India has seen rapid acceptance for crypto or digital currencies for trading and investment purposes. The number of crypto exchanges or the businesses involved in the blockchain sector have also increased multi-fold in the country in the past 24 months. But the absence of specific regulation and lack of a legal framework with respect to these currencies has created a bottle neck in the innovation and adoption of blockchain technology and cryptocurrencies in the country.

For the better part of the last 24 months, there has been an uncertainty on the legal status of cryptocurrencies and dealing with the same by residents. The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 (‘Bill’) proposing a sweeping ban has been listed twice in the legislative business of Lok Sabha in the past one year but has not been introduced yet. Indian bureaucrats were not receptive to industry demands of recognising ‘virtual currencies’ as a class of asset. However, the shelfing of the Bill for the second time and precluding it from introduction in the last winter session has given a signal that the government is now considering adopting a calibrated approach towards crypto currency, than outright banning it as proposed by the Inter-Ministerial Committee in 2019.

While the draft Bill was at the dock, the Finance Minister in her 2022 Budget Speech announced taxation of crypto profits. The proposed taxation at 30%, with the cost of acquisition as the only allowable deduction, is among the highest rates of taxation for cryptocurrencies in the world. The tax rate is on par with the rate on profits arising from gambling. It is pertinent to note that, as on date, taxation of crypto currency as an asset class for income tax does not provide for an automatic recognition under the law.

The definition of a virtual digital asset under the Finance Bill, 2022 is very wide and covers emerging digital assets including Non-Fungible Tokens (NFTs), assets in the metaverse, digital currencies, etc. The wide definition, high tax rate, and cost of tax compliance can be a dampener in the growth and usage of crypto currency in India. For the purpose of income tax, the Government has now specifically recognised virtual digital assets as ‘property’. The proposals intend to clear the uncertainty and at the same time disincentivise investing in these virtual assets.

The proposals, when implemented, may also increase the cost of compliance for exchanges and other operators, and individual sellers, as TDS @ 1% on crypto transactions is to be deducted. Expectedly, vide the Central Government retained the power to exclude certain classes, by a notification. This seems to have been done probably to carve out ‘Central Bank Digital Currency’ from being treated as a virtual digital asset for taxation.

Further, the Central Government must notify what constitutes an NFT but with an already expansive definition, almost every NFT would qualify as a virtual digital asset without separately notifying them. This is likely to create ambiguity in the future.

Taxation on certain aspects like treatment of blockchain fees, airdrops, mining proceeds is expected to be clarified in future. The requirement of deduction of TDS may bring in all crypto transactions taking place through crypto exchanges into the ambit of regulatory scrutiny.

At this juncture, it is pertinent to note that the Ministry of Corporate Affairs vide Notification dated 24 March 2021, had made it mandatory for all companies to disclose the details of cryptocurrency/ virtual currency in their balance sheets, in accordance with Schedule – III of the Companies Act, 2013, effective from financial year 2021-22, including the following:

1. profit or loss on transactions involving crypto currency or virtual currency,
2. amount of currency held as on the reporting date, and
3. deposits or advances from any person for the purpose of trading or investing in crypto currency/virtual currency.

The proposed taxation regime and the requirements under the Companies Act are in line with the updated guidance for virtual assets issued by Financial Action Task Force, an inter-governmental organisation, in October 2021, mandating member countries to adopt a mechanism for supervision and monitoring of virtual assets service providers, customer due-diligence provisions and sanction measures against money laundering and terrorist financing.

Treatment of cryptocurrency across jurisdictions:

Governments across the world are at different stages of enacting a regulatory regime for crypto currencies. While a major economy like China has banned the use of crypto currencies, small economies like El Salvador and Panama have embraced the new technology. El Salvador declared bitcoin as their legal tender in 2021. Being a dollar adopted economy for two decades, the adoption of bitcoin by El Salvador had little impact on the global economy.

Singapore, a major economy centre in Asia, enacted the Payment Services Act of 2019 legalising crypto and laid down provisions to regulate it. Notably, the Singapore law excludes stable coins i.e., cryptocurrency coins pegged to be a currency from the definition of digital payment tokens. The proposed changes to Indian tax laws includes stable coins within its ambit. The e-Tax Guide on Treatment of Digital Tokens issued by Singapore Inland Revenue Service clarifies that tax is levied based on the nature of activity carried by using the coins. Where goods or services are bought in Singapore in exchange for crypto currencies, it is treated as a barter trade and the value of the underlying goods provided/ services performed is taxed.

In the U.S.A., a virtual currency is treated as a digital representation of value, other than a representation of the U.S. dollar or a foreign currency that functions as a unit of account, a store of value, and a medium of exchange. U.S.A. treats virtual currency as a property and general tax principles applicable to property transactions apply to transactions using virtual currency, with capital gains and losses considered for arriving at the tax amounts.[1]

Canada, on the other hand, treats the income arising from virtual currencies as a business income or capital income based on the nature of the activity carried out. The tax is also payable when you exchange one coin for another.[2]

The UK treats crypto currency income as capital gains or business income depending upon the nature of the transactions while allowing set off of losses. Similarly, Australia treats crypto as an asset for capital gains tax purposes.  Australia exempts capital gains from cryptocurrencies procured for personal use cases for less than $10,000.[3]

Comment:

The law on crypto currencies is evolving every day and more clarity is expected with the laws in India when a comprehensive regulation is enacted. At present, the Central Government has cleared the ambiguity surrounding taxation on gains from crypto currencies. This clarity in taxation may bring on board, corporates and individuals who could not foray into the sector due to regulatory uncertainty.

[The author is a Senior Associate in the Corporate and M&A advisory practice in Lakshmikumaran & Sridharan Attorneys, Hyderabad]

1. [1] https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions
2. [2] https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/compliance/digital-currency/cryptocurrency-guide.html
3. [3] https://www.ato.gov.au/General/Other-languages/In-detail/Information-in-other-languages/Cryptocurrency-and-tax/