Monday, January 2, 2012

Virtual Currency in Virtual Economies: Implications for Income Tax

"Virtual Currency in Virtual Economies: Income Characterization Issues for Social Media Companies" by Jim Carr, Jason Hoerner, and Carlos Kaplan of KPMG LLP was published in the November 21, 2011 (Vol. 64, Number 8) issue of Tax Notes International.

This article examines income characterization issues related to taxation of virtual currency. Some social media companies offer digital currency (so-called virtual currency) for online players to use in virtual words, online games, and other applications. Players can use virtual currency to purchase assets or services from other players within these online worlds. Players selling such items can convert the virtual currency to U.S. dollars or other currencies through online auction sites or the social media company that issued the virtual currency (Known as “real money trades”).

The authors discuss how the characterization of income derived in connection with an offering of virtual currency is pivotal to assessing the U.S. income tax consequences of that income from a cross-border perspective and how understanding the characterization may facilitate greater planning opportunities.

I highlight some of the more interesting findings below:

Page 3: "Because of the lack of U.S. guidance, social media companies engaging in cross-border transactions with consumers face uncertainty about U.S. federal income tax consequences."

Page 4: "Other social media companies' terms of service may permit virtual currency exchanges to be operated by third parties. Players may trade the virtual currency on these exchanges with other players for real currency, usually at their own risk without any guarantees from the social media company permitting the trade."

Page 9: "There is no comprehensive definition of currency under the IRC or Treasury regulations. For a CFC [Controlled Foreign Corporation], factors to consider in the typical transaction that may be relevant for this determination could include:

whether the player can purchase anything with the virtual currency outside the opportunity to play the MMOG;

the extent to which there are restrictions placed on what a player can buy and/or transfer to another player;

the right of the social media company to terminate a player's virtual currency at its sole discretion or if certain conditions occur; and

the ability of the player to exchange the virtual currency for true cash, whether through the MMOG or through third-party exchanges."

For further reading:
"Virtual currency: regulation and taxation issues", e-commerce law & policy, November 2008

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