Can NFTs be Used as an Instrument of Tax Evasion?

Being a very young innovation, the current range of uses for NFTs and blockchain at large are just a scratch on the surface. The applications are bound to increase over time with the potential to touch on people's everyday activities. Can those with ill intent utilize the unique features of NFTs to evade tax? Read on to find out.

Understanding the Nature of NFTs

An NFT is a unique unit of cryptographic data or asset stored on a blockchain that can't be interchanged with a unit of another crypto asset. Unlike other types of digital assets on the blockchain, the underlying metadata can't be replicated and is therefore always unique to a specific NFT.

This uniqueness makes NFTs so different from cryptocurrencies and other tokens. For starters, it can't be used as a currency or unit of exchange since currencies must be fungible (interchangeable) with units of each other. However, it is perfect for use as a digital representation of unique assets due to its non-fungibility.

Possible Avenues of NFT Based Tax Evasion

There are some possible avenues through which NFTs can be used to evade paying taxes. They include;

Failure to Report NFT related Proceeds as Income

NFTs and their marketplaces are increasingly becoming a key source of income generation for people like artists. It is made possible by creating NFTs to attach to their art pieces, which they then trade in the NFT market spaces. It increases their market reach and reduces the costs of setting up or booking spaces in physical markets places.

Tax evasion occurs when the persons generating income via NFTs fail to report the income to tax authorities. Such income is treated similarly to any other source of income and should thus be subject to income tax.

Under Reporting of Declared Assets

High privacy levels characterize the entire blockchain world. Most platforms are non-custodial, with the transaction partners' identities usually being anonymous. 

While other types of blockchain-based cryptographic assets usually have a known value attached to them, NFTs are different. The underlying asset, which may run into millions of US dollars, represents the value of the NFT. It thus provides an avenue for hiding the true identity of persons acquiring assets that NFTs represent. 

Such assets, when not declared, may be passed down to the next of kin or other new holders without the due tax being remitted to authorities. Such a form of tax evasion could result in very substantial values in asset transfer taxes escaping the taxman.

Cross-Ownership Evasion via False Asset Transfers

Cross-ownership is where a venture owns a portion of its trading partners. It enables the creation of stronger business relationships and enables vertical integration. With the advent of NFTs, individuals and businesses can carry out tax evasion via cross-ownership of NFT wallet accounts. 

A venture wishing to escape future capital gain taxes can set up 2 separate wallets. Ownership of the first wallet can easily be tied to the venture and even go by its name since it is where the NFT attached to the asset in question will be. A second account can be set up with absolute anonymity, after which it proceeds to purchase the NFT from the first account. 

Since proving the venture is the owner of both wallet accounts is very difficult, such a transaction represents a fraudulent transfer of assets to new owners. The venture will, in turn, avoid being liable for capital gains taxes, especially where the new holding account is registered in a tax haven nation.

Possible Remedies by Tas Authorities

While there exist ways in which individuals and ventures can evade paying tax via NFTs, there is good news. Such tax evasion strategies have been practiced in other non-blockchain activities. Authorities have crafted ways of reducing their incidences, so the NFT-based possible evasions could finally have a remedy.

A good way of remedying the occurrence could start with authorities seeking the services of crypto trackers. They are platforms that specialize in tracing the path of specific crypto back to its source. They are increasingly efficient, even in the face of increased privacy when users opt for crypto tumblers or privacy coins.

Authorities should legislate laws that require the reporting of NFT and general blockchain-based incomes. Legislation has been slow to catch up with the fast-evolving blockchain space, NFTs being one such rapidly innovative area. It leaves room for individuals with ill intent to use the space as an avenue for evading tax obligations.

In turn, the general public must be sensitized to the need to report NFT and blockchain-based incomes. They need to know their tax obligations and the potential repercussions if they fail to.

Lastly, authorities need to stop treating the entire blockchain world as a renegade invention that has to come to a halt. Such sentiments make it all the more attractive to criminals, such as those willing to evade their tax obligations. By accepting and even adopting NFTs and blockchain, governments can participate in their operations and better regulate the space. 

Take Away

Every good thing has its dark side. NFTs are no different, with issues such as being a possible hotbed for tax evasion. The evasion can cover several aspects of tax obligations, such as income tax or capital gains tax. The figures in question have the potential of being very significant. It's why senior figures in the authorities have noted the fear.

There is, however, room for correcting the loopholes that may lead to tax evasion. The onus is on the authorities to implement relevant laws, sensitize people and contract the services of crypto trackers.