‘NFT artists and collectors and traders take care,’ was last month’s envoi concluding a selected survey of the current state of the art NFT landscape. Key emerging legal issues include copyright infringement, stealing then minting and selling digital art, and questionable terms and conditions of sale from online trading platforms. Further legal issues not included were the potential imposition of taxes and financial regulations on those involved in art NFT trading transactions – especially when paying with cryptocurrency.
Taxation of trading transactions depends on the legal nature and status of the ‘thing’ traded. As for art NFTs, art historian Bendor Grosvenor’s latest monthly blog suggests that: ‘What you’re really buying is the sequence of code entered onto the blockchain, which is unique and thus tradable. If enough people believe the line of code is worth something then you can sell your Turner jpeg for a profit. Think of it as the emperor’s new code.’
Grosvenor referenced the British Museum’s recent minting, and offering for sale at up to £5,000 each, of NFTs of a score of JMW Turner’s original watercolours in its collection. He went on to say that ‘of course it’s about money’. ‘Sure,’ he went on, ‘you can call your Turner NFT “art” if you like, but only in the same way a £5 note is art because it has a portrait of the Queen on it.’ What ‘thing’ is being bought as an art NFT is currently exercising the little grey cells of financial policy and lawmakers.
Art lawyers often explain that an art NFT is essentially a digital deed proving ownership of an artwork located elsewhere – rather like a real estate title deed proving ownership of property and its physical location. For taxation purposes, an art NFT may be treated by fiscal laws as a taxable asset.
Taxes are enforced by legal taxation authorities, and most regard the latest price paid as good evidence of the market value of any ‘thing’ bought – which would thus invariably be assessed as taxable when owners of assets have opted to trade them for gain/profit. Some owners of art NFTs split their whole token into smaller parts or shares to sell them, in which case any gain/profit from such fractional trading may also be taxable in some fiscal jurisdictions – but not yet in others, in this rapidly innovating art NFT marketplace.
Such fast-moving developments include many art NFT buyers not wanting to acquire and retain the artwork to which the token relates, but whose sole aim is investment: owning a capital/market asset with a view to it being subsequently traded as a whole or in part-shares for gain/profit. And most states worldwide are yet to decide whether art NFT transactions could and should be treated as ‘securities trading’, which falls within the scope of existing regulation by the various financial services authorities, such as UK’s Financial Conduct Authority, China’s Securities and Regulatory Commission, and the US’s Financial Industry Regulatory Authority.
However, a growing number of countries have already banned or restricted use of the key form of payment for buying art NFTs – cryptocurrency – and by doing so have effectively hobbled such trading from within their own fiscal realm. Probably the most robust financial regulations were enacted by China in September 2021. Ten central government authorities, including the People’s Bank of China, then jointly announced that: ‘Cryptocurrency is not a legal tender … all cryptocurrency transactions in China are considered illegal, including offshore exchanges to provide services to Chinese citizens … China-based employees of offshore crypto exchanges or any companies providing services to them will be investigated and prosecuted.’ Simultaneously, China’s local governments were advised how to wind down cryptocurrency mining activities in their areas. The People’s Bank of China sees cryptocurrencies as volatile investments, and has concerns about their being used to launder money, saying that ‘cryptocurrency seriously endangers the safety of people’s assets’.
In the US, federal law and policy makers have taken a more cautious approach to the exponential growth in recent times of art NFT trading – and its potential abuse by criminals. The US is the largest art market worldwide, representing around 42% of sales by value in 2020. In February 2022 the US Treasury published a report of its year-long investigation commissioned by Congress into the art trade: Study of the Facilitation of Money Laundering and Terror Finance Through the Trade in Works of Art.
The study examined ‘art market participants and sectors of the high-value art market that may present money laundering and terrorist financing risks to the US financial system’. The report identified steps that ‘government agencies, regulators, and market participants could undertake to further mitigate the laundering of illicit proceeds through the high-value art market’. The way high-value art is traded in the US was a particular concern because of its attraction to criminals through, for example, ‘the high dollar value of transactions, transportability of goods, a longstanding culture of privacy and use of intermediaries (eg, shell companies and art advisors), and the increasing use of high-value art as an investment class’.
The report especially highlighted that ‘the emerging digital art market, such as the use of … NFTs, may present new risks, depending on the structure and market incentives’; but, unlike China, the report decided against imposing financial regulations – for the time being. Instead, it adopted a delicate approach by recommending a few non-regulatory and regulatory ‘options’, including: encouraging the creation and enhancement of private-sector information-sharing programmes to foster transparency amongst art-market participants; updating guidance and training for law enforcement, customs enforcement and asset recovery agencies; using the financial crimes enforcement arm of the US Treasury to support information collection and enhanced due diligence; and applying Anti-Money Laundering (AML) requirements (such as suspicious activity reporting and know-your-customer procedures) to art-market participants.
The EU and UK do not currently ban or restrict use of cryptocurrencies, but do embrace their use within recent anti-money laundering laws. Mirroring the EU, the UK’s Money Laundering and Terrorist Financing (Amendment) Regulations came into force in January 2020, aimed at outlawing the washing of dirty money – including cryptocurrencies – used in transactions valued at £10,000 or more by UK’s art-market practitioners.
On 14 February 2022, the UK’s tax authority (HMRC) seized three NFTs during a VAT fraud investigation of 250 alleged fake companies. Three people were arrested on suspicion of attempting to defraud HMRC of £1.4m by hiding their identities using ‘sophisticated methods’, including ‘false and stolen identities, false addresses, pre-paid unregistered phone numbers, VPNs (virtual private networks), false invoices, and pretending to engage in legitimate business activities’. NFT artists and collectors and traders beware.© Henry Lydiate 2022