Cryptocurrencies - Evolving Regulatory and Tax aspects
India has become one of the largest markets for Cryptocurrencies. Indians have parked nearly USD 6.6 billion1 in cryptocurrencies until May this year, as compared to USD 923 million until April 2020. India ranks 11 out of 154 nations in terms of cryptocurrency adoption, as per blockchain data firm Chainalysis. While this growth has given Indian cryptocurrency exchanges a reason to celebrate and attract global investors, the regulatory framework around the same has always remained unclear and ambiguous. The Reserve Bank of India (RBI), in its Financial Stability Report 2013, warned the public against banking on Cryptocurrencies as they posed a challenge to the economy in the form of regulatory, operational, and legal risks. Later, the RBI, in its circular 'Prohibition on dealing in Virtual Currencies' dated 6 April 2018,2 prohibited the entities regulated by it from dealing in/providing any services w.r.t virtual currencies, with a 3-month ultimatum to those already engaged in such services.
However, on 4 March 2020, the Supreme Court (SC) issued its landmark judgment on the said issue reviving the market of Cryptocurrencies by holding them valid under the constitution, thereby giving a new lease of life to crypto companies, dealers and exchanges. However, in its judgment, the SC nowhere justified or determined the legal status of Cryptocurrencies in India. Currently, despite the above case, which sheds some light on the legal characteristics of virtual currencies, there is no law that expressly classifies virtual currencies as assets or goods or commodities, services, securities, derivatives or currencies. The categorization of virtual currencies into one or more of these stated classes is important, as the existing law would apply differently based on the categorization of the cryptocurrency.
On its face, cryptocurrencies could be thought of as meeting all of these 'money' roles. However, in order to be classified as money, cryptocurrencies need to satisfy the four functions of money:
- A unit of account;
- A medium of exchange;
- A store of value; and
- A standard of deferred payment.
It is important to note that cryptocurrency does not fall within the definition of currency/coin provided under the Reserve Bank of India Act, 1934, the Banking Regulation Act, 1949, the Payment and Settlement Systems Act, 2007, or the Coinage Act, 2011. Thus, what is not a currency in the first place cannot be a foreign currency under the same law. However, this question has become even more curious recently as El Salvador has recognized Cryptocurrencies as its legal tender.
The definition of 'Securities' of 'Foreign Securities' under the Securities Contract Regulation Act, 1956 is a nonexhaustive definition and does not include cryptocurrencies. Furthermore, cryptocurrencies do not derive their value from the prices or index of prices of underlying securities and hence cannot be termed as derivatives. Inconsistent with its recognition as a valid mode of payment and legal currency, the virtual currency will have to be tested as "goods." Given that cryptocurrencies are both movable and intangible, they can be considered as property in India. Based on Indian jurisprudence, such intangible movable properties may fall within the ambit of goods. A similar view was held by SC in the case of Tata Consultancy Services3.
Apart from regulatory contradictions on digital currencies, it is also pertinent to understand the provisions of the Income-tax Act, 1961 (ITA) determining its taxability. The taxable events in relation to cryptocurrencies can be broadly divided into two categories-events that lead to the creation or generation of a cryptocurrency and events that relate to the secondary disposal of a cryptocurrency. A plain reading of the ITA shows that cryptocurrencies can be taxable both as capital gains tax or business tax. The ITA provides that any income arising through or from any property, asset or source in India or through the transfer of a capital asset situated in India, would be taxable in India under the head 'capital gain.' Accordingly, for a transaction to be charged to tax under the head capital gains, the following conditions should be satisfied:
- There must be a transfer of an asset; and
- The asset transferred must fall under the definition of a capital asset.
While 'capital asset' has been defined to include all kinds of fixed, movable or immovable, tangible or intangible, the property would qualify as a capital asset. However, the term 'property,' has no statutory meaning, yet it signifies every possible interest that a person can acquire, hold or enjoy. Thus, if the currencies are made for the purpose of investment, and the object of the investment is to derive dividends, then they should be treated as capital assets.
The sale of such capital asset would be liable for Indian Capital Gain tax, where such capital asset is situated in India. However, an intangible capital asset (like virtual currency), by its very nature, does not have any physical form, it does not exist at any particular location. Accordingly, it is difficult to identify the situs of such property. It is pertinent to note that the Delhi High Court(HC), in the case of CUB Pty. Ltd.4 has followed the well-accepted principle of "mobilia sequuntur personam" which stated that the situs of the owner of an intangible asset would be the closest approximation of the situs of an intangible asset. Accordingly, the sale of cryptocurrency by Indian residents would be liable for Capital Gain Tax in India. As per ITA, capital gains on the sale of cryptocurrencies are taxed based on their period of holding. It is qualifying as long-term capital gains if cryptocurrencies are held for more than 36 months, else short-term capital gains.
Furthermore, it should be important to note that where a series of transactions have taken place for buying and selling a property, then such activity could be classified as business income rather than capital gain. There are many judicial precedents in India that serve as a guide to determine if the income from buying and selling of property (like shares of a company) would be considered as business income or capital gains. Drawing an inference from the same, when a series of cryptocurrency transactions are undertaken on a regular basis with an intention to earn profits, the cryptocurrencies are held as stock in trade, thus the income should be classified as business income. Although the above parameters can also be applied to cryptocurrencies to determine whether they should be taxed as an investment or trade asset, there is a need for explicit regulations to propound clarity to investors of the future contingencies.
Also, cryptocurrencies generated during the 'mining' process can be classified as self-generated capital assets. In such a case of self-generated assets, if the cost of acquisition of an asset cannot be ascertained, the machinery provision for computation of capital gains will fail. Therefore, no capital gains can be levied on the transfer of such assets. This view was upheld by the SC in the case of B.C. Srinivasa Setty5.
Despite the growing acceptance of cryptocurrencies, the Indian regulatory framework (including tax laws) have provided no guidance on the same. Also, it would be important to note that the Indian government has proposed to place the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, before the parliament, which would provide a regulatory framework on cryptocurrencies soon. If the bill does in effect pass and codifies into statutory law, it could prove to be very useful for digital transactions as it would provide more comfort to the Investors as well as exchanges facilitating the transactions. With the world inching towards digitization and growing technological innovation, India needs to acquire a dynamic approach and a vibrant cryptocurrency segment could add value to India's financial sector.
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2. RBI/2017-18/154 DBR No.BP.BC.104/08.13.102/2017-18
3. Tata Consultancy Services  115 Taxman 478 (SC)
4. CUB Pty. Ltd  71 taxmann.com 315
5. B.C. Srinivasa Setty  5 Taxman 1 (SC)
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