UK: Income Earned In Virtual Worlds: Taxation Issues

Last Updated: 26 June 2007
Article by Graeme Nuttall

Originally published in e-Finance & Payments Law & Policy, Volume 1, Issue 7, April 2007

The explosion in virtual worlds has raised some interesting questions about when taxation should apply. Does tax apply to a virtual transaction that takes place in a virtual currency, or does it apply when that income is converted into ‘real world’ currency? Graeme Nuttall, a partner with Field Fisher Waterhouse LLP, examines these issues and the view of taxation authorities from around the world.

Some frequently-asked questions need answering regarding trading in virtual worlds. Perhaps the most common of these involves the misconception that money can be made tax free by trading in virtual worlds. The UK tax system and other tax systems worldwide are designed to tax trading whatever its form. Tax systems coped well with electronic commerce and are probably wide enough in scope to tax trading in virtual worlds.

The answer to this question surprises many, who are of the view that tax surely cannot be paid on the equivalent of ‘Monopoly money’. They are correct that there is no tax on the players in a game of Monopoly. However, in a game of Monopoly, the winner does not convert their winnings into US Dollars. The Monopoly money gets put away until the next game is played. The Second Life ‘currency’, Linden Dollars, can be exchanged for what any tax authority would recognise as real currency. The fact that Linden Dollars can be converted into US Dollars is an important and very real difference from Monopoly money. This is what has attracted the tax man’s attention.

However, the position is still unclear about whether HM Revenue and Customs (HMRC) will charge tax on Second Life ‘inworld’ profits. This is a developing area of tax law.What HMRC will do is apply general principles to arrive at the current tax treatment under existing law, and the UK Government will then decide whether or not that tax treatment is an appropriate tax treatment, taking into account a range of policy issues.

HMRC is likely to publish guidance on the tax treatment of in-world trading. There is a precedent in relation to individuals trading on eBay. If you (as an individual) buy items with the intention of selling them on as quickly and as profitably as you can, then you are a trader. HMRC has issued clear guidance that if you are running a business online, you will be regarded as selfemployed for this trade and you must register with HMRC. You may have to pay income tax and national insurance contributions. You may also need to register for value added tax.

There is also likely to be some de minimis exemption. The way HMRC defines trading means that not every sale for a profit by an individual is taxable. HMRC has provided helpful guidance that you are not trading if you:

  • sell occasional, unwanted personal items through internet auctions or classified advertisements;
  • attend a car boot sale once a year to sell unwanted household items.

This practical guidance could easily be extended to cover sales of occasional unwanted virtual items through internet auctions or inworld.

Under the definition of trading for UK tax purposes, there is a circular definition in tax legislation that a ‘trade’ includes every trade, manufacture, adventure or concern in the nature of trade. There are numerous reported cases on what is and is not a trade. A 1955 Royal Commission on the taxation of profits and income1 lists six ‘badges of trade’:

  • the subject matter of the realisation;
  • length of period of ownership;
  • frequency or number of similar transactions;
  • supplementary work on assets sold;
  • reason for sale; and
  • motive.

Court decisions emphasise that these badges do not provide a comprehensive list and no single item is in any way decisive.

If someone reproduces, through their combined efforts in the real world and in-world what would clearly be a trading activity in the real world, it seems likely that this would be accepted as a trading activity under UK tax law.

For income tax purposes, the profits of a trade arising to a UK resident are chargeable to tax under the Income Tax (Trading and Other Income) Act 2005, wherever the trade is carried on. You cannot argue that trading in cyber-space is not taxable. This issue has been considered in relation to e-commerce.

In relation to corporation tax, UK resident companies are charged to tax, under the Income and Corporation Taxes Act 1988, on profits or gains arising or accruing from any trade whether carried on in the UK or elsewhere.

It is also a misconception that tax does not apply to items sold that are not ‘real’. There is no need for your customer to receive something tangible for you to pay tax.What is the difference between, say, paying to experience an inworld concert and attending a concert at an auditorium? The customer takes away the experience. They do not take away anything tangible.

The legal rights underpinning an in-world transaction are, however, relevant in determining whether or not there is or can be a trade, or the value that can be placed on a transaction.

There are indications that the tax authorities could take the position that tax is only payable when virtual currencies, such as Linden Dollars, are converted into real currency. The starting point in the UK, however, is to remember that barter transactions are taxable. There is clear HMRC published guidance to this effect in respect of real world transactions. In other words, you do not have to receive currency in order to generate a profit from a sale. If you are paid ‘in-kind’, you may still have been paid from a tax point of view. You could be taxed on the ‘fair value’ of what you receive even though it is not immediately convertible into money.

There is, however,merit in the argument that Linden Lab retains the ability to cancel accounts and to confiscate Linden Dollars, so HMRC should not apply tax until virtual currencies are exchanged for ‘real’ currency. This argument may influence Government policy. There is a risk under the terms on which Linden Research, Inc. offers you access to its services that you may lose your Linden Dollars.

However, HMRC could argue this is no different from other risks faced by traders. A trader might be paid in a foreign currency which generates a taxable sterling profit in one accounting period, only to see that foreign currency’s sterling value fall at a later date. At best, HM Revenue and Customs may say this risk factor affects calculations of ‘fair value’.

Another argument that has merit is that income earned in virtual worlds is through betting and not trading. In the UK the basic position is that betting and gambling as such do not constitute trading.Winnings are not taxed as trading income, even if betting is habitual2. There is also an exemption from tax on capital gains for winnings from betting, although an organised activity to make profits out of the gambling public will normally amount to trading.

It is not easy to define a bet or wager. It has been held essential to a wagering contract: ‘...that each party may under it either win or lose, whether he will win or lose being dependent on the issue of the event and, therefore, remaining uncertain until that issue is known3

It is difficult to see how anyone can argue that every transaction on Second Life can be considered a bet or wager unless you can show, say, significant instability in the Second Life environment. Nevertheless, a similar taxation policy could be developed. HM Revenue and Customs could decide that any business making profits in Second Life is taxable on those profits (whether or not they are taken out of Second Life), whilst a private individual could be allowed to make whatever in-world profits they wanted, tax free. If the private individual ever cashed in their in-world currency, this may or may not amount to trading, depending on the circumstances.

The US position

The Joint Economic Committee (JEC) of the Congress of the United States announced in October 2006 that it would examine the public policy issues related to virtual economies. A press release, dated 17 October 2006, stated that:

‘Based on existing law, if an individual generates cash income in US Dollars from transactions in virtual economies, the question may arise whether a tax is due on that real world income. However, if the transaction takes place entirely within a virtual economy, then it seems there is no taxable event’.

The aim of the forthcoming JEC study is to ‘head off any premature attempt to impose a tax on virtual economies’.More recently4, an IRS spokesman is reported as stating:

‘Any time someone wins a tangible prize or award, the value is reportable as taxable income. An accumulation of ‘points’ would not result in tax consequences, but redeeming or selling them for money, goods, or services would’. Please note this is a comment on US tax law not UK tax law.

The UK position

An HMRC spokesman, reported by Reuters on 31 October 2006, commented as follows on the JEC study:

‘Our reaction to this at the moment is it’s something that’s very interesting and we are considering it.Where we stand at the moment is it’s not something that’s having a significant revenue effect.We don’t see a possibility of people being able to exist solely on money within Second Life. They’d have to withdraw the money and when that happens they’d be expected to pay a normal tax bill. Obviously we’ll be considering what comes out of the U.S. review on this, Our general current consideration is that income from all online games should be declared to the revenue, in exactly the same way for Second Life as they would be for eBay, say’.

The Australian position

An ATO spokeswoman is reported as stating5:

‘If you are getting a monetary benefit then it’s not treated any differently - normal rules apply’, in what is believed to be a world first. ‘Your income will not be treated any differently than if you earned it working nine to five in an office’. If a virtual transaction has real world implications - if it can be attributed a monetary value - it attracts the attention of the Tax Office. Sites such as set rates for swapping Second Life’s Linden dollars. ‘In addition, there may be GST [i.e. value added tax] to consider’, points out the spokeswoman.

In other words, if you are turning over the equivalent of more than A$50,000 selling virtual jewellery to Second Life avatars, you must get an ABN and register for GST. People trading in virtual worlds should consider very carefully whether they are conducting a business or a hobby, the Tax Office advises. If conducting a business, then all money earned is generally assessable income. But expenses, such as the cost of computer equipment for accessing the virtual world, can be deducted. Any loss can be offset against other income.

The Swedish position

A Swedish tax authority spokesman is reported as stating6: ‘We’re not interested in ordinary gamers.More than 99 per cent of them play internet games for the sake of playing and most people keep their virtual money on their game account. However, if they move it out of the virtual world into the real world, then we’re interested in them’.

The Swedish Taxman says those instances should be taxed as income because the person involved, although existing and ‘working’ primarily in the virtual world, has sold the added value of that labour in the real world. It is expected that a special tax code for such people and transactions could be in place by 2009.

Discovering or winning items of value

These questions and answers focus on Second Life because of the freedom participants have to operate within Second Life and the existence of Linden Dollars. In relation to more structured environments where items are discovered or won in the course of a game, there should be a different tax treatment. Items that are discovered are probably, in effect, bought from the game’s operator through payment of a regular licence fee. Any items that are won in the course of a game should be accepted in the UK as non-taxable winnings from playing a game. The nature of a games world will probably mean it is unlikely that anyone can trade (within the tax definition) in that world. Although barter transactions can take place in the course of a game, in the overall context of that game, we would expect HMRC to accept that the participants are not trading. The sale of an occasional unwanted item for real currency should be covered by the published HMRC guidance that this is not taxable trading.

Research papers

Leandra Lederman has published a paper Stranger Than Fiction: Taxing Virtual Worlds7. This paper deals with US tax rules, but nevertheless provides an interesting analysis of the relevant issues. Professor Lederman recognises that all virtual economies are not alike and that there is a strong case for not taxing in-game receipts and trades in game worlds, including sales within those games for virtual currency. The real world value that can exist for in-game items as a result of trading by some players should not transfer game world successes into taxable income. However, in intentionally comodified virtual worlds, such as Second Life, then on her analysis, tax issues do arise that need to be addressed and that may require changes in US tax law to ensure inworld trades of non-currency items go untaxed (if this is the agreed policy objective).

Bryan Camp has published The Play’s the Thing: A Theory of Taxing Virtual Worlds8. He also considers the issues for US taxpayers. Professor Camp’s central thesis is that while player activity in virtual words produces measurable economic value to the player, player activity that occurs solely within the online virtual world is not gross income under the law. He argues for a ‘cash out’ rule. Players whose added wealth consists solely in what are defined as ‘units of play’ should not be taxed unless and until they convert those units into cash or property that is something other than a unit of play. Conversely, when the play ceases, taxation begins.


1. 955 HMSO CMD 9474

2. Graham v Green [1925] 9 TC 309

3. Carlill v Carbolic Smoke Ball Company [1892] 2 QB 484

4., 9 March 2007 and elsewhere.

5., 31 October 2006 and elsewhere.

6., 5 February 2007 and elsewhere.

7. March 2007 Research Paper Number 76, Indiana University School of Law - Bloomington Legal Studies Research Series.

8. 15 April 2007 Available at SSRN:

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions