitious set of legislative proposals to bolster the European Union’s rules for combating money laundering and terrorist financing (AML/CFT).
This comprehensive package includes the 6th Directive on AML/CFT, new regulations concerning AML/CFT, such as the introduction of an EU-wide limit of €10,000 ($10,688) for significant cash transactions, and a proposal to establish a new authority tasked with fighting money laundering—the Anti-Money Laundering Authority (AMLA).
This extensive package grants the AMLA the authority to oversee the activities of digital asset companies across all EU member states. Additionally, the agency will play a role in enforcing the comprehensive regulatory framework known as MiCA concerning anti-money laundering and terrorism financing concerning digital asset companies. The primary goal is to enhance the detection of suspicious transactions and address regulatory gaps.
The AMLA is expected to become operational in 2024, coinciding with the planned implementation of the MiCA regulations, which should take effect the same year if they pass their final vote next month. It’s worth noting that the vote was postponed from February to April 2023 due to challenges translating the nearly 400-page document into the 24 official languages of the European Union.
The increased scrutiny of NFTs by the forthcoming AMLA fills a notable gap in the MiCA regulation that may have caught some industry participants off guard or led to excessive preparations.
Exploring the Impact of MiCA, the European’s New Crypto Regulations
The European Union’s new crypto regulations, known as the Markets in Crypto-Assets (MiCA), have officially become law as of May 31. These regulations mark a significant milestone in providing clear guidance for EU crypto assets and service providers.
Initially drafted in 2020, this regulatory package will govern various aspects of the cryptocurrency market, including issuance and service scope.
The European Parliament approved the MiCA regulations on April 20, after which the bill moved to the European Council for final approval. On May 31, European Parliament President Roberta Metsola and Swedish Rural Affairs Minister Peter Kullgren signed the framework into law, with Sweden holding the EU Council presidency.
MiCA was published in the Official Journal of the European Union (OJEU) on June 9, initiating the countdown for the law’s implementation. This means crypto businesses have specific timelines to adhere to MiCA’s requirements. Rules for stablecoins will apply starting from June 30, 2024, while regulations for exchanges will take effect on December 30, 2024.
MiCA defines a crypto asset as “a digital representation of value or rights that can be electronically transferred and stored using distributed ledger technology or similar technology.” The legislation also clarifies what qualifies as “cryptocurrencies” and how certain digital assets are classified as “tokens.”
Furthermore, MiCA sets standards for crypto asset service providers (CASPs) and cryptocurrency asset issuers. Issuers of crypto assets must adhere to disclosure and transparency standards, providing complete and transparent information about the crypto assets they issue. CASPs are required to implement security measures and comply with Anti-Money Laundering regulations.
MiCA establishes CASPs as distinct legal entities. These service providers can obtain licenses in any of the 27 EU member states and operate within their jurisdictions. They must prevent market manipulation and abuse and will be subject to regulatory oversight from entities like the European Banking Authority.
Stablecoin service providers will be mandated to furnish a white paper containing critical information about the product and key stakeholders involved in the business. This document should include details of the public offering, the blockchain verification mechanism used, the associated rights of crypto assets, potential investor risks, and a summary to aid potential investors in making informed decisions.
It’s important to note that MiCA does not govern digital assets that qualify as transferable securities and function similarly to shares. The EU legislation also excludes nonfungible tokens (NFTs) and crypto assets already categorized as financial instruments under existing law.
MiCA does not regulate central bank-issued digital assets, including those from the European Central Bank or national central banks, or services related to crypto assets offered by these institutions.
David Schwed, head of the blockchain cybersecurity firm Halborn, considers MiCA a pivotal development, establishing a comprehensive framework to provide clear guidance in specific market segments. He notes that while MiCA excludes certain aspects of crypto, such as NFTs and decentralized finance, it represents a significant advancement for the crypto community and sets a precedent that other regions may consider adopting.
NFT Taxation in the European Union
The taxation of Non-Fungible Tokens (NFTs) in the European Union (EU) is a complex issue that involves various aspects of VAT regulations.
Taxable Persons and Type of Supply
Definition of Taxable Person: According to the VAT Directive, a taxable person is any individual or entity that independently engages in economic activities, regardless of their purpose or outcomes. This definition implies that individuals or businesses trading NFTs can be considered taxable persons for VAT purposes.
Types of Supplies: The VAT Directive distinguishes between goods and services. Goods refer to the transfer of tangible property rights, while services encompass transactions that do not involve tangible goods. The Directive provides a comprehensive definition, which includes electronically supplied services delivered over the Internet or electronic networks.
This definition covers various aspects, such as the supply of digitized products, services generated automatically from a computer in response to a specific input, and the transfer of the right to list goods or services on online marketplaces where automated bidding occurs.
NFTs as Electronically Supplied Services
NFTs as Services: NFTs, despite their unique nature, are considered electronically supplied services for VAT purposes. This categorization is based on several factors, including the digital certificate of authenticity representing the NFT as the transaction object and the absence of physical delivery of associated digital files.
Taxable Amount: The taxable amount for an NFT transaction is typically the sale price, whether inclusive or exclusive of VAT. It does not matter if the NFT is sold at a higher or lower price than the initial purchase.
VAT Rate: The standard VAT rate applicable in each EU Member State is generally applied to the sale of NFTs. However, in cases where NFTs are donated for charitable purposes or qualify for reduced VAT rates due to their use in art donations (e.g., CryptoArt movement), different rates may apply.
NFTs’ Place of Supply
Destination Principle: VAT is levied based on the destination principle, which should be imposed in the country where the final consumption occurs. This principle aims to achieve VAT neutrality in international trade. However, determining the place of supply for services, especially in digital environments like NFT transactions, can be challenging.
EU VAT Legislation Reforms: In July 2021, the EU introduced VAT reforms to adapt to the digital landscape. These reforms extended the optional one-stop shop (OSS) regime, simplifying VAT collection for digital services to cover EU and non-EU schemes. Nevertheless, tracking the exact place of supply for NFT transactions remains complex due to the digital nature of NFT trading, where parties may be located anywhere.
Navigating the VAT treatment of NFTs in the EU involves various considerations, including classifying NFTs as electronically supplied services, determination of taxable amounts, and challenges related to the place of supply.
While VAT reforms have aimed to address digital transactions, the unique characteristics of NFTs continue to pose challenges for tax authorities and market participants. Individuals and businesses involved in NFT trading must stay informed about VAT regulations and seek professional advice when necessary.
NFTs regulations in Europe represent a dynamic and evolving landscape that reflects the unique nature of digital assets in the modern era. While the European Union has made significant strides in defining taxable persons, types of supply, and VAT treatment for NFT transactions, challenges remain.
The classification of NFTs as electronically supplied services has clarified their VAT treatment and introduced complexities related to determining the place of supply in a digital environment. VAT reforms, such as the one-stop shop (OSS) regime, have aimed to simplify VAT collection for digital services. Still, the global and decentralized nature of NFT trading continues to challenge traditional tax frameworks.
As NFTs gain popularity and diversify into various industries, including art, gaming, and entertainment, regulators must adapt swiftly to address emerging issues. Clear guidelines, transparent taxation processes, and international cooperation will be essential to provide certainty for market participants and ensure a fair and efficient regulatory environment for NFTs in Europe.
Market participants and stakeholders should closely monitor regulatory developments, seek professional advice, and proactively engage with authorities to effectively navigate the evolving landscape of NFT regulations in Europe.