How the metaverse economy will affect – and be affected by tax

In this episode of EY Tax & Law in Focus, we explore how the metaverse will nurture a blossoming layer of e-commerce and why companies must adapt to manage tax risk

Key takeaways:

However skeptical some individuals may feel about the metaverse and web3, real change is happening right now. Foundational technologies are converging, NFTs are being issued, cryptocurrencies are being developed, innovative smart contracts are being created and taxable events are taking place. Tax teams must keep pace with developments.
There is a growing expectation that individuals will be using the metaverse daily within just five years.
To ensure the metaverse economy is a success, companies and governments must ensure tax, law and regulation work together to reduce high levels of uncertainty and complexity.

For your convenience, the full text transcript of this podcast is also available.

Susannah Streeter

Hello and welcome to the EY podcast on the challenges of tax and the metaverse. I'm your host, Susannah Streeter. The digital landscape is shifting fast. A new virtual world is emerging through the collision of the latest technologies in social media, gaming, artificial intelligence and crypto. The metaverse, this vast vision of the future, is heralding a really big shift in how we react with technology. The biggest tech giants are already investing heavily into this new leap forward for the internet. The expectation is that the Metaverse will become the centre of the new digital economy, where users will create, buy and sell goods and services, which can be taken from one platform to another, hang out socially, and even work. The Metaverse is expected to give rise to a blossoming layer of ecommerce generating global annual revenues predicted to exceed $1 trillion. This brave new world has been founded on predominantly blockchain-based enabler technologies known collectively as web 3.0, on which cryptocurrencies and non-fungible tokens, NFTs, have developed alongside innovative programs called smart contracts, and they have the potential to cause seismic change in the payments industry, and ultimately, the global financial system. Although a truly seamless digital experience is still only a vision, there is a growing expectation that individuals will be using the metaverse daily within five years. So companies are having to assess just how they will operate in these new virtual worlds, particularly in dealing with the thorny issue of just how this type of economic activity will be taxed. Some problems may be able to be solved with the adaption of existing legislation, but in other areas, whole new rules of engagement will need to be drawn up to cope with added layers of complexity. Different jurisdictions are developing very different attitudes towards digital assets. So what models should companies adapt to minimize tax risk? And what role should international institutions have in creating a more level playing field? We'll be discussing all of these issues, and more in this podcast. And I'm delighted to say I'm going to be joined by a great panel of thought leaders to discuss all of these topics, and they'll have plenty of other insights to bring to the table. But before I introduce them, please remember conversations during this podcast should not be relied on as accounting, legal investment nor other professional advice. Listeners must of course, consult their own advisers.

Now let me introduce first of all, Dennis Post, EY Netherlands Partner Tax, Global Leader in Blockchain Tax Services. Hello there, Dennis. Welcome to the podcast. Where are you in the Netherlands today?

Dennis Post

Yeah, hi, Susannah, dialing in from Amsterdam, where it is a lovely summer day. And thanks for having me today.

Streeter

Great to have you with us. And I'm also delighted to introduce David Wren, who's EY's UK Tax Associate Partner. So David, where are you talking to us from?

David Wren

Hi, yeah, I'm joining from London, just actually in sight of the office, but joining from home.

Streeter

Lovely. Thanks very much, David. And I'm also very pleased to welcome Mercy Joseph, Partner of Financial Services tax at EY in Singapore. Mercy, great to have you with us. What's Singapore like this evening?

Mercy Joseph

Hi, Susanna. Hi, everyone. Glad to be joining you today. Singapore is having a beautiful sunset with clear skies right now. So it's great to be talking to you from here.

Streeter

Fantastic. Well, the sun is rising on the metaverse. Dennis, just tell me first of all, how transformative you think it'll be for our daily lives.

Post

Yeah, absolutely. And let me just start by saying, you know, Metaverse has really, you know, great opportunity, you know, to really disrupt the way we interact with each other. My expectation is that people will spend a number of hours per day in either shape or form in the Metaverse. So you know, you can think of it as a, you know, future iteration of the internet used for gaming, shopping, interacting, you can go to concerts together, but also to create like immersive learning experiences, obviously backed by web three technology like crypto, blockchain and NFTs which we're going to talk about later on as well. So this weekend, I was actually reading this quote from an Australian philosopher David Chelmer, who actually said on the Metaverse, you know, just because it's a simulation doesn't mean it's an illusion, right. And so it's already here, and it's here to stay for sure. We just need to see the pace at which this will develop.

Streeter

David, let me bring you in. Crypto and NFTs were really sideswiped by volatility sweeping through financial markets in the spring and summer of 2022. Are you concerned the volatility surrounding crypto in particular could affect opportunities in the Metaverse revolution?

Wren

Yeah, I think it's fair to say it's been an interesting few weeks. And I suspect kind of a very negative few weeks for a few people in this area. Having said that, we went through the same at the outset of the internet, the kind of .com, boom, back in the early 2000s. And although there's a great deal of volatility and, at the moment, quite a downward pressure on asset prices and other things, as Dennis says the technology that we see has the opportunity to change the way we interact with a lot of the kind of daily aspects of our lives, everything from financial services, where I'm particularly interested to things like gaming, music, assets, art, and a lot of other things. So I think it's important to maybe separate out the current kind of downward pressures in the market, from the kind of underlying technology and the opportunity that that that will bring.

Streeter

So Dennis, what's your take on this? Do you think this bust and rebuild is what's needed to kind of shake the tree?

Post

Yeah, absolutely. And, you know, as David mentioned, you know, this is not uncommon in this industry. It's a very nascent industry that is evolving at a rapid pace, but you actually also see, you know, a couple of elements coming together, right? It's the hype around NFTs where it's now boom, bust. And then I would definitely expect rebuild in that sense as well. It's a specific area of crypto around decentralised financing, that is moving into a very specific direction. But it's also the correlation of all these trends with let's say, the traditional economy that's happening. Obviously, we see a lot of volatility in the market right now, more broadly than just crypto. And this is actually converging. So in that sense, what's currently happening today is not unsurprising to me.

Streeter

So Mercy, let me bring you in. We're entering this brave new world, but just how large are the gaps in knowledge about future obligations among companies and how much of a risk is this for larger firms in particular?

Joseph

If I look at the tax area, I still see knowledge gaps within the traditional financial institutions, with the more established setup and access to resources. I think this has contributed by a few factors, including the fact that the compliance expectation and burden that is placed on various companies in the past few years has tremendously grown. Companies, mainly intermediaries, are now expected to act as agents of tax authorities, which is not an easy task to cope with. I think also that the regulations are catching up to what the technology can do for the regulators. And therefore the regulators are now looking at intermediaries slightly differently. Now, companies that have been operational for years and years have invested a lot of time and effort in building systems, processes to comply with these new rules. To expect a high level of compliance from this industry, which as Dennis rightly pointed out, is still at a nascent stage and growing rapidly. This is a very tough ask. That said, I think there is also a realisation that all these asks about knowledge and plugging the loophole and risks, etc. This should not be in the to do list of one person or one team. There's an increasing reliance on the ecosystem, whether it is systems that help in complying with some of these regulations, or even looking at outsourcing all these new functions that are coming up. And I think these options are now realistically good options to mitigate some of the risks for these companies.

Streeter

And do you think if there was greater understanding, Mercy, about obligations, do you think more companies would embrace the Metaverse?

Joseph

I think so, yes. So we've seen that the clearer the regulations are a lot easier for the companies to decide if the geographical base that they're looking at is also aligned with their own corporate objectives, knowing the regulators' challenges and perspectives around this, I would say that most of the regulators that we speak with already have this as a top priority, but regulations are still at an early stage. And I would expect that it will take time to get to the desired level of clarity and certainty.

Streeter

So David, let me bring you in. You heard there from Mercy that we still need clarity, but even so do you think these new realms will be a game changer for ecommerce operations?

Wren

Yes, I think there's certainly a lot of belief and a lot of kind of technical viability in what the kind of prospects of the Metaverse and web 3.0 and blockchain technology in particular can do for us. You know, the ability to have cross border payments, remittances to have those kind of settled instantaneously and with few intermediaries. Some of the prospects for quicker settlement around trading in stocks and shares and other assets as well. Those are real-world kind of viable solutions for what's kind of happening and what the Metaverse can bring about. But I think we see a bit of a kind of tension in that space as well, which is, at the moment, the technology is still kind of emerging and to do anything much more than just buying and selling cryptocurrency requires a reasonable amount of technical understanding of what you're doing. Yeah. And accordingly, a reasonable amount of risk if you get things wrong. And so I think one of the tensions we're going to see is how do we take these brilliant ideas, and it's great technology and make it available to everyone across the market. And particularly in the wake of actually, of some of the recent kind of drops in asset prices. There's a kind of a big focus on consumer protection from governments, you know, how do we protect consumers? How do we put that Metaverse kind of environment on the same kind of grounding as the banking app on your phone or, or even kind of going into the bank. Against that, of course, one of the kind of central kind of tenants of web 3.0 And Metaverse is decentralisation and removing intermediaries. So there's going to be a tension. And I think it'd be interesting to watch how we get that into a place where people can use it in their day to day lives, and feel confident in it and feel kind of trusted with that against that idea maybe that there are not very many intermediaries or no intermediaries between you and whoever you're sending money or other things to. And that's going to be a really interesting kind of piece to watch I think in terms of future developments.

Streeter

It certainly is. So let's get Dennis's view on this. To what extent do you think some of the tensions that David's outlined could be solved by extensions of existing ecommerce regulations? Where do you see the limitations of current frameworks?

Post

Yeah, that's actually a really interesting question. And you know, some of you are old enough to remember the introduction of ecommerce in the 90s. We faced similar problems, then. And ultimately we were, to a large extent, able to actually solve that by really looking at transaction flows, and how do those transaction flows convert into, you know, today's existing tax frameworks, and I think we will see something similar here as well. So we need to actually, you know, bring these technology developments into or convert them into today's tax frameworks and today's tax problems and today's tax consequences. And at the same time, you know, because we're dealing with new technologies and new ways of transacting, as David just outlined, we're dealing with a decentralised technology. It's also fair to say that most likely we will also need, you know, new tax systems or new ways of actually thinking how we can actually tackle those transactions before we're able to tax them. So it's a bit of both sides of the coin really.

Streeter

Well, let me bring in Mercy. Mercy, we're seeing new regulations of crypto currencies around the world. Do you think they're going to help? Or do you think they could in fact throw up new challenges given that different jurisdictions appear to be adopting very different attitudes towards digital assets?

Joseph

Well, if you look at Asia Pacific as a region, Asia Pacific has a big target population, and the adoption of technology in APAC has generally been very high. This makes APAC a good target market for crypto, Metaverse, etc. But the regulations in APAC has been very diverse, so far across various individual geographies. The fact that different countries in Asia Pacific have adopted these technological changes at a different pace, adopted a different approach to digital assets, makes the adoption by the companies a little bit more challenging. So if you can imagine someone trying to set up shop in the region, and trying to navigate all the different regulations, it's going to be a tough task. So if you look at, for example, Australia. Australia already has draft tools, and is trying to introduce a sharing economy reporting regime. Singapore has generally sent a welcoming message to the industry while putting in place regulations like the Payment Services Act and other proposals to mitigate risks. Hong Kong, Japan, Korea seem to be moving towards regulating without stifling the industry. On the other hand, China and India sometimes have adopted a more cautious approach by prohibiting provision of some of these crypto services. So, you can see how diverse these approaches are. And it's going to be that much more challenging to navigate these different regulations.

Streeter

Yeah. So David, do you see this as a real challenge as well? How much interest are you receiving about developments and how different jurisdictions are going in different directions in this space?

Wren

Yeah, there's a huge amount of interest in watching what people are doing and I think what we see globally is a bit of a race. Yeah, there are countries who are trying to position themselves as the go-to location for cryptocurrency. Whether that's the UK, which is our chancellor has just come out and said, we want to be the kind of hub for cryptocurrency. Obviously the US has a big head start and a regulatory environment that welcomes that kind of innovation. We see other places like the Netherlands, where Dennis is based and the Nordics and Germany also doing their best to foster a great environment for cryptocurrency businesses to be in. And I think one of the things that we see in the market and certainly in the news is a big focus on the taxation of the investor. So the person investing in the cryptocurrency, what sort of taxes are they going to pay? Is it capital gains? Generally yes, actually. Is it income? You know, how did the rules work for them? Actually, one of the most interesting things for a lot of our clients will be what does it look like for the institution? You know, is this a good place to be from an institutional perspective? As Mercy says, does the regulatory environment work? And actually, do you feel that long term commitment from the government, from the regulators towards making sure that this is a good place to be for cryptocurrency. As one of my colleagues often says, we have to get kind of tax, regulatory and law all to work together, rather than seeing all of those as three separate problems.

Streeter

So Dennis, what's your take on this fragmented approach that's emerging? What steps do you think should companies be taking right now, in terms of tax challenges to ensure that they can keep up with all these different approaches?

Post

Yeah, well, there are a couple of things, I guess, you know, companies could actually do, obviously, you know, contact us, because we're definitely able to help navigate companies throughout this uncertain and very nascent landscape. But at the same time, the most striking challenge that companies are facing today is that you would have, you know, a tax authority in country A, taking a different stance on a certain transaction than a tax authority in country B. And it's very good that we see tax authorities actually standing up and coming out with, you know, guidance and legislation on how certain transactions need to be taxed. But what is really interesting and challenging is that if you have disparate views, or you know, that could potentially lead to double taxation, or double non taxation, or uncertainty, and this is actually what every company would like to avoid. But you know, I think the good thing is that this is such a fast developing environment, we see disparate case law emerging in the EU, for example, where Spain has issued some case law around NFTs taking a different stance than, than, for example, Germany on this, but I think it's, you know, again, this landscape is emerging and developing so fast that even though there may be uncertainty right now, we're definitely able to help navigate companies through this landscape and more certainty will definitely be there in the very short run, I think.

Streeter

Mercy given that the direction of travel is still so opaque right now, how do you think companies should be navigating this uncertainty and preparing for web 3.0?

Post

So picking up on what Dennis just shared, while the regulations are evolving I think how we generally approach this is we will look at the current regulations. Now granted, the current regulations are not fully geared to answer all of the questions that this new world of web 3.0 and digital assets raises. But we should expect the thinking of the regulators in how they want to achieve equitable tax collection, all those principles should still remain. And therefore the core principles of taxation should also remain. That is how we navigate the world currently, for our clients who are interested in knowing the answers right now when the regulations are still uncertain. But this also means that the industry has to be more agile, because as soon as there is new regulations or clarity, they will have to do the bust and rebuild even in the tax world.

Streeter

David, talking about perhaps the role of leadership here. Do you think international organizations like the OECD should take the lead and help create a framework for countries to follow?

Wren

Yeah, I think it's been really interesting to see the OECD has been very responsive on this. There was a report back in 2020 already starting to look at how crypto and digital assets were being taxed all over the world. We see new rules being brought out, the crypto assets reporting framework, which aims to enforce tax rules and make sure that people are paying their tax in this new world. It's interesting because there's really never been an opportunity like this before. We have a brand new world class of assets, types of transactions, way in which people are interacting with each other that is being opened up. And that's never really happened before. You know, everything that tax authorities have done previously has been going back trying to fix problems, close gaps and other things as well. So it's fantastic to see the OECD and others kind of taking that leadership. We see similar sort of things in, for example, the financial crime and anti-money laundering space, as well. And that's absolutely brilliant. Equally, I think some of the countries that are doing particularly well are those that encourage innovation, and don't come down hard on people when subsequently rules are changed. And I think one of the biggest risks will be tax authorities effectively legislating after the event, bringing out new rules, new guidance, that catch people unaware, and potentially hit them with very large tax liabilities. Now actually it's possible we're gonna see some of that coming in the next kind of six to 12 months. You know, as the market takes a downturn, a lot of people are suddenly going to be sitting on losses in the crypto space rather than gains, tax authorities are generally very, very quick to come and tax gains and income, perhaps not quite so quick to give relief for losses and other things in the market. And so I think we might see some of those issues starting to bubble up over the next 12 months or so.

Streeter

It's interesting, you talk about the potential for a more softly, softly approach there, David. Dennis, what's your view? Do you think first and foremost, existing tax law should be used rather than the reflex action of introducing new legislation, which could potentially clamp down on innovation?

Post

Yeah, well, you know, I think first and foremost, I think, to some extent, existing tax frameworks, and legislation can be a good fit to actually tax some of these transactions. And as mentioned, you know, the analogy of ecommerce development in the 90s, actually, you know, pops to mind. And at the same time, we will see that in not all situations, this is sufficient. But I think the fundamental change, let's say, with, you know, ecommerce in the 90s, with what's happening today is that, we really need to understand the technology behind what's actually happening here. And that, for example, if you look at a topic, like NFTs, right, non-fungible tokens that are used widely, by companies to actually you know, enhance their brand strategy, what have you. Fundamentally, if you want to tax NFTs, there's obviously a crypto element. But there's also what's really behind this NFT, right, is it really like this digital piece of art? Or like this electronic supply of service? Or is it something more? Is it an entitlement to a physical product, for example, and I think that's where we can actually say, okay, this is where potentially existing legislation is deficient. And at the same time, there are instances where we could say that, you know, we may need some new frameworks. And I think to a large extent, this development has already started with, let's say, the taxation of the digital economy and everything and all the challenges that are happening there. This is not new. It's just, I think it's just emerging that more faster pace and those challenges around taxation of the digital economy. For example, if one artist hotshot does a concert in Fortnight, for example, how do you actually tax that? Do you tax that at the level of the viewers? Or do you tax that where the concert is actually taking place? And where is that, actually? So those interesting questions are already there in today's world, we just need to think fundamentally, and strategically, also how we actually deal with that.

Streeter

David, do you think indirect tax rules could be more useful here?

Wren

Yeah, I think when I talk to my indirect colleagues, and indirect tax is VAT for anyone in Europe, when I talk to my indirect tax colleagues, they often get to a much more sensible result much more quickly. The overall approach of VAT seems to be if it looks like a duck and quacks like a duck, it's a duck. And therefore, actually, the rules often make a lot more sense. And actually, I think there's something in the way in which VAT approaches the problem. What they really get down to is what's actually happening down on the ground, you know, what's the reality of the transaction, you know, outside of the marketing bluff, and everything else that's laid over the top, you know, what's actually happening? What are the transactions, and who's involved? And I think, yeah, whatever the tax problem we are looking at, fundamentally, most people are going to have to apply existing and often very well-known kind of tax concepts, and whether it's things like transfer pricing or location of assets or cross border flows, and apply that to new transaction flows and new products and other areas. And fundamentally, that really means what's happening down on the ground and what does that all look like?

Streeter

Now, you mentioned earlier, David, about this drive by the UK government to be a centre of excellence for innovation for potentially the Metaverse in terms of crypto. Do you think that overall we'll be guided by the direction of governments like the UK in another way in terms of its use of stable coins because it's likely that they are going to play a much bigger role in the future financial system. So what impact could this have on other crypto assets and their position in the Metaverse?

Wren

I think inherently what governments decide can make or break the crypto market in that country. And whether that's in tax or legal or regulatory areas, whether it's in areas like consumer protection and other things as well, that can have a massive bearing on not just the success of the market, but also what the market looks like, and what kind of products are being offered. You know, and if we look at something like the traditional banking space, most of the products that are offered to people and we'd be familiar with on the high street, are in large part driven by the tax incentives, the regulatory position, what the regulators say, and what the banks do. Stable coins is a really interesting one. So we've seen a number of products out there, which are stable coins. And as it turns out, some of them are considerably less stable than previously believed. You know, governments have the ability to issue Central bank digital currencies, backed by the state and fundamentally kind of replace that market or offer something new. And the statistic is something like 81% of global governments are looking at Central bank digital currencies. So I think that kind of innovation could be huge. And I think again, because most central banks will then involve the existing financial services, regulatory framework and financial services players that provides us a space for a lot of traditional financial services companies to get into.

Streeter

And Dennis, what's your take on this? Are you leaning more towards Central bank digital currencies or stable coins as kind of a dominant force in the future Metaverse?

Post

Yeah, so, and obviously, you know, my guess is as good as anyone's, but I'm not sure if I'm actually as optimistic around the future of central bank digital currencies as opposed to stable coins. Let's say from a tax perspective, central bank digital currencies are very interesting conceptually, because you could think of building in tax programmable elements into CBDC. So you can make tax collection easier. But there's also, let's say, more challenging issues around the implementation of central bank digital currency that go way beyond taxation around privacy around, you know, KYC, and how you actually deal with a lot of these issues. So I think I'm actually more leaning towards a stable coins that have robust security in place that have audit mechanisms in place that are subject to regulatory requirements. And obviously, you know, David mentioned that we've definitely seen some stable coins that were very volatile that we could not trust. But a trustworthy stable coin, in my view, has better opportunity and more benefits over central bank digital currencies in the long run.

Wren

And I think what will be interesting, it comes back to that idea of consumer protection and how people can feel secure in the market. You know, we're sitting here a month or so after the collapse of stable coin down to zero, lots of money lost globally as a result of that. Now, if you're in the UK, reading the report on that feels very familiar. Because in 1992, in the UK, you could invest in a algorithmically linked stable coin, which was linked to the German Deutsche Mark, and it was called pound sterling. And our bank used to actively peg the currency to the Deutsche Mark. It's kind of hard to believe if you weren't there at the time that that was a thing, but it definitely was. And very similar mechanisms were used to crash it, effectively. People started a snowball of selling, and ultimately, that kind of rolled on and crashed. At the end of the day, though, Sterling didn't crash to zero, it crashed significantly outside of the Exchange Rate Mechanism. And some people made a lot of money and the government lost a lot of money. But there was still value there because the currency was backed by the Bank of England. You know, when we saw the, the other currency crash, not that long ago, it crashed to zero. And so I think one of the tensions will be just how secure, auditable, how safe are the assets underpinning those stable coins?

Streeter

And is that why you think that actually there will be more support for CBDCs in the future to avoid crashes of that kind?

Wren

Inherently, a currency backed by a government is probably going to be more secure, at least in the near term, than a currency being backed by assets elsewhere. Of course, like all government debt that relies very much on your level of trust in the government. I think what's perhaps interesting, as we see some of the consultations coming out and the EU consultation is out at the moment is how enabled will those central bank digital currencies be, you know, if they're on their own blockchain, if they are kind of relatively limited to the domestic market, great, but you know, then they're not necessarily doing anything super interesting. If we see some which are able to interact with Aetherium or some of the other kinds of blockchains, that gets a lot more interesting because then you're talking about a currency that's not just being used domestically to replace card transactions in shops and cash but one that could be used globally.

Post

If I can make just one reflection on that, because I think, you know, all the points that David just raised, I think could almost equally be achieved with stable coins if they're properly regulated. And I think the biggest challenge that we see right now is that you know, these stable coins are not regulated. So it leads to a lot of uncertainty, leads to stable coins going to zero. But I think stable coins ultimately have the benefit of being more easily implemented without let's say, some of the challenges that go beyond tax that CBDCs may have.

Streeter

Have more flexibility, less rigidity, and greater use, perhaps globally. Let me bring in Mercy. What do you see are the key risks of using digital currencies for tax collection, of course, given that in many cases, they could circumvent traditional tax reporting systems?

Joseph

Well, the risks really are that the current processes for ensuring better tax collection may not necessarily work as efficiently and the various touch points in this new world have to be revisited again, entirely newly. If I look at, for example, the upgrade to the Common Reporting Standard, also known as CRS 2.0, and the crypto asset reporting framework. There is clearly an attempt by the OECD to treat some of these CBDCs and other digital assets on par with financial assets when it comes to tax reporting at least. And I think that this clarity and intention that the OECD has put out there, to some extent reduces short term risks that may arise up to the point of effective implementation of these new rules.

Streeter

Do you think there is a risk of rushing perhaps these new rules through too quickly without pause to think what implications there could be for innovation?

Joseph

That's a very good question that you raised. So we at EY, we regularly collaborate with tax authorities to exchange ideas on what we see on the ground visa vie what the intention of the regulators could have been or is and then we look at how to meet in the middle. In this conversation, what is becoming increasingly clear is that the regulator administering compliance may not be fully aware of the operational aspects of this whole new world, which means that if there is not sufficient time and energy devoted to consultations and regulations are rushed out, the regulations may not be able to fully achieve what the regulators are trying to achieve. Actually, worst case scenario, any regulation that is rushed out without thinking through risks, may even hamper the growth spurt that we are seeing in this industry, because there are various issues like take, for example, data privacy, there was a reason consolidation that OECD had on the crypto asset reporting framework, the CARF, and some of the industry players had some insightful feedback as to the data privacy risks that the proposed regulations may not necessarily have fully considered. So to your point, there are gaps currently within the knowledge gaps within the regulators also. And it's important to make sure that we take the time to look at all the risks and plug them properly.

Streeter

And David, let me bring you in here. Do you think some of the solutions to tax reporting collecting issues thrown up by the advent of blockchain applications can actually be found within the technology?

Wren

Yes, I think there are solutions in the technology. I'm not sure that they are solutions that everyone will like. So one of the things that the crypto assets reporting framework, the CARF that mercy was just talking about, proposes is a collection of wallets addresses for unhosted wallets. If you buy your crypto currency and exchange, transfer it to your phone, to your computer, anything that's not kind of intermediated, the wallet address gets reported. Wallet addresses are a bit more than just a bank account number and sort code. If you know someone's wallet address on one of the public blockchains you can see their entire history on that blockchain. You can see what else they've done with those assets. You can see where they came from, you can see what other transactions they have got. And if you've got multiple points of entry onto that blockchain, you can actually start to see a huge amount of information, not just about individuals, but about networks or meta data about how people are interacting and what they are doing. So actually, I think there are some proposals out there for some solutions, which are going to go much too far in terms of what they are proposing. And you know, is it right that a government could see your entire transaction history just because you bought some cryptocurrency and transfer it to an unhosted wallet? On the flip side, there are some great opportunities. Digital identity is a big piece linked to blockchain technology in general. That idea of being able to kind of prove who you are, through the use of NFTs, or increasingly we're talking now about the kind of sole-bound tokens. So things that are issued to validate that you've got a qualification or something else can't be transferred away from you and are held by you. Some of those use cases are fantastic, and could be brilliant for tax authorities, institutions and individuals in terms of streamlining the processes involved in things like tax returns, and others, and actually increasingly move us towards that kind of Nordic model where a huge amount of information is provided to the government, but they actually calculate your taxes, do your tax return, and only a very small percentage of people actually need to file their own tax returns. You know, very different in large parts of Europe, and certainly in the US,

Streeter

I would love that I must be honest, somebody to file my tax return for me. So many other people would as well. But as you say, there are privacy implications. Dennis, what exciting initiatives are you seeing about the use of blockchain in this space? And do you share the same privacy concerns?

Post

So actually, in the blockchain and tax space more broadly, we always say that, you know, the combination of let's say, some of the, you know, benefits of blockchain and the challenges that we see in the Tax Practice, if you combine those, you have the potential to actually create a really robust tax system. And we, you know, we see some initiatives from tax administrations across the globe that are experimenting with that. And also from an EY perspective, we are definitely developing, you know, blockchain systems to facilitate a more robust tax system in a world of withholding taxes in a world of global trade. So that compelling combination is definitely there. And at the same time, there are quite some challenges from a legislative perspective to actually make that happen. Because as we always say, blockchain is a team sport, right? So, you know, we cannot just have a tax administration by itself, trying to issue this on its own, you really need to collaborate with all the relevant stakeholders that are part of this ecosystem. And I think that's fundamentally where the biggest risk lies from, to actually get to that opportunity level that we all see to that implementation level, where we have those challenges and privacy to your point, is a really important one. I think there are ways to actually solve that by means of technology by actually shielding a transaction that is not visible to everyone who's transacting on the blockchain. There are also quite some questions and challenges around how do we actually fit these into existing tax frameworks, what we talked about earlier, but you know, I think, tax administrations as well as companies just need to start embracing this technology, embracing the opportunity and really work together to make it happen.

Streeter

And is that crucial, do you think, this collegiate approach, to ensure that there isn't a too heavy handed approach being made by tax authorities if you've got diversity of thought, Dennis?

Post

Absolutely. I think, you know, on the one hand, you know, you really need that, you know, tax administration perspective on how you actually want to tackle some of these things. And, obviously, from a tax administration perspective, the tax policy considerations are first and foremost, I think they're key really, the focus is really how do we actually tackle some of these transactions that are currently hard to grasp, hard to tackle? And at the same time, you need insights from industry on, you know, what are some of the tax challenges that we face today? How much insight do I actually have in my supply chain to get all the relevant information in order for me to assess what is necessary from a tax perspective? And if we actually combine that together in that ecosystem, and this is where, you know, blockchain technology can really play a key role. This is where you can actually see great opportunity emerging. But it actually requires this fundamental paradigm shift in terms of how do we actually collaborate with each other? And do we actually acknowledge that there's an ecosystem benefit? If we actually, you know, do this together, rather than just focus on our own problems and trying to solve them one sidedly?

Streeter

And, David, do you think this will really help ease the tensions that exist between innovators and authorities?

Wren

Yeah, I think what most people are looking for is certainty. You know, the last thing you want to be hit with is a tax liability down the road that you didn't budget for, regulatory penalties or even things like remediation efforts. You know, if a regulator decides you should have been doing AML KYC on something that you're not, going and fixing that is incredibly expensive, regardless of any penalties. So there can be a real challenge there, I think as you are pushing innovation, and people want to be first to market and bringing new products online, against the environment in which you find yourself. I think there has to be an element of kind of trust in both directions. You know, I think most companies who bring themselves into mature, well-regulated markets are trying to do the right things for consumers, they're trying to do the right thing for the market and for other participants, and they've got to be able to trust that the government are working with them and understanding what they're doing. We see quite a lot actually in the in the regulatory space. So these idea of kind of things like regulatory sandboxes, this idea of being able to kind of play and explore and work out what's going to be needed. And I think those kinds of ideas are a fantastic idea for tax authorities to explore as well.

Streeter

Dennis, would you agree? I mean, David's there talked about this need for certainty. Plenty of multinationals, for example, want to issue NFTs but there is a lack of clarity. And how much of an impediment is that to progress?

Post

Well, it is an impediment. But I think, luckily, we are able to navigate clients through that journey. And I think ultimately, it really comes down to what is it actually, that you're trying to achieve? And, as we talked about earlier, right, when we talked about NFTs, there's no one size fits all. So there are definitely ways that we can actually shape certain transactions or, you know, think of ways or characteristics of NFTs that we are able to characterise from a tax perspective. And others are, let's say a little bit more unclear. I think fundamentally what companies need to do, because we see a lot of companies in several sectors actually experimenting with this topic, I think what they fundamentally need to do is try to get their arms around a strategy, what do you really want to achieve, and let's say a lot of activity by companies in this space, is that it's just an experiment, it's all over the place, which obviously is fine at this current, you know, state of where it's at. But if you really want to think about this, fundamentally, think of it at a more strategic level, how to actually incorporate that into your operating model, and really embrace what's possible. And then I'm pretty sure that we can solve a lot of these issues that are out there along the road.

Streeter

I like that note of optimism. So just before we ended, like to scan the horizons and ask you all just what is achievable in certain timescales. So Mercy, how confident are you that over the next five years at the knowledge bank of tax obligations in this new digital world will be filled up and that corporates will be able to fully grasp their responsibilities?

Joseph

I think David and Dennis spoke about how the industry is definitely in a rapid growth stage. And while I do recognise that tax challenges very much exist, perhaps reliance on the ecosystem would be our best effort at the moment. But overall, I'm hopeful that the ecosystem and the technology available today should help us bridge the knowledge gap and catch up.

Streeter

Good to hear. So Dennis, are you confident that in five years big corporates will have got to grips with the opportunities presented by the Metaverse?

Post

Not confident, but I'm very hopeful. And the reason why I say this five years in this environment is almost like a light year right? Or it's light years, perhaps. This technology is emerging so fast. I see companies catching up really quickly. I see we as a firm are really upping our game when it comes to understanding where this needs to go. So I'm very optimistic that there's lots of certainty along the road and at the same time, new challenges will come up along the way. But that's obviously not new in in the world of tax.

Streeter

It certainly isn't. Okay. And David, how do you see the regulatory framework playing out over the next half decade? Do you think new rules will quash innovation? Or do you think in fact, they might enable them to flourish?

Wren

Yeah, I think the reality is we are seeing things happen now. You know, however sceptical you may feel about the Metaverse and web 3.0, down on the ground digital assets, NFTs are being issued by companies now, we are talking to our clients about tax and typically tax are the last people to know anything that's happening. So that means that things are really kind of coming to fruition. In the regulatory space, one way or another we will have rules. You know, people are going to issue products and rules are going to exist, I think what really is up for grabs is how streamlined and how aligned those rules are to what we are doing. Right now, you can do a lot of things. And the rules, maybe are not particularly favourable, maybe don't get you to the same place and the level playing field with financial services or other industries that you might be trying to compete with. The opportunity really is to create a regulatory framework that works internationally and encourages this market, rather than one where there's kind of a constant tension between new innovation and existing rules.

Streeter

Well, thank you so much to David, Mercy and Dennis. it's been really fascinating to talk to you all today on the cusp of such revolutionary change and how we interact with technology.

Post

Thanks Susannah, thank you so much for having me and thank you for this interesting conversation. Always love to talk about tax and technology and how it comes together. So thanks so much.

Wren

Likewise, yeah thanks. So always great to speak to Dennis and Mercy and yeah, I really enjoyed it. Thank you.

Joseph

Thanks, Susannah, and thanks everyone for tuning in, and it was a pleasure talking to all of you.

Streeter

For more information visit ey.com. And a quick note from the legal team. The views of third party set-out on his podcast aren't necessarily the views of the global EY organization, nor its member firms. Moreover, these should be seen in the context of the time in which they were made. I'm Susannah Streeter I hope you'll join me again for the next edition of the EY podcast.

Presenters

Susannah Streeter

International broadcaster and financial analyst

Podcast

Episode 8

Duration

45m 11s

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

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How the metaverse economy will affect – and be affected by tax

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Susannah Streeter