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