When I began TinyFaces NFT, it was initially an experiment to delve deeper into the NFT space. I didn't initially consider the tax implications, as my focus was more on the creative and technical aspects of NFTs, particularly around creating a unique PFP (Profile Picture) collection.
However, in April 2022, the project unexpectedly sold out, leading me to confront significant financial realities. I found myself with £560k worth of crypto in my wallet, and the tax implications were daunting. At that time, the most expensive NFTs were making headlines, but practical advice on tax management for NFT creators was scarce.
Today, there are many guides available, but back then, I started searching online and found only a few articles. I ended up spending most of my time on forums like Reddit, trying to understand how people were handling their crypto. However, I soon realized that these forums weren't reliable sources. Some claimed that governments couldn't trace crypto wallets, but this didn't seem accurate to me because all wallet transactions are publicly visible on Etherscan. It was clear to me that when you convert crypto into traditional currency like British pounds, a link is established between your wallet and bank account, making it possible for governments to trace the funds and calculate taxes. Even if you buy something like a Tesla with crypto, the fact that the car has to be delivered to someone means there is a traceable link.
Back then, there wasn't much information available on how governments were tracking crypto wallets. However, my instinct was correct, as exchanges are now required to share this information with the government. Those who assist in money laundering by converting crypto into retail vouchers can face legal consequences, including jail time.
I had more questions than answers...
A few days later, while having dinner in Italy with my in-laws, I received a message from Matt DesLauriers congratulating me on the project's launch. Matt is a friend of a friend, and we often meet at parties in London. I valued his advice because of his success in the generative NFT space with his Meridian collection.
After some messages back and forth, the topic of taxes came up, and Matt advised, "I recommend exchanging 50% or more to fiat right away. If you wait too long holding only ETH, there's a risk that the price of ETH will go down, but you will still owe taxes based on the price of ETH at the time of sale."
I panicked when I realized I had to pay taxes based on the crypto's value on the day of the sale. In the UK, this could mean paying anywhere from 20% to 60% in taxes, depending on your tax situation. That could be around £336k in taxes. If Ethereum were to fall by 50%, I'd only have £280k left but still owe £336k in taxes, leaving me with a loss of £56k.
However, withdrawing the money for taxes wasn't an easy decision. People worry about rug pulls when they buy an NFT, meaning they fear the creators disappearing. So, when they see Ethereum leaving the wallet, they immediately think of a rug pull, and the project loses credibility. Remember, wallets are publicly visible on the internet, so every move is tracked.
Despite the pressure to keep ETH in the wallet, I informed everyone with a TinyFaces NFT that I had decided to cover the taxes and would transfer 75% to fiat that same night to cover them. Thankfully, I had that conversation with Matt because over the next two months, Ethereum crashed by a whopping 30%. Luckily, I withdrew most of it, and by the time it dropped 15%, I withdrew the remaining 25%.
I realized I needed professional help from an accountant and financial advisor.
After sending out a few emails, I quickly found a financial advisor who advised me to deposit the necessary funds for taxes with the National Savings & Investments (NS&I) of the government. This was because in the UK, only bank deposits up to £85k are government-protected, while NS&I offers full protection. With banks like Metro Bank and Silicon Valley Bank still experiencing failures, I didn't want to take any chances and risk losing the money I need to pay my taxes.
Finding an accountant was challenging as there weren't many with crypto experience, and some who claimed they did were quickly exposed when I asked NFT-specific questions. Eventually, I found Alexander Wilson, an accountant specialized in crypto tax, who explained that there were significant unknowns regarding NFT creation and its tax liabilities. The biggest concern was whether VAT (sales tax) would be due on the sales, potentially adding an additional 20% tax. However, determining VAT for crypto transactions is complicated because IP addresses or credit card information isn't available to determine a buyer's location on the blockchain, and VAT was only due for individuals, not corporate entities.
We had no choice but to reach out to HMRC through a formal letter for advice. After waiting for six months, we finally received a response stating that HMRC considered NFTs as financial securities stored in a blockchain, and the supply of NFTs would be outside the scope of VAT.
Please be aware that this may not be applicable to all NFTs, particularly those involving the shipment of physical products such as t-shirts, posters, or paintings. In such instances, location can be established through the shipping address. It's crucial to individually pursue VAT clearance for your specific situation.
I thought I was on track to resolve all my tax concerns, but then my accountant left his firm, leaving me in search of another accountant. After sending many emails, I finally found CryptoCountancy to handle the remaining taxes.
When I began TinyFaces NFT, I didn't establish it as a limited company. This meant that I would have been personally responsible if something went wrong, which was a risk considering that many projects often made unfortunate mistakes, ranging from creating faulty smart contracts to having their social media accounts hacked. In all these cases, the individuals behind the project are held accountable for any losses. Fortunately, nothing detrimental occurred, but in hindsight, not forming a limited company wasn't a wise choice.
Initially, I also regretted not setting up a limited company for tax purposes. However, given that my current tech job and side projects already placed me in the highest tax bracket in the UK, with a 45% income tax rate plus national insurance contributions, opting for a limited company would have meant paying 20% in corporation tax. Nevertheless, dividend payouts from the company would still be subject to an additional 39.35% tax rate in my case. Unless the NFT market continued to thrive, forming a limited company wouldn't have provided significant tax benefits, unless I intended to leave my job and dedicate myself full-time to TinyFaces NFT.
Here we are. As an individual, I'm subject to tax, which could be either income tax or capital gains tax. Things get tricky because it's up to the individual and their accountant to decide on a tax position based on the badges of trade, determining which tax applies. The tax rates for these two are significantly different. For someone like me in the highest tax bracket, income tax generally means 45%, while capital gains tax is only about 20%. However, the situation is more complex because with income tax, you can't offset losses from the depreciation of the crypto; remember, Ethereum crashed by 30%.
While working with my accountant, we determined that sales through the smart contract would fall under capital gains tax for multiple reasons:
Although the income from the contract may not fall within the badges of trade due to my specific situation, the royalties from marketplaces like OpenSea are consistently identified as taxable income, as confirmed by various accountants.
To be certain, we felt it was again necessary to reach out to HMRC, but we haven't received any response to date. It's crucial to get this right, as the fines and interest that HMRC can impose might equate to paying an additional mortgage.
Reflecting on my experience, I firmly believe that seeking guidance from an accountant before embarking on any NFT project is crucial. While some may assume I'm living a life of luxury with the money I've earned, the truth is, I haven't touched a penny of it, and I face daily uncertainty about the financial burden that awaits me, which could be anywhere from £100k to £300k in taxes.
I've chosen to write this blog post because it's a topic I frequently get asked about. Moreover, I aim to shed light on the practical aspects of navigating tax regulations within the NFT space, sans any glamorous façade. It's essential to note that I'm not a certified accountant, and the information I've provided should be approached with caution. Every individual's or company's circumstances are distinct, underscoring the importance of consulting a qualified accountant and collaborating closely with HMRC to gain a comprehensive understanding of your tax responsibilities.