Virtual businesses: taxman gets unreal

Over the past year a joint economic committee of the US Congress has been investigating the issues of taxing enterprises that exist simply on a computer server.

Its findings are due to be published very soon and will be read with interest, and not only by the US taxman, the IRS.

No doubt its UK counterpart at HM Revenue & Customs will also be interested to see if there are any opportunities to tax a new breed of online entrepreneur.

It might seem nonsensical, perhaps even comical, to seriously consider taxing a business that only really exists in the form of binary code on a server, but it certainly offers revenue possibilities.

But what are virtual worlds? And are businesses that have prospered in a digital dimension worth pursuing?

Simply put, virtual worlds are rough, online copies of our own society, and that goes for their economies as well.

Take Second Life as an example. With nine million user accounts, a tiger economy growing at 10-15% monthly and a GDP that is currently estimated at $600m, it is no wonder that the IRS is taking note.

All the more so because Second Life’s virtual currency, the linden dollar, can be exchanged with its US equivalent at a rate pegged between $260 and $320.

Profits from virtual activity aren’t such a far-fetched idea. At the turn of the year, it was confirmed that Second Life had produced its first US (not linden) dollar millionaire, Ailin Graef.

But it is not going to be simple and straightforward for HMRC to act even if trends continue and large numbers of UK residents of virtual worlds start to make significant revenues.

First, there are some hard questions that need to be answered.
For example, do you tax residents of a virtual world in that virtual world or after they have converted their money to recognised currencies?

If HMRC taxed virtual profits, it would have to accept payment in currencies such as linden dollars.

Then there is the question of whether virtual wealth forms part of an estate for inheritance tax purposes. Is VAT really payable on goods that only actually exist on a computer?

You can ask the same question of capital gains. Domicile, my favourite, and the issue of where profits arise get more complicated: the virtual world is based in the US, your business bank account in Canada, and you live in Manchester. Interesting.

So will the HMRC act and, if so, how? To quote Johnny Nash’s 1960s hit: ‘There are more questions than answers.’

Mark Simpson is tax planning director of Simpson Burgess Nash