'Crypto Tax' has been the buzzword following the unveiling of India's Union Budget (Finance Bill) for 2022! While a Government bill proposing to ban and criminalise the investment and trading of cryptocurrencies has been in the pipeline since 2019, the Finance Bill has introduced, in an unexpected move, a capital gains tax on the transfer (by way of sale, exchange, or gift) of ‘virtual digital assets' such as cryptocurrencies and non-fungible tokens (NFT).
Introduction to Cryptocurrencies, Non-Fungible Tokens
Both cryptocurrencies and NFTs are based on blockchain or other distributed ledger technologies. Oversimplified, blockchain is a manner of storage of data in a decentralised manner such that no one person (or group) can exercise absolute control over the data. The term ‘blockchain' refers to the manner in which new packets of data (called blocks) when added are linked to the last added block of data, thus forming a chain of data blocks linked chronologically. A key feature of blockchain technology is the manner in which data blocks are verified and added. This occurs through a network of computers working in parallel, without any one computer regulating the blockchain or exercising superior control over the management or storage of the data or the verification processes. Data once added to a blockchain cannot be deleted, modified or tampered with, thus a blockchain forms an accurate and reliable chronologically arranged record of all data that has been added to the blockchain. As a result, even if there is any human error in the data being added, the added data cannot be edited to rectify the mistake; only a new block may be added to acknowledge and address the error.
One application of the blockchain technology is cryptocurrencies where a finite set of ‘currency' units, referred to as coins, are used as an electronic cash system. This may be linked to an underlying asset or have some inherent value. Bitcoin is one of the most popular cryptocurrencies, being the first cryptocurrency introduced in January 2009 by its pseudonymous creator Satoshi Nakamoto. As on date, there are over 10,000 cryptocurrencies that have been launched, hoping to mimic the popularity and value appreciation of Bitcoin.
NFTs are another application of blockchain where tokens, which are similar to coins, can be bought and sold in a digital form. Unlike cryptocurrencies where the coins are homogenous, NFTs are non-fungible, i.e., non-interchangeable by nature such that each token is unique and has a value that is distinct from other tokens. NFTs are linked to one or more underlying assets such as artwork or real estate, which gives it its value.
Virtual Digital Assets
While cryptocurrencies continue to not be recognised as legal tender, the Finance Bill proposes that ‘virtual digital assets' be recognised as a separate class of capital assets under the Income Tax Act, 1961, distinct from other identified classes of capital assets, or as a generic capital asset. Irrespective of the legality of the transaction, such classification would permit the taxation of the gains arising from the sale or other transfer of virtual digital assets.
Hence, from April 1, 2023, any income arising from the transfer of virtual digital assets will attract tax on the capital gains at the rate of 30%. Additionally, a withholding tax at the rate of 1% will be applicable on the payment of sale consideration for virtual digital assets, should such consideration cumulatively exceeds INR 10,000 (approx. USD 130) in any financial year.
As per the Finance Bill, the term ‘virtual digital assets' includes both cryptocurrencies and NFTs. The criteria for identification of cryptocurrencies or similar applications as virtual digital assets has been intentionally kept wide in scope. Besides the differences in their attributes cryptocurrencies ultimately act as payment systems, where units are transferrable and represent some value.
A cryptocurrency, by whatever name called, would be considered a virtual digital asset, taxable under the Income Tax Act, 1961 if it meets the following criteria:
- It's in the form of information, code, numbers, or tokens;
- It's generated through cryptographic means or otherwise;
- It acts as a digital representation of value;
- It has some inherent value; and
- It allows for the storage and transfer of its units or tokens.
Government issued digital currencies, both Indian and foreign, have been specifically excluded from the scope of virtual digital assets;
By direct reference, NFTs have been included within the scope of virtual digital assets.
Additionally, the Government is empowered to identify classes of digital assets that would be excluded or included within the scope of the term ‘virtual digital assets'.
The framework proposed for taxation of gains arising from virtual digital assets differs from that for taxation of gains arising from other classes of capital assets. For instance, the expenses associated with acquiring, holding or selling virtual digital assets are not deductible from the gains arising from their transfer when determining the tax incidence. Also, any losses suffered on the transfer of any such assets may not be treated as a capital loss capable of being adjusted against any capital gains, or any of the other heads of income (such as from salary, from a business or profession, or from a housing property, other capital gains, or any other form of income). Hence, the benefit of carrying forward and adjustment of capital losses over the subsequent eight financial years, afforded to other classes of capital assets, will also not apply to virtual digital assets.
Indian Government's View on Cryptocurrencies
Since 2013, India's central bank, the Reserve Bank of India (RBI), has warned citizens of the risks associated with trading virtual currencies, and how trading of such currencies in overseas exchanges may result in violation of foreign exchange regulations (FEMA).
RBI has clarified that virtual currencies may not be used as legal tender in India. In that sense, a cryptocurrency could neither be treated as a foreign currency (as identified under FEMA) or be used in lieu of the Indian Rupee. It can be inferred that the payment of consideration with cryptocurrency for purchase of goods or services would be treated as an exchange instead of an outright sale.
In parallel, reacting to the sharp appreciation in value of Bitcoin and similar trends with other cryptocurrencies, the Income Tax Department had in December 2017 issued half a million notices to high net worth individuals who own cryptocurrencies seeking confirmation that there are no unpaid taxes arising from their trading of cryptocurrencies.
Having realized the underwhelming impact of such warnings, RBI adopted a different approach issuing a circular in April 2018 restricting banks and other financial institutions from facilitating the trading of cryptocurrencies on both Indian and overseas exchanges. These directions rendered Indian cryptocurrency exchanges effectively defunct overnight.
This was challenged before the Indian Supreme Court in May 2018 by the Internet and Mobile Association of India on the ground that such a circular would tantamount to a denial of cryptocurrency traders' constitutional right to carry on any trade or profession, and would thus be violative of Article 19(1)(g) of the Indian Constitution. In its judgement of March 2020, the Supreme Court set aside the RBI circular observing that in the absence of any legislative ban on the buying or selling of cryptocurrencies, RBI is not authorized to impose disproportionate restrictions on Indian cryptocurrency exchanges. While holding that casual traders or those undertaking trading of cryptocurrencies as a business would not be entitled to a claim under the said article, the Supreme Court observed that the circular disconnected the banking sector from cryptocurrency exchanges despite the RBI not having found anything wrong with the functioning of these exchanges. It was also noted that before issuing the circular, the RBI did not explore the availability of alternative less intrusive measures such as regulating cryptocurrency trading and cryptocurrency exchanges.
The Cryptocurrency & Regulation of Official Digital Currency Bill, 2019 released in December 2019 intended to ban and criminalise the holding, selling or trading of cryptocurrency, punishable with imprisonment of up to 10 years, or a fine, or both. The bill further distinguished and permitted the other applications of the underlying distributed ledger technology for experiments, research, or teaching. It additionally permitted RBI to roll out a government endorsed digital currency.
Presently, RBI continues to express its apprehensions in legalising cryptocurrency transactions, and its ability to destabilise the Indian economy, and to bypass government efforts to monitor and control the flow of money by illegal means and for illicit activities. In light of this, RBI suggests a hard-line approach by banning and criminalising all decentralised cryptocurrency transactions. This contrasts sharply with the Central Government's proposal to give virtual digital assets legal status. Accordingly, this differing stance on the legality of virtual digital assets, coupled with the evolving view of courts, certainly makes the future of virtual digital assets uncertain.
Global Acceptance of Cryptocurrencies
Other countries have taken varying views on the legality of cryptocurrencies, with Singapore taking the lead in endorsing cryptocurrency market growth. Separately, El Salvador in June 2021 has accepted Bitcoin as valid legal tender. Some countries such as Belarus (tax exemption until 2023), Germany (gains for assets held over a year are tax free), Malaysia (tax-free, due to no legal status), and most notably Portugal (tax exempt since 2018) serve as tax havens for cryptocurrency gains. Several other countries such as China, Egypt, Morocco, and Turkey, to name a few, have taken a hard-line approach banning all crypto currency transactions. Similar to India, Russia has walked the line, giving cryptocurrencies legal status, and thus taxable, however, they proceed cautiously, having expressed the application cryptocurrencies might play in money laundering and other illegal activities. Presumably to curb its use in Government corruption, in January 2021, Russian civil servants were restricted from owning any cryptocurrency assets.
Virtual Digital Asset Trading
In the present day, trading of virtual digital assets invariably happens in overseas exchanges. The value of such assets is not linked to any underlying government issued currency or commonly traded commodity, and is thus highly volatile and impacted by the continuous and rapid evolution of both Indian and overseas government restrictions or regulation of such assets, and is significantly impacted by global market sentiments. We may thus infer that this distinct treatment of virtual digital assets, vis-à-vis inability to adjust capital expenses and losses, points to the Government's efforts to discourage the sale of virtual assets at a loss, such as those arising from flash sales of such asset holdings induced by rapid devaluation or downward fluctuation in the traded price for such assets. Another practical challenge lies in the sheer inability of the Government to monitor or cross-verify digital holdings and transactions against the figures (selectively) disclosed by tax assessees. The rate of 30% would certainly impact both investors and traders of digital virtual assets, as the specified rate is applicable across the board and does not distinguish between short term and long term capital gains.
Gifting of Virtual Digital Assets
Gifts of virtual digital assets would also be taxable, presumably as per the prices of such assets reflected in mainstream indexes, or at fair market value or ready reckoner rates determined by the Government from time to time. This approach may not however be practical for determining the value of NFTs, which are non-fungible by nature and the value of each token is independent of that of other tokens.
India's Central Bank Digital Currency
While the Government of India continues to not recognise cryptocurrencies as legal tender, the Finance Bill appreciates the possible applications of the underlying blockchain technology and has announced India's very own Central Bank regulated Currency (CBDC), which will act as the digital counterpart of the Indian Rupee. As the RBI would be the regulator for such digital currency, it departs from the decentralised manner in which other cryptocurrencies presently operate.
As on date, there are 9 countries that have launched CBDCs including Nigeria, the Bahamas and 7 east Caribbean countries. Early adoption of CBDCs by such developing countries points to an attempt by their Governments to promote financial inclusion of its unbanked citizens, and to promote cross-border payments that could indirectly facilitate investments into their countries. Presently, 70 other countries including developed countries such as Canada and Australia are at various stages of research, development, and testing of CBDCs, presumably also driven by the cost effectiveness of such a payment system, given that the management and distribution of physical cash across large territories can prove to be quite expensive.
Advaya Legal is a member of Ally Law, a global law firm network providing sophisticated legal services to major corporations with a sharp focus on value. Its 72 firms include nearly 3,000 lawyers in 100 business centers worldwide. For more information, visit www.ally-law.com.
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.
