I left off at the end of Part 3, a bit over a month ago, with the idea that transactions in virtual worlds might someday become taxable. A lot can happen in a month. On April 21, 2007, a press release announced a partnership between Dynamedia and Pizza.net “to bring real world food to Second Life.” (http://secondlife.com/whatis/ “What Is Second Life?”)
Residents of Second Life will be able to teleport their avatars to their favorite virtual pizza joint and order real-life pizza, to be delivered to and consumed by their real-life bodies. The practical part of my mind has to wonder how it’s going to work when, say, six pals meet up in a virtual pizzeria. None of them share the same real-world space – they might be separated by thousands of miles. So they can’t order a large pizza and split it. Unless each of the six virtual friends has several hungry real-world bodies on hand, each friend will have to order a small or medium pizza, or pay for a large pizza and throw most of it away or eat leftover pizza for a while, or eat way too much and risk the health hazards of obesity. Will it be economical for the pizzeria to deliver small pizzas? Will they charge a premium? I don’t know the answer to these questions. I haven’t ordered pizza since I was in college many, many years ago. We order it sometimes at the office, but the secretary takes care of the technical details such as placing the order.
But never mind, I’m sure the pizza restaurant owners have worked out the practical problems and come up with a solution. Back to the concepts. According to the press release, when an order is placed from Second Life, payment can be made in Linden Dollars (L$), Second Life’s local currency, presently trading for $267 L$ for each US$. A Second Life resident can sell virtual land, furniture, design services, or whatever and use the proceeds to buy real-life pizza, without ever converting the L$ to real-world currency.
A month ago, when I was writing Part 3 of this series of articles, I would have said that L$ should only be taxable if the L$ are converted into US dollars or Euros, or Pesos, or some other real-world currency. Maybe one could still argue that taxation should enter the picture only at the point in time when L$ are converted into either real-world currencies or real-world assets such as pizza. Certainly I would be willing to make this argument on behalf of a client.
But looking at the question of taxation of virtual transactions in theory, taxation of virtual transactions is consistent with U.S. tax law. If you’re a marketing expert and I’m a tax lawyer, and if you plan a web marketing campaign for me in exchange for tax planning advice, the transaction is taxable. I have income equal to the fair market value of your marketing services, and you have income equal to the fair market value of my tax advice. It doesn’t matter that no money or tangible assets changed hands. Don’t get me wrong here – the last thing I want to do is give a Second Life to IRS. But my role is to interpret the tax law and warn my clients about legal and tax matters they need to be aware of. This is a heads-up for my clients and readers who conduct business in virtual worlds.