PSL Advocates and Solicitors | View firm profile
Introduction
On 1st of February 2022, Finance Minister of India, Nirmala Sitharaman, while announcing taxation on Cryptocurrency, in her Annual Budget Speech, projected the positive mindset of policy framers in adopting to changing technological advancements in and around the world. It is said that early bird gets the worm, while, around the world, uncertainty looms around the use of Cryptocurrency and Blockchain, this step taken by the policy framers has placed India at the forefront and opened gates to technological and business wizards of the Country to exploit this Industry.
As a step further, the Finance Minister also announced that by 2023, a Blockchain-based and RBI-backed currency, i.e., Central Bank Digital Currency (“CBDC”) will be introduced.[1] The objective is to boost and enhance the digital economy in India by making it more efficient and cheaper. This appears to be a step towards digitalization and a paper free economy.
While the Government, through Taxation has given Cryptocurrency a stamp of approval, the manner in which Cryptocurrency will be regulated will be required to be seen and we may see regulations in this regard in the near future. As of now, it has been stated that 30% tax will be charged on income from transfer of virtual digital assets and no set-off will be allowed in case of any loss. Further, gifts in virtual digital assets will also be taxed and Tax will be deducted at Source on transactions falling under such asset classes above a certain threshold.
Taxation Regime Of Cryptocurrency In India: Story So Far Prior To The 2022 Annual Budget
Cryptocurrencies refer to a form of decentralized digital money which functions through blockchain technology by being connected to a network of computers. India has seen a massive boom in Cryptocurrency as it has around 10.07 Crore Crypto-investors today and is the world’s largest country for global Crypto adoption.[2]
In 2018, however, Reserve Bank of India (“RBI”) attempted to impose a ban on Cryptocurrency by restricting banking facilities to all the Cryptocurrency exchange houses. The Hon’ble Supreme Court of India overturned this decision observing that a blanket ban was disproportionate and would violate Fundamental Right under Article 19(1)(g)[3] of the Indian Constitution.[4]
Thereafter, several attempts have been made to regulate Cryptocurrency in India. In 2019, the Banning of Cryptocurrency and Regulation of Official Digital Currency Bill was introduced but was never tabled. In 2021, the government listed the Cryptocurrency and Regulation of Official Digital Currency Bill for the winter session of Parliament. However, the same was again delayed.
Prior to amendments in The Income Tax Act, 1961 (“1961 Act”) by way The Finance Bill, 2022 (“2022 Bill”), the 1961 Act did not had any specific mandate for taxation of Cryptocurrency. Nevertheless, taxpayers were still required to report their transactions if they have invested in Cryptocurrencies and made profits under the ambit of Capital Gains in the Income Tax Act, 1961. Earlier, to pay tax for gains from Cryptocurrencies, profits were classified as capital gains if they fell under the ambit of ‘capital assets’[5] under 1961 Act. In order to tax Cryptocurrencies as a capital gain, they were ascertained as a short-term or a long-term capital gain. Further, investors who traded in Cryptocurrencies had to report their gain as business income. This would then be taxed according to the slab rates.
Another ambiguity which previously was there was whether the Central Goods and Services Tax Act, 2017 (“GST”) would apply to Virtual Asset based transactions or not. Though, going forward the earnings from the Cryptocurrency will incur 30% taxation, but the question on applicability of GST on such transactions still hovers.
Implications of 30% Tax on Cryptocurrency
The new measures are set to come into effect from 1st of April 2022 once the Union Budget is deliberated upon and passed in the Parliament. However, the impact of this measure may negatively affect the market.
High tax may discourage existing and prospective Cryptocurrency investors: By levying a tax as high as 30% for investment in Cryptocurrency, Crypto investors are bound to be discouraged and deterred from trading further. The decision of the Government reflects and an aim to reduce the incentives and attractiveness associated with crypto assets. Taxation rate at par with income derived from lottery, game shows, puzzles etc.[6], will wean off many Crypto investors.
Imposing a 30% tax on the profits or loss of the total earning will deter the crypto investors from investing more in the future. This can be seen from a basic calculation below:
Therefore, it is evident that a high tax rate would increase the apprehension of investors to invest in Cryptocurrency.
Increase in compliance by digital marketplaces: Various Crypto-exchanges and digital asset marketplaces will have to follow the policy of 1% TDS on transactions. They will have to establish a transaction tracking mechanism to regulate taxation measures. However, the enforcement of such a mechanism on India based and foreign entities working in this space will prove to be difficult. However, advanced advocacy and knowledge disbursement by the Government on the tax compliance measures by these select entities can answer many a questions of the stakeholders involved.
Rise in sell-off by Indian investors: Introduction of income tax on Cryptocurrencies and Non-Fungible Tokens (“NFTs”) will see an increase in sell-off of these assets from Indian investors. The taxation will increase the burden on Cryptocurrency investors, as they will have to pay a third of their returns on profit to the Government now. Consequently, they will sell-off or liquidate their portfolios before the measure is implemented.
Tax evasion: It is also possible that by virtue of such high tax rate, Cryptocurrency investors might resort to trading in underground Over-the-Counter (“OTC”) Markets. This is a type of decentralized market where stocks, commodities and currencies are traded without a central exchange or broker. Since these markets do not have a physical location and functions electronically, Cryptocurrency investors might trade here in order to evade the high taxation rate of 30%.
Legality of Cryptocurrency: The announcement for taxation of virtual digital assets proves that the Government does not aim to ban Cryptocurrency altogether. However, taxation itself does not imply legality of Cryptocurrency. Though Cryptocurrency was never illegal in India, it was completely unregulated. This decision has legally recognized the usage of Cryptocurrency by Indian investors for the first time. An exclusive Cryptocurrency Bill will throw more light on the manner in which digital currency will be regulated.
No provision for set-off of against losses incurred: 2022 Bill proposes insertion of Section 115BBH in the 1961 Act. This states that no set-off of loss from transfer of virtual digital asset will be allowed against income computed under any other provision of this Act. Considering the vast variety of crypto investors in India, such a decision can be detrimental to their financial stability. Multiple companies will have to, thus, bear the brunt of the volatile nature of cryptocurrency.
Indefinite threshold for TDS: The Budget announced that TDS will be imposed on payments for the transfer of crypto assets at a rate of 1% for transactions over a certain threshold. However, the ‘threshold’ itself was not defined. It is imperative that different levels of threshold are established for investors with different levels of income.
Amendment to Section 2 of 1961 Act: The 2022 Bill has also proposed changes to Section 2 of the 1961 Act by adding a new clause Section 47A, which now defines what constitutes a ‘Virtual Digital Asset’. It would mean any information/ code/ number/ token that has been generated through cryptographic means and provides a digital representation of value.
While the Government has aimed to lay down a holistic definition, certain factors have not been given due consideration. The definition finds no mention of Blockchain technology. It states that NFTs and any other token of similar nature must be included in the definition. However, ‘any other token’ has not been clarified further and which can result in ambiguities. The proposed amendment also finds no mention of the term Cryptocurrency or what it entails. The vast nature of Cryptocurrency has not been addressed by the Government which puts the interests of investors at stake.
Moreover, it also provides for the Central Government to notify any other virtual digital asset as a virtual digital asset under this section by the way of notification in the Official Gazette. This will prove to be an arduous task for the Government as they will have to continuously update the list of virtual digital assets that arise most often.
Status of CBDC under 1961 Act: Interestingly, it is yet to be seen whether the CBDC to be introduced in 2023 will fall within the ambit of this definition and will be taxed accordingly. The proposed change finds no mention of whether the CBDC will be included under this definition or not. However, the 2022 Bill does aim to seek clarity on whether CDBC should be regarded as bank notes under section 2 of Reserve Bank of India Act, 1934.
Sole provision for taxation will not protect investors’ interests: The provision for taxation on Cryptocurrency is a welcome step for its recognition in India and removing uncertainties revolving around its legality. However, a more robust regulatory regime is required to protect the interests of investors. Other aspects that need to be regulated includes market manipulation, allowing selected Cryptocurrencies, preventing fraud and cyber security risks and restricting money laundering.
Tax Treatment Of Cryptocurrency Around The World
United States of America: In US, there exists no Federal law which deals exclusively with regulation of Cryptocurrency. It was in 2014 that the Internal Revenue Service (“IRS”) stated that ‘virtual currency’ will be taxed as ‘property’ type and not as a currency. This led to individuals and businesses to keep records of their Cryptocurrency purchase and sales. They had to pay taxes on any gains made for purchase or sale of Cryptocurrency. Further, when filing income tax return, the gains or losses from sale of virtual currency was to be considered as ‘capital asset’. Several states in US have enacted their own laws and frameworks for regulation of virtual currency.
European Union: The EU has developed a comprehensive regime for regulation of Cryptocurrency. Virtual currency is legal across the EU with individual member states having their own regulations. The taxes imposed on Cryptocurrency vary from country to country and ranges from 0 to 50%.
United Kingdom and Australia: The UK considers Cryptocurrency but not as a legal tender. The tax paid by investors fall under the category of capital gains tax and there is no specific threshold of taxation for Cryptocurrency. Similarly, Australia also identifies Crypto as a legal property which is then subject to capital gains tax.
Conclusion
By introducing and implementing a taxation scheme for Cryptocurrency, the Government has taken a step forward in regulating various aspects of digital currency. Any ambiguity that existed before February 2022, regarding taxation of Cryptocurrency has been put to rest. Though the step taken by Government must be appreciated, there are still some grey areas that need redressal. These aspects must be taken into consideration in upcoming Cryptocurrency Bill 2021 to be introduced in the Parliament.
The Government has identified the vast number of Cryptocurrency investors in India and the need for regulating this space. With the hope for introduction of Government’s own digital currency in future, it is evident that substantial steps are being adopted to regulate the complex mechanism of Cryptocurrency. The forthcoming Cryptocurrency law will be a step in the right direction. It can be visualized that the Government will soon come up with a comprehensive law for Cryptocurrency which would include investor protection provisions and grievance redressal mechanism, definitions and differences between various types of Virtual Digital Assets, regulator(s) involved – their roles and powers, data security and other necessary provisions enabling better channel of digital financial regulation between exchanges, investors/miners, other stakeholders and Government.
Authors:
- Soayib Qureshi, Associate Partner, PSL Advocates & Solicitors
- Pintu Babu, Innovation & Knowledge Associate, PSL Advocates & Solicitors
- Charvi Krishna, Intern, 4th Year of Symbiosis Law School, Pune
[1] Budget 2022-2023 Speech of Nirmala Sitharaman, Minister of Finance, 1 February 2022, “Digital Rupee”, p. 19 available at https://www.indiabudget.gov.in/doc/budget_speech.pdf (last accessed on 02 February 2022).
[2] Broker Chooser Annual Crypto Proliferation Index, 2021 available at https://brokerchooser.com/education/crypto/crypto-countries (last accessed on 02 February 2022).
[3] Article 19(1)(g) in The Constitution of India 1949 – “to practise any profession, or to carry on any occupation, trade or business”.
[4] Internet and Mobile Association of India v. Reserve Bank of India, WP No. 528 of 2018.
[5] Section 2(14) of the Income Tax Act, 1961.
[6] Section 115BB of the Income Tax Act, 1961.