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Offshore NFT

EST. 1996

Offshore NFT: How to Make Money from NFTs w/ A Tax-Free Offshore Company

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With the massive rise in awareness and popularity of NFTs (non-fungible tokens), along with stories of average Joes making millions in a matter of months, everyone is now trying to understand how they may partake in this market and have their share of the pie. 

If you are one of those individuals looking into ways to make money from NFTs, it is important to also consider the practical implications such as taxes.

Taxation of NFTs is complex and generally unfavourable in traditional onshore jurisdictions. As such, many investors and NFT businesses are turning to tax-free offshore company structures through which to operate in the NFT space. 

Table of Contents:

In this article, we define what an NFT actually is, and the various ways you can make money from them. We then discuss how NFTs are taxed in the US and how you can incorporate a tax-free offshore company to better optimise your NFT taxes. 

What Is an NFT?

A non-fungible token (NFT) is a type of digital asset that exists on a blockchain. NFTs are similar to other types of cryptocurrencies like Bitcoin and Ethereum, except that they are non-fungible in nature. This means that no two NFTs are exactly the same.

NFTs are frequently used to represent real-world collectible objects such as art, music, videos, and even in-game assets or characters. They are frequently referred to as “digital art”. While the image of an NFT can easily be saved by anyone, the underlying token which serves as proof of ownership on the blockchain is what holds the actual value of an NFT.

NFTs have exploded in popularity in recent years, with the most popular collections (e.g., Bored Ape Yacht Club, CryptoPunks, Tyler Hobbs’ Fidenza collection, etc.) regularly fetching well into the 6-figure price tag. They have become highly coveted online status symbols.

  

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Large, community-based “PFP” (profile picture) style collections generate almost cult-like followings and enable holders to feel that they are part of an elite community, which further adds to the perceived value and subsequent price action of these assets. 

NFTs are most commonly bought and sold on open marketplaces such as OpenSea (Ethereum), Rarable (Ethereum), and Magic Eden (Solana). They are usually priced in the cryptocurrency of their native blockchain (e.g., Ethereum, Solana, Binance Smart Chain, etc.).

How Do You Make Money from NFTs?

The most common way for new entrants in the NFT market to make money is simply by trading (i.e., buying and selling) NFTs. The immense volatility in NFT markets which give rise to rapid price increases allows investors and short-term traders (aka “flippers”) to make significant gains.

It also creates an extremely high-risk environment where less fortunate traders can incur substantial losses, so one should proceed with caution. 

Those who choose to make their money through the buying and selling of NFTs can broadly be divided into two groups: short-term traders and longer term NFT investors. Many people will fall into both categories as they make some short-term trades and longer-term investments (one year or more).

This will have a direct implication on taxation of profits, as profits from short-term buying and selling of NFTs would be treated as income for tax purposes, while proceeds from the sale of longer-term investments (more than one year) would be considered capital gains and so usually taxed at a lower rate.  

Aside from making profits by trading, other ways to make money with NFTs include:

  • Starting an NFT marketplace: This is a more ambitious yet very achievable goal. You could develop an NFT marketplace which matches buyers and sellers of NFTs and charges a percentage fee on each and every sale. With the massively growing volumes of NFT sales taking place, this can undoubtedly be a profitable venture in years to come. 
  • Creating and selling NFTs: Artists, photographers, musicians, and just about anyone with a creative flair, can directly make money by creating their own NFTs and selling them either on open marketplaces or via private auctions and other mediums. While this requires more time and effort than simply trading and investing in NFTs, it comes without the risk of incurring major losses. 
  • Renting NFTs: Some NFTs have inbuilt utility, whether in the sphere of gaming or elsewhere. This allows owners of the NFT to actually rent them out to other users and collect a fee in return.
  • Play-to-earn (p2e) NFT gaming: blockchain gaming is a fast-growing industry that allows users to earn tradeable cryptocurrencies, NFTs, and other valuable digital assets through playing the game. There are stories of people in low-income countries like the Philippines supporting their entire families just through playing blockchain NFT games (e.g., Axie Infinity).  
  • Royalties: it is common for NFT collections to have royalty fees attached to them. This means that every time an NFT is traded on the secondary market, a percentage royalty fee goes to the creators of the NFT. Attaching a royalty fee to your NFT is a great way to make ongoing passive income every time your NFT is resold.
  • Staking NFTs: “Staking” has been become a buzzword in NFT markets. Similar to staking a traditional cryptocurrency, this involves depositing your NFT into a smart contract that is connected to a De-Fi protocol or other yield generating instrument to earn ongoing yield from your NFT. Many of the most successful NFT brands have launched their own native fungible token that holders can earn in exchange for staking their NFT and thereafter sell the tokens they earn on the open marketplace. This provides an excellent way to earn money from your NFT without having to actually sell it. 

How Are NFT Sales Taxed in the US?

The taxation of cryptocurrency and other digital assets is notoriously complex and unclear, and NFTs take this to a whole new level. The IRS has not released clear guidance on the tax treatment of NFTs in particular, so it is up to taxpayers to use the existing laws as a framework as best they can, and be prepared for more detailed guidance and reporting requirements from the IRS in future on the NFT market. 

In terms of existing tax laws, NFTs would most likely be viewed as intangible property for US federal tax purposes. Short term capital gains would be taxed at the taxpayer’s highest marginal tax rate (up to 37%) while those who hold their NFTs for more than a year can expect to be taxed at the more preferential long-term capital gains tax rate of maximum 20%.

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However, many tax experts believe that NFTs may ultimately be viewed as collectibles by the IRS (similar to art, antiques, etc.) which means they may be taxed at a higher rate of 28%. With these high tax rates, it clearly makes sense to seek alternative means to eliminate your taxes on NFT sales, such as by using a tax-free offshore company. 

To make matters more complicated, NFT transactions are usually completed with cryptocurrencies, not fiat currency. This means that NFT investors’ capital gains or losses are two-fold whenever they engage in an NFT trade.

This is because every time an NFT is bought or sold, you cannot only consider the tax basis of the NFT, but also need to consider the current market price and tax basis of the underlying cryptocurrency that you have used for the transaction.

Furthermore, the duration of the holding period of both the underlying cryptocurrency and the NFT determine whether each transaction is taxable as capital gains or income. 

An Example

The simplest example is when an investor purchases an NFT with cryptocurrency (let’s assume Ethereum) and sells it a year later. This has now generated two taxable events.

The first taxable event was at the time of purchase of the NFT, whereby the investor effectively disposed of their ETH to buy the NFT. Let’s assume the investor bought the NFT for 1 ETH, and ETH has a current market value of $2000. However, the investor originally bought that ETH one year earlier at a market price of $1000. The investor has therefore made a capital gain of $1000 on that ETH at the time of purchase of the NFT.

If the investor sells the NFT one year later for 2 ETH and ETH has a market value of say $1500 at that time, they have now sold the NFT for $3000 and therefore made an additional capital gain of $1000 at that time.

There will be a third taxable event when they finally decide to sell that 2 ETH, which they have effectively bought for $3000 by disposing the NFT. As you can see, it can get extremely complicated, especially when dealing with multiple transactions over different time periods with different underlying cryptocurrencies. 

How to Sell NFTs Using a Tax-Free Offshore Company

Due to both the unfavourable and complex tax treatment of NFTs in the US and other traditional onshore jurisdictions, tax-free offshore structures are particularly suitable for engaging in this industry.

In addition, NFTs are completely non-tangible in nature and therefore have no practical physical presence requirements. This makes incorporating a company anywhere in the world much easier than with traditional brick-and-mortar businesses. 

Irrespective of how you intend to make returns on NFTs; whether it be actively trading, investing, creating and selling, or even starting your own NFT marketplace, doing so via a tax-free offshore company can help you to greatly reduce your tax liability. Furthermore, it can save you time and money that would otherwise be spent on complex tax reporting procedures and compliance in your local jurisdiction of residence. 

Steps for setting up an offshore company for NFTs

The process for setting up an offshore company for selling NFTs is not much different to setting up an offshore company for other personal and business reasons. The steps are as follows:

  1. Form an offshore company (aka “International Business Company” or “IBC”) in a favourable tax-free offshore jurisdiction. Examples of popular offshore jurisdictions for incorporating tax-free companies include Cayman Islands, Bermuda, Belize, etc. 
  2. Set up an “offshore management system” in the form of an offshore nominee director, and ideally form an offshore private foundation to act as the shareholder of the company. These will both add additional layers of protection and privacy.
  3. Develop the necessary technical systems and/or equipment needed to operate your NFT business venture. This will depend on the type of activities you are engaging in. If you are starting an NFT marketplace you will need to develop a website and necessary software. Creating and selling NFTs will also require specialised software and an online presence. The offshore company will be the owner of the website, software, and any equipment you have purchased for your NFT business. 
  4. The offshore company should be the sole owner and operator of the NFT business, including any websites, trademarks, etc. and nothing should be owned in your personal capacity. The business should set up its own offshore bank account in a zero-tax offshore jurisdiction where payments will be received.
  5. All receipts, whether it be royalties from selling NFTs you have created, trading fees from operating a marketplace, or profits from trading, should go directly to the offshore company. Any contracts entered with customers should be through the offshore company too and signed by the nominee director in the zero-tax offshore jurisdiction in which the company is based. 
  6. The primary income received by the offshore company would be tax-free due it being based in a tax haven. The best way for you to repatriate some of the profits to your personal account in your home country is by being directly contracted/employed by the offshore company for services that you provide. This could be reported as advice, management, website maintenance, etc. You would then invoice the offshore company and receive the profits in the form of personal income. This income will itself be taxable in your home country, but the reported amount could be greatly reduced by claiming various expenses and tax deductions. 
  7. The key point is that you need not repatriate all the profits, but only the portion that you require as ongoing income. The rest could be kept offshore and reinvested without any taxation, leading to greater profitability and significant reductions in realised tax. (This depends on where you live and the CFC laws that are applicable. ie. this does not work for Americans)

Conclusion

The rapidly expanding market of NFTs offers many new and exciting business opportunities and ways for individual investors to make money. Whatever way you may be looking to get involved in this industry and make profits, it is important to consider the tax implications of doing so.

Taxation of NFTs is still mostly unchartered territory, and can lead to great complexity. You may find yourself generating multiple taxable events and losing a great deal of your profits to taxation. 

For this reason, it is definitely worth incorporating a tax-free offshore company through which to conduct your NFT market activities. This will enable you to significantly reduce your taxes, give you greater freedom of the activities you may engage in, and increase your privacy and safety. 

  

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***Note for U.S. citizens: US citizens are limited in their tax reduction possibilities due to FATCA and CFC laws. Opening an offshore company can increase privacy and asset protection, but you can not eliminate your taxes without giving up your citizenship. If you are a US citizen you are obligated to pay taxes on all worldwide income. Read more here about FATCA and CFC laws.

 

 



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