Insights

Metaverse: What’s the Deal?
The metaverse, often referred to as the future of the internet, is being championed by Facebook- now rebranded as Meta. But what exactly is it? Simply put, the metaverse is an interconnected 3D virtual universe that blends multiple virtual worlds. Conceptually, it can be seen as the next iteration of cyberspace. In fact, replacing “metaverse” with “cyberspace” doesn’t significantly alter its meaning. The term “metaverse” originated from Neal Stephenson’s 1992 novel Snow Crash, which described a virtual reality people could navigate through avatars.

The urgency of creating such a virtual realm has been amplified by the COVID-19 pandemic, which underscored the importance of virtual socialization. Earlier this year, The Economist reported skyrocketing virtual property prices in SuperWorld, another metaverse platform. Brands are increasingly keen to establish their virtual presence with the world’s first metaverse mansion, Hampton Hall, recently being listed for $40 million. Buyers of the real-world mansion also receive its digital blueprint as a Non-Fungible Token (NFT), which is a digital certificate that verifies the authenticity and ownership of a digital or physical asset.

While this concept is undeniably exciting and offers unprecedented possibilities, it comes with significant challenges. As the metaverse evolves, regulating such a vast, boundaryless virtual environment becomes a daunting task.

Taxation Challenges for Virtual Transactions in India
The growing adoption of the metaverse in India has led to an increase in taxable transactions but the lack of a clear mechanism for taxation hinders effective levy and collection. Despite the implementation of Goods and Services Tax (GST) in 2017, challenges and ambiguities remain in applying it to metaverse transactions.

A key challenge in taxing metaverse transactions is determining whether they should be classified as goods or services. Whether metaverse transactions involve virtual goods or services, they are treated as services for GST purposes including virtual property sales or event hosting and metaverse transactions are classified under “Other online contents nowhere else classified,” under the GST Act with an applicable tax rate of 18%. These transactions, whether building a house or purchasing a car in the Metaverse, essentially involve the transfer of data over the internet, which is treated as “online content” under Goods and Services Tax. 

In the Metaverse, land is considered an NFT, and income from its transfer is taxable under Section 115 BBH of the Income-tax Act, 1961, provided the government designates it as an NFT for this purpose. However, it remains unclear why only notified NFTs, and not all crypto assets, are treated as Virtual Digital Assets (VDAs). Given that the government did not classify virtual land as a VDA, the income arising from its transfer will be subject to taxation at the rates applicable to the transfer of a standard capital asset. 

The next key issue is determining the valuation of transactions under GST. When payments are made in Indian currency, the transaction value is straightforward, and GST at 18% is applied. However, payments made in cryptocurrencies, which are not legally recognized in India, pose a challenge since they are treated as barter transactions. Under Section 7 of the GST Act, barter transactions are subject to GST. In such cases, Rule 27 and Section 15(4) require that the market value of the cryptocurrency at the time of payment be used to determine the transaction value. GST at 18% will then apply to this value.

The jurisdiction of transactions is another concern, as the metaverse operates without physical borders, making it difficult to determine where the transaction occurs and who collects the tax. Additionally, there is uncertainty over who should pay the tax in the case of virtual businesses—whether it is the real-world company or its virtual counterpart.

The possibility of classifying NFTs as financial instruments has been considered, but existing laws do not permit this and to ensure fair and efficient taxation in the digital economy, clear guidelines are required to define the taxability of digital assets in the Metaverse, covering aspects like classification, jurisdiction, valuation and tax rates.

Trademark Infringement in the Metaverse: Emerging Challenges
Expansion of virtual marketplaces are increasingly leading to complex trademark infringement and brand protection issues.  In the metaverse, the trade of virtual items featuring third-party trademarks significantly heightens the risks of infringement and counterfeiting and a key challenge in trademark protection within the metaverse lies in identifying and tracking unauthorized users and infringers. While current laws extend trademark protection beyond the physical world to virtual spaces, legal action against infringement in the metaverse requires registering trademarks specifically for digital goods and services since trademarks registered for physical goods alone do not cover virtual counterparts.

One of the most notable legal disputes concerning trademark use in the metaverse is Nike Inc. v. StockX LLC, where Nike has sued StockX, a sneaker resale platform who were accused of using Nike’s registered logos and products to enter the NFT market without authorization. Nike claims this constitutes trademark infringement, while StockX argues that its Nike-branded NFTs merely represent ownership of physical Nike products securely stored in its vault, which it contends does not amount to infringement.

Similarly, in Hermès v. Rothschild, the luxury brand Hermès has sued an artist for creating and selling counterfeit versions of its products as NFTs in the metaverse. This case involves allegations of both trademark infringement and cybersquatting.

Additionally, in India, trademarks are granted on a territorial basis, meaning protection is limited to the country. However, as the metaverse blurs national boundaries by creating a shared virtual reality, tech-companies must secure legal protection for the names, marks and characters they develop for this digital space and as result existing laws have yet to adapt to the evolving demands posed by the metaverse.

IT Act in Shaping the Metaverse
From platforms like Roblox and Second Life to virtual stores such as Nike’s “Nikeland” or the National Football League’s (NFL) virtual space, the metaverse is redefining how consumers and brands interact. However, alongside its potential, this digital universe raises critical concerns about data privacy, standardization and content regulation.

India’s regulatory framework, primarily governed by the Information Technology Act, 2000 and its associated rules, plays a pivotal role in addressing these challenges. The IT (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011 emphasize the protection of user data by mandating documented security practices and adherence to international standards such as IS/ISO/IEC 27001. These provisions ensure organizations implement technical, operational, and physical measures to safeguard sensitive personal information.

To further standardize data practices, the Bureau of Indian Standards (BIS) introduced IS 17428, which outlines privacy management systems for entities collecting user data. By narrowing definitions of personal and sensitive personal information, and setting mandates for consent, disclosure, and portability, IS 17428 aims to provide various privacy safeguards. Organizations are required to conduct audits and establish mechanisms to mitigate data breaches, ensuring compliance with both national and international norms.

Moreover, the IT (Intermediary Guidelines and Digital Media Ethics Code) Rules, 2021, mandates social media platforms with over five million users to employ tools for proactively identifying and removing harmful content. This rule ensures a safer virtual environment while promoting accountability among digital platforms operating in the metaverse.

While these laws aim to create a secure digital landscape, challenges persist due to the metaverse’s borderless nature, which complicates the application of Indian laws to foreign entities operating within Indian cyberspace. Additionally, concerns about freedom of speech and expression arise when content moderation practices are perceived as overreaching.

Conclusion
The metaverse brings immense opportunities but also significant challenges in areas like taxation, trademark protection and regulatory frameworks. The GST implications for virtual transactions such as NFTs, highlight the need for clear guidelines addressing classification, jurisdiction, valuation and tax liability. Similarly, trademark laws must adapt to safeguard intellectual property in this borderless digital space. While India’s IT Act and related rules provide a foundation for data privacy and content regulation, the metaverse’s global nature demands collaborative international efforts. To harness its potential while ensuring fairness and compliance, legal and regulatory systems must evolve alongside this rapidly transforming digital ecosystem.