Salman Khan, Amitabh Bachchan, Sunil Gavaskar, Manish Malhotra and Kamal Hassan are only some of the big names in India who are hopping on to the NFT bandwagon. But what is NFT that is increasingly becoming the hot topic of discussion across platforms and industries?
While the legislature is yet to clear the air on various regulatory aspects of virtual currencies such as bitcoin and the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 (Crypto Bill) is yet to be introduced before the Lok Sabha, investor(s) are inching to another kind of crypto asset which are “non-fungible tokens” (NFT).
With NFT gaining popularity, some of the often-asked questions are about the nature and classification of the same. Is NFT different from bitcoin? Is NFT just another cryptocurrency? How is NFT classified? These are some of the questions that this article seeks to answer. With this background, the authors attempt to analyse the indirect tax implications of NFT in the Indian context.
What are NFTs
In economics, a fungible asset is something with units that can be easily and readily interchanged with similar or identical object. Example: Money, it is fungible because we can exchange Rs 10 for another Rs 10 and both will still have the same value. In fact, this is what makes money a medium of exchange. Non-fungible assets on the other hand, are something that cannot be interchanged. For example, a masterpiece painting cannot be interchanged with something else. If it is bartered or exchanged, the value will not be the same and thus there can be only one of that original masterpiece painting which is unique.
NFTs are digital blockchain tokens that represent ownership of such unique items which could be digital or physical. Since digital works of art are prone to easy duplication and copying, the need arose to “tokenise” such digital files to create a certificate of ownership. NFTs can represent a wide array of things such as art, music, literature, real estate and even bizarre items such as iconic tweets, etc.
How is NFT different from cryptocurrency like bitcoin
Blockchain is the technology used for creating NFTs. Although blockchain was initially devised for fungible assets like cryptocurrencies such as bitcoin, it has evolved to enable users to create a unique crypto asset which unlike bitcoin is non-fungible and therefore, cannot be used as a “currency” of any kind.
While NFT itself is not a medium of exchange, one requires some other medium of exchange such as fiat currency (Government sanctioned currency) or cryptocurrency to acquire an NFT. Paying for NFT essentially means paying for the ownership and right to transfer the token to one’s digital wallet. The token proves that the item that one purchases is original. A key value proposition of NFTs is also the fact they are programmable thereby enabling automation of secondary transactions thereby allowing exploitation of underlying asset. For instance, artists can automatically get paid a programmed percentage of royalty each time a secondary sale of their original work takes place. In the physical or rather traditional world, the artist would have had to go through a lengthy legal process to recover/collect such a royalty.
Thus, NFTs make trading of digital art easier thereby offering ways to make money. For example, companies like Taco Bell have auctioned their themed art work to raise funds.
NFT— Use cases, classification and implications under GST law
Over the course of time not only the popularity but also the uses of NFT have increased. As discussed supra, NFT itself is merely a digital token that showcases the ownership of different assets. Different items, digital as well as physical, can be created and sold as NFT. It appears that, NFT’s classification would depend on the underlying asset it represents. In other words, classification of NFT would depend on what it corresponds to. To understand the tax implications under GST law of popular use cases of NFTs, it is to be determined whether they fall within the ambit of either goods, services, securities or actionable claims. Accordingly, we have analysed each use case independently to determine the classification.
One of the most popular use cases of NFT is artwork (paintings– physical/digital/designs) and even India has taken to its market relatively well. Several Indian artists have sold their artwork as NFT. In fact, as per the founder of homegrown crypto platform WazirX, art makes 90% of the NFT in India. By the logic of NFTs representing the underlying asset as explained above, when an artist sells his artwork as NFT then the classification of the NFT will be the artwork getting tokenised. In this case, if the seller is a registered supplier under the Central Goods and Service Tax Act, 20172 (the CGST Act) then the sale of such NFT will be classified as supply of goods and will be exigible to CGST. This is because the underlying asset being an artwork such as a painting is covered under the definition of goods under Section 2(52)3 of the CGST Act and accordingly sale of such goods will qualify to be a “supply” under Section 7 of the Act4. The intangible nature of NFT will not be factor excluding it from the definition of goods as it is now settled by various decisions of the Supreme Court that “goods” may be a tangible property or an intangible one.
The point to be analysed in such cases is transfer of ownership, possession and right to use. In sale of NFTs while there is always a transfer of ownership, transfer or right to use goods and transfer of possession is disputed as the underlying asset is always in digital form. Thus, while the definition of goods includes intangible movable property, one can question the nature of supply when NFTs are being sold.
Furthermore, individuals who are not registered in terms of the provisions of the CGST Act, may sell their artwork as NFT and in such cases the transactions may not be subjected to CGST (subject to the turnover meeting the monetary threshold for registration). The income tax implications will however be something that should be kept in mind even in such cases. For example: Cricketer Dinesh Karthik immortalising his 2018 winning moment’s artwork as an NFT may not be subjected to GST as the cricketer is not a registered supplier under the CGST Act. But a similar supply of NFT by a registered company will be subjected to GST as supply of goods.
ii) Fashion and lifestyle
Designers selling their collections as NFTs is not unheard of. Recently, Indian celebrity fashion designer, Manish Malhotra launched his fashion themed NFTs. One of the items of this collection was sold for a whopping 3,000 WRX (which is the native token of WazirX) that, as of today, amounts to $3753 (roughly Rs 2.8 lakhs).5 In this case, the underlying asset being a good makes the transaction a supply of goods (as discussed in the use case pertaining to artwork) exigible to tax under the CGST Act.
Indian music artists have also joined the fad and have released albums as NFT.6 Supplying music NFT means that ownership transfers to the purchaser meaning thereby that depending on the arrangement, the artist as well as the purchaser will earn share of royalties the music will make on streaming platforms. With no third parties being involved, sale of music as NFT make it more lucrative for the artists.
Based on the transaction it needs be examined whether the IP in the music is given or the music is transferred as it is.
Where the artist transfers the copyright in the said music to say another individual, then the activity would be classifiable as an intellectual property right service on which GST is payable at the applicable rate on royalty being charged subject to provisions on reverse charge mechanism.
In cases where the music is transferred electronically, the underlying asset being a digital content viz. music, the supply will be in the nature of Online Information Database Access and Retrieval Services (OIDAR) service and taxable subject to the supplier being within the threshold to discharge GST.
The Integrated Goods and Services Tax Act, 20177 (‘the IGST Act’) defines OIDAR to mean services whose delivery is mediated by information technology over the internet or an electronic network and the nature of which renders their supply essentially automated and involving minimal human intervention and impossible to ensure in the absence of information technology and includes electronic services such as advertising on the internet, online supplies of digital content (movies, television shows, music and the like), etc. Further, in case of transfer of part ownership or subsequent sale of same music which would attract royalty will arguably make the transactions a case of supply of IP right service.
Open issues and the way forward
NFTs are gradually becoming a widely talked about development in the field of blockchain technology and individuals as well companies are increasingly trading in the same. With its fast gaining popularity, regulatory bodies are also taking this up for consideration. The tax research unit of Central Board of Indirect Taxes and Customs (CBIC) has recently been quoted to be working on a proposal to tax the use of blockchain for commercial purposes even before legislation on cryptocurrencies is brought in.8 Thus, the issue of determining the tax implications becomes even more pertinent.
While some of the use cases have been analysed above, there can be a plethora of cases where each NFT and its tax implication will require independent assessment of each kind of use cases. For instance, some experts opine that NFTs are derivatives as defined under the Securities Contract (Regulation) Act, 19569.10 Derivatives include a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security and its value is derived from that volatility to which it is linked. Transactions of NFT can be classified as derivatives only when the transaction in question resembles a risk instrument or a contract for differences. Therefore, in cases where the NFT is not being sold as a collectible or artwork but as a speculative trading instrument, can it qualify as a derivative? In that case what will be the tax implications? Further, can NFTs fall within the ambit of actionable claims? These are only few of the many questions that remain open to assessment.
As discussed above, while on one hand the case that can be set up for taxing NFTs is by classifying it as per its underlying asset, it can also be argued that in view of the absence of any classification provided in law for “NFT” itself, the same cannot be taxed under the law as it exists today. However, each use case of NFT will have to be independently examined to assess the arguments in this regard.
It is high time that the Government provides clarity on this issue to ensure that there is certainty on taxation and to avoid endless and long-drawn litigation. It will be interesting to see if the tabling of the Crypto Bill will throw some light on this issue.
*Principal Associate, Lakshmikumaran & Sridharan.
**Joint Partner, Lakshmikumaran & Sridharan.
NFT | 90% Art, 10% Music: WazirX on Top NFT Categories in India, The Hindu, 16-7-2021 at<https://www.thehindu.com/entertainment/art/wazirx-on-top-nft-categories-in-india/article35362130.ece>.
3Goods are defined under S. 2(52) to mean every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply.
5Designer Manish Malhotra Drops First Fashion NFT Collection, Records Fastest Sale, Gadgets360°, 8-10-2021, <https://gadgets.ndtv.com/cryptocurrency/news/manish-malhotra-wazirx-nft-fashion-2568596>.
6Indian Rock Band Euphoria set to Launch its Next Album as an NFT, Business Insider, 10-9-2021 at https://www.businessinsider.in/cryptocurrency/news/euphoria-set-to-launch-its-next-album-as-an-nft/articleshow/86091831.cms.
8Investing in Cryptocurrencies, NFT? Soon, You May have to Pay 18% GST, Business Standard, 10-11-2021, <https://www.business-standard.com/podcast/economy-policy/investing-in-cryptocurrencies-nft-soon-you-may-have-to-pay-18-gst-121111000016_1.html>.
10Non-fungible Tokens are Now in India, but mind the Legal Pitfalls, Mint, 8-2-2021, <https://www.livemint.com/money/personal-finance/nonfungible-tokens-are-now-in-india-but-mind-the-legal-pitfalls-11617557315927.html>.