Is Uncle Sam not far behind?
By Jack B. Winn
The taxman may be paying a visit to Facebook's offices soon, according to a pair of U.S. financial analysts.
In a white paper authored by international tax consultants Jim Carr and Jason Hoerner of KPMG's Silicon Valley branch, the duo raise the delicate question of whether virtual currency--such as tokens--could be considered taxable income.
"Social media companies should understand that the tax consequences of these conversions [to real world currency] could have significant ramifications for international transactions," Hoerner and Carr write in "Virtual Currency in Virtual Companies: Income Characterization Issues for Social Media Companies.”
The paper appears in the recent issue of Tax Notes International, a trade journal for financial analysts.
Carr and Hoerner pull no punches, addressing not just the legal ramifications of taxation for US companies, but also the transnational implications of virtual trading, everything from Lindens to Facebook Credits.
"Because of sparse tax guidance to date," Carr writes, "social media companies engaging in cross-border transactions with consumers may be unsure whether and how their virtual currency may be taxed."
Prior to the success of sites like Facebook, virtual currency was not a concern for governments. Sites like Second Life allowed individuals to buy and sell virtual goods using virtual money--such as Lindens--but since there was no intrinsic value to the currency, it wasn't taxable.
With the introduction of Facebook Credits in 2009, individuals could purchase tokens to purchase in-game items for apps like Farmville or Mafia Wars--not unlike putting money into an arcade machine. The credits can be purchased with real world money in at least 15 countries, and Facebook nets 30 percent of all the revenue generated from the transactions--making it one of the most lucrative enterprises for the social network.
But as the years have passed, the lines have gotten blurrier. Online auction sites already allow individuals to bid on real world items with purchased tokens, and sites like eBay treat Second Life as a bona fide merchant, allowing users to exchange Linden dollars for items they buy or sell.
Then there are sites like Groupon, which don't use virtual currency but make money on the virtual activities of real world individuals.
With an estimated 14 billion in global profits projected to be made from virtual markets, governments are eager to get in on the action. Taxing virtual currency isn't a novel idea. For example, China already taxes the virtual currency of Internet users, and in South Korea, virtual currency is as good as cash.
Is Uncle Sam not far behind?
According to Reuters, the U.S. Congress looked into just such an idea in 2006. The issue was raised again in a 2009 article by David Wolman in Wired, speculating that paper money would no longer be viable as a currency--and thus, the need for a virtual tax. But as virtual currencies like Facebook Credits become more viable, Uncle Sam's interest in taxing Lindens and Facebook Credits is perking up.
Facebook isn't taking any chances; they've already retained Carr and Hoerner as counsel. Their advice: do your homework.
"To reach an informed conclusion regarding characterization," Carr says, "social media companies should carefully consider the terms of service they offer players."
At issue is the type of services social networks like Facebook and Second Life provide. Whether it is property, deposits, or a special service, each form means companies like Second Life could be paying millions of dollars in property taxes for homes that don't exist.
The problem is the technology is so new, no one quite knows what to tax--or whether Facebook Credits could be taxed at all. The issue has vexed tax preparers and lawyers who aren't quite sure what to make of it.
In the meantime, social media companies are bracing for the taxman's appearance. But whether he shows up depends on whether tax law can catch up with technology.
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