A Non-Fungible Token („NFT“) is a type of digital token stored on a blockchain network that represents a digital certificate of authenticity. All types of digital objects such as photographs, music recordings, video recordings, audio books, virtual land, and content from Twitter profiles can be bought and sold in the form of NFTs.
To understand the legal regulation of NFTs, it is important to define several terms first, including blockchain, digital token, digital asset, virtual currency, and digital art.
- Blockchain is a method of performing transactions where they are placed in blocks, and blocks are tied together in a chain so that it is not possible to change any previously placed block while keeping the others unchanged. All data of one block is encrypted in a specific way (hash algorithm), and the resulting value enters the next block. Moreover, blocks are linked and cryptographically locked, which explains the complete security, safety, transparency, and anonymity of the blockchain.
- Digital token is a type of digital asset and represents any intangible property right that in digital form represents one or more other property rights, which may include the right of the user of the digital token to receive certain services.
- Digital asset, or virtual asset, denotes a digital record of value that can be digitally purchased, sold, exchanged, or transferred and that can be used as a means of exchange or investment, where digital assets do not include digital currency records that are a legal means of payment and other financial assets that are regulated by other laws, except where otherwise provided by this law.
- Virtual currency is a type of digital asset that is not issued and whose value is not guaranteed by a central bank or other public authority, which is not necessarily tied to a legal means of payment and does not have the legal status of money or currency, but physical or legal entities accept it as a means of exchange, and it can be bought, sold, exchanged, transferred, and stored electronically.
- Digital art is any form of art created using digital technology such as computers, software, or tablets. This may include different styles and techniques, such as digital painting, graphic design, 3D modeling, and animation.
If we want to understand the existence and functionality ratio of NFTs, it is most expedient to start from real life. Namely, if you look at the pictures hanging on the walls of the house you live in, or the book you read before going to bed, you will see that the author’s signature is in the corner of the picture, and on the back of the book, you can see information about the publishing house, or the author. Excluding the potential emotional value and aesthetic or other attraction you may have to these goods, it is undeniable that you have chosen to own them because you knew their origin and decided to legally pay the price and acquire property rights over them. Therefore, we conclude that what gives value to these goods is their origin, i.e., the credibility/popularity/appreciation that their author possesses. If we were to try to assess the value of the Mona Lisa in this context, we could undoubtedly conclude that some of the reasons for its extreme value are the authenticity it possesses and the origin that its author carries with it.
Similarly in the digital world (“WEB3“), an artist who creates digital art, creates “their Mona Lisa” with their work. However, their “unique digital signature”, or formal legal certificate of their creation, is not found on the artwork itself, as is the case with physical objects. Instead, an NFT (non-fungible token), a digital certificate of authenticity for the artwork linked to the blockchain, confirms ownership by a specific individual, whether the creator or another person. Therefore, what gives value to digital art in the WEB3 world is the fact that its origin, just like the origin of physical goods, can be determined with 100% certainty, thanks precisely to the NFT.
The 100% certainty comes from the fact that the blockchain records not only data on authorship, but also all other relevant information, such as ownership data, sale price, and the person who has become the new owner. Since the blockchain represents a decentralized network composed of thousands of different computers, there is no possibility of modifying data once it has been recorded. Therefore, any change and every trace associated with a specific digital work can be traced and determined at any time with 100% certainty.
In conclusion, in the WEB3 world, there are works of art that are valued just as much, if not more, than works in the real world. Since it is very easy to reproduce digital works, the most effective way to ensure the originality and origin of a particular work is through its connection to an NFT, or its digital certificate of authenticity.
Having explained “what NFT is for”, it is necessary to consider the legal framework in which it currently exists in order to successfully explain the tax aspect of how NFT is currently regulated. In this regard, it should be noted that there are several different laws that indirectly regulate NFTs, and an overview of these laws and the position of NFTs in them will be presented below.
The Value Added Tax Act (“VATA“) in Serbia regulates the turnover of digital tokens, including NFTs, which are considered a type of digital token. According to Article 25, paragraph 1, item 1a) of the VATA, the transfer of virtual currencies and the exchange of virtual currencies for legal tender in accordance with the law governing digital assets are exempt from value-added tax (“VAT“) without the right to deduct input tax. This exemption began to apply from the date of the implementation of the Law on Digital Assets (“LDA“).
Since NFTs are a type of digital token, they can be classified as digital assets. Digital assets refer to any intangible property right that represents proof of ownership over one or more other property rights in digital form. The Tax Procedure and Tax Administration Act (“TPTAA“) prescribes the principle of factuality, which means that tax facts are determined based on their economic essence. This means that the legal nature of a specific transaction or deal involving digital tokens is determined based on the economic nature of the legal fact or economic law underlying the digital token. Therefore, tax authorities have the right to view every transaction in terms of substance over form doctrine.
Under Article 25, paragraph 1 of the VATA, the holder of an NFT will be exempt from paying VAT if:
- The transfer of the NFT can acquire specific goods or services without receiving any guarantees from the issuer of the digital token (“Issuer“), or without the possibility of making any claims against the Issuer. In this case, the transfer of the specific NFT is subject to Article 25, paragraph 1, item 1a) of the VATA, as NFTs are treated as virtual currencies.
- The transfer of the NFT from the Issuer or a third party acquires goods or services established on the day of issuance of the specific NFT, and the same NFT has elements of a valuable voucher in accordance with the VATA. In this case, the rules regarding single-purpose and multi-purpose valuable vouchers under Articles 7a, 7b, and 7c of the VATA will apply to the transfer of the digital token.
- If, based on the ownership of a specific NFT, certain rights can be obtained from the issuer (such as the right to receive principal and interest payments, the right to a monetary benefit based on a percentage share of the issuer’s token profits, or the right to a monetary benefit based on a percentage of certain types of income), Article 25, paragraph 1, item 5) of the Value Added Tax Law applies, which means that in this situation, the holder will be exempt from paying VAT.
This tax treatment of digital tokens applies to their transfer by the issuer as well as their turnover between the holder and interested third parties.
To conclude, the tax treatment of digital tokens and NFTs, according to the Value Added Tax Law, is subject to those exemptions that can be applied to the field of digital commerce in general.
Regarding the connection between the Property Tax Law (“ZPI“) and the treatment of digital tokens, and therefore NFTs, it is important to note that the ZPI regulates the tax aspect of the process of inheriting digital tokens and, therefore, NFTs. Article 14, paragraph 2, item 4a) of the ZPI stipulates that inheritance and gift tax must be paid even if the subject of inheritance or gift is digital property. Additionally, in relation to provisions related to persons who may be taxpayers of inheritance and gift tax, it is interesting how Article 15, paragraphs 2 and 3 of the same law define which persons can be taxpayers of inheritance and gift tax in relation to the territory where the subject of the gift or inheritance is located. Thus, the law defines that the taxpayer of inheritance and gift tax can be a resident of the Republic of Serbia for items received as inheritance or gifts located in the Republic of Serbia or abroad. Therefore, if a person is a resident of the Republic of Serbia and receives digital property as inheritance or a gift located in Serbia or abroad, that person may be a taxpayer of inheritance and gift tax. On the other hand, a taxpayer of inheritance and gift tax who inherits or receives digital property as a gift can also be a non-resident of the Republic of Serbia, i.e., a foreigner, for items located in the territory of the Republic of Serbia.
The Law on Corporate Income Tax (“CIT Law“) – The most significant aspect of the CIT Law that regulates the issue of digital tokens is capital gain. According to Article 27, paragraph 1, item 5) of the Law, a taxpayer realizes a capital gain by selling or transferring digital assets for consideration (“Sale“). However, this will not apply if the taxpayer, under the Digital Assets Law, has a license to provide digital asset-related services in the event that it has acquired it solely for further sale in the course of providing digital asset-related s ervices in accordance with that law. Some of the services defined as digital asset-related services in Article 3, paragraph 1 of the Digital Assets Law include: Receipt, transfer, and execution of orders related to the purchase and sale of digital assets on behalf of third parties, services for the purchase and sale of digital assets for cash and/or funds in an account and/or electronic money, services for exchanging digital assets for other digital assets, services for maintaining a register of pledges on digital assets… Therefore, in order for a digital asset-related service provider to be exempt from realizing capital gains or losses from the sale of digital assets acquired solely for sale, it is necessary to be registered under the Digital Assets Law to provide digital asset-related services. On the other hand, all other legal entities that are not registered under the Digital Assets Law to provide digital asset-related services realize a capital gain or loss from the transfer of digital assets for consideration, regardless of whether they acquired digital assets solely for further sale. We also believe that this, to our understanding, applies to digital asset-related service providers if they acquire digital assets solely for further sale but not in the course of providing digital asset-related services.
The Law on Digital Assets (DA Law) – As the “umbrella law,” the DA Law directly and indirectly regulates many aspects of NFTs, digital assets, and digital currencies. In addition to the context seen so far, what is particularly interesting about this Law is its Article 14, paragraph 1. Namely, according to this provision, virtual currencies cannot be entered into a company as a contribution, but can only be converted into money and then entered as a monetary contribution. However, when it comes to digital tokens (and therefore NFTs), they can be entered into a company as non-monetary contributions, but only if their legal purpose does not relate to the performance of work or the provision of services. In addition to the above, it is useful to note two more facts. In order to determine whether a particular token is credible for entry into a company at the time of its founding, it is most appropriate to consult the Securities Commission, which establishes a list of digital tokens. Also, it is interesting that non-monetary contributions can also be in digital tokens related to the provision of services or the performance of work in the case of a partnership or limited partnership.
From all of the above, it is clear that although the domestic legal and sublegal tax regulations do not fully recognize digital assets and NFTs, there are certain provisions that regulate these matters, and it is important to comply with them to avoid potential legal and tax consequences.
Definitely, although very unstable, the NFT market will undoubtedly grow and advance in the coming period, so the space for creating new legally unregulated situations will be increasingly wider. Legal regulations will almost always lag behind the real world, but this time, delays will also occur in the unexplored WEB3 space, which will require a completely different approach to successfully defining clear and precise provisions for the final and permanent regulation of this area.
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