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A case of collectables: Important considerations around NFTs

Non-fungible tokens are unique trading tokens; an asset held digitally with a unique code attached to it.
It is crucial that passwords, private keys, and access information is known by or passed down to your future beneficiaries. Image: Chris Ratcliffe, Bloomberg

A lot has been said and written about the new phenomenon of non-fungible tokens (NFTs), referred to as a ‘nifty’. However, very little has been said about their tax, exchange control and fiduciary considerations.

NFTs are unique trading tokens; an asset held digitally with a unique code attached to it. Similar to a Monet or a Picasso, there could be prints for everyone to frame, but there is only one original NFT to trade.

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Why should I care about NFTs?

Digital artist Mark Winkelmann, more commonly known as Beeple, sold his third NFT for $69 million via the renowned auction house Christie’s, making ‘Everydays: The first 5 000 days’ the third most expensive art piece (fine art included) by a living artist.

The band Kings of Leon released their latest album ‘When you see yourself’ in March 2021 in NFT format. With three different NFT packages available to choose from, one of its packages consisted of their new album together with lifelong front-row seats for live performances in future.

Similar to these examples, NFTs could also consist of in-game assets for online gaming fans, investing in professional sportsmen’s contracts (both examples which have already crystallised) or acquiring any other digital asset on a NFT platform with an identifiable and quantifiable value attached to it.

Although most NFT platforms are crypto-based, specifically Ethereum, NFTs could also be bought by debit or credit card where this is the preferred payment method. NFTs are therefore not just crypto-based.

A NFT is an asset, and although it is held digitally, it still forms part of your estate.

Why would I invest in NFTs?

Five pertinent reasons for practical and obvious purposes come to mind as to why someone would want to buy or invest in NFTs.

  • Firstly, NFTs are traded on various digital platforms via blockchain, ensuring transparency and security. Only the seller and the buyer have the NFT’s unique code.
  • Secondly since you are holding the asset digitally, there are no expensive specialised storage costs which may apply to fine art if this is preferred to being displayed.
  • Thirdly, as blockchain is transparent with a unique code attached to the digital art, the safety of the NFT is rather robust. Some collectors prefer digital art to physical art for various reasons, among others the safekeeping thereof. It would take an experienced and super hacker to steal the digital asset.
  • Fourthly, reputable auctioneers have taken part in the auction of NFTs, for example Christies, lending NFTs an element of gravitas and respectability.
  • Lastly, and this is where the sentiment lies, although many images of the NFT may be available, the owner of the NFT has the bragging rights of being the sole owner of the digital asset (akin to an original Picasso or scarce artefact).

Underlying contract of the NFT

The buying-and-selling of a NFT is underpinned by a ‘smart contract’ on blockchain which may, among others, include infinite royalties to the artist or seller should the buyer dispose of the NFT. The smart contract will also determine the type of rights to the digital asset that you buy or sell. It could be purely an exclusive personal right to the NFT or it could entail intellectual property rights which could for instance be licensed.

Tax and exchange control considerations

The scenarios from a South African tax and exchange control perspective are endless. The digital transaction could be concluded between a South African tax resident seller (e.g. artist) and a South African tax resident buyer. It could also entail a South African tax resident seller with a non-tax resident buyer, or vice versa. The same applies to exchange control’s definitions of resident and non-residents. This means there are a legion of tax consequences to be applied on a case-by-case basis.

Capital versus revenue

Consideration should be given to whether the seller or buyer is trading in digital assets or whether the digital asset is part of his collectables.

It comes down to the classic tax question: is it revenue or capital in nature?

Estate duty or inheritance tax

Should royalty payments form part of smart contract, one would need to consider if there is enough liquidity in the owner’s estate (which will be regarded as a ‘disposal’ for capital gains tax purposes to an heir) to firstly pay royalties to the original seller per the smart contract. Also, if the digital asset is capital in nature, and capital gains tax applies, the estate should have sufficient liquidity to settle this liability to prevent a sale of other assets, or even end up with an insolvent estate.

Exchange control considerations

For exchange control purposes, intellectual property forms part of ‘capital’ which could be externalised subject to South African Reserve Bank (Sarb) approval.

Let’s take an example:

I buy a NFT which includes a cute caricature, like Mickey Mouse for example, to the value akin to Beeple’s recent digital art. Due to the headlines, hype and features of this transaction, the specific caricature becomes so popular that a demand is created to manufacture figurines globally. Should the NFTs contract include intellectual property rights and I want to sell 50% of the intellectual property (IP) rights to Disney (a non-resident for exchange control purposes) to share in the profits of the figurines, then I should obtain Reserve Bank approval to do so.

Why? As it is not an outright sale to a non-resident third-party and because I intend to partake in the ‘upside’ as a result of the selling of figurines by Disney, I need to obtain Sarb approval to firstly externalise the IP and then partake in the profits of selling the figurines which stems from the externalised IP.

Fiduciary considerations

The only way to pass down digital assets, NFTs or cryptocurrency is to make sure that they will be accessible in the future.

It is therefore crucial that your passwords, private keys, and access information is known by or passed down to your future beneficiaries.

Looking at NFTs specifically, it is critical that the owner of the NFTs makes sure that the future executors or inheritors of their estate are not only aware of the NFT but will also have access to the NFTs in the event of the death of the owner. If we look at other assets, such as bank accounts, the executor or agent is generally able to contact the financial institutions and, after providing the required documentation, the institution can confirm whether the deceased held accounts there and if so, the executor or beneficiaries can obtain access to the accounts.

The problem with NFTs (and ironically also one of their biggest strengths) is that they are decentralised and there is no governing body or directory to request information from.

The best way to ensure that your digital assets will be distributed according to your wishes is to include them in your last will and testament. However, although the existence of digital assets and who should be the ultimate beneficiaries of such digital assets should appear in your will, it is best to keep the details of your digital estate plan in a separate and highly secure document with password managing software or in a digital wallet or exchange, but each one comes with its own risks.

Some aspects that are vital to consider when buying and managing NFTs within your estate plan include that NFTs are written with smart contracts governing the actions of the NFTs, including managing their exchangeability, and validating their ownership and conditions. NFTs can be programmed to link to other digital assets and when an NFT is made or ‘minted’, the underlying smart contract code is written, and this is what governs the qualities of the NFT.

It is important to recognise the distinction between owning an NFT as a one-of-a-kind token vs owning the content that the NFT may be linked to.

For example, purchasing a piece of art does not in itself transfer all intellectual property rights or copyright of the art to the purchaser.

The copyright is only included if the owner of the copyright proves in writing that their intention is to transfer such rights in addition to the piece of art.

This provokes the question, when buying an NFT, what rights am I buying? It depends, and will differ for each NFT as it is dependent on the underlying smart contract. You could be buying only the right to use and display an NFT art piece, or you could inherit the intellectual property rights thereto, determining different consequences from a tax, exchange control and fiduciary perspective.

The future

It may be time to seize the new and exciting digital opportunities that are upon us. Including digital assets in your estate has never been more important and we suspect its popularity and value will increase exponentially in the years to come.

Suzanne Smit is a fiduciary and tax consultant, and Gina Lazarides an intern – both at Fidelis Vox.

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also don’t forget the NFT is not the item itself but the receipt that shows ownership. The actual item is on a server. If the server goes down so does your item, but you’ll still have proof of purchase with the NFT. Do with that info what you will.

Counterpoint for anyone reading this article: stay far away from NFTs in their current form. They’re the embodiment of Peak-bubble insanity and euphoria. At the moment it is just another method of efficiently sending money from the dumb ‘investors’ to the smart creators. They have no serious use-case or utility yet. In the future they might. Please stay far away for now. Buying someone’s tweets or digital artwork (that can easily be copied) is nothing more than a novelty

End of comments.

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