Tax in the digital economy - are you ready for the metaverse?

The metaverse is here, and growing exponentially. More than 80% of the business leaders taking part in a 2022 PwC Metaverse Survey expect the metaverse to be part of business-as-usual within the next three years.

But many are still uncertain about how to tackle the tax issues opened up by this new way of engaging with retail and business customers. A perceived lack of clarity on tax could hold back companies’ moves into the metaverse, or heighten the risk of tax disputes and/or accounting errors arising.

We’ve found that the more you get to know about the metaverse, the more the answers to these tax puzzles become clearer. What have we discovered in our journey through this virtual environment?

The metaverse allows you to immerse yourself in a virtual world, marking the next evolutionary step in the digitisation of everyday life.

The metaverse isn’t just for gaming, far from it. Whether you put on a headset or just use a screen, the metaverse allows you to socialise, hold meetings or try on and buy clothes, devices and other products just like you already do, on your computer or smartphone. The main difference is that it’s a virtual you – your avatar – that is engaging and exchanging within a more immersive virtual world.

In terms of maturity of the platforms, there is still some way to go. The ‘ultimate’ version of the metaverse (fully immersive, with seamless and secure transactions among a multitude of metaverse inhabitants) doesn’t exist yet. Businesses are, however, already looking to the metaverse to enrich the consumer experience and collect new data on customers. They are also using the platform to introduce exclusive digital assets or products only available in the metaverse, but which translate to real revenues and costs.

For example, a leading fashion brand has created exclusive outfits for characters in a popular Chinese video game. A hybrid market for physical and digital products is also in place. Separately, a famous sportswear brand’s immersive virtual runway show for New York Fashion Week included the chance to acquire non-fungible tokens (NFTs) that could be redeemed with limited edition physical sneakers.

To allow us to see the possibilities for ourselves, PwC has purchased a plot of metaverse land, establishing an internal PwC metaverse campus, to meet colleagues from around the world. Our presence in the metaverse helps explore the possibilities first-hand, and will eventually provide a platform for engaging with businesses and clients also operating within the virtual marketplace. We have also been helping clients establish their own commercial metaverse activities, providing tax and wider regulatory and commercial insights.

A new global marketplace

The metaverse is any one of a number of new, immersive 3D virtual worlds, focused on social connection, gaming and commercial activities. The results provide stunningly engaging opportunities to interact with customers and communities, buy and sell goods and services, and recruit, train and retain talent. It has the potential to allow users to have a single ‘real’ persistent identity that makes their interactions far more than just a video game.

Tax puzzles: What does this mean from a tax perspective?

Right now, many businesses are struggling to make sense of transactions that have one foot in the virtual world and the other in the physical world. Not being able to apply effective tax policies could make it harder to take advantage of the opportunities opening up in the metaverse. It could also put your business at risk of tax disputes.

The good news is that having looked at metaverse tax implications in detail across a range of clients, it’s increasingly clear that where specific tax rules don’t exist, many existing principles can be applied to allow businesses to move forward. To get a better handle on the tax dynamics, let’s look at an illustrative metaverse outing and unpick some tax issues for different participants:

You’ve been invited to a wedding and want to buy some new shoes. Rather than going to the high street or looking online, you put on your headset and watch as your avatar browses through the virtual stores. The avatar mimics your shoe size and can be wearing the same outfit as you plan to wear at the wedding. This 3D immersive experience can therefore make it easier and more fun to choose the right shoes than searching through 2D websites. To help pay for your metaverse purchases, you and some friends have sold some old clothes through an exchange in the metaverse. Eventually you find the right shoes – matching pairs for real-life-you and your avatar – which you can buy using the cryptocurrency in your account. You also drop by the virtual pizza shop next door and a few minutes later you hear the delivery driver at your front door with a freshly baked sourdough margherita.

Let’s break down this outing and the commercial transactions within it into their tax components:

The headset
The means of exchange
The premises – the virtual shop and pizza restaurant
The shoes sold - virtual and physical
The second-hand clothes exchange
The pizza

The headset

The manufacture and supply of the headset is likely to involve customs duty, VAT and corporate income taxes throughout the supply chain. Following the transfer pricing trail leading back to the developers, risk-takers and decision-makers will be key. An R&D tax credit claim might even be available to boost profits, or a patent box or innovation box claim may reduce the effective rate of corporation tax on those profits. All of this may be complicated but at its heart it is a traditional business model to which traditional tax rules apply.

The means of exchange

Within the metaverse digital tokens will be used to assign ownership. These tend to be exchangeable such as cryptocurrencies or NFTs. The tax treatment of digital tokens can be complicated, and would depend on whether you’re an issuer or a holder. Different countries may take different positions on the tax treatment of digital tokens, and may have different reporting requirements. In general, they are simply another form of asset, which you buy or sell for value, and are taxed on the resulting gain or loss. The categorisation of the asset as a currency, or a commodity, or a security, or something else may vary depending on the exact detail of the asset and the territory in which the parties are taxable.

The premises – the virtual shop and pizza restaurant

The shop and restaurant need to be created. The virtual land for development might be bought or rented from the metaverse creator, potentially represented by the issue of an NFT. This buyer has an expense (tax deductible?) and the creator has income to tax. VAT is often a key consideration at this stage, with the question of whether or not this is a digital service that is subject to VAT where it’s consumed. In most countries around the world there are rules on how to identify the consumer of digital products and tax the revenue streams. Developing the virtual building site will also have its own set of requirements. Any branding or designs used could involve the exploitation of valuable intellectual property developed elsewhere in the group and transfer pricing and withholding tax issues may be relevant.

The shoes sold - virtual and physical

The first thing to address is whether VAT applies to both the avatar’s and physical buyer’s shoes. This will depend on where the shoes are physically delivered to and from and virtually received and indirect tax e-commerce rules can help answer these questions. If cryptocurrency was used in the transaction, there will be other things to consider too (we consider the tax implications for cryptocurrencies and NFTs in this article). Other issues for the vendor will depend on the detail of how they structure and operate the virtual store. If virtual shop assistants are controlled by real people, analysing their role in the sales process will be important. Also, IP issues such as withholding tax on cross-border royalties will be relevant.

The second-hand clothes exchange

The platform may have specific platform VAT obligations. Whilst the rules for second hand/antique clothes are different to new goods, these e-commerce rules have again been in place for long enough to know where to start finding the answers. Other issues such as the OECD’s digital platform reporting rules may also apply to the exchange.

The pizza

The pizza was ordered in the metaverse, but delivered to the buyer’s home. This could still be considered a digital service, subject to digital service taxes. Where it gets complicated from a tax compliance point of view is whether conventional or cryptocurrency were used to pay for it. For country specific VAT/customs/excise and other food related taxes, the place of delivery of the pizza will be key. It will also be important to ensure that this sale from a virtual location is recorded in local books in the same way as a till sale, which is often the tricky point in practice. As for the physical shoes, withholding tax on cross-border royalties may also be a consideration.

Taking the lead

While managing tax in the metaverse isn’t straightforward, it shouldn’t act as a brake on strategic execution. If tax teams are up to speed, you can work with your board and business teams to help lead strategic development and market roll-out. To get there, three key priorities stand out:

Engage with your business
Speak to business teams to find out about their metaverse development plans, how they intend to position themselves and who they will partner with. The earlier you engage, the better you’ll be able to prepare from a tax perspective and the fewer unforeseen risks you’re likely to encounter. A collaborative approach that brings together tax professionals and business teams driving metaverse strategies at this early development stage will benefit everyone.
Break down the environments into the data elements we need for tax
Be granular about all the elements that contribute to the metaverse presence from transaction flows to the location of key people and functions. This will enable you to determine how operations will be treated for tax purposes, how to manage potential risks (e.g. territorial tax claims or differing rules on NFTs) and your compliance demands (e.g. VAT registrations and filings). Earlier developments in digital commerce underline the importance of providing clear justification for what can be complex decisions on substance and transfer pricing arrangements.
Find out for yourself
One of the best ways to know what the metaverse means for tax is to experience it for yourself. Your business may be running sandbox trials – ask to take part. As we’ve found, trying it can be great fun, and certainly eye-opening.

If you would like to know more about the metaverse and how to get to grips with the tax implications, please get in touch.