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Though it is widely understood that profits made running a business that deals in virtual goods or services are taxable, tax agencies have not yet seriously pursued enforcement, and there is an open question regarding when these profits are taxable. Two recent presentations suggest that enforcement is getting incrementally closer, both in the EU and the United States, and more interestingly, both commentators suggested that profits may be taxed even before they are converted to “real” currency.

CIOT LogoFirst, Second Life’s ‘Tax Anderton’ (in real life, a member of The Chartered Institute of Taxation in the U.K.) participated in a Q&A on U.K. tax law. Rivers Run Red has made an audio recording (.mp3) of the event available, along with a summary (.pdf). The presentation is U.K. specific, but covers a wide range of topics. ‘Anderton’ said that though there is no case law or code that directly addresses the question yet, existing laws clearly require users to pay tax on profits that they withdraw from virtual worlds, and may also require payment of tax on profits that have not yet been converted to real-world assets. ‘Anderton’ said that though it is a gray area, “if I were a betting man, I’d say that case law is more likely to decide that regardless of whether you’ve actually made a conversion [to real currency] it will be liable to a U.K. tax.”

Metanomics LogoSecond, Bryan Camp, Professor of Law at Texas Tech University, recently discussed taxation of virtual world commerce with more of a U.S. focus as part of the Metanomics speaker series in Second Life. Camp, like ‘Anderton,’ opined that profits made in virtual worlds could be taxable even before they are withdrawn as dollars. Camp’s suggested that in-world currency may be seen as analogous to barter credits, although he also offered an alternate interpretation and did not come down definitively on either side of the question. He observed that the easier it is to buy real goods with virtual currency (e.g. order a real life pizza) the more likely the IRS will see exclusively in-world profits as taxable. A video recording of Camp’s presentation is available on the Second Life Cable Network.

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9 Responses to “Two Experts Suggest Virtual World Profits May Be Taxable Even Before Conversion to Real World Cash”

  1. on 23 Oct 2007 at 8:22 amTony

    So this raises a question in my mind then. Would this just be an extra level of tax? Or if you are taxed on a virtual good sale, would you be exempt from income tax when that amount was withdrawn?

    It doesn’t make sense to get taxed once for “virtual income” and then again (on the same money) for “real income”. This would make it double taxation for personal sales and such and even TRIPLE taxation for larger businesses.

    Something like this seems counter-productive in trying to foster this new industry’s growth.

  2. on 23 Oct 2007 at 8:34 amBenjamin Duranske

    Tax isn’t my specialty, but I am certain that these guys both mean that the income is taxed only once. The question is when it is realized as gross income — when it is earned in-world (and, say, becomes part of your Linden balance in Second Life) or when it is withdrawn as your local currency. Up until now, conventional wisdom has said that the line will be drawn at withdrawal. It’s interesting to me that these guys are talking about at least the possibility (and in Anderton’s case the probability) that it will be considered taxable at the point it is earned, even if it is left as part of a user’s in-world balance. The thing that seems to be driving this shift is that the line between in-world and not in-world is getting blurrier, as we move toward being able to order real world goods and services with our in-world balances.

  3. on 23 Oct 2007 at 9:18 am

    This sounds right. After all, I pay taxes when I sell a stock, not when I convert the shares back to cash.

  4. on 26 Oct 2007 at 11:28 amMagnum Serpentine

    Ok, Can you tell me how to split a penny into 1/16th or 1/2000th of a penny so I can pay my taxes???

    As stupid as my comment sounds, thats about how stupid it is for any government to tax the net.

  5. on 26 Oct 2007 at 12:30 pmBenjamin Duranske

    @4 – the idea with these presentations wasn’t an “internet tax” exactly, but just a regular application of current tax law on income generated using a virtual world. I think it’s pretty well beyond dispute that income generated by selling digital only content (at least when cashed out) is taxable. It’s no different than a web page where you sell digital-only stuff (say, pdf game guides, or software). The question with virtual worlds that have their own currency is whether that’s profit before you take it out of the world as real-world cash, and that’s what these guys were getting at.

  6. on 30 Oct 2007 at 6:31 pmCaroline

    Thanks for the info (we’ve posted a link on the above blog for the benefit of French virtual world users)…Naive though I may sound, what rate of tax will be used for Virtual World taxing ? I could be doing virtual world trade in Outer Mongolia or Paris or even Easter Island on my internet or mobile phone access to SL and in each of these ‘real’ worlds the rate of tax is (if I’m not totally mistaken) different. Which Virtual UN Tax authority are we going to see come into existence to deal with this ???

  7. on 30 Oct 2007 at 6:35 pmBenjamin Duranske

    I’d guess there no universal tax authority coming – you’ll just pay income based on your own nation’s income tax regime. Think of it like the internet, not a new place. If I sell you something over a web site, I pay tax on it here. If you sell me something from your Outer Mongolian (or Parisian) website, you pay tax on the income there, based on whatever rules apply. Same deal here, at least for the far foreseeable future.

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