Tax law and the metaverse - what tax challenges do companies face in the virtual world?

Impressive innovations are anticipated in the metaverse and are thus causing an extraordinary stir in a multitude of areas of life. In the meantime, hardly any other field of law has to deal with various realities of life as comprehensively and in depth as tax law. It is only logical that this gives rise to diverse challenges for companies that are present in the metaverse. In practice, a diversity of perspectives gives rise to legal questions in this context:

• Does the exchange of virtual currencies for real or other virtual currencies lead to tax consequences in Germany?
• Are offers in the metaverse, such as purely virtual gambling, subject to taxation at all?
• Are employees deemed to receive non-cash benefits when their employers provide them with metaverse benefits?
• Can the acquisition and lease of digital land be taxable in Germany?
• Can a commercial enterprise be operated digitally and does digital agriculture and forestry exist?
• Do assets acquired in the metaverse, such as

To date, there has only been a – preliminary, incomplete - discussion of these and other questions. Naturally, it will be several years before the supreme courts can comment on such issues. Nevertheless, an evaluation of a first decision of the Federal Fiscal Court (Bundesfinanzhof, “BFH”) on the metaverse can provide some insights into initial questions.

Recognition of virtual worlds in analogue law

In its ruling of 18 November 2021, Case: V R 38/19 (source), the BFH took a position for the first time on the (turnover) tax classification of a virtual reality against the background of the metaverse "Second Life". The BFH addressed the fundamental question of whether purely virtual transactions - in the case at hand, the lease of virtual land - can be recognised under German tax law.

The BFH made four statements that have a determinative effect on the future:

(i.) In the virtual world, processes can take place that would trigger a (turnover) tax liability in real life. Contrary to the opinion of the Cologne Fiscal Court, however, the BFH ruled that any significance beyond the gaming experience was not associated with purely virtual transactions such as the lease of digital land. Hence, such transactions are not to be classed as tax-relevant events.

(ii.) In contrast, the possibility of exchanging in-game currencies for real currencies, which is often provided for in games, represents a transaction that is anchored in the real world. According to the BFH, this is fundamentally subject to turnover tax as a so-called "other service". In the specific case at issue, virtual tokens (so-called "Linden dollars") could be exchanged for US dollars via a game-internal exchange ("LindeX"). Since it has a game economy of at times several hundred million US dollars, this BFH ruling is already of enormous significance in relation to "Second Life". Furthermore, this appraisal is also worth noting for in-game exchanges of virtual objects and for comparable situations. Metaverse game providers and operators in particular are therefore called upon to analyse a possible turnover tax liability and should include this in their considerations when designing their virtual worlds.

(iii.) The BFH also points out a special feature of turnover tax law. In certain constellations, turnover tax law stipulates a reversal of the turnover tax liability (so-called reverse charge procedure). According to the BFH, it is not inconceivable that users of the metaverse might incur a tax liability for exchanging currency. The resulting adverse bureaucratic consequences for participants should, to the extent possible, already be addressed by companies when designing their virtual worlds. This requires a precise analysis of the planned service relationships.

(iv.) A further decisive factor for a tax liability under German turnover tax law is that the place of performance of the exchange relationship is located in Germany. According to the BFH, the place relevant for German turnover taxation can only be determined precisely in the individual case. Thus, in consideration of the registered office and server location of the metaverse provider, the BFH concludes that the place of performance is in the USA and thus denies a tax liability for the exchange of gaming currency in Germany. Companies should therefore pay particular attention to determining the place of the concrete exchange of services for turnover tax purposes. The BFH left open which place is decisive in the event of a discrepancy between the registered office and the server location of the company. It thus provides grounds for future disputes in this area, which in turn opens up design potential for companies.

Outlook - digital worlds and local tax law reference

The latter aspect in particular is omnipresent in tax law - a large number of tax regulations are linked to a specific place of performance or activity. This issue is more explosive than ever in the context of discussions on the taxation of the digital economy and the associated international distribution of taxes, which is mainly being conducted at OECD level. Naturally, this also raises the question of what effects this new dimension of the digitised world will have on the numerous location-based tax regulations against the background of the performance of actions in the metaverse. In conclusion, we name but a few exemplary regulations that could give rise to such discussions:

• Location of the management when holding management board meetings in the metaverse;
• Qualification of the income from the metaverse as domestic income generated in Germany;
• Residence of persons and companies for double taxation treaty purposes in the case of a purely virtual activity;
• Access and provision of data and activities in the metaverse for audit purposes;
• Locally competent tax office for purely virtual business operations in Germany;
• A trade or business conducted in Germany for trade tax purposes by means of purely virtual operations in the metaverse.
   

Conclusion

The BFH ruling has drawn up the first guidelines for the taxation of purely digital transactions in the metaverse. However, the facts underlying the ruling concerned the game "Second Life", which was first published in 2003. Particularly against the background of the much more far-reaching possibilities of the virtual worlds that have since followed, a constant updating and refinement of the case law can be expected. However, the BFH ruling can be classified as a first visible indication. Both politically - here especially at the level of the OECD - and with a view to the case law, a watchful eye l needs to be kept on matters in order to anticipate developments, plan ahead and keep pace with the course of the discussion. One thing is certain, however: the volume of digital exchanges will grow and their social significance will continue to develop.

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