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Income Earned In Virtual Worlds: Taxation Issues.

Article Excerpt
Originally published in e-Finance & Payments Law & Policy, Volume 1, Issue 7, April 2007

The explosion in virtual worlds has raised some interesting questions about when taxation should apply. Does tax apply to a virtual transaction that takes place in a virtual currency, or does it apply when that income is converted into 'real world' currency? Graeme Nuttall, a partner with Field Fisher Waterhouse LLP, examines these issues and the view of taxation authorities from around the world.

Some frequently-asked questions need answering regarding trading in virtual worlds. Perhaps the most common of these involves the misconception that money can be made tax free by trading in virtual worlds. The UK tax system and other tax systems worldwide are designed to tax trading whatever its form. Tax systems coped well with electronic commerce and are probably wide enough in scope to tax trading in virtual worlds.

The answer to this question surprises many, who are of the view that tax surely cannot be paid on the equivalent of 'Monopoly money'. They are correct that there is no tax on the players in a game of Monopoly. However, in a game of Monopoly, the winner does not convert their winnings into US Dollars. The Monopoly money gets put away until the next game is played. The Second Life 'currency', Linden Dollars, can be exchanged for what any tax authority would recognise as real currency. The fact that Linden Dollars can be converted into US Dollars is an important and very real difference from Monopoly money. This is what has attracted the tax man's attention.

However, the position is still unclear about whether HM Revenue and Customs (HMRC) will charge tax on Second Life 'inworld' profits. This is a developing area of tax law.What HMRC will do is apply general principles to arrive at the current tax treatment under existing law, and the UK Government will then decide whether or not that tax treatment is an appropriate tax treatment, taking into account a range of policy issues.

HMRC is likely to publish guidance on the tax treatment of in-world trading. There is a precedent in relation to individuals trading on eBay. If you (as an individual) buy items with the intention of selling them on as quickly and as profitably as you can, then you are a...