Money-laundering poses a serious threat to financial systems of the countries across the globe. In India, the Hawala system has been a method to launder money where funds are transferred between countries without physically moving money.
To tackle this issue, the Indian Government enacted the Prevention of Money Laundering Act, 2002 (“PMLA”) which seeks to prevent and control money-laundering activities and to confiscate and seize any property obtained from the proceeds of laundered money. In recent times, digital currency has gained immense popularity as an alternative source of investment. It provides anonymity to its users as well as secures itself from any Government scrutiny. The digital currency market had remained unregulated until very recently which led to criminal activity and money laundering. Funds can be easily moved from one currency wallet to another, making it difficult for law enforcement agencies to trace these transactions. An official press release[1] by the Ministry of Finance has stated that Enforcement Directorate (“ED”) has attached proceeds of crime worth nearly INR 936 crores related to cryptocurrency under the PMLA as on January 31, 2023.
Therefore, to regulate the trading of cryptocurrencies and other virtual digital assets (“VDA”)[2] the Ministry of Finance has issued a notification dated March 7, 2023 to bring all transactions involving VDAs within the ambit of the PMLA. VDA has been defined under Section 2 clause (47A) of the Income Tax Act, 1961.
CRYPTOCURRENCIES: LEGALITY IN INDIA
The Reserve Bank of India (RBI) has always taken a cautionary approach by warning citizens of the risks associated with trading of VDAs and that it cannot be held as legal tender in the country. In 2018, RBI issued circular restricting banks and other financial institutions from facilitating the trading of cryptocurrencies in both Indian as well as overseas exchanges rendering Indian cryptocurrency defunct. Upon challenge before the Supreme Court by the Internet and Mobile Association of India that such a move would deny rights under Article 19(1) (g)[3] of the Indian Constitution the Supreme Court set aside the RBI circular based on lack of any legislative ban on trading of cryptocurrencies. The Court further stated that RBI is not authorised to impose disproportionate restrictions on Indian cryptocurrency exchanges.
Currently the RBI continues to take an apprehensive approach in legalising cryptocurrency transactions. On the other hand the Government has shown that it intends to not take a hard approach and instead gradually legalise VDAs and cryptocurrencies in the country.
VIRTUAL DIGITAL ASSETS AND CHANGES UNDER THE PMLA
Virtual Digital Assets (“VDA”) have been defined under the Income tax Act, 1961 as any information, code, number or token (not being Indian currency or foreign currency) generated through cryptographic means. VDA also includes Non-fungible tokens (“NFT”) which are assets that have been tokenised by block chain. NFTs can be traded and exchanged for money, cryptocurrencies or other NFTs. NFTs can represent digital or real world items like art work, real estate or properties etc.
In order to address the growing concern of fraud the Ministry of Finance issued a notification[4] on March 7, 2023 which essentially brings the trading of cryptocurrency and other virtual digital assets within the ambit of PMLA. With this, cryptocurrencies have been brought within the anti-money laundering regulations which now affords authorities more power to monitor transactions of all crypto businesses including outside of India.
Under the PMLA any ‘reporting entity’ i.e. a banking company, financial institution, intermediary or a person carrying on a designated business or profession[5] shall verify identity of its clients and their beneficial owners, maintain records of transactions, report suspicious transactions, and comply with the Know your Customer (KYC) norms. The above notification expands the scope of “person carrying on designated business or profession” to include entities engaged in the following activities carried out for or on behalf of another natural or legal person in the course of business which are exchange between VDAs and fiat currencies; exchange between one or more forms of VDAs; transfer of VDAs; safekeeping or administration of VDAs or instruments enabling control over VDAs; participation in and provision of financial services related to an issuer’s offer and sale of VDA.
As a result of the above, all entities that deal with VDAs shall now be covered within the definition of reporting entities and are now subject to certain compliances such as undertaking customer KYC norms of clients and beneficial owners, undertaking due-diligence on transactions facilitated by VDA service providers in relation to VDAs and maintaining transaction related records under PMLA (Maintenance of Record) Rules, 2005. (“PML Rules”)
Reporting entity under PML Rules
Reporting Entities have to comply with PML Rules framed under PMLA. Cryptocurrencies and other VDA service providers have now come under the definition of ‘reporting entities’ which will mean that they must necessarily comply with similar rules requiring them to conduct KYC verification and follow reporting standards as are required by other regulated entities.
Additionally, this would also mean that ED will now have greater powers to search and seize while investigating any VDA service provider for potential violations under the PMLA. The consequences of violating the provisions of the PMLA could subject them to rigorous penal consequences including imprisonment of 3-7 years, in addition to the attachment of their properties. This Notification brought the VDA transactions at par with other ‘reporting entities’ in terms of the power of the ED to investigate instances of money laundering effected through transactions in VDAs.
MANDATORY COMPLIANCE UNDER THE PMLA (MAINTENANCE IF RECORD) RULES, 2005
Verify identity of clients
VDA service providers will identify their clients and also see whether they are acting on behalf of a beneficial owner. If client is acting on behalf of beneficial owner then the beneficial owner’s identity must also be verified. Identification of the client needs to be done at the time of commencement of an account based relationship and for an amount equal to or exceeding INR 50,000 or on any international transaction.
Due Diligence and KYC
VDA service providers will have to carry out due diligence with every client and examine each transaction undertaken by the client. In case VDA service providers suspect any suspicious activity of money laundering or terror financing it shall review the due diligence measures including obtaining client information and the nature of business relationship. The client due diligence shall include policies, controls and procedures approved by the senior management of the reporting entity.
Further, VDA service provider shall register with the [*] and file e-copy of the client’s KYC records with the Central KYC Records registry within 10 (ten) days of commencement of an account based relationship with a client.
Maintaining Records of Transactions
VDA service provider will have to maintain records of (i) all transactions in a manner that enables the statutory authorities to reconstruct individual transactions (ii) all clients and beneficial owners as well as account files and business correspondence relating to its clients. VDA service providers shall also maintain physical records of the identity of its clients after filing e-copy of such records with the Central KYC Records Registry.
Reporting suspicious transactions
Entities will be required to appoint Designated Director and Principal Officer who will be responsible for furnishing information related to suspicious transactions, and other prescribed transactions within the prescribed time limit. The details then have to be furnished to the Financial Intelligence Unit India[6] (FIU-IND)
Penalty for non-compliance
In case there is non-compliance by any reporting entity under PMLA, the director of the FIU-IND may issue a show cause notice to a reporting entity on account of failure to comply with the requirements of PMLA Rules. Director of FIU-IND may pass an order imposing a monetary penalty which shall not be less than INR 10,000 but may extend to INR 1 lakh for each failure.
TAXATION AND VIRTUAL DIGITAL ASSETS
The Finance Act, 2022 introduced a new tax regime for income arising from the gains from the transfer of VDAs including cryptocurrencies and NFTs which will now be taxed at 30%.
Further, a modification to the Income Tax Act under section 271C has been added, which punishes failure to pay Tax Deducted at Source (TDS) on VDAs. This was another attempt at regulation of cryptocurrencies. The said modification introduced a fine equal to the unpaid TDS or a sentence of up to six months, in the event of non-payment.
By way of these amendments, the ED has the authority to look into any financial misdeed concerning cryptocurrency assets. The new regulations will require cryptocurrency exchanges, custodians, administrators to alert the FIU-IND to any questionable behaviour. Members of the cryptocurrency sector must now take appropriate efforts to verify and maintain accounts for individuals and transactions as well as report any suspicious behaviour to the FIU-IND. Additionally, this action gives the government unlimited access to the data maintained by cryptocurrency exchanges.
GLOBAL STATUS OF CRPTOCURRENCIES
Countries across the globe have taken varying views on the legality of cryptocurrencies. Singapore has led the market by endorsing cryptocurrencies. El Salvador has legalised Bitcoin as a valid tender. Several countries such as China, Egypt and Morocco have taken a hard approach banning all forms of crypto currency transactions. Some countries like India have taken precautionary steps like Russia giving cryptocurrencies legal status by taxing it but treading carefully as far as the regulation for money laundering and illegal activities are concerned. It is important to bring Global consensus on the status of crypto currency which would benefit all the countries in regulating the global market keeping in mind the ever evolving nature of cryptocurrencies.
CHALLENGES AND WAY FORWARD
By bringing VDAs within the purview of the definition of ‘reporting entity’ under PMLA any financial transgression or non-compliance will allow Government/enforcement agencies to investigate. This can be viewed with a boost of confidence by the industry as a step towards regulation rather than imposing a complete ban on the crypto industry which was viewed with caution up till now by investors.
However, there still remain some challenges in implementing these regulations. As VDAs operate on a global scale there needs to be a centralized authority to regulate them especially while dealing with compliance requirements in case there is an investigation against any entity.
Also, the industry is looking to transition slowly to a crypto ecosystem with the first steps of regulation being implemented through PMLA, but there are industry concerns that no time frame or the extent of PMLA rules that will be applicable has been provided.
Another concern that the Indian Government will face is the lack of public awareness about VDAs among the general public. Cryptocurrencies are a relatively new term and the Government will need to educate the public at large on how it works and the risks and benefits associated with it. It is vital to protect consumer from fraud and financial loss and also inform them of their rights, resources for dispute resolution and how to navigate through any questions regarding this new market space.
Going forward, the move to bring VDAs/Cryptocurrencies under the PMLA is a step towards the right direction to combat money laundering and terror financing activities. The Indian Government will now be able to monitor trading of these assets, bringing them under the tax net and reassure investor confidence. Currently India has crypto unicorns operating domestically and is home to major VDA players With India taking over the Presidency of G20 this year there is an opportunity to make significant progress and try to bring global consensus to put in place a centralised framework to regulate the market worldwide. Thus, India has this unique opportunity to lead the global stage and set the benchmark for crypto regulation.
The Indian government’s move to include cryptocurrencies under the PMLA is a step in the right direction towards combating money laundering through cryptocurrencies. Cryptocurrencies have been a boon for criminals, allowing them to launder their illegal funds with ease. However, with clear regulations in place, the Indian government will be able to regulate and monitor the trading of cryptocurrencies, bringing them under the tax net and boosting investor confidence. While there are challenges that the Indian government will face in implementing these regulations, this move is a positive step towards combatting money laundering through cryptocurrencies.
Authors:
Varun Vaish, Associate Partner
Prachi Negi, Associate
Footnotes:
[1] www.pib.gov.in//PressReleaseDetail
[2] section 2 (47A) of the Income tax Act, 1961
[3] ‘right to practice any profession, or to carry on any occupation, trade or business’
[4] https://egazette.nic.in/WriteReadData/2023/244184.pdf.
[5] Section 2(1) (wa) of the Prevention of Money Laundering Act, 2002.
[6] FIU-IND is an independent body reporting directly to the Economic Intelligence Council (EIC), responsible for receiving, processing, analysing and disseminating information relating to suspect financial transactions. FIU-IND is further responsible for coordinating and strengthening efforts of national and international intelligence, investigation and enforcement agencies in pursuing the global efforts against money laundering and financing of terrorism.