US taxman targets virtual world booming on the internet

The economies of "virtual worlds" created within multi-player computer games, such as World of Warcraft and Second Life, have grown so big they could face regulation and taxation in the real world, US lawmakers have signalled.

As Second Life signed up its millionth "resident" this week, a powerful congressional committee has decided that the phenomenon can no longer be dismissed as just a game.

Second Life's creators have established a world that looks remarkably similar to our own, where players can trade property and start their own business, and where profits can be converted back into real dollars. The Joint Economic Committee has launched an examination that will examine some of the philosophical problems thrown up by people and corporations conducting valuable business inside a computer game.

The committee chairman, Jim Saxton, said that the development of virtual economies has outpaced the law. "The goal of the forthcoming study is to help lawmakers understand the issues involved and head off any premature attempt to impose a tax on virtual economies," he said.

Second Life is the most sophisticated of all the virtual realities to have been created since role-playing computer games migrated to the internet and began allowing players to interact with potentially unlimited numbers of their peers across the world. While games such as Vivendi's World of Warcraft and others have concentrated on fantasy worlds and attracted traditional gamers - stereotypically teenage boys - Second Life claims that 43 per cent of its residents are female and their median age is 31. Because it mainly mimics the real world (albeit with the laws of physics suspended) it has aspects of social networking and chat sites. However, with its 3D graphics, and users' ability to shape their online character - or avatar - to any form they wish, it makes Rupert Murdoch's social networking website MySpace appear positively stone age.

And many residents have an entrepreneurial streak, attracted by Second Life's boast that players can "make real money in a virtual world. That's right, real money".

The virtual world has its own capitalist economy where residents can create virtual goods and services and are able to sell them at various virtual-world venues for the local currency, Linden Dollars. Monthly subscribers to Second Life are also able to rent plots of land, so property development and speculation is rife.

Residents who have amassed lots of Linden Dollars are matched at a currency exchange with new players who want to buy Linden Dollars for use in the game. At the current exchange rate, 270 Linden Dollars converts to about $1 and the most successful entrepreneurs are on course to make more than $200,000 (£107,000) a year.

Without a doubt, something of real-world economic consequence is going on, and that is why it has attracted the attention of lawmakers on Capitol Hill.

It does not take too much imagination to see how individuals and corporations might one day use a virtual world to conduct transactions that would otherwise attract taxation. But if governments start to foresee a threat to their income from sales taxes, capital gains tax or stamp duty, it is far harder to work out what on earth they might do about it.

The economics of these online worlds is becoming steadily more sophisticated. World of Warcraft long ago spawned a class of professional players - usually in the developing world, and notably China - who amass gold for use in the game, or who progress through the game to win advanced powers for their avatars before selling them to lazier players in the West.

Second Life's Linden dollars are already tradeable on third-party exchanges - and on eBay, where it is only a matter of time until some bright traders spot an arbitrage opportunity.

Now Second Life has attracted dozens of companies looking to market or even sell their wares. Toyota is giving away virtual cars; Starwood Hotels has built a virtual model of its new chain; Duran Duran has bought an island where the band will perform an online concert; companies from Adidas to Reuters have a presence.

Sony BMG sells music from its stable of artists for users to listen to within the game. And already companies such as Amazon - whose founder, Jeff Bezos, is an investor in Linden Lab, the company behind Second Life - are considering how to use the virtual world as a marketplace for real-world goods.

Silicon Valley-based Linden Lab created Second Life in 1999 and sees itself as a technology platform rather than as a media company in its own right. It makes its money mainly from leasing land within the virtual world and, although it keeps its finances secret, is said to be close to profitability.

David Fleck, vice-president, says that lawmakers proceed with caution and see how the virtual economy develops. By instinct, he believes that the income derived by virtual entrepreneurs should be taxed in the country in which they convert them back into real-world currency.

"We want to be good corporate citizens, and we are being pro-active and working with the Joint Economic Committee, not just sitting back waiting for something to be handed down.

"But the Linden dollar is not a real currency, it is not recognised by any banking system in the world and the legalities are unclear.

"It has to play out, and we have to make sure we understand the implications. It will have to be examined against regional tax laws, country by country, even state by state."

As for commercial transactions within Second Life and other virtual worlds, a way of taxing them will emerge in the same way as it did for e-commerce transactions, Mr Fleck says: eventually.

The Republican Mr Saxton sees his committee's review as an attempt to head off pressure for taxation that might stymie an emerging entrepreneurial phenomenon.

"There is a concern that the Internal Revenue Service might step forward with regulations that start taxing transactions that occur within virtual economies," he said. "This, I believe, would be a mistake."

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 congressional investigation is aiming for "clarification, not taxation". Dan Miller, chief economist for the Joint Economic Committee, said earlier this week that it would start with a blank slate and be completed by the end of the year.

Get a Second Life and indulge in some fantasy role-playing

Second Life

Second Life is currently the most high-profile virtual world with almost 500,000 active inhabitants and more than 1 million residents.

The site has been developed by the Californian company Linden Labs and was established in 1999. Users can set up one basic account for free or pay $9.95 for additional accounts and membership privileges that allow a character to own land.

The vast digital continent is teeming with businesses where users can buy, sell and trade using the 'Linden Dollar' that can be exchanged for real currency.

Even the BBC has a business in Second Life where it showcases music concerts from the likes of U2 using digital characters.

It differs from other online virtual communities in that it is not a competitive game.

World of Warcraft

Based on a successful video war game, World of Warcraft is the massively successful online version of the fantasy role-playing action game that is akin to the old Dungeons and Dragons role-playing game.

Since its parent company Blizzard launched the online version late in 2004 it has attracted 6.5 milliom users, which makes it the largest online gaming community in the world.

Users buy and sell items such as weapons and shields using WoW Gold that can be bought, using real currency, from other players via eBay.

Sims Online

The computer games giant Electronic Arts launched the online version of its massively successful The Sims game in 2002, heavily marketing the service to the teen market.

It costs users $39.95 for the game and then a further $9.95 a month. Players aim to earn as many 'simoleans' - the online currency of The Sims - as possible to decorate their virtual homes.