Will there be a sales tax holiday in the metaverse?

Most states haven’t yet said whether tax applies to sales occurring in virtual worlds like Decentraland or Nikeland. That doesn’t mean such sales are necessarily exempt.

Many states do have relatively clear policies governing the taxability of digital goods and services, such as an electronic book or a streamed movie. For example, the 24 Streamlined Sales Tax (SST) member states have specified how they tax digital codes, products, and services. Scott Peterson, vice president of Government Relations at Avalara and former executive director of the Streamlined Sales Tax Governing Board, says SST states likely believe they’ve provided all the guidance necessary to determine the taxability of, say, a virtual car. (Yup, that’s a thing.)

But Avalara senior director of North America Tax Content David Lingerfelt isn’t convinced. “An NFT is a unique digital asset, not a digital token that you can exchange for digital property,” he explains. If the SST now considers an NFT to be a “digital code,” it should make that clear. “Failure to do so invites tax controversy.”

Then there’s the fact that a lot of businesses operating in the metaverse are “focused on marketing to generate sales in the real world. For example, musicians are performing concerts on virtual stages to promote their albums … [and] clothing brands are participating in virtual fashion shows to drive interest in their latest duds.”

Peterson points out that while many states don’t tax intangible assets, they generally do tax transactions linked to the sale of tangible personal property. Furthermore, one state’s intangible asset may be another state’s tangible personal property; apart from SST member states, there’s little consistency in how states define the term “intangible.”

The more money changes hands in the metaverse, the more tax authorities will take note. And according to Peterson, states are talking about NFTs.

All states with a general sales tax have economic nexus and marketplace facilitator laws that tax sales made through online stores and marketplaces. Therefore, it’s not hard to imagine states broadening laws to tax sales made through the metaverse, which is composed of online platforms.

If indeed they must.

Peterson thinks at least some states would assume existing laws can be applied to the new technology. States may not see the need to clarify policies they think are already clear.

Lingerfelt says NFTs aren’t your average digital code. They’re a new technology, and that means existing sales tax laws may not adequately cover them. He believes states should address the taxability of NFTs head-on, because the longer they wait, the more costly battles will arise.

Both experts are probably right.

It’s taken years, but most states have identified how sales tax applies to digital goods and services. Some states enacted new laws; some crafted their position based on existing law.

Yet there’s also precedence for states to tax transactions not previously identified as taxable. Last fall, for example, the West Virginia State Tax Department clarified that although digital products are exempt from sales and use tax, streaming services are taxable. This contradicted earlier guidance; previously, the department suggested sales tax did not apply to streaming services.

And lawsuits? They happen. Already, Nike is suing an online marketplace reseller for selling NFTs based on Nike shoes. The case isn’t about sales tax, but it does hinge in part on what an NFT is. Battles over the taxability of NFTs can’t be far behind.

So, if you sell an NFT of a hat, or an NFT of a hat that gives the consumer the right to purchase a hat in real life, sales tax may apply to one or both of those sales. Likewise, any eligible transaction occurring through the metaverse could be fully or partially exempt during the tax-free period.

It’s in your best interest to collect applicable sales tax on taxable sales and to exempt nontaxable transactions. State tax authorities will be looking to see that you do. If you’re not sure which sales to tax, check with a trusted tax advisor or the state department of revenue.

Ah, but which department of revenue? One of the most devilish aspects of sales of intangible personal property is that sellers don’t need to capture the physical address of the buyer.

Most states base sales tax on the destination of the sale — the location where the buyer takes possession of the goods or benefits from the service. But you don’t need a physical address to sell someone an e-book or a skin for their avatar. So how do you source a sale if you don’t know where the sale is?

Lingerfelt believes “ZIP code sourcing for digital property transactions is inevitable.”

One of the things I admire about David Lingerfelt is that he thought about sales tax while streaming the Netflix show “Squid Game” during a flight. Were Netflix to ship tangible personal property to him, it would need his street address and would base sales tax on that address. But he knew Netflix only had his name, email address, ZIP code, telephone number, and payment method, not his physical address. So, how should Netflix source the sale of a service that can be accessed anywhere he can connect to Netflix? 

Netflix policy sources sales to the location where the digital property was first made available for transmission. But is that Lingerfelt’s home address, or an airport where he may first have felt the need to have a Netflix account? Because people are always on the move, Lingerfelt thinks it makes the most sense to base sales tax on the buyer’s ZIP code. At the same time, Lingerfelt knows that would result in “the loss of pinpoint accurate sales tax calculations for digital property transactions.”

Sourcing is just one issue states will need to confront as they start taxing sales in the metaverse (assuming they do, which for most states is likely).

Though some of us may still be trying to figure out what the heck the metaverse is, others are already selling an array of items in virtual worlds. Some of those products, tangible or intangible, may be subject to sales tax. And some may qualify for the full or partial exemptions provided by sales tax holidays.

Like it or not, the metaverse is here. Read more about how it affects real-world sales tax obligations in Taxing the metaverse: The basics, and Selling goods in a virtual world can have real tax implications.