German court ruling declares no VAT when renting virtual land


In its ruling of 13 August 2019, the Cologne Tax Court (8 K 1565/18) ruled that "renting" virtual land in the context of the online computer game "Second Life" constitutes other vat-able services (but not a service rendered by electronic means).

The German Federal Tax Court, however, firmly rejected this ruling with its decision of 18 November 2021 (V R 38/19). In the case of "revenue" generated purely within the game, the court decided that there is no consumable benefit within the meaning of harmonised VAT law. This decision could have significant implications for the Metaverse.

Renting out land in "Second Life"

The claimant operated an internet trade for goods of all kinds and purchased virtual land in "Second Life" as part of this internet trade. It parcelled out the land and partially redesigned it before renting it out to other users of the online computer game through "rental agreements". The claimant actively advertised the "renting out" of the virtual land on its homepage.

It used the rental income in the form of the in-game currency "Linden dollars" to pay its own fees to the game operator and to exchange this in-game currency for US dollars on the operator's central trading platform.

The tax office and subsequently also the Cologne Tax Court treated the rental income as subject to VAT. Renting out the virtual land constitutes other services. The claimant is an entrepreneur and also participates in the game in this capacity as a service provider, not merely as a standard user. Even if the in-game currency is not to be recognised as a means of payment within the meaning of VAT law, there would be exchange-like revenue. The tax office and the Cologne Tax Court assumed, on the basis of the claimant's German-language internet presence, that an estimated 70 % of the revenue had been generated in Germany. As a result, German VAT would be payable on this percentage of the rental income.

Renting out of virtual land parcels not a consumable benefit for the service recipient

According to the German Federal Tax Court, the Cologne Tax Court had correctly assumed an exchange of services in connection with the claimant's use of "Second Life", but had incorrectly determined the object of the exchange of services. It is not the "renting out" that constitutes a fundamentally taxable service, but the exchange of "Linden dollars" into US dollars on the operator's trading platform.

Regarding "renting out", the German Federal Tax Court justifies this position due to the fact there is no benefit for the service recipient that leads to consumption within the meaning of the harmonised VAT law. This would require an identifiable consumer to be given a benefit that could form a cost factor in the activity of another participant in the economy.

The German Federal Tax Court denies this, however. In-game "revenue" between persons that is limited to mere participation in the online computer game and thus to designing the gaming experience in interaction with other game participants does not, in the opinion of the German Federal Tax Court, generally constitute participation in real economic life. Thus, it should generally not be possible for pure gaming benefits in the context of game play to constitute a cost factor for an economic activity. In this case, they do not constitute consumption within the meaning of harmonised VAT law, but merely represent non-economic benefits of the gaming world. This is also independent of whether the player has an option to "sublet", as this also takes place purely within the game.

The German Federal Tax Court, drawing on the rules of interpretation under civil law (section 133 German Civil Code), also considers the concluded "contracts" to be irrelevant, since according to the intention of the parties, they are not deemed to be based on a legally binding obligation.

Player and operator are to be distinguished

The German Federal Tax Court also rejects the equal treatment demanded by the tax office between the claimant as user and the game operator. The game operator offers users the opportunity to play in real economic life and is thus the organiser of the game. This would not apply to the claimant, however, since its activity takes place purely within "Second Life", despite the advertising on its homepage.

Somewhat smugly, the German Federal Tax Court points out in this context that equal treatment of the claimant and game operator would otherwise also have to mean that the claimant is entitled in principle to deduct input tax from purely in-game "initial services", such as the virtual "development" of virtual land by other users. However, the outcome of the oral hearing revealed that even the tax office had not assumed this to be the case.

Exchange of "Linden dollars" into fiat currency as an exchange of services

The German Federal Tax Court does, however, consider the exchange of the virtual game currency "Linden dollar" via the game operator's stock market to be an exchange of services within the meaning of VAT law.

In the opinion of the German Federal Tax Court, the "Linden dollars" are limited licence rights, the redemption of which in exchange for US dollars constitutes an assignment for consideration and thus a service within the meaning of section 1 (1) no. 1 German VAT Act. Unlike the in-game "renting out" of virtual land, the exchange of the "Linden dollars" takes place on a real market and not merely within the game.

Since the German Federal Tax Court assumed a service commission (section 3 (11) German VAT Act) and thus a fictitious chain of services (i.e. claimant à game operator à user/counterparty to the exchange) in this context due to the terms of use of the trading platform, the location of the service rendered by the claimant was determined by the location where the game operator runs its business (section 3a (2) sentence 1 German VAT Act). The game operator was based in the US, meaning that it was ultimately not possible to tax the service in Germany.

Reverse-charge cases conceivable

Based on the object of the service, the German Federal Tax Court considers it conceivable that, insofar as the claimant itself acquires "Linden dollars" via the trading platform, the claimant, as the recipient of the service, owes the tax on his own acquisition of the limited licences pursuant to section 13b (2) no. 1, (5) sentence 1 German VAT Act. However, as the Cologne Tax Court had not made any findings in this regard, it was not necessary to decide on this in the appeal.

In practice, however, an interesting question may arise here as to whether the claimant would have been entitled to the corresponding input tax deduction that is generally possible in reverse-charge cases.

No VAT in the Metaverse?

Apart from the positive outcome of the ruling for the claimant and, if the tax authorities adopt the opinion, possibly also users of comparable game worlds, the German Federal Tax Court ruling also adds an interesting question and facet to the topic of "legal advice in the Metaverse". At first glance, it could be concluded from the ruling that VAT taxation in the Metaverse can only occur in exceptional cases, provided that the pertinent "revenue" takes place purely between the users and within the virtual world. Would this ruling apply to other virtual products? Could Nike sell sneaker NFTs in the Metaverse to users who have no point of connection in the real world?

However, to draw the conclusion from the German Federal Tax Court ruling that the Metaverse is exempt from VAT would be premature. The particular facts of the case may provide too many ways of making a different assessment than the German Federal Tax Court did in the constellation of its decision. In addition, the question will have to be asked as to how long the separation between "real" and "virtual" market activity can be maintained as a criterion of demarcation in view of the Metaverse's rapid development.

For more information on this ruling and German tax law, contact your CMS client partner or local CMS experts Martin Friedberg and Hendrik Arendt.