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Gateway to financial independence or risk of litigation? | Brownstein Hyatt Farber Schreck

NFTs, or “non-fungible tokens,” are everywhere. What was once considered a collectible for crypto geeks and LeBron James TopShop fanatics is now gaining popularity with a much wider audience. Take the recent example of elite winemaker Robert Mondavi and French porcelain house Bernardaud’s NFT, which would give wine lovers one of the 1966 Limoges porcelain Magnum bottles. The very premise of NFT appeals to a clientele that is largely comprised of high net worth investors, potentially from the older generation. Or consider the even more exclusive appeal of Quentin Tarantino’s seven NFTs, previously unseen scenes from his handwritten script. Marketed as a new “asset class” and a unique investment opportunity, NFTs are expected to sell for millions. Dare we say, NFTs are becoming mainstream.

As NFTs continue to grow in popularity, a growing narrative is that NFTs will allow creatives to gain financial independence and bypass third-party producers and promoters. It is in this spirit that artists like Snoop Dogg and john legend recently announced the launch of proprietary NFT platforms, which will allow new and upcoming musicians to raise funds from their fans by selling NFTs on their platforms and releasing blockchain-based songs on their music houses. “NFT” discs.

Before jumping head-first into publishing an NFT, creatives should consider the risks of participating. We outline some of these considerations and risks below:

Tax

As with other digital assets like cryptocurrencies, NFTs pose new tax questions. The possible taxes due vary according to whether the taxpayer is a creator, a buyer or a seller. When the NFT is initially minted, or created, and sold by the creator, the creator will pay taxes on the revenue earned from the sale. Since NFTs allow creators to potentially continue to generate income through secondary sales, any income generated from these sales will also be subject to income tax. Buyers may also be subject to taxes when purchasing an NFT using cryptocurrency based on any gain or loss on the cryptocurrency used to make the purchase from the date the buyer originally purchased or received the cryptocurrency.

Additionally, since NFTs are considered a form of property for tax purposes, sellers of NFTs incur capital gains or losses when the NFT is transferred or sold based on changes in the value of the NFT between the date of purchase and the date of its disposal. The capital gains rate will depend on a few factors, including whether or not the NFT qualifies as a collectible, which are subject to a higher capital gains tax rate, and the length of time the NFT is held, for example in the short term. long-term and long-term capital gains tax rates.

The classification of NFTs as collectible versus non-collectible is another area that continues to evolve as the different use cases for NFTs continue to grow. The IRS definition of a collectible includes works of art, antiques, metals, gems, stamps, liquor, and other personal property that the IRS considers a collectible in under Section 408(m) of the Internal Revenue Code. NFTs that depict digital artwork or a Lebron James NBA Top Shot NFT will likely be classified as collectibles by the IRS. NFTs that represent ownership and tokenization of real-world assets, such as real estate or commercial property or goods for sale subject to a smart bill of lading, will likely be subject to standard capital gains tax rules for property. An example of real-world asset tokenization was the sale of $18 million Aspen Coins digital real estate token by Elevated Returns that tokenized ownership of the iconic St. Regis Aspen Resort in Colorado. By purchasing an Aspen Coin, investors were able to participate in the indirect equity investment in the hotel. As the tokenization of real-world assets grows, potential boundaries between collectibles and other assets may continue to blur.

Copyright/Trademark

The creation and sale of NFTs also brings new intellectual property issues.

Most NFTs are associated with copyrighted works of authorship, such as digital artwork, music, and other collectibles. It is important to note, however, that much like purchasing a tangible object, such as a painting or vinyl record, purchasing an NFT does not automatically transfer copyright in the underlying work. underlying to the buyer. Unless the creator of the NFT transfers title to the intellectual property rights underlying the NFT (which is the new approach taken by the Bored Ape Yacht Club) or, at a minimum, transfers certain license rights to the buyer, buyer may not be able to reproduce, publicly display or create derivative works of the NFT. Significantly, this could even affect the right to resell the NFT.

Under the first-sale doctrine, owners of tangible works can resell physical copies of copyrighted works even if they do not own the underlying copyright. Currently, however, copyright law does not contemplate any first-sale doctrine for digital works. Therefore, buyers willing to spend many thousands or millions of dollars on an NFT should be aware of the intellectual property rights they are actually acquiring, including the right to resell the NFT. On the other hand, creators of NFTs can gain a competitive advantage by transferring title to the underlying intellectual property to buyers. Like a recent post discussing Bored Ape Yacht Club’s approach notes, “a [model] gives its owners the right to use the underlying material and they are simply allowed to have something to watch.

NFTs also pose intellectual property issues for rights holders, such as artists and trademark owners. NFT creators can easily copy physical or digital artworks, giving them new life as NFTs. Of course, copying a work of art constitutes At first glance copyright infringement, but the creators of NFT seem to be banking on the likelihood that some artists, such as Banksy, won’t enforce the infringement. Due to the prospect of unchecked copyright infringement, some NFT platforms and auction sites are already introducing processes under the Digital Millennium Copyright Act to target and remove infringing and unauthorized NFTs. Brands, too, are fighting back against perceived infringement of their trademark rights. Recently, the famous Hermès brand took legal action against a digital artist for selling unauthorized Birkin Bag NFTs for six-figure sums. Hermès claims that these “MetaBirkins” infringe on the brand’s famous Birkin trademark. It remains to be seen whether Hermès can prove the crux of a trademark infringement case, which is that digital versions of the famous Birkin bag are confusing consumers. Other brands will certainly be following this case closely, while considering whether they should start engaging in brand monitoring on NFT platforms and auction sites.

money laundering

Creatives also need to ensure that the NFT issued is perceived to have genuine value. The US Treasury Department recently released a study on NFTs as a vehicle for money laundering and criminal financing. NFT promoters should work with an attorney to mitigate their risks of being perceived as facilitating money laundering. Contrary to popular belief, registering ownership on the blockchain can help deter criminal enterprises because transactions will be recorded and traceable.

Securities

We have previously written on the risk that certain NFT products constitute “securities”. The SEC continues to comment publicly on the risk of NFT. The question then becomes what type of potential liability an issuer, say, creative, could assume for the NFT, even if they use a third party to run the promotion. The answer is a little. If a person receives the profit or gross proceeds from an illegal, unregistered securities offering, they may be liable for restitution as a “redress defendant”. To be clear, the relief defendants are not necessarily accused of wrongdoing, but rather of benefiting from illegal products. Creators considering publishing an NFT should engage a securities advisor to ensure that their NFT is not designed to attract or market investment value, but rather is advertised as a form of access or charitable support to an artist.

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