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There has been a large coverage in the media about NFT and
Metaverse during the last year which also continues this year.
Indeed the “tokenmania” that has taken roots within the
gaming and art industries seem to expand now to financial products
and consequently trigger national or regional regulation.
What are NFTs?
NFTs (Non-Fungible Tokens) are not only tokenized assets
representing immaterial values such as pieces of art collections.
NFTs are also “non-fungible”. Whereas fungible assets can
be replaced by other equal assets and are interchangeable (10
shares, 10 euros, 1kg of rice etc., is replaceable by their
respective equivalence), non-fungible assets cannot be replaced by
anything and are therefore not interchangeable. They are
one-of-a-kind assets, with very exclusive attributes, that cannot
be found in any other existing asset.
To the contrary of cryptocurrencies, NFTs were designed to be
indivisible by default and cannot be divided into smaller units.
Indeed, a token cannot be broken down into new “smaller
units” to be attributed to new owners.
NFT aim to provide access to digital works while being a proof
of “ownership” of such works or access. Indeed,
“exclusive” access or “ownership” most of the
time are only common words to design a licensee of a digital
collection, not necessarily an ownership of the digital artwork
itself.
NFTs may be particularly useful for copyrighted works
considering they are not registered with any Intellectual Property
organization (unlike trademarks and patents). They may serve as a
tool to tag isolated works with great precision, establishing the
original authorship, attributing exact timestamps to transactions,
publicly determining all subsequent ownership, and thus preventing
copy. This may also explain why most items represented by NFTs seem
to be copyrightable items, such as paints, drawings and songs.
Yet not every item may be valuable or adequate to be tokenized
by NFTs. Assets with more than one owner and subject to
co-ownership rules (i.e. buildings) may not be suitable to be
represented by NFTs. The NFT creator should have something unique
belonging exclusively to him, and something that could be
represented by, and transferred through, an NFT.
Still in this regard, it is worth to point out that NFTs are
programmable. In other words, when creating an NFT, it is possible
to select and incorporate into it different sorts of information.
Among that information, it is certainly the identification of the
ownership as well as the price. It is also possible to add the
conditions applicable to a given NFT when being sold.
Once NFT are created they are recorded in the blockchain. Just
as cryptocurrencies or other virtual assets, NFTs are held in
digital wallets. A wallet is a program with a similar purpose of
that of a bank account: it tracks one person’s holdings on a
specific DLT.
From the wallets, NFTs may then be traded on different
specialized marketplaces. NFTs transactions are possible thanks to
smart contracts. Like wallets, smart contracts are also programs
contained in the DLTs that are triggered when someone related to
the NFT (the purchaser or the seller) interacts with it. It serves
the purpose of an authenticity seal. In turn, these interactions
are recorded on the DLT and those ensure the transactions
authenticity.
DLTs or Blockchains?
NFTs rely on DLTs or more specifically on blockchains. Although
DLT and blockchains share the same conceptual origin and are often
used to designate a ‘blockchain’ (because of the success of
the latter), those two terms actually refer to different things.
Not all DLTs are blockchains, and a Blockchain is not the only
existing type of DLT.
A distributed register/ledger technology (or DLT) is a
shared/distributed database where logs are recorded in a structured
manner, managed by multiple participants, through a network that is
spread across different locations (decentralized digital database).
A DLT may therefore be defined as “a novel and fast-evolving
approach to recording and sharing data across multiple data stores
(or ledgers). This technology allows for transactions and data to
be recorded, shared, and synchronized across a distributed network
of different network participants” ( World Bank, 2017).
On the other hand, a blockchain constitutes a particular type of
data structure used in some DLTs. Although a distributed ledger,
the data stored and transferred through a blockchain is grouped
into ‘blocks’ locked by immutable cryptographic signatures
called ‘hash’. Those hash signatures are a fixed series of
alphanumeric characters unique to any specific transfer. Therefore,
the hash is a transfer fingerprint and any change to that transfer
would generate a different hash. Each new block in a blockchain
includes a hash of the previous block, and all blocks are linked to
each other in a digital chain of blocks (or blockchain).
A blockchain may thus be defined as a “recording mode for
data produced in a continuous manner, in the form of blocks linked
to each other, according to their validation chronological order,
each of the blocks and their sequence being protected against any
modification” ( Legifrance).
When applied to NFTs, the blockchain is like an open book in
which it is published everyone’s properties – similar to
a deed published by the notary.
What is the Metaverse?
Metaverse, on the other hand, is a 3D digital environment, or a
“virtual reality”, or an “augmented reality”,
close to a gaming space, that comprises avatars, representations,
artwork, code and graphics. This environment includes exchanges of
virtual assets and access to digital representations. There, NFTs
issued on a blockchain come as the best means to ensure a secure
and transparent consumption of those digital properties.
Generally speaking, Luxembourg has a wide range of various
financial incentives for different businesses, including to finance
technical feasibility studies, start-up aids (Fit4Start), aid for
young innovative enterprises, aid for SMEs IP protection, etc. A
joint public-private partnership – the Digital Tech Fund – was also
created, in 2016 to support the Luxembourg technology startup
ecosystem in different sectors, such as in the so-called Fintech
sector.
Otherwise, Luxembourg was elected the best location for data
centers in consideration of its low energy price and reliable
electricity supply. The Luxembourg VASP provisions have contributed
to legal certainty, and whenever stocks and real estate property
will be ‘turned’ into NFTs, some recent legislative
initiatives may be interesting, such as the so-called Blockchain
laws of Mars 2019 and January 2021.
NFTs and Metaverse seem to represent excellent opportunities,
especially for Arts and Gaming industries. However, they are quite
new and have mostly not yet fallen under the radar of national
regulators, which does not mean that NFTs and Metaverse are beyond
the reach of national regulations and judiciary decisions.
Despite their novelty, there are existing legal provision that
must be taken into account when setting up a venture in Luxembourg,
in connection with NFTs and Metaverse.
Luxembourg Law Definition of NFTs and Metaverse
As of today, Luxembourg law provides no stand-alone definition
for NFTs or Metaverse. However, the Luxembourg Law of 12 November
2004 on the fight against money laundering and terrorist financing
(the “AML/CFT Law”) currently provides two definitions
that may be relevant for NFTs : that of “Virtual Assets”
(20ter) and of “Virtual currencies” (20bis). The first
one of these two definitions may include NFTs. Indeed, a
“Virtual Asset” is defined as “a digital
representation of value that can be digitally traded, or
transferred, and can be used for payment or investment
purposes”. Whenever an NFT fulfils these general
characteristics, it could potentially be considered a virtual
asset, which entails a certain number of obligations (please see
our comments to the last point). It may be worth to note that the
AML/CFT Law expressly provides that “virtual currencies”
are included within the Virtual Asset definition.
The Metaverse is not defined nor regulated per se in Luxembourg
law, and it is unclear how it would be treated. It may not ever be
fully regulated in a single text but by provisions from different
texts, which may apply depending on the qualification of the
actions taken within the Metaverse. The Income tax, for example,
seems to apply “regardless of whether the income is realized
in a real or virtual world” – Luxembourg Direct Tax
Administration Circular L.I.R. n° 14/5 – 99/3 –
99bis/3 of 26 July 2018.
Luxembourg regulations on NFTs and Metaverse
One of the first questions that comes to mind when dealing with
sale of virtual properties is tax provisions: To the best of our
knowledge, no Luxembourg income tax provision expressly states as
applicable to NFTs, nor did the Luxembourg tax administration make
any statements specifically on NFTs taxation. Nevertheless, the
Luxembourg Direct Tax Administration Circular L.I.R. n° 14/5
– 99/3 – 99bis/3 of 26 July 2018 provides that
“concerning the income tax, business tax and wealth tax,
virtual currencies, such as Bitcoin, shall constitute intangible
property”. This Circular was adopted before the “Virtual
Assets” and “Virtual Currencies” definitions were
introduced within the AML/CFT Law, the 20 March 2020. Therefore,
the Circular could not possibly refer to “Virtual
Currencies” .
Although NFTs may not be considered virtual currencies, it is
reasonable to assume that they may as well be considered an
intangible property by the Luxembourg administration. Should this
be the case, the NFT income may be subject to an income tax
whenever this income “falls into one of the categories of
income listed in Article 10 L.I.R.” (Ndlr. L.I.R. = the
Luxembourg income tax law).
Furthermore, any person who, on behalf of or for their clients,
provides specific services listed by law that are related to
virtual assets (which, as we have seen, may cover NFTs) must comply
with a certain number of obligations: apply for a Virtual Asset
Service Provider authorization (the “VASP”) before the
CSSF (the Luxembourg authority supervising the financial sector),
pay the CSSF fees for the VASP registration, comply with AML/CFT
legal provisions, have at least two persons responsible for the
VASP management (article 7-1(3) AML/CFT Law), have these persons
approved beforehand by the CSSF, etc. Other licenses and
regulations may also be applicable depending on the activity
performed in relation with the NFTs (see Point 5 herein).
It may be worth to mention that, having regard to the Commission
Proposal for Markets in Cryptoassets Regulation (MiCA), NFTs would
likely fall into the ‘catch-all’ category of other
crypto-assets and may require a license for a Crypto-Asset Service
Provider (the “CASP”) – Skadden (Various authors),
Regulatory Approaches to Nonfungible Tokens in the EU and UK, 15
June 2021.
Direct and indirect taxes with reference to the issue and sale
of NFTs
NFTs may be considered intangible property by the Luxembourg tax
administration and the income resulting from NFTs may potentially
be subject to an income tax. Should this be the case, the NFT
income resulting from transfer operations (alienation, exchange)
may be considered, for taxation purposes, either as a
“business profit” (Art. 10(1) L.I.R.) or, alternatively,
as a “miscellaneous net income” (Art. 10(8) L.I.R.). In
this regard, an NFT income may be a “business profit” if
it is the result of an “independent profit-making activity
carried out on a permanent basis and constituting a participation
in general economic life, when the said activity does not
constitute agricultural or forestry exploitation or the exercise of
a liberal profession” (Art.14 L.I.R.).
As for indirect taxes, in an ECJ Judgment of 22 October 2015
(C-264/14), the European Court of Justice considered that the
“exchange of traditional currencies for units of the
‘bitcoin’ virtual currency and vice versa” are
transactions “exempt from VAT within the meaning of provisions
from article 135(1)(e) of the VAT Directive”. However, it
cannot be assumed that the same conclusion would also be applicable
to NFT, in that, unlike virtual currencies, they do not serve the
purpose of a means of payment (C-264/14, 24 to 26 and 52; cf. also
article 135(1)(e) of the so-called VAT Directive of 28 November
2006).
In any case, Luxembourg tax administration have not yet made any
statement in this regard.
Specific Luxembourg authorizations / registrations required for
operators issuing / intermediating NFTs All professional economic
activities are subject to a business permit (autorisation de
commerce) granted by the Luxembourg General Directorate for Small
and Medium-Sized Enterprises. Those activities are also subject to
specific registration and publication obligations before the
Luxembourg Trade and Companies Register (RCS) and the Luxembourg
Beneficial Owners Register (RBE).
Furthermore, one may need to apply for a VASP authorization
before the CSSF (which entails a certain number of obligations), as
well as for other licenses depending on the intended
activity(ies).
In the near future, it may also need to apply for a CASP
authorization before the same authority (it is currently unclear
whether the VASP and CASP regimes will coexist or be superseded).
As for VAT, one may need to register for VAT with the Luxembourg
tax administration (especially if the annual turnover exceeds
35.000.- EUR), usually within 15 days from the start of the
activity, with some exceptions.
Finally, one may take in consideration that intermediating NFTs
may be understood as intermediating the goods/services that those
NFTs represent. In such case, specific authorizations and
obligations may be needed, depending on the nature of those
goods/services.
Decisions regarding legal and tax aspects of NFT and
Metaverse
The European Court of Justice as well the Luxembourg Direct Tax
Administration have issued decisions on virtual currencies that we
mentioned in our previous points. However, they concern
specifically virtual currencies and do not address NFTs or virtual
assets in general.
Since the creation of the VASP regime, the CSSF also published a
series of documents in its website concerning investments in
virtual assets as well as the depository duties in the context of
virtual assets (documentation that is mainly directed towards
specific entities under the CSSF supervision: funds/undertakings
for collective investment, and banks/credit institutions). In one
of these documents dated on 29 November 2021, the CSSF briefly
refers NFTs, seemingly framing them within “virtual
assets” definition, and indicating that the aforementioned
entities may or may not invest in them, depending on the risks and
on the specifics of their activities. No sentence (court decision)
or statement from a Luxembourg authority seems to have been
published regarding Metaverse, up to this date.
The Financial Action Task Force (FATF) considered that NFTs
“are generally not considered to be VAs” (Virtual Assets)
but “it is important to consider the nature of the NFT and its
function in practice” since “the FATF Standards may cover
them, regardless of the terminology. Some NFTs that on their face
do not appear to constitute VAs may fall under the VA definition if
they are to be used for payment or investment purposes in
practice” ( FATF, Updated Guidance for a Risk-based Approach –
Virtual Assets and Virtual Asset Service Providers. October 2021.
p.24).
All companies and undertakings wanting to use a specific
technology, but having doubts concerning its legal value and
implications, are advised to verify those points with a legal
professional.
Originally published 22 March 2022
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.