Taxation of Virtual Digital Assets - A Primer

Need for recognizing and taxing Income from VDAs:

The world has witnessed massive growth in demand for and transactions in cryptocurrencies, non-fungible tokens (NFTs) and other digital assets. These digital assets have attracted several investors around the globe. This outlook of investors in digital assets have led to an increased demand and trade of digital assets, thereby resulting into exponential value appreciation and in turn the value of digital assets.

Specifically, when we talk about the cryptocurrencies, there are several thousands of cryptocurrencies in circulation; inter alia, Bitcoin and Ethereum being the top 2 cryptocurrencies in terms of market share. Presently, the global crypto market is of USD 1.06 trillion. Likewise, according to the report of ‘Market Decipher’, the global market size of NFT itself is estimated to be at USD 232 Million, as in the year 2020 and subsequently, is expected to grow 3 times of its current size by the year 2031. According to certain reports, India tops the chart of countries with most cryptocurrency holders in the world, with cryptocurrency investment of approximately USD 6.6 billion, as of May 2021.

Many countries have denied recognizing cryptocurrencies as legal tender and have either banned them or have imposed strict regulations against their usage and acceptability. However, interestingly, a country like El-Salvador has recognized “Bitcoin” as their legal tender. Further several countries have recognized cryptocurrencies and other digital investments as assets.

Accordingly, due to Indian population’s huge investment in cryptocurrency, NFTs and other digital assets as well, the Government of India (GOI), in its Finance Act 2022, recognized and introduced taxation of a new class of asset under The Income Tax Act, 1961 (hereinafter referred as “the Act”), 1961, called as VDAs.

What does VDA Include?

The definition of VDA as given under section 2(47) of the Act, is an inclusive definition. However, the Central Government may, vide a notification, exclude any digital asset from the definition of VDA.

VDA as defined under the Act inter alia, includes:

A. Any cryptographically generated Information/Code/Number/token

• not being Indian or foreign,
• having an exchange value represented in digital form,
• exchanged with or without consideration,
•  with the promise or representation of having inherent value; or
• functions as a store of value or a unit of account,
• that may be used in any financial transaction or investment,
• and can be transferred, stored, or traded electronically.

B. NFT or any other token of similar nature; or

C. Any other digital asset as may be notified by Central Government[1].

Digital asset excluded from the definition of VDA

The Central Government has excluded following digital assets from the definition of VDA through a notification[2]:

1. Gift card or vouchers that may be used to obtain goods or services or discounted goods or services;
2. Mileage points, reward points or loyalty cards without monetary consideration and that may be used only to obtain goods or services or discounted goods or services;
3. Subscription to website or platforms or application; or
4. Any NFT backed by an underlying tangible asset where transfer of such NFT results in legally enforceable transfer of ownership of such tangible asset.

How will the Income from VDA be taxed?

The Finance Act, 2022 has inserted Section 115BBH in the Act to bring VDA under tax.

As per the calculation of gain on transfer method given under Section 115BBH, there is a metaphoric representation of taxing of gains arising upon transfer of VDA similar to that on transfer of any other capital asset. However, the law has not restricted the nature of holding of VDA to a “Capital Asset” alone. Hence, any gain on transfer of VDA held as stock-in-trade or otherwise shall also be taxed as per the provisions of Section 115BBH.

Further, any VDA received against no or low consideration would be taxed in the hands of recipient as ‘’Income from Other Sources’’, as per the specific provisions of section 56(2)(x) of the Act.

Calculation of gains on transfer of VDA

For computation of gains on transfer/ sale of a VDA, the cost of acquisition of such asset must be deducted from its sale price.

Deductions available in computation of gains from VDA

The law does not allow any other form of deduction except the cost of acquisition of such VDA for computation of gains arising out of the transfer.[3]

Availability of Indexation benefit on transfer of VDA

The law has categorically denied any benefits of indexation or cost of improvement with respect to computation of gains on the sale/ transfer of VDA.

Allowability of Set-off of Loss on VDA

In a scenario of occurrence of loss on the transfer/ sale of virtual assets, such loss cannot be set off against:

1. Gain arising on the transfer of another VDA.
2. Income under any other head of income.

A simple example for the same would be as follows:

Person “A” sells VDA “X” and makes a profit of Rs.60,000 in one transaction and in another transaction incurs a loss of Rs.1,00,000 on sale of VDA “Y”.

In this case, he/she will be liable to pay tax on the profit made of Rs.60,000, but the loss that he/she has suffered, would not be set off against the profit made, even though the transactions may have been simultaneously done and falling under the same head of income.

Allowability of carry forward of losses on VDA

The loss arising on VDA cannot be carried forward. This development is interesting to note as all other asset classes have the benefit of setting off losses and carrying forward of those losses into the next year, making this particular asset class the least investment friendly.

Rate of Tax on gain on transfer of VDA

The gain on the transfer of VDA is to be taxed at a flat rate of 30%, plus cess and surcharge[4].

Applicability of Tax Deduction at Source (“TDS”) provisions in case of VDA

Section 194S was inserted vide Finance Act, 2022 for withholding of tax on transfer of VDA. The details are as follows:

When to deduct tax at source?

TDS must be deducted at earliest of:

1. making payment (by any mode); or
2. crediting of such sum to the account of the resident  

Threshold for TDS

The person making payment would be liable to deduct tax under following circumstances:

Whether TDS applicable in case of recipient being Non-Resident?

TDS u/s 194S is to be deducted by any person making payment to a resident person. Hence, no TDS to be deducted u/s 194S if the Recipient is a Non-Resident. However, the provision of Section 195 would get attracted in such cases.

Rate of TDS

TDS must be done at the rate of 1% of the total consideration (excluding GST, if any).

Valuation of consideration for the purpose of deduction of tax on transfer of VDA

The transfer of VDA can take place either:

1. Through Exchange
2. Through Peer-to-Peer

Valuation of consideration under the following circumstances is discussed below:

A. Liability to deduct tax when the consideration is in Cash

1) Transfer on Peer-to-Peer:

2) Transfer through Exchange:

Value of consideration will be Actual Amount Paid/Credited by buyer (deductor). Further, liability to deduct TDS when the consideration is in Cash under different scenarios, is discussed below:

a. Exchange making payment/crediting amount to seller/broker being the seller [i.e. broker is owner of the VDA]: Exchange is liable to deduct tax under section 194S.

b. Exchange making payment/crediting amount, but broker involved in transfer is not the Seller: Both, the Exchange and the Broker will be liable to deduct TDS, unless there is a written agreement between Exchange and Broker, making only the Broker liable to deduct tax.

c. VDA owned by and transferred through Exchange

Primarily, Buyer/Broker being the person making payment would be liable to deduct TDS. However, upon a written agreement between Exchange and Buyer/Broker, the Exchange may itself deposit the amount of tax and file quarterly statement in Form 26QF

“Exchange” means any person that operates an application or platform for transferring of VDAs, which matches buy and sell trades and executes the same on its application or platform.

“Broker” means any person that operates an application or platform for transferring of VDAs and holds brokerage account/accounts with an Exchange for execution of such trades.

B. Liability to deduct tax when the consideration is in kind, wholly or partly, or in exchange of another VDA and cash is not sufficient to meet TDS liability

Person making payment should ensure that the required tax on such consideration is deposited, before releasing the consideration.

1) VDA against VDA under Peer-to-Peer:

Under Peer-to-Peer transaction of VDA against VDA, both the parties are buyer as well as seller, hence both parties are liable to ensure that the tax is deposited by another before release of consideration.

2) Transfer of VDA against another VDA through Exchange:

In case the transaction of transfer of one VDA against another VDA is through Exchange, for the sake of convenience, the Exchange may opt to deduct and pay the tax on the Buyer as well as the Seller. This can be done by the Exchange through an agreement with Seller/Buyer.

Valuation of TDS deducted in ‘Kind’ under transaction of VDA against VDA:

If the Exchange opts for tax deduction, the possibility of tax deduction in kind may arise and hence the need for its conversion to cash before deposit with Government may arise.

To this the CBDT has specified following mechanism:

Illustration:

VDA Monero is traded against the VDA Deso (both not being primary VDAs) through the Exchange. And the tax @ 1% of Monero and Deso is deducted by the Exchange in kind.

Special Case: Transaction where Payment is made through Payment gateway.

Payment gateway would NOT be required to deduct tax if person required to deduct tax (as discussed above) has deducted the tax. For implementation of this, payment gateway may take an undertaking from the person responsible to deduct tax in this regard.

Effective date of Section 194S: 01st July 2022

How the threshold limit of Rs. 50,000 or Rs. 10,000 is to be calculated?

1. CBDT has clarified[5] that the consideration threshold limit of Rs. 50,000/Rs. 10,000, is to be counted from 01 April 2022.

Hence, if the threshold limit of Rs.50,000/Rs.10,000 is exceeded by 30.06.2022, TDS is to be deducted on all the payments/credits made on/after 01.07.2022.

Summary Views:

The framing of tax law to curb tax leak on the gains arising from a VDA is a valiant step. The CBDT has vide introduction of the tax provisions on VDA and the subsequent notifications, tried to address the several issues on taxing of VDA transactions. However, the concept of trading in VDA is yet globally evolving and with passage of time certain practical difficulties are likely to arise, necessitating further clarifications and guidance by CBDT vis-à-vis taxation of VDAs. This would have to be done transparently, on a dynamic and pro-active basis.

Under the current laws, in situations where the buyer and the seller are both residents, are unknown to each other and are trading through an Exchange operating outside India, would require further analysis on who shall be liable to deduct the TDS. Forgoing this, how these transactions will be identified and who would be the reporting entity, would remain an important question that would need to be addressed.

Game of GST – Winter is Coming

This article has been co-authored by Palak Goyal (Manager, TMSL).

The second biggest market for online gaming industry is astonished by the DGGI issuing a SCN of a whooping INR 21,000 crore alleging non-payment of GST. India, only second to China has more than 400 gaming companies and caters to more than 420 million online gamers. This incredible rush in the number of gamers is driven by the average age in the country, higher disposable income and easy and cheap access to smartphones and internet. However, the surge is not yet over; according to a study, the Indian gaming industry is set to soar to 5 billion dollars by 2025!

With these facts, it did not come as a surprise when our Hon’ble Finance Minister stated animation, visual effects, gaming, and comics sector (AVGC) as one of the sectors to focus upon and hence a task force was formed for the same. However, recently when the DGGI slammed one of the unicorns in gaming industry with an INR 21,000 crore notice, it sent a shock wave in the country. Being one of the biggest SCN ever issued in the GST regime, there is much hype about the matter.

Background

The assessee in this case had been issued an intimation in Form DRC-01A dated 8 September 2022 alleging non payment of GST @ 28% on the activity of the assessee. The assessee subsequently filed a writ before the Karnataka High Court demanding an interim stay on the intimation and a to stop the revenue from acting upon the same. The petitioner relied upon the following submissions to obtain an interim stay:

• The petitioner is engaged in hosting skill based online games on its platform as an intermediary.
• Rummy, constitutes more than 96% of games played on petitioner’s platform. Various courts including the Apex Court have time and again held that rummy is a game of skill and not a game of chance.
• The petitioner is a bona fide taxpayer as it has deposited INR 1500 crores tax (income tax and GST) till 30 June 2022.
• The intimation is wrong in law as it alleges that the petitioner is involved in the supply of an actionable claim which is not the case. The only actionable claim was between the players and the petitioner did not have any claim or beneficial interest.
• The intimation invokes Rule 31A of the CGST Rules 2017, the validity of which is seized and sub-judice before the division bench of this court.
• The notice suffers from lack of jurisdiction since its not been issued by proper officer. The same is also vitiated with malice. It is also arbitrary and violative of Article 14,19 and 21 of the Constitution of India.
• The petitioner has earned a little over INR 4000 crores during the period June 2017 to June 2022. However, the notice has been issued for the same period for INR 21,000 crores. If the demand is enforced, it will cause irreparable damage and hardships to the petitioner.
• The GST Council has not yet taken any decision on taxability of online gaming sector; hence, the intimation is contrary to the same.

The revenue on the other hand contested the petition on the grounds that a petition cannot be maintained against an intimation only, which is only an option for the petitioner to exercise payment of tax, interest and penalty (15%). Therefore, the said petition is liable to be dismissed. Also, merely because the GST council has not taken any decision, the petitioner cannot rely upon the same.

However, the Karnataka HC stated that the issue at hand is a culmination of contentious issues and disputed questions which will have to be decided at the time of final disposal of petition. Hence, the HC granted an interim stay against the intimation issued.

Nonetheless, the department issued a SCN to the assessee on 23 September 2022. The issuance of SCN could have been made due to the time barring limitation of period specifically for demand pertaining to FY 2017-18 . Pursuant to such issuance of SCN, the Karnataka HC commenced the hearing on 27 September wherein the petitioner stated that considering the entire value of online gaming industry in India is INR 14,000 crores, a demand of INR 21,000 crores on petitioner alone is absurd! Moreover, the petitioner in the apprehensions of attachments and arrests, sought a stay on the SCN till the time the hearing commences post Dussehra break.

How the industry works and GST implications

Online gaming industry has several streams of revenue. The key ones are:

1. The gaming platform charges ‘rake fees or enrollment fees to the players for usage of online gaming platform. In such cases, the platform may or may not allow gaming through monetary methods.
2. In case players play games with monetary amounts, there is generally a prize money pool which is nothing but a pool of all monetary contributions. This prize money is later on released to the winner of the game after deducting a commission of the platform. However, in case of non-monetary games, only rake fee is charged from players for facilitating the game.
3. The gaming platform or app does not charge any rake fees to the player. However, the player may have to pay for any additional features such as unlocking the next level, buying extra life, performance boosters etc.

Apart from the above revenues, a gaming platform also derives significant advertising revenue from in-app advertisements. From the GST perspective, the possible treatment of such revenues is given below (which may differ basis the facts of each case):

1. Rake fees or enrollment fees – May be subject to GST
2. Prize money pool or contest fee – The pool created by collecting money from all players may not be subject to GST provided that the same is refunded to the winner. Any deductions whether in the form of commission or otherwise may attract GST.
3. Additional charges for unlocking other features on the app – GST may be applicable on such revenues.
4. Advertising revenues – GST may be applicable on such revenue.

However, the industry is currently not levying GST on money deposited by players with the platform in the form of a wallet and contribution to prize pool as the same is considered to be in the nature of actionable claims which are excluded from the definition of ‘supply’. Moreover, no GST is currently being paid on prize money distributed by gaming companies to winners as the same is considered as ‘transaction in money’. Thus, the only revenue which is offered to GST is platform fee.

The pertinent question and the bone of contention here is whether GST should be levied on the entire prize pool money/ contest fee or only earnings derived from it by the gaming platform which is commonly termed as Gross Gaming Revenue (GGR). Another question is whether the gaming platform is engaged in hosting games of skill or games of chance; depending on the classification, the rate of tax would be determined – whether 18% or 28%!

These two questions have more or less given sleepless nights to the entire gaming industry. Their only ray of hope was the Group of Ministers (GoM) who have been entrusted with the responsibility of clarifying the taxability on the online gaming sector. However, this GoM in July 2022, suggested that a flat rate of GST @ 28% should be levied on the entire consideration, whether they are games of skills or games of chance. This suggestion sent the industry in a pandemonium, thus forcing the GoM to rethink their report and suggestions. While we await the GoM to pronounce their verdict and GST council to agree on such verdict, the industry is receiving intimations and notices.

In the notice at hand, the SCN has alleged that the assessee has collected a contest money of INR 77,000 crores and has levied tax @ 28% on the same. The assessee has defended its ground on the premise that it only retains a platform fee and has already discharged GST @ 18% on such fees. The question here is that if the assessee has distributed the entire contest money barring its platform fees, there remains no revenue to levy tax on. However, the assessee must be able to substantiate the amount distributed to the winners. Another point to ponder here is that the assessee has stated in the petition that 96% of its platform is used for rummy which is a game of skill. However, the remaining 4% of INR 77,000 crores which amounts to INR 3,080 crores is also not an insignificant sum.

One can also draw parallels from the Cryptocurrency industry. Whether GST should be levied only on the exchange fees of crypto platforms or on the entire traded value – is a question which is haunting the crypto industry as well. However, a distinction can be drawn from the horse racing industry as one could interpret horse racing as a game of chance or betting or gambling as against online games which mostly are games of skill. 

Conclusion

A good start to scatter the clouds of ambiguity would be to frame accounting standards specific to online gaming sector, in lines with global best practices. Once accounting standards are in place, determining taxability becomes much simpler. Moreover, if one was to refer to global practices, most countries levy tax on platform fees or GGR earned by gaming companies. These include UK, Sweden, Germany, Denmark etc. 

Possible next steps for the Industry and the Government

• Frame Accounting policies or standards in association with professional bodies to understand the long-term impact on the sector
• Give due consideration to global best practices
• Deliberate and frame the taxation rules - Direct tax and Indirect tax both. It would be vital to have certain members from the industry onboarded for such deliberation to consider both sides of the coin
• Roll out these policies at the earliest to avoid any undue litigations and disputes
• From an industry perspective, strong representations need to be made to the policy makers and for companies which have yet not become a part of these representations, may wish to have themselves onboarded.

Nonetheless, multiple trade bodies and professional firms have highlighted that levying GST on the contest money would send the industry in spiral. The industry has been contributing significantly to the tax treasury of the country. An optimum tax structure could increase these collections and make the sector soar high also supporting the AVGC vision of the hon’ble Finance Minister. However, the opposite could mark the end of a reign of online gaming sector in India, as there will only be a handful companies which would be able to survive this tax regime.

[The views are personal.]

“Non-Fungible Tokens and GST”

An abundance of digital financial assets (as termed by the OECD) or Virtual Digital Assets as defined under the Income Tax Act, 1961 have flooded the markets, from crypto currencies to NFT’s and tokenised forms of real-world assets like gold and other commodities. While the true nature of these new age financial instruments has everyone scratching their heads, NFT’s have captured the imagination of the world.

While the Silent Generation collected paintings and art work, Generation X collected marbles, trading cards, cigarette wrappers, etc.  The Millennials; Generation Z are focused on 21st century digital collectables and NFT’s with digital scarcity as a selling point. Powered by the blockchain technology and existing completely in the digital space, NFTs in essence are lines of computer code, that manifests as a digital representation of some other data, i.e. (metadata – data that references other data).

The Supreme Court in the case of Tata Consultancy Service Vs. State of Andhra Pradesh[1] had held that the term ‘goods’ as used in Article 366(12) of the Constitution of India and as defined under the said Act are very wide and include all type of movable property whether the properties be tangible or intangible.  Even intellectual property, once it is put on to a media whether it be in the form of books or canvas (in case of painting) or computer disc or cassettes and marketed would become goods.  As in the case of painting or books or music or films, the buyer is purchasing the intellectual property and not the media that is paper or cassette or disc or CD. The term "all materials, articles and commodities" includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc. The software programmes have all these attributes. Goods include all material, commodities and articles.  Commodity is an expression of wide connotation and includes every thing of use or value which can be an object of trade or commerce.

Whether NFTs would qualify as goods in the light of the test laid down by the Supreme Court in TCS case is an interesting question by itself.  The Finance Act, 2022 amended Section 56 of the Income Tax Act, 1961 to recognize Virtual Digital Assets (VDA) as ‘property’.  

Spanish Tax Ruling

The Spanish Tax Authorities in a recent ruling in Binding ruling V0482-22, of March 10, 2022, issued by the Spanish General Directorate of Taxes discussed the nature and taxability of NFTs. In the case, from an analysis of the Spanish VAT provisions, it was inferred that the ‘any natural or legal person would be carrying out an economic activity when it orders for its own account material and human resources of production, with the purpose of intervening in the production and/or distribution of goods or services. In such a case, and, if carried out independently, the person should be considered, as a general rule, a taxable person for VAT.’

Further, while discussing the nature of NFTs either as a good or a service, the Tax Authorities drew the conclusion that in the cases where NFTs are not representatives of real-life goods (which is mostly the case), NFTs then take the nature of digital certificates of authenticity associated with a single digital file. Therefore, the NFTs act as unique digital assets that cannot be exchanged with each other. In accordance to the Spanish VAT legislations, the Authorities made the ruling that in light of the above finding it would not be appropriate to deem NFTs to be goods and their trade a supply of goods where the NFTs do not correspond to a right for their holder to be entitled to some underlying tangible goods. As per their finding therefore, the object of supply is the digital signature without any other underlying supply. Once the inference that NFTs are not goods was made, the Spanish Tax Authorities also made one particular finding that proves relevant when measured against our GST laws. In the operative part of the ruling, the Authorities also made a finding that NFTs are electronically supplied services which are services that, by their nature, are mainly automated and require minimal human intervention and are not feasible without information technology.

This categorization of NFTs by the Spanish Tax Authorities when compared with Indian GST provisions would require the examination of OIDAR services defined in terms of Section 2(17) of the IGST Act.  Clause (ii) covers provision of e-books, movie, music, software and other intangibles through telecommunication networks or internet.  Therefore, another perspective would be whether NFTs would qualify as ‘other intangible’ and thus fall under OIDAR services.

In the context of income tax, all NFTs are not considered as virtual digital assets.  In terms of Explanation (a) to Section 2(47A) of the Income Tax Act only notified NFTs shall be considered as virtual digital assets for the purpose of income tax.

German Court

Recently, the Federal Finance Court of Germany in the case of Bundesfinanzhof, BFH has held that mere participation in a game and ‘in game sales’ which shapes the gaming experience in interaction with other game participants does not constitute participation in real economic life.  Thus, renting of ‘virtual land’ in a game was not considered to be a service liable to VAT.  However, when the in-game currency is exchanged against real fiat money the same is taxable.

Five dimensions

In the GST scenario no amendments have been made in the statute in the context of crypto currencies or crypto assets.  Whether NFTs would constitute good or service can always be the subject of debate.  In fact, debate currently exists even with reference to intellectual property rights and the general view is that transfer of intellectual property rights would amount a supply of goods while licensing of intellectual property rights would fall within the domain of service.  There are five dimensions to the exercise of examining GST applicability on a sale of NFT.

Assuming, there is an NFT created and owned by a celebrity who is a resident of another country without any place or establishment in India and the said NFT is purchased by an individual in India, the first dimension is that, if the transaction is considered as a supply of goods, there is no point of import or physical import for levy of customs duty or IGST. The second dimension is that, where the transaction is considered as a supply of service and falls within the scope of OIDAR services, the recipient would be a ‘non-taxable online recipient’ and the liability to pay GST would be on the foreign supplier.  Enforceability and implementation would be an issue.

The third dimension to the issue is the aspect of consideration.  Assuming, the individual in India has a wallet in which cryptocurrency purchased by him is loaded and the said cryptocurrency is used to purchase the NFT, whether cryptocurrency can be considered as consideration or not can be a matter of debate.  The definition of ‘consideration’ includes payment whether in money or otherwise. Given the fact that cryptocurrency is yet to be recognized as legal tender, it will not qualify as ‘money’.  Whether it can fit into ‘otherwise’ is another open question.

The fourth dimension is whether NFT constitutes consideration for the transfer of cryptocurrency or whether the exchange of cryptocurrency for NFT constitutes a barter transaction.

The fifth dimension to the issue is jurisdiction.  The blockchain would exist in the internet and thus could be anywhere.  The wallet could exist anywhere.  Tracking of such transactions for the purpose of examination of GST applicability can be a humongous task.  If the decision of the German Court is applied transactions that take place in the virtual world using virtual currencies may even be outside the ambit of the GST in the real world.

Given the various ramifications and the complexities in the existing statutory framework, taxation of transactions involving crypto assets such as NFTs in the GST regime is not going to be easy.  The law may have to be amended to provide for a simpler system.  However, it would still be a huge challenge to track transactions unless the nature or price involved in the transaction attracts media attention.

Taxation in the World of Metaverse

The World of Metaverse:

Nowadays, Metaverse is a trending topic to discuss on, Metaverse is the most promising advancement of technology in the world of digitalization.

The metaverse is a decentralized platform based on blockchain technology that enables users to create their own virtual worlds. Metaverse is a digital/virtual universe based on technology, where human beings can digitally be present at anywhere in the world and do anything which could either be possible in real life, they can purchase, roam, interact with others, and engage in a wide range of activities, including shopping, banking, and social networking, experience the place which may be far apart from him in person. This technology is basically based on Web 3.0 application, which may revolutionize the world.

As, the demand of Internet and its accessibility has been increased drastically in the couple of years, where, Latest figures​ show that an estimated 4.9 billion people are using the Internet in 2021, or roughly 63 per cent of the world’s population. This is an increase of almost 17 per cent since 2019, with almost 800 million people estimated to have come online during that period[1]. Being shopping online, or surfing online, the data of the target consumers can also easily be traced by companies for better analysis and strategic planning to increase its turnover. Thus, the Companies are spending billions of dollars on the digital world to give more satisfactory and user-friendly experience to its customer during the screen time. So, as the case with Metaverse.

In the age of Digitalization, many companies are in the process of listing themselves on the metaverse and many had already listed themselves on the world of Metaverse. Following are the few companies, listed on the metaverse. Microsoft, Google, Facebook, Amazon, Nykaa, Apple, Epic Games, Roblex Corporation, Nike, Decentraland, etc[2]. Moreover, Banks are also getting Listed on the Metaverse, The Standard Chartered Bank, recently became the largest major bank to embrace the technology of metaverse[3].

Nike recently launched its 20,000 Sneakers as it’s a part of Nick Dunk Genesis Cryptokicks on Metaverse as NFTs out of which 98 were scare items making it more valuable and someone paid $130,000[4] for those sneakers. It’s an economical fact that scares the resources higher the price would be.

Singer Daler Mehndi, is the first Indian Singer to purchase the Land on Metaverse, named as “Balle Balle Land” to host films and concerts over the VR technology which will sell the merchandise as NFTs over Blockchain technology[5].

Similarly, as in the actual world, payments in the metaverse can be made in an assortment of ways. As organizations and people rush to the metaverse, new payment systems are being created to oblige the necessities of this developing local area. The most well-known technique for payment is made by means of blockchain-based computerized monetary standards, which can be utilized to buy labor and products from vendors inside the metaverse. One of the critical advantages of computerized cash payments in the metaverse is that they are borderless. This implies that clients can send and get installments from anyplace on the planet without stressing over exchange rates. While the advanced adaptation of blockchain technology, the cryptocurrencies and non-fungible tokens (NFTs) may be used as payment strategies in the metaverse.

The Land on the Metaverse can be purchased through Cryptocurrency, especially in Ethereum. You will also need to have virtual wallets that can store NFTs like Metamask or Binance. Once you buy a land, the sale and ownership of the land are recorded via the transfer of NFTs. The transfer will take a few seconds as it will verify if your digital wallet has enough currency to buy the said land, after that it will be conveyed that you now own the land legally[6]. The Land on the Metaverse shall be measured in tiles, which will be unique from any other tile in the metaverse, making it Non-Fungible. (Non-Fungible means, Unique, which cannot be replaced with something else).

Taxation Aspect:

In the Metaverse, NFTs are to be sold on the Blockchain technology and through Cryptocurrencies.

According to the Section 2(47A) of the Income Tax Act, 1961,

“Virtual Digital Asset” means

(b) a non-fungible token or any other token of similar nature, by whatever name called;

Explanation- For the purpose of this clause:

1. “non-fungible token” means such digital asset as the Central Government may, by notification in the official Gazette, specify;

As per the ITA, only those NFTs shall be taxed which are notified by the Government. As of now, no NFTs has been notified.

As and when Government notifies any NFT under this section, the laws of Section 2(47A) shall be applicable and those NFTs shall be considered as Virtual Digital Assets. But, for this article, let us assume that Government has notified the NFTs (See point 2 below).

There are few methods which may be followed to earn income from the Metaverse, which may be as follows, 1) Renting of Land, 2) Sale of Land, 3) Running the Business, 4) Hosting an event, etc.

Let us see, how these transactions be taxed under the current Income Tax Act, 1961.

1. Renting of Land:

According to the ITA, rental income shall be taxed under the head “Income from House Property”, whereas the charging section of IHP, say that the income should be earned from the house property and the land appurtenant thereto, in the case of metaverse, there is no house property or the land appurtenant thereto, therefore the income earned from letting out of Virtual Land in Metaverse, cannot be taxed under the Head House Property.

The Rental Income shall be taxed under the Head “Profits and Gains from Business and Profession” (PGBP) or “Income from Other Sources” as applicable on the case.

2. Sale of Land:

As, discussed above, Land is the NFT, and the transfer of NFT shall invoke Section 115BBH(1) of the ITA:

“Where the total income of an assessee includes any income from the transfer of any virtual digital asset, notwithstanding anything contained in any other provision of this Act, the income-tax payable shall be aggregate of-

1. The amount of income tax calculated on the income from transfer of such Virtual Digital Asset at the rate of thirty percent; and……”

As per Section 115BBH(1), the income arising from the transfer of VDAs shall be taxed at 30% plus surcharge and cess. Such income shall be computed without deduction of any expenditure, except the cost of acquisition of the VDAs, if any. Further, loss arising from the transfer of a virtual land shall not be allowed to get set-off against any other income, whether from VDA or not.

3. Running the Business:

Any income earned from running of business on metaverse shall be taxed in the same manner as any other business income is taxed in ordinary course. All the expenses relating to business shall be claimed, and other deductions can also be availed by the assessee. There is no specific treatment for the business operated under metaverse.

TDS Requirement u/s 194S (effective from 01 July 2022):

Section 194S to the Act, which would provide for a 1% tax deduction on payments made for the transfer of a virtual digital asset to a resident. However, no deduction will be required if the consideration paid during the financial year does not exceed ₹50,000/- (in the case of a specified person) or ₹10,000/- (in the case of a non-specified person) in any other case.

For the purposes of section 194S, a Specified Person is defined as

An individual or a HUF whose total sales/gross receipts in the fiscal year immediately preceding the fiscal year in which such virtual digital asset is transferred do not exceed ₹1 crore (in the case of a business) or ₹50 lacs (in the case of a profession). And an individual or HUF who receives no income under the heading “Profit and gains of business or profession.”

When the consideration is entirely in kind or in exchange for another virtual digital asset, there is no part in cash; or when the consideration is partly in cash and partly in kind, but the cash portion is insufficient to meet the liability for a tax deduction in respect of the entire transfer, the person paying such consideration must ensure that the tax has been paid before releasing such consideration.

Payments made by a individual will be exempt from the provisions of Sections 203A and 206AB. And the section further states that once the tax has been deducted under section 194S, no other TDS/TCS provision applies to the transaction. Where tax is deductible under both section 194-O and proposed section 194S, tax is deducted using section 194S rather than section 194-O.

Concluding Remark:

The metaverse is still in its beginning phases of improvement, yet it is rapidly turning into a well-known objective for web-based shopping. As blockchain innovation and the metaverse keep on advancing, we can hope to see an expansion of payment techniques accessible for dealers and purchasers to browse. Shoppers can exploit the developing interest in the metaverse by tolerating digital forms of money and NFTs, depending upon the labor and products being advertised.

Decrypting the Crypto Tax

Crypto currency has been the buzz word over the last couple of years. Even though the same has been in existence for quite long, never before were they in limelight among all the stakeholders. The response in the international arena towards cryptos has been widely different. On the one side, we have China which has banned cryptos entirely and the other hand we have various states in Switzerland accepting tax payments in cryptos. The IMF has also cautioned about the impact of cryptos on the monetary policy and has advised Elsalvador to reverse its decision to accept Bitcoin as legal tender. India had perfect thriller script in the case of cryptos as well. The RBI first banned the cryptocurrencies which was overturned by the Honourable Supreme Court, later, the Government was set to introduce a bill banning mining of cryptocurrencies in India which was not tabled in the Parliament. Further, there were different views that Government would not go for complete ban on cryptocurrency and that it would only restrict its usage only as an investment asset.

Amidst this chaos on the policy stand point, cryptocurrency has attracted quite a large number of investors in India without class discrimination where both the HNIs and the lower middle class population has invested aggressively in cryptos. The digital asset arena is not limited only to cryptocurrencies but others such as NFTs and Metaverse which have already been stated as the next big revolution which would transform the future landscape.

NFTs

The other technological advancement based on the block chain technology, which is gaining traction is NFTs (Non Fungible Tokens). There are multiple types of assets based on NFTs. The prominent among them would be digital assets (copyrighted photographs, art, music album, video etc) of prominent sportspersons, Bollywood stars etc., the ownership in which is being distributed with the help of transferable NFTs issued to the subscribers. The other prominent type of NFTs are the shares (tokens) in the virtual companies. In USA, Decentralized Autonomous Organisation (DAO) also works on block chain technology based smart contracts and issues token (shares) to members. Other countries are yet to catch up with this. But though the tokens are in the nature of shares, they are nevertheless NFTs.  

Metaverse:

With gaining traction in cryptocurrencies and NFTs, the spotlight has also turned on the new virtual reality and digital life “Metaverse”. Metaverse is a virtual world where you can connect with people via your digital avatars. A digital avatar is a close replica of a real human being. In the recent past, accomplished MNEs have shown keen interest and have started revolutionizing into the new era. Recently, Microsoft cited metaverse as a reason for acquiring the game developer Activision Blizzard for $68.7 billion, saying the deal would provide “building blocks for the metaverse.” Facebook’s founder, Mark Zuckerberg, has also bet on the metaverse and renamed his social networking company Meta. Few other game development companies like Roblox, Epic Games, Tencent are focusing on building a metaverse platform where people can talk to each other, talk to brands and can even stay in the virtual world for more. The top footwear brand Nike has built its virtual world “Nikeland” in collaboration with Roblox, wherein, players will get a chance to try new sports shoes and run marathons in Nikeland. 

The India Story:

Industry estimates suggest there are 15 million to 20 million crypto investors in India, with total crypto holdings of around 400 billion rupees ($5.37 billion). No official data is available on the size of the Indian crypto market. However, as per Triple A (a business enabler of cryptocurrency solutions headquartered at Singapore), it is estimated that over 100 million people, 7.30% of India’s total population, currently own cryptocurrency as of 2021. According to a report by cryptocurrency research firm Chainalysis, India is one of the world's fastest growing crypto markets, increasing by 641% between July 2020 and June 2021.

There are many crypto exchanges in India such as CoinDCX, Zebpay, WazirX, CoinSwitch Kuber, Unocoin and Bitbns. Leading cryptocurrency exchange, WazirX, witnessed record trading volume of over $43 billion in 2021 – the highest in India – a growth of 1,735% from 2020. BitBns, another leading exchange, increased its user base by 849% and trading volumes by more than 45 times in the last year.

On the NFTs front, the volume of NFTs that are traded in the market has increased by 43% from April 2021 to June 2021. According to Reuters, the proportion of NFT sales during the first 6 months of 2021 grew to $2.5 billion.

As per BitsCrunch, a blockchain analytics firm, India contributes around 5% of the global NFT space. The firm also added that determining the exact number is difficult as a lot of buyers use pseudonyms through decentralised exchanges.

It has been evident that India’s top IT services firms are working on embedding various technologies to tap the Metaverse market, which is estimated to provide a $8 trillion opportunity, as per global investment bank Goldman Sachs. Further, few other start-ups as well have explored avatar-based immersive platforms that enables virtual conferencing and networking in a 3D environment.

More than 500,000 Indian users have shown their interest in NFTs and metaverse projects from the beginning of November 2021, according to a report by DappRadar, a company that tracks user behaviour across blockchain projects.

India has been ranked fifth only behind the US, Indonesia, Japan and the Philippines in terms of interest in metaverse projects, according to the report that was published on 24 November, 2021.

Taxing the fad:

The increasing interest of Indians in the crypto space and the persisting uncertainty on its legal framework, called forth the ambiguity on taxation of the gain on cryptos with divergent views that the gains should be taxed either as income from business or profession or capital gains.

An Inter-Ministerial Board constituted in 2017 to study the issues related to virtual currency, laid forward its report along with a draft Bill in 2019. The report highlighted that, large fluctuations in price preclude cryptocurrencies from being a suitable store of value and that they lack intrinsic value. It was set forth clearly that the lack of Sovereign backing prevents crypt currencies from being a legal tender, and therefore have no inherent value beyond the utility their underlying technologies represent. In this back drop, the pendulum was tilting towards categorising the investments as speculative in nature rather an investment for appreciation of value.

The Government in the Union Budget 2022 has provided much needed direction on the taxability of cryptocurrency and other digital assets.  The Finance Bill 2022 proposes to tax the income from the transfer of virtual digital assets at the rate of 30% without any recourse to setoff of loss either from the same source or other sources of income and the carry forward of loss is also prohibited. More importantly only the cost of acquisition of the asset is allowed as deduction and no other expenditure shall be allowed to be claimed while computing the income from the transfer of virtual digital asset. This approach clearly indicates that the Government intends to discourage the investments in virtual digital assets especially the cryptocurrencies. This is understandable considering the fact that there is no law at present to regulate the crytpo currencies and the extent of risk involved is also not clear. The estimate on the number of people investing in these cryptos varies drastically from source to source. It’s a welcome move that the Government proposes to bring its own digital currency based on the same technology, showing inclination towards adopting the technology which promises to be a solution for various issues being faced currently. 

NFTs has had its share of success in various instances across the globe. One such is that the technology could help in protecting the copyrighted assets from piracy.  India faces huge financial loss due to piracy and the Government also losses tax revenue by virtue of it. The Government should quickly bring in a law to regulate the NFTs and encourage its use and remove it from the 30% tax bracket. Though the Act uses the term NFTs, it has not been defined and has provided the Board the right to include various assets under this list and along with power to notify the NFTs which would be excluded from the 30% tax bracket. New withholding tax regime has also been introduced for the transfer of virtual digital assets with onus being on the person responsible for the payment of consideration to deduct tax @ 1% on payment of consideration of over and above Rs.10,000 in a year in general and in specific cases for Rs.50,000 and above. As in the case of many a tax regulations, there are certain ambiguities even in the case of the taxation of virtual digital assets such as the follwing :

- The definition of Virtual Digital Assets is very broad and might end up covering within its ambit the reward points, flexi points etc which is offered by various companies to its customers

- The responsibility to deduct TDS is on the person responsible for payment. In the case of cryptocurrencies where the transaction happens through crypto exchanges, whether the person responsible for payment would be the actual seller or the exchange through which the payment is routed

- In the cases where the payment of consideration is through crypto assets, the person responsible for payment shall ensure that the tax on the transaction is paid. No proper mechanism has been prescribed for the same, which could create lot of ambiguity on the part of the person responsible for making the payment.

- The amendments are effective from the FY 2022-23 but as stated earlier, numerous transaction have taken place in the last couple of years, the taxability of the same would be subject to litigation. However, with proper documentation to support the claims, the litigation could be averted with income being taxed as profits and gains of business or profession or capital gains as the case may be.

Despite the above ambiguities, the introduction of a tax regime for virtual digital assets is a step in the right direction and iterations are expected considering the fact that it’s a newly evolving technology and not yet regulated. Introduction of tax regime alone shall not be construed as the government’s intention to legalise the cryptocurrency. Though the latest indications as such are that the government would permit holding of crypto currencies as assets but not as a legal tender, we have to wait and watch for the proposed regulation to be tabled in the parliament.

Crypto Tax - Everything You Need to Know

This article has been co-authored by Om Rajpurohit (Director, Corporate & International Tax, AMRG & Associates).

Introduction

The long-awaited Cryptocurrency Bill, which was supposed to be introduced in Parliament during the winter session, got delayed. Previously, the government had refused to grant cryptocurrencies the status of legal tender. In 2018, the RBI attempted to impose a ban by restricting banking services to cryptocurrency exchanges. The ban, however, was later overturned by the Supreme Court.

Finance Minister Nirmala Sitharaman proposed a crypto tax on transactions of virtual digital assets (VDA) like Bitcoin and Ethereum on February 1, 2022, while presenting the "Budget 2022". Additionally, she stated that the Reserve Bank of India (RBI) will launch its own digital currency in 2022-23. The announcement has put an end to long-running speculations about how the Government of India will approach the evolving digital currency space, particularly in light of concerns raised by various sections.

The rollout of a central bank's digital currency will significantly boost the digital economy. Additionally, the digital currency will result in a more efficient and cost-effective currency management system.

What is Virtual Digital Asset?

Proposed new clause states that virtual digital asset(“VDA”) mean:

a) any information or code or number or token, generated through cryptographic means, providing a digital representation of value exchanged, with the promise or representation of having inherent value;

b) a non-fungible token;

c) any other digital asset, as notified.

Finance Minister, Nirmala Sitharaman announced a 30% tax on income from virtual digital assets, stating that the size and frequency of such transactions necessitated the creation of a specific tax regime.

Will you have to pay tax on both gains and losses from crypto?

Crypto investors cannot set off any loss arising from the transfer of virtual digital assets and such loss will not be allowed to be carried forward to subsequent financial years.

In simple words in case any taxpayer has earned any income from the transfer of a virtual digital asset, the said income shall be subject to tax tax @ 30%. This source cannot be combined with any other source of income. If all the tranactions during the year results in positive income, the same amount shall be chargeable to tax at the rate of 30%.

No deduction in respect of any expenditure other than the cost of acquisition of a VDA shall be allowed to the taxpayer under any provision of the act.

Losses arising from the transfer of crypto assets cannot be set off against any other income and also it cannot be carried forward. However, intra-head consolidation of all VDA transactions entered during the year is permissible.

Let's look at an example to better understand this-

A taxpayer gained Rs. 5 Lakhs on the sale of Cryptocurrency A and posted a loss of Rs. 2 Lakhs on the sale of Cryptocurrency B. The taxpayer can set off the loss and the net gain from the sale of crypto assets (both Cryptocurrency A and B) and Rs. 3 lakh would be subject to tax @30%.

Will you have to pay more than 30% tax on crypto income?

The effective tax rate on income from the transfer of cryptocurrencies, NFTs, or other virtual digital assets may be higher than 30% because this flat rate excludes any applicable surcharges and cess.

The surcharge is applied at the rates of 10%, 15%, 25%, and 37% of the tax amount, depending on the taxable income, and the cess is applied at the rate of 4% of the tax and surcharge amount. As a result, gains from the transfer of Crypto assets may be subject to effective taxation at rates of 31.2 percent, 34.32 percent, 35.88 percent, 39 percent, and 42.744 percent, depending on taxable income in the case of individuals/HUFs.

TDS Implications on Virtual Digital Asset

Any person who pays consideration to a resident for the transfer of a virtual digital asset is required to withhold TDS at the rate of 1%.

There will be no TDS implication if the consideration is paid:

a) by a specified person and does not exceed INR 50,000 in the fiscal year.

b) By anyone other than the specified person, if the amount does not exceed INR 10,000 in the fiscal year.

There will be no TCS implications where TDS has been deducted.

Gift of Virtual Digital Asset

The Union Budget for 2022-23 broadens the definition of "property" to include Virtual Digital Assets, which will become effective on April 1, 2022. As a result, the gift of a Virtual Digital Asset will be taxable in the hands of the person who has received it.

Open issues

Even though this is a good beginning for the Indian crypto eco-system, certain aspects require clarification from the long-term stability perspective.

The First would be whether the acquisition cost will include direct expenses such as brokerage charges, exchange fees, and various directly incidental expenses.

There are various types of coin-like stable coins, utility coins whose value is derived from an underlying asset.  Government did not clarify whether such underlying assets would also be taxed at 30% or not.

Many times moneys are routed through the exchanges and sometimes it's not apparent who's responsible for deducting TDS on exchange transactions when the buyer and seller can't be identified, if that happens, would the taxpayer be required to figure out who's selling on the other side or buying on this side and comply? This is a real problem that has to be addressed by the government.

Another intriguing aspect is that the new provision states that taxpayers must withhold 1% of the tax on the exchange of virtual digital currency, whether it is entirely on exchange or barter, or partly in cash and partly in exchange. When the cash component is insufficient to cover the 1% TDS, the person in charge of paying must ensure that the recipient, i.e. the seller, has paid the tax. It is unclear how this will be accomplished, whether taxpayers will be required to rely on the CA certificate, the advance tax challan, or some other method. Clarity is required in this regard in order to avoid future contractual and legal litigation.

There has been no clarification provided in the laws regarding the impact of TDS/TCS on global cryptocurrency exchanges. Though it is anticipated that overseas crypto exchanges will not deduct TDS, taxpayers will still be required to pay tax on their crypto gains. If this is not the case, the individual may be prosecuted with tax evasion, which will result in heavy penalties when detected.

In India, more than 100 million people are involved in cryptocurrency exchanges, whereas just 60 million people file their annual income tax forms, according to the government. Now that the finance minister has recognised cryptocurrency exchanges as virtual digital assets and has levied a 30 percent tax on income derived from them, the number of annual returns submitted in India may shoot up very soon.

According to Finance Ministry officials, government will levy goods and services tax (GST) on cryptocurrency transaction fees rather than the digital asset's gross value. The definition of virtual assets in the budget would classify cryptocurrencies or non-fungible tokens as 'intangible goods,' subjecting them to GST.

It is still unclear whether GST will be levied on the margin or the gross value of the virtual asset. As a result, in order to address such anomalies, the government must provide clarification.

Conclusion

Indian government is beginning to recognize crypto as an emerging asset class, and thereby introduction of Crypto tax was a milestone in Indian income tax laws. 30% taxation will have a negligible impact on trifling crypto investors as tax brackets are already similar to regular taxes on short-term securities holdings.

Next issue on the block would be to untangle the GST levy on the crypto transactions. Several state tax officers are definitely working on this thread to identify the areas for which taxation needs to be clarified. We hope with clarification from government on GST by Budget 2023 would add stability to the overall taxation of crypto in India.

Taxation of Virtual Digital Assets – The Finer Aspects

Background

The Reserve Bank of India had reportedly been pushing for a complete ban on all cryptocurrency transactions. In spite of these concerns, investments in digital assets have been rising across the country. Due to the increase in the frequency and volume of transactions of Virtual Digital Assets, for the first time, the provision for the taxation of virtual digital assets is introduced in Budget 2022, bringing Cryptocurrencies & Non-Fungible Tokens (NFTs) under the tax net.

Basic scheme of taxation under the Act

The Finance Bill, 2022 proposes to tax income from the transfer of Virtual Digital Assets (VDA or VDAs) under section 115BBH. Before any income can be taxed under the Income tax Act, 1961, one has to find out:

• Whether the assessee is an Indian resident or not?

• Whether the situs of the VDA is in India or outside?

• How to determine the situs of the VDA - depending on the residential status or citizenship of the assessee transferring the VDA or that of its miner / creator or based on the place where the exchange is registered or any other factor?

In the absence of guidance on these key aspects, the general provisions of the Act would continue to apply. This means that in the case of determining the taxability of a non-resident in India, one has to take recourse to the general provisions under sections 4 and 5 of the Act. Thus, if the situs of the VDA is not located in India, its income may not be taxable in India.

Having said that, we now proceed to analyse the definition of VDA as proposed by the Finance Bill, 2022. The scope of this article is restricted to the analysis of the definition of VDA under the proposed section 2(47A) and the plausible implications.

Definition of VDA

The proposed section reads as:

‘(47A) “virtual digital asset” means––

(a) any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;

(b) a non-fungible token or any other token of similar nature, by whatever name called;

(c) any other digital asset, as the Central Government may, by notification in the Official Gazette specify:

Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein.

Explanation.––For the purposes of this clause,––

(a) “non-fungible token” means such digital asset as the Central Government may, by notification in the Official Gazette, specify;

(b) the expressions “currency”, “foreign currency” and “Indian currency” shall have the same meanings as respectively assigned to them in clauses (h), (m) and (q) of section 2 of the Foreign Exchange Management Act, 1999.’.

As one would observe, the definition of VDA is very widely worded. This implies that the Revenue desires to bring to tax digital assets in any form. For the sake of simplicity, let’s assume that we are analyzing whether ‘Gothic’ is a VDA or not.

Coverage

As per the definition, Gothic would be considered as a VDA if it is covered under any of the clauses (a), (b) or (c) above. This means that it may be either:

a. An information or code or number or token meeting the other conditions; or

b. A non-fungible token (NFT) or any other token which is similar to NFT – Explanation to section 2(47A) provides that NFT is a digital asset which is notified by the Central Government; or

c. Any other digital asset as notified by the Central Government.

It implies that if Gothic is not notified under clauses (b) and (c), it may still be covered under clause (a).

Characteristics of VDA for the purpose of clause (a) of section 2(47A)

If Gothic is not a VDA under clauses (b) or (c) of section 2(47A), it may still be considered as a VDA under clause (a). For this purpose, Gothic must be considered as any information or code or number or token which cumulatively satisfies the following conditions:

Cryptocurrencies

The proposed amendments do not mention or define the word ‘cryptocurrencies.’ As per the Merriam-Webster’s dictionary:

“Cryptocurrency means: any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions”

In real life, cryptocurrencies may be simply used as an investment asset. They are also being accepted as a valid currency in the virtual world. They are being used to:

• Make low-cost and quick money transfers across the globe;

• Make private investments in companies;

• Buy and sell goods or services;

• Play online games or buy new features of the games; or

• Travel worldwide (being considered as a universal currency) etc.

This means that cryptocurrencies can be used as a medium of exchange apart from being considered as an investment or a speculative asset. Thus, not every transaction in cryptocurrencies may be a taxable transaction (eg. NRIs using cryptocurrencies to remit money to Indian relatives). Yet, it may be taxable considering the current drafting of the proposed provisions. It is pertinent to note that the Revenue cannot subject to tax the transactions which are not otherwise taxable under the guise of the VDA regime.  Hence, the provisions should be amended to tax the transactions which are in the nature of investment / speculative transactions; the transactions where cryptocurrencies are being used as a medium of exchange should be specifically excluded from the purview.

NFT vs Cryptocurrencies

It may be worthwhile to note that non-fungible token (NFT) and cryptocurrencies are two different things. As per the Merriam-Webster’s dictionary:

Non-fungible token means

a: a unique digital identifier that cannot be copied, substituted, or subdivided, that is recorded in a blockchain, and that is used to certify authenticity and ownership (as of a specific digital asset and specific rights relating to it)

b: the asset that is represented by an NFT

A preliminary analysis of the definition indicates that cryptocurrencies and NFTs are two characteristically different things.

NFTs lead to the creation of digital assets like designs, paintings, graphic characters etc. Digital geeks and students have developed innovative digital designs known as NFTs which have a booming market.  The creator owns these assets (akin to patents). These NFTs can be sold outright or retained by the owner to earn royalty from allowing others the 'right to use'. The fact that NFTs can be traded or transacted in cryptocurrencies does not mean that NFTs are cryptocurrencies.

Besides, as the definition of NFT stands today u/s 2(47A), an item may be considered NFT only if it is notified by the Central Government. There are millions[5] of NFTs being traded in the virtual world and new NFTs are constantly being invented. It may not be possible for the Government to notify all these NFTs or the new ones being created. This may lead to unintended consequences of tax arbitrage (explained later in this article) amongst NFTs that are notified and those which are not. Rather, the Government may consider adding NFTs like any other tangible physical assets and the tax treatment accorded must be the same as other tangible assets.

Exclusions from VDA

Proviso to the section provides that the Government may also notify certain digital to be specifically excluded from the purview of VDA. Thus, if Gothic is specifically excluded from the definition of VDA, it will not be taxable under the proposed section 115BBH. This does not mean that it is automatically exempt. It simply means that income from Gothic would be taxable under the normal provisions of the Act which provide for:

• Categorization of income as business income, capital gains or income from other sources

• Benefit of deductibility of expenditure incurred on such income

• Benefit of set-off of losses and carry-forward of losses

• Benefit of slab rates of tax

It may be worthwhile to think whether the proposed definition is opening up the possibility of tax arbitrage by determining whether an asset can be taxed as a VDA or under any other provision of the Act which may prove to be more beneficial.

Virtual digital asset vs digital asset

The definition of VDA uses two terms – “virtual digital asset” and “digital asset”. Usage of 2 different terms would leave open a room for future litigation in the matter.

Our suggestions

It is true that the quantum of trading in VDAs has increased exponentially over the years. People have made money from it and the same should be brought to tax. The Revenue has rightly cleared its stance on the taxation of VDAs. However, the Revenue may be advised well to tread step-by-step on this path. For instance, the proposed definition could have been an exhaustive definition taxing a limited number of VDAs which are clearly identified. Once successfully implemented as a pilot project the definition of VDAs may be further expanded.

Cryptocurrency- Key GST Questions Post Budget 2022

This article has been co-authored by Onkar Sharma (Principal Associate, Khaitan & Co).

1. Background

While the legality of cryptocurrency / assets in India remains under a shadow of doubt, the following developments in the recent past have once again put a spotlight on the Goods and Services Tax (GST) implications vis a vis various transactions in cryptocurrency / assets:

1. Proposal in Finance Bill, 2022 to introduce a new scheme of taxation of ‘virtual digital assets’ (VDAs) to levy income tax and mandate tax withholding at source (TDS) on transfer of VDAs: VDAs have been defined in a wide manner to cover all varieties of cryptocurrencies, NFTs, etc.,

1. income arising from transfer of VDA’s taxable at 30 % (plus applicable surcharge and cess) with no deduction of expenses or set-off of any losses except for the costs incurred in acquiring the VDA’s; and

2. persons making payments to Indian residents towards the transfer of a VDA, to withhold tax at 1 % on such sum.

2. Inspections conducted against 5 (five) crypto-exchanges by the Directorate General of GST Intelligence (DGGSTI) in the last few months resulting in recovery of more than INR 80 (eighty) crores of GST in back-taxes. Per the media reports on the said inspections, the key issue seems to have been non-payment of GST on commissions / facilitation fees earned by such exchanges in certain scenarios, viz.,

1. commissions for facilitating transactions by foreigners; and

2. transactions where commission was earned in native crypto.

Given the proposal to introduce a new scheme of taxation of VDA’s to levy income tax, a question arises as to whether, it is now possible to infer that under the GST regime, cryptocurrencies / NFTs will qualify as ‘intangible goods’ and therefore, will be liable for payment of GST accordingly.  The same has been examined below.

2. Nature of cryptocurrency from a GST perspective

Unlikely to qualify as ‘Security’: Securities are specifically excluded from the definitions of both ‘goods’ and ‘services’ under the GST regime. Section 2(101) of the Central Goods and Services Tax Act 2017, (CGST Act) read with the explanation to Section 2(h) of the Securities Contracts (Regulation) Act 1956, defines “Securities” as below:

“Securities include-

 (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;

(ia) derivatives;

(ib) units or any other instruments issued by any collective investment scheme to the investors in such schemes;

(ii) government securities;

(iia) such other instruments as may be declared by the Central Government to be securities; and

(iii) rights or interest in securities.”

While the definition begins with ‘include’, given the very specific enumerations thereafter, it appears that the word ‘securities’ has to be understood in light of the specific categories mentioned above. All these categories, stripped to their bare essence, envisage certain rights that the recipients obtain over the issuer of ‘securities’. Given that cryptocurrencies do not have a centralized issuing authority that undertakes to repay the value represented by a unit of cryptocurrency, cryptocurrencies are unlikely to qualify as ‘securities’ and thus get excluded from GST accordingly.

The foregoing conclusion is based upon the law as it stands today. The lawmakers may, as a policy decision, decide to amend the definition of ‘securities’ under GST to include cryptocurrencies, thereby taking it out of the ambit of levy of GST on its own.

Unlikely to qualify as ‘actionable claim’: Schedule III of the CGST Act specifies “Actionable claims, other than lottery, betting and gambling” as “Activities Or Transactions Which Shall Be Treated Neither As A Supply Of Goods Nor A Supply Of Services” and thus will not be liable to GST. Section 2(1) of the CGST Act read with Section 3 of the Transfer of Property Act 1882, defines ‘actionable claim’ to envisage two scenarios: (i) an enforceable claim to an unsecured debt; and (b) an enforceable claim to a beneficial interest in a movable property that is not in possession of the claimant.

Given that cryptocurrencies do not have a centralized issuing authority which undertakes to repay the value represented by a unit of cryptocurrency, cryptocurrencies do not appear to fall under (i) above. Further, given that cryptocurrencies are themselves likely to qualify as ‘movable property’ (which would typically be in ‘possession’, in the relevant cryptocurrency ‘wallet’), it would be difficult to argue that cryptocurrencies represent claim to a beneficial interest in a movable property which is not in possession. Thus, cryptocurrencies are unlikely to qualify as ‘actionable claim’ either.

‘Goods’ or ‘Services’? - Section 2(52) of the CGST Act defines ‘goods’ to mean “….every kind of movable property other than money and securities but includes…..”. Section 2(36) of the General Clauses Act defines ‘movable property’ in a rather all-encompassing manner - “movable property shall mean property of every description, except immovable property”. The word ‘property’ has also been interpreted in a wide manner by courts in various contexts to be a bundle of rights which the owner has over or in respect of a thing, tangible or intangible, or the thing itself over or in respect of which the owner may exercise those rights. Given the foregoing, cryptocurrencies are likely to qualify as ‘goods’ under GST laws in India, albeit intangible ones – unless otherwise clarified by the Government.

The introduction of ‘virtual digital assets’ as a new category for income tax purposes can be referred to under GST laws as well to buttress the foregoing conclusion in as much as ‘digital assets’ as a class would qualify as ‘intangible goods’.

3. GST implications if cryptocurrency qualifies as ‘intangible goods’ for GST purposes

In the wake of media reports about inspections against crypto exchanges, most of the discourse has focussed on potential implications on such exchanges. However, before going into that, it is pertinent to examine the GST implications when cryptocurrency is used to pay for goods / services, in a scenario where cryptocurrency qualifies as ‘intangible goods’ for GST purposes.

1. Implications when cryptocurrency is used to pay for goods / services

The term ‘consideration’ has been defined under Section 2(31) of the CGST Act to include “...any payment made, whether in money or otherwise, in respect of the supply of goods or services...”. Here, it would be necessary to refer to the definition of the term ‘money’ as provided under Section 2(75) of the CGST Act.

As per the definition ‘money’ means “…the Indian legal tender or any foreign currency,….or any other instrument recognised by the Reserve Bank of India…”. Thus, it can be stated that a currency would qualify as ‘money’ under the CGST Act only if the said currency has been recognised by the Reserve Bank of India (RBI). The initial ban by RBI was overturned by the Supreme Court, however, the RBI has not recognised cryptocurrency (like Bitcoin, etc.) in any manner whatsoever. Therefore, as on date, ‘cryptocurrency’ cannot be classified as ‘money’ under the CGST Act.

At this juncture, it may be noted that the phrase “or otherwise”, which is occurring in the definition of the term ‘consideration’, would include situations / transactions like ‘barter’. This is because typically in ‘barter’, the recipient of supply does not make payment to the supplier by paying ‘money’, instead, the ‘consideration’ is paid by the recipient in ‘kind’; meaning thereby, that the supply is received either in lieu of some other specific goods or services. Thus, using cryptocurrency to pay for goods / services may lead to the transaction being treated as if it is a barter transaction (supply of goods / services against receipt of intangible goods i.e., cryptocurrency) and accordingly, be made liable to GST.

GST law in India is not quite settled apropos certain aspects of barter transactions. Accordingly, if a transaction qualifies as a ‘barter’ under GST, following issues may require greater analysis:

1. There is ambiguity as to which leg of the transaction would qualify as a ‘consideration’ and which leg would qualify as a ‘supply’. This may lead to a scenario where GST authorities in India may argue that transfer of / payment in cryptocurrency received by Indian parties is a separate ‘supply of intangible goods’, thereby, making the parties (located in India) liable to deposit tax / GST[1].
2. In the case where payment through cryptocurrency is construed to be the ‘consideration’, it is unclear as to how value will be ascribed to such ‘consideration’ for the purpose of levying GST.

Practically, if an Indian customer uses cryptocurrency to pay for goods / services, GST can apply at two levels, (i) GST borne by the customer for acquiring cryptocurrency upon payment in money; and (ii) GST applicable on the purchase of goods / services, which have been paid for using cryptocurrency.

Impact on ‘export’ position under GST: One of the key conditions for availing the benefit of ‘zero rating’ for exports under GST is the receipt of the consideration in ‘convertible foreign exchange’. The term ‘convertible foreign exchange’ will have to be interpreted in light of the provisions stipulated in Indian foreign exchange laws. As the laws stand currently, it would be difficult for cryptocurrency to qualify as a ‘convertible foreign exchange’ thereby jeopardizing the tax benefits of ‘export’ transactions under GST.

2. Implications vis a vis cryptocurrency exchanges

In this regard, it is pertinent to quote Mr Vivek Johri, Chairman, Central Board of Indirect Taxes and Customs (CBIC) - “Our interpretation is that there is clarity in the law and the commission paid to the operator or an exchange, which is providing a platform for transaction in digital currency, is in a view of service he provides to the users of that platform and, therefore, it is the supply of service which is chargeable to GST.” (Source: Link)

As per the media reports, the crypto exchanges do not seem to be disputing that they are providing services to traders and that the said services are liable to GST. The dispute appears to have arisen vis a vis valuation of such commission in as much as whether the value of that part of the commission which was being received in cryptocurrency. Since ‘transaction value’ constitutes the taxable base for levy of GST and given the wide definition of ‘consideration’, there doesn’t seem to be any scope to exclude the portion of commission received in modes other than money (including in crypto currency). Nonetheless, it would be ideal, from a certainty of tax position perspective, for the CBIC to issue a formal clarification to this effect.

3. Lessons from Australia and the United Kingdom (‘UK’)

Australia: Till July 2017, the position in Australia was similar to what has been discussed above. As per the ruling no. GSTR 2014/3 from the Australian Tax Office (ATO), using cryptocurrency to pay for goods / services would have led to the transaction being treated at par with a barter transaction. GST was to be paid on the value of the cryptocurrency in Australian dollars, at the time of the transaction. The problem of dual-level taxation (as mentioned above in the Indian context) was identified in Australia too and the position was reviewed.

From 1 July 2017, the guidance note provided by ATO[2] states that: “Sales and purchases of digital currency are not subject to GST from 1 July 2017. This means that you do not charge GST on your sales of digital currency and similarly, you are not entitled to GST credits for purchases of digital currency.”  Basically, a treatment comparable to ‘exempt supplies’ under Indian GST laws have been prescribed.

The note further prescribes: “…..No GST consequences arise when you use digital currency to pay for goods and services in your business. Digital currency is a method of payment and the consequences of using it as payment are the same as the consequences of using money as payment…..If you receive digital currency as payment for your sales of goods and services normal GST rules apply.”

UK: The UK HM Revenue and Customs (HMRC) released its internal Crypto-assets manual[3], to provide guidance for tax treatment of crypto-assets for its staff and to assist professional advisors and customers in understanding HMRC’s interpretation of law.

The manual clarifies: “VAT is due in the normal way on any goods or services sold in exchange for cryptoasset exchange tokens. The value of the supply of goods or services on which VAT is due will be the pound sterling value of the exchange tokens at the point the transaction takes place……no VAT will be due on the supply of the token itself”. Effectively, the position seems similar in UK and Australia today.

4. Concluding thoughts

With some level of clarity emerging under income tax as proposed vide Finance Bill 2022, the next few GST council meetings would be crucial to see if similar clarifications are announced for GST as well. In any case, the budgetary announcements have certainly made it clear that crypto currencies / assets would not escape Indian taxation.

One hopes that akin to Australia and UK, clear and progressive guidelines will soon be issued in India apropos GST. 

Tax on Virtual Digital Assets – Another Step Towards Digital Taxation

This article has been co-authored by Viraj Kurani (Senior Manager, Deloitte Haskins and Sells LLP) & Harshula Khatri (Deputy Manager, Deloitte Haskins and Sells LLP).

VDA – Proposed Provisions:

The Bill has proposed to tax the transfer of VDAs at the rate of 30% (excluding surcharge), and taxpayers would not be able to claim deduction of any expenditure other than the cost of acquisition of such VDA, while computing the income from transfer of such VDA.

No set-off of any loss arising from the transfer of VDA would be allowed against any other income under the Income-tax Act, 1961 (‘the Act’). Further, unlike the case of taxation of shares and securities or speculative transactions, such loss would not even be allowed to be carried forward to subsequent assessment years. In other words, loss on transfer of VDAs in any year may only be set-off against income from transfer of other VDAs in the same year itself, and the losses remaining to be set-off, would have to be foregone by the taxpayers. However, a clarity in this regard by the government would be appreciated.

Further, the Bill also proposes to tax gift of VDAs in the hands of the recipient.

Tax Withholding on VDA transactions:

In order to enforce the compliance on reporting and tracking of these transactions, the Bill has proposed to insert the provisions for TDS on the transfer of VDAs to a resident at the rate of 1% of the transfer value.

However, there are certain minimum threshold limits provided for triggering of tax withholding provisions as under:

It has also been clarified that in cases where the provisions of section 194-O of the Act dealing with TDS on payments made by an e-commerce operator to an e-commerce participant are also applicable, then the proposed provisions of TDS on VDA transfers shall apply and not the provisions of section 194-O of the Act.

Certain open issues regarding the proposed provisions:

Who is liable to deduct tax - exchanges or actual buyers of VDA?

In the absence of any formal exchange in India for regulating these VDAs, and challenges in tracking of buyers and sellers, it could be difficult to verify and track these transactions. Also, whether in these cases the ‘Exchange’ handling the VDA transactions could be considered as ‘payer’ and thereby, be responsible for making TDS compliances, needs clarity.

How to value the transaction if payment made in kind? How to ensure tax is paid even before payment is made to seller?

In the proposed provisions, it is provided that in case the payment for transfer of VDAs is wholly in kind or in exchange of another VDA where there is no part in cash or partly in cash and partly in kind and the cash portion is not sufficient to meeting the TDS liability, the buyer of such VDA should ensure that tax has been paid in respect of such consideration, before making the payment.

However, in the absence of any guidance on the valuation of the assets transferred in kind and the mechanism for the buyer to ‘ensure’ that tax is paid, unintended hardships on the buyers can be caused.

For example, if a seller ‘S’ sold VDA1 on Exchange X, in return for VDA2 to buyer ‘B’, then:

• Who would be liable to deduct tax? Buyer ‘B’ or Exchange X, as the transaction is done through the Exchange?

• What would be the value on which tax is required to be deducted?

• How will the buyer or the Exchange ensure that taxes are paid even before the payment is made to the seller when there is no, or inadequate monetary consideration paid in this case?

• Even in case the transaction was made by way of monetary consideration, how would the buyer ensure that the seller has paid the tax even before releasing the payment to the seller?

Considering these practical challenges, the taxpayers would expect clarifications from the government.

Distinction between taxability on transfer of shares / securities vis-à-vis VDA:

Although for practical purposes, the investment and manner of trading of VDAs may be somewhat similar to dematerialised shares/ securities by the investors, however, the manner of computation and levy of tax on income from transfer of these assets are not alike. A few instances are discussed hereunder:

Thus, there seems to be a conscious move to distinguish the scheme for taxability of shares / securities vis-à-vis VDAs.

Parting thoughts

With the trading in cryptocurrencies and NFTs gaining popularity and the increasing magnitude of the transactions, the taxing of these transactions was inevitable. The clarity on its taxability provided by the Bill  is certainly a welcome move, however, the high rate of tax along with no ability to set-off and carry forward the losses appears to be little harsh.

Further, clarity as to whether VDA covers digital wallets, digital gold, etc. will go a long way in avoiding unnecessary litigation.

Cryptic Start to Cryptocurrency Tax!

This article has been co-authored by Harshal Sutaria (Chartered Accountant) & Shaili Bheda (Chartered Accountant)

Amid uncertainty, ambiguity, speculation and unparallel buzz around the regulatory and tax aspect of digital currency / tokens in India, the Indian Government has finally by way of Budget 2022 has shed some light on their intent and attempted to provide direction with respect to taxability of digital currencies / assets.

The Hon’ble Finance Minister in her speech stated there has been a phenomenal increase in transactions in virtual digital assets (VDA) and consequently, it is imperative to provide for a specific tax regime for transactions affecting VDA. In light of the same, it is proposed in the Budget 2022 to tax income from transfer of VDA at a flat rate of 30%, similar to the tax rate on winnings from lottery, game shows, puzzles, etc. 

The Hon’ble Finance Minister in Union Budget 2022 also announced the launch of India's own digital currency based on Blockchain technology. The Reserve Bank of India (RBI) shall introduce digital currency, its central bank digital currency (CBDC) in the fiscal year beginning April 2022. Like various other countries India will have its own virtual form of a fiat currency and unlike other private digital tokens or crypto tokens, the CBDC will be regarded as bank notes. A successful implementation of the digital currency would not only curb black money and reduce cash management which will result in substantial savings but would also counter the fad for private digital or crypto tokens which according to the Government’s past stance lacks any fundamentals.

In the ensuing paragraphs, we have attempted to discuss the proposed provisions which will advent taxing of income on transfer of VDA and also, the open points / key areas where appropriate and timely clarification is warranted to bring certainty in the tax proposals.

Tax provisions surrounding Virtual Digital Assets in India

The Hon’ble Finance Minister in the latest budget has proposed to levy a tax on virtual digital asset. In this regard, section Section 2(47A) is proposed to be inserted to the Income-tax Act, 1961 (‘Act’) which defines virtual digital assets (VDA) to cover not only digital tokens, i.e., crypto tokens but also Non-Fungible Tokens (NFTs) and any other digital asset as notified by the Government.

New scheme has been proposed with respect to taxation of VDA in form of Section 115BBH which shall be effective from fiscal year 2022-23. As per the proposed provisions, income from transfer of VDA is proposed to be taxed at a flat tax rate of 30 percent irrespective of purpose and period of holding. It is also interesting to note that no expenditure in the nature of deduction / allowance shall be considered in computing the income except for the cost of acquisition of such VDA.

Further, while computing the total income of the taxpayer for a given year, loss arising from transfer of VDA shall not be eligible to be set off against any other income. Also, in case of loss arising from transfer of VDA, the same shall not be allowed to be carried forward to subsequent years.

Further, Section 56(2)(x) of the Act has been proposed to be amended to include VDA in the definition of property. Thus, gifting of VDA (between unrelated parties) over the threshold of INR 50,000 is proposed to be taxed in the hands of the recipient.

In order to maintain and collect the details in respect such transactions, the finance minister has proposed to introduce withholding tax on consideration on transfer of VDA by residents taxpayers. In this regards, section 194S is proposed to be introduced from 1 July 2022 which provides that  tax at the rate of one percent would be required to be withheld by the person paying consideration for transfer of VDA. However, tax would not be required to be withheld by following persons –

It has also been clarified that the Individual or HUF (as covered above) responsible for paying consideration on transfer of VDA would not be liable to obtain TAN or undertake the recently introduced verification of non-filer of return of income.

The said bill also proposes that if tax has been deducted under section 194S,
then no tax is required to be collected or deducted under any other provision of Chapter XVII of the Act.

Further, in case the transfer of VDA is carried out in kind or partly in cash or partly in kind and the cash component is not sufficient to meet the withholding liability in respect of the transaction, the person responsible for making payment of consideration on transfer of VDA shall ensure that the appropriate tax has been paid in respect of such consideration before making payment of such consideration.

Currently the proposed tax regime surrounding VDA announced in Budget 2022 is met with divergent views across the industry players in India. While some believe that this is a welcome move by the Government which will help in providing clarity, others believe that steep tax rate of 30% coupled with no deductions and set off of losses is deterrent to the interest of the investors and miners.

While the long awaited ask for clarity on taxation of VDA seems to be addressed by the Budget, clear directives / regulations will be required to be issued to address various open areas to mitigate practical difficulties which would be faced by industry players, some of which are highlighted below.

Key issues emanating from proposed amendment –

Issues pursuant to insertion of section 2(47A) –

• Definition of foreign currency - In the proposed section 2(47A), VDA has been defined to mean any information or code or a number or token excluding foreign currency and Indian currency. Further, explanation to the proposed amendment stated that foreign currency would be stated to mean the foreign currency as defined under Foreign Exchange Management Act, 1999 (FEMA). As per FEMA, foreign currency means any currency other than Indian currency. There are several countries which have adopted cryptocurrencies or some of the cryptocurrencies as their legal currencies (for e.g., EL Salvador has adopted Bitcoin as their legal currency). On literal interpretation, this might imply that Bitcoin is a foreign currency and consequently, may be argued that such currency is outside the ambit of VDA in India. While going by the Hon’ble FMs speech this does not seem to be the intention of the Government, timely clarification in this regard would be welcome to match the intent of the Indian authorities and reduce litigation arising, if any.

Issues pursuant to amendment in section 56 of the Act –

• Fair market value of VDA - As per the proposed amendment in section 56 of the Act, VDA has been added to the definition of property and as a result, gift of VDA from one person to another person (in case both the above persons are not relative), would be taxable in the hands of the recipient. As per the provisions of section 56(2)(x) of the Act, fair market value (FMV) of the VDA would be considered as the income in the hands of recipient. However, the current rules do not prescribe methodology to calculate FMV of the VDA. One would have to wait for the final budget and amendment in the relevant rules to see the methodology for arriving at FMV of VDA. Having said so, given the nature of VDA being very volatile and prominence of foreign players, it may be difficult to assert methodology for arriving at the FMV of VDA.
• Cost of acquisition in the hands of the transferee – As per the current provisions, when a capital asset is transferred by a person to another person as a gift, cost of acquisition of the previous owner is available to the transferee of the gift. However, there is no similar clarity under proposed amendments on the cost of acquisition to be considered on the subsequent transfer of such asset i.e., whether cost to previous owner would be available while computing the cost of acquisition. For example, Mr A. transfers VDA as a gift to his son Mr. B (covered under the definition of relative) the same shall be exempt in the hands of Mr B. However, when Mr. B in turn transfers such VDA, no clarity is provided with respect to the cost of acquisition available in the hands of Mr. B.

Issues pursuant to insertion of section 115BBH –

• Set off of losses within section 115BBH - Proposed section 115BBH specifies that no loss arising on transfer of VDA shall be allowed to be set off against any other income. However, the section is silent in respect of inter head setoff of losses against the gain arising from multiple transactions on transfer of VDA. For example, Mr. X undertakes multiple transaction during the fiscal year, i.e., he sold Bitcoin and incurred a loss of INR 5,000 and Mr. X further during the said fiscal year also sold NFTs making a gain of INR 7,000. The current provisions do not explicitly provide clarity whether the loss of INR 5,000 on transfer of Bitcoin would be allowed to be set off against gain on transfer of NFT. While this might not the intention of the Government, appropriate clarification in this regard would be welcome to set certainty towards the voluminous transactions that an investor may undertake of VDA.

• Taxability in the hands of Miner – Miners play an important role in creation of VDA. Basically, miners are the individuals who undertake series of complex transaction related algorithms to generate the VDA. The miners then either offload the VDA on several exchanges or sell to third parties. The proposed provisions states that any income received by the taxpayer on transfer of VDA would be taxable. Further, no deduction in respect of any expenditure other than cost of acquisition of VDA would be allowed in the hands of the transferor of VDA. However, as VDA is self-generated asset to a miner, there is an ambiguity whether the expenses incurred by a miner in creation of VDA would be allowable while arriving at the income from transfer of such VDA. 

• Income in Barter transaction – As discussed above, the proposed provisions state that any gain on transfer of VDA after deducting cost of acquisition would be taxable in the hands of the transferor. However, in practice, there are various service providers who accept VDA in lieu of services performed. In such a scenario, the proposed provisions do not provide any clarity on the valuation of the income to be taxed in the hands of service provider.

• Method to be followed to determine cost of acquisition – As stated above, cost of acquisition of the VDA is the only expenses which a transferor of VDA can deduct from the income received from transfer of VDA while arriving at the taxable income on transfer of VDA. While in case of NFT, each token is uniquely identifiable the same does not hold true for crypto tokens wherein challenges would be faced in accurately calculating the cost of acquisition. In practice, the traders and investors, may have bought relevant VDA at different intervals at different cost. The proposed provisions do not prescribe any method to arrive at the cost of acquisition of the VDA. In the absence of guidelines, there is no clarity with respect to the method to be followed for calculating the cost i.e., FIFO, LIFO or weighted average.

• Applicability to Non-resident – The proposed provisions provide for charging of tax on total income of all taxpayers, including non-residents. As, VDA are virtual in nature, if one would argue to apply the provisions on source-based taxation rules, it would pose a serious challenge. For e.g., Mr. M (Non-resident Individual) transfer VDA to Mr. N (Indian Resident) from outside India and Mr. M has other income arising or accruing from India for which he pays taxes and files return of income in India. Would the proposed provisions be applicable to Mr. M? Also, whether Mr. M would be able to classify the said income from transfer of VDA as other income and be able to claim DTAA benefit? While such farfetched taxability may not be the intent of the Government, necessary clarification in this regard will assist in bringing certainty amongst the industry players.

Issues pursuant to insertion of section 194S -

• Applicability of Equalisation Levy 2.0 – As per the extant provisions of Equalisation Levy, non-resident e-commerce operator who is facilitating online sale of goods or services to a resident, shall be liable to collect and pay equalisation levy at the rate of 2% on the consideration received from the resident. As per the proposed provisions of section 194S, any person responsible for paying to a resident consideration for transfer of VDA shall be liable withhold tax at the rate of 1%, subject to certain exemptions. In practice, there are various digital exchanges which are non-resident which assist Indian residents in trading in VDA. While the proposed provisions provide clarity that once, a person is liable to withhold tax under the proposed provisions of section 194S, they would not be liable to withhold or collect any tax under the said chapter. However, equalisation levy being different provisions, there is an ambiguity whether, the non-resident digital exchanges would be liable to withhold tax under section 194S as well as collect equalisation levy on the said consideration.

• Applicability of section 206AA and 206AB of the Act – As per the proposed provisions, Individual or HUF (who would fulfil certain conditions) are not liable to undertake higher withholding of tax in case the payee is a non-filer of return of income as per the provisions of section 206AB of the Act. However, no such clarification has been provided with respect to section 206AA of the Act i.e., non–availability of PAN. Thus, as per current provisions in absence of PAN, higher withholding tax at the rate of 20% would be applicable, which may lead to various issues such as excessive compliance requirement in the hands of the transferee of VDA, working capital issues, etc.  Further, the aforementioned relaxation is only provided to certain Individuals or HUFs, which means that any other person paying consideration would be liable to undertake the compliances from 206AB perspective, which lead to practical difficulties due to voluminous transactions and substantial compliance requirements.

• Withholding in swap transactions – As per the proposed provisions, person responsible for paying consideration for transfer of VDA shall be liable to withhold tax even in a scenario where consideration for transfer of VDA is paid in kind. Consequently, the digital exchanges would be liable to withhold tax even in case of swap of VDA (purchase of Ethereum against sale of Bitcoin). This may lead to unwarranted practical difficulties in the hands of digital exchanges and investors. 

Other broader implications -

• Advance tax – As per the extant provision, taxpayer is liable to discharge their tax liability in the form of advance tax on the income earned by them in a fiscal in prescribed quarterly instalments. However, for certain incomes such as dividends, income from capital gains, which are earned in subsequent quarter, taxpayer is not liable to interest on default in payment of advance tax instalments. However, the current Budget 2022 amendments do not provide for any relaxation towards, income from transfer of VDA. Consequently, taxpayer would be liable to pay interest on default in payment of advance tax instalments even if, the income from transfer of VDA was earned in subsequent quarters and no income was earned in a particular quarter.

Concluding remarks by the authors -

• While the current Budget 2022 provides much needed clarity on the tax implication on VDA, the same does not have any footing that the Government has acknowledged VDA as legal. The same is also evident in the taxability proposed on transfer of VDA which is akin to taxability of income earned from lottery, horse race, etc. Also, there are several judicial precedents, wherein, tax has been levied on income earned from illegal activities.

• On the tax front, while the Government has not only laid out taxability of income on transfer of VDA but also outlined withholding tax provision, which will assist in keeping track of transactions. Having said so, due to lack of regulatory framework and global nature of the transactions coupled with absence of a centralised regulatory authority will pose serious challenges in traceability of these transactions.

• Also, it remains to be seen whether the Union Budget 2022 has in reality put an end to the uncertainty and ambiguity around taxability of virtual assets or has it just opened a pandora’s box from a litigation and compliance perspective. At least going by the above, it seems that Government would have to undertake substantial tweaks while finalising the Finance Act or provide relevant clarity to mitigate uncertainties.

India Opens the Door to Crypto Tax Maze!

This article has been co-authored by Amar Kumar (Chartered Accountant, Singhvi Dev & Unni LLP).

The Finance Minister has introduced a new regime – Tax on income from Virtual Digital Assets (VDA), - on transactions involving Cryptocurrencies, which could also extend to other token-based transactions using the block-chain technologies. The introduction of the new regime is akin to entering a maze. As we discern the provisions, more questions arise, but we want to believe it’s moving towards the goal - tax certainty for the crypto world.

CHARGE OF TAX

Why are transactions in Crypto - income?

Income-tax is a levy on income. Under the Income-tax Act the liability to tax is attracted either on the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in bookkeeping, an entry is made about a hypothetical income, which does not materialize.[1]

Originally, the first Cryptocurrency i.e., bitcoin, came into existence through a decentralized and distributed ledger system gathering its value based on its demand and supply within the block-chain. Assuming the world did not accept the Cryptocurrency as a medium of exchange for a service or good which can be measured in “fiat currency”, it really would be no different from either an entry in a ledger or a coin in a video game!

Today, with the explosion of this new tokenized world, the transactions in the block-chain can be equated to some form of fiat currency or a commodity whose value is represented in fiat currency. It is in this backdrop that the transactions involving VDAs could be construed as real income, akin to a barter transaction where the money’s worth is the medium to measure.

Is it a gain from a capital asset?

The characterization of the income is a debate, particularly in the context of VDAs qualifying as capital assets. VDAs should qualify as a capital asset, since the term ‘capital asset’ is defined to include property of any kind. On the contrary, doubts exist on it qualifying as an asset in light of its inherent volatility, its characteristics as a medium of exchange and concerns on enforceability of ownership rights.

The legislative intent appears to recognize VDAs as capital assets. The regulators have directly provided for a specific computation and rate of tax on the income arising from the transfer of any VDA. The term “transfer” has been defined in the Income Tax Act in relation to a capital asset. Further support for the view is found in the proposal on taxing gift of VDAs under Section 56(2)(x), which proposes to include VDAs under the definition of “property”, which in turn refers to capital assets.

This view would be relevant for the tax positions on historical transactions. The income from VDAs could be determined on principles as applicable to transactions involving sale of securities to determine whether it is trading income or capital gains.

After 31 March 2022, the characterization of the income arising from VDAs is not of much relevance, as there is a specific regime providing for a rate of tax, with no deductions or carry forward of losses, for all incomes arising from the transfer of a VDA. However, there are more turns in the maze which are to be navigated – What is a VDA? What is ‘transfer’ of a VDA? If not recognized by law, are there legally enforceable rights which are transferred?

WHAT IS A VDA?

The regulators have proposed a broad definition to the term VDA, and at times you would think it probably is beyond the Cryptocurrency transactions as well.

Characteristics of a VDA

The definition specifically includes non-fungible tokens (NFTs) and other tokens unless excluded through a notification.

An unintended ambiguity - will the wallets in retail apps, reward points & in-game coins be considered as VDAs?

Given the all-encompassing definition of VDAs, any digitally represented balance attributable to a specific user could be covered within the definition of VDAs. This may cover cashback points in payment aggregator applications, loyalty points accumulated on membership cards specific to shopping outlets, credit card reward points, promotional balance and virtual coins provided to users in online games and other applications. The foregoing is not an exhaustive list, and VDAs could cover any digital representation of any asset, property etc., if the characteristics discussed above are satisfied.

If the definition is to be construed narrowly, it could be contended that if the issuer of cashback points, reward points and tokens stipulates that these virtual points have no inherent monetary value and are not transferrable to any other user (apart from the initial accrual of the points for a user) and can only be used in-app or in-store to be eligible for a discount while making an eligible purchase, then these points would not satisfy the criteria of being transferred and being traded electronically, and consequently be outside the ambit of VDAs.

To address the above ambiguity, a clarification from the government would help allay the concerns regarding the probable unintended applicability of the VDA taxation regime.

WHAT IS TRANSFER OF A VDA?

The regulations propose to levy a tax, at the rate of 30%, on the income from the transfer of a VDA. The term transfer is defined in the Act, in the context of capital assets and typically represents a sale, exchange or relinquishment of the Asset or the extinguishment of any rights therein. In the context of the Cryptocurrencies, we look at select transactions to discuss whether they tantamount to a transfer or raise further ambiguity.

Is Generation of a VDA a transfer?

For a Cryptocurrency miner, by convention, the first transaction in a block is a special transaction that starts a new coin owned by the creator of the block, which is an incentive for miners to support the network, and it provides a way to initially distribute coins into circulation, since there is no central authority to issue the Cryptocurrency.

A mining transaction does not involve a transfer of VDAs from one person to another (staying true to the peculiar characteristic of a decentralized network). As such, the coins are created or mined by the miner and enter circulation. There is no ‘transfer’ of the mined cryptocurrency to the miner.

It appears that the intent of the legislature is to introduce a transitory regime for taxation of VDAs by placing the trigger of taxation at the stage of conversion of VDAs to fiat currency or conversion to another VDA having reference to the fiat equivalent of such VDAs. A clarification from the board would help, considering the technological attributes specific to VDAs. Currently, it is ambiguous if the receipt of cryptocurrency by the miners will trigger a tax under Section 56(2)(X) and how the same could be valued.

Acquiring a NFT say Collectibles; is it a transfer?

Several brands have started offering NFTs to its users under a direct sale or by an auction. These NFTs are minted using smart contracts and they are tracked and stored on the Blockchain.

Typically, in the context of Collectibles the rights of the Collector/Owner appear to be limited to the use of the Collectible in defined scenarios e.g. for the purpose of sharing or promoting on social media platforms, blogs, digital galleries, or other digital media; or  within decentralized virtual environments, virtual worlds, virtual galleries, virtual museums, or other navigable and perceivable virtual environments, including simultaneous display of multiple copies of the Works within one or more virtual environments. 

Another emerging transaction model pertains to the merging of a NFT art with the exclusive physical commodity. This would typically involve sale of NFTs of 3D artwork featuring the tangible underlying (for ex. Footwear). In exchange for payment, the user is granted the NFT ownership with a future option to redeem the NFT for the underlying physical object (subject to applicable terms and conditions imposed by the issuer of the NFT).

Acquiring a NFT does not generally result in an acquisition of all the underlying intellectual property rights by the user. The acquisition of the NFT merely is the right to sell an authenticated NFT, or the right to display such NFT in a suitable environment (e.g., the metaverse).

Does the acquisition of a NFT tantamount to a “transfer” or is it a grant of a right? The proposals do provide the legislature with the powers to exclude certain types of NFT / tokens from the definition of VDA. It would augur well to have immediate clarifications for this fast-emerging segment.

Sale of VDA - Peer to Peer (P2P) transactions

Several platforms enable users to use fiat currency funds in exchange for certain Supported Cryptocurrencies with other Users on the platforms in so-called “P2P transactions.” In a P2P transaction, usually the platform will hold the digital currency in escrow between the two counterparties until payment in fiat currency funds between the buyer and seller is confirmed by the respective parties. Such Supported Cryptocurrency is released to the wallet of the buyer as soon as the payment is confirmed. The platform typically does not take custody or facilitate transfer of the fiat currency funds in this model, and the transfer of the fiat currency funds is solely between Users.

In a P2P transaction, the resident seller being the transferor of the VDA, as envisaged under the proposal, is liable to tax on the appreciation in value of the VDA. The buyer is required to deduct tax at source under Section 194S of the Act at the rate of 1%.

The reporting of these transactions and the liability of the non-resident seller / resident buyer would need further clarification.

Sale of VDA – On a centralized exchange

Centralized exchanges (‘CEX’) commonly facilitate trades between users by maintaining an order book. An order book is a collection of buy and sell orders posted by traders. Orders are requests to buy or sell a certain amount of a specific cryptocurrency at a certain price. CEXs aggregate orders from their users and then use special software to match and execute the corresponding buy and sell orders.

CEX users do not actually exchange crypto or fiat currencies with each other. Instead, when they deposit their funds onto an exchange, the exchange takes over the custody of those assets and issues a corresponding amount of IOUs to the trader. The exchange tracks every user’s IOUs internally as they change hands in trades and only converts them into actual currency upon withdrawal of funds.

The tax implications will be like a P2P transaction; however, on the TDS, the person responsible for deduction of tax is likely to be the CEX.

LOOKING AHEAD

The introduction of a taxation regime for Cryptocurrency is a welcome move. While the intent for the same appears to be to bring to the tax net the gains made in the Cryptocurrency markets, a broad-brush approach of classifying and taxing the transfer of Cryptocurrencies and NFT’s may lead to a disconnect between the evolving business models and the taxation regime. 

It should be acknowledged that the Web3 technology is not limited to gains arising on account of high volatility in the Cryptocurrency markets. As the markets mature and technologies evolve further, the tax regime would need to address the peculiarities of the underlying technology and the new business models.

Further, the interplay of The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 (‘Crypto Bill’) (yet to be introduced), which was initially intended to prohibit all private cryptocurrencies in India, while allowing for certain exceptions to promote the underlying technology of cryptocurrency and its uses, with the taxation regime remains to be seen. More clarity on the legalization of Cryptocurrencies and technology relating to NFTs, smart contracts is expected once the Crypto Bill is introduced.

Disclaimer: The views expressed in this article are the personal views of the authors. The authors acknowledge the significant contributions of Mr. Varun Korada to the above article. 

Crypto Taxation – One Step Forward

This article has been co-authored by Ipsita Agarwalla (Member, International Tax, Nishith Desai Associates).

Crypto tax seems to have created a buzz amongst participants in the crypto ecosystem with user sign ups jumping by 30%-50% on crypto platforms on the budget day.[1] As the crypto industry in India was raging, the Government announced the much-awaited tax regime for taxation of virtual digital assets (“VDAs”) in India applicable from financial year 2022-23. It is important to bear in mind that taxation of VDAs should not be considered as regulation of VDAs. On the regulatory front, the question of nature and classification of VDAs is still in limbo. However, recognition of VDAs in tax laws, does provide some much needed clarity to the sector.

Meaning of VDAs

An exhaustive but broad meaning has been given to VDAs. Non-fungible tokens have specifically been included in the definition of VDAs as a separate category. The government has also reserved the power to notify / exclude any digital asset from the definition of VDA. Indian currency and foreign currency are not included within the ambit of VDAs. The use of words ‘information’, ‘code’, ‘number’ makes the definition of VDA all encompassing. Further, the presence of ‘or otherwise’ in the phrase “generated through cryptographic means or otherwise”, may be interpreted to mean that any information or code which is generated through non-cryptographic means could also be covered under definition of VDA. Therefore, questions regarding scope of VDA remain and absence of clarity may lead to confusion and litigation in future.

Manner of taxation

The government proposes to tax income from VDAs in a manner similar to gambling wins.[2] Any income from transfer of VDAs will be subject to tax at flat rate of 30% (plus applicable surcharge and cess) irrespective of the period of holding. Prior to this amendment, it was possible to categorise transactions as either trading income and claim expenses or claim long term capital gain rate of 20% based on the facts of the case. The Budget also provides that taxpayers will not be permitted to take any deductions (except the cost of acquisition) while computing income from transfer of VDAs. The taxable event seems to be income from ‘transfer’ of VDAs. Section 2(47) of the Income-tax Act, 1961 (“ITA”) defines transfer in an inclusive manner to include sale, exchange relinquishment of asset. Therefore, it may be possible to interpret that in case of crypto to crypto transactions, both the buyers and sellers will be subject to tax at 30%.

Set off or carry forward of losses from VDAs have also not disallowed. Therefore, while the investors will pay 30% tax on income from VDAs, they will not be permitted to take any benefit of losses from VDAs against income under any other heads of income from tax perspective. Having said this, it is unclear whether intra-head adjustment of losses i.e. set off of loss within VDA class will be permitted or not.

Further, the amendments have also proposed application of the infamous gift tax under section 56(2)(x) on VDAs. Therefore, going forward receipt of VDA by taxpayers for a value less than its fair market value should be subject to tax under head income from other sources. However, there is no clarity whether such recipient will get a step up in cost on subsequent sale of VDAs. This may result in double taxation of income. Issue of promotional tokens by crypto exchanges, airdrop of tokens etc. are likely to be impacted by this change. Having said this, absence of guidance on valuation of VDAs may pose a challenge on implementation of this gift tax.

Withholding taxes

With the intent to track transactions in relation to VDAs, the government has also proposed to introduce withholding provision on person responsible for paying consideration for transfer of VDA. The aforesaid withholding provision should technically be applicable on the buyer of VDAs and crypto exchanges (marketplace) should not be considered as ‘person responsible for paying consideration’, the obligation to withhold tax under section 194S may practically be on crypto-exchanges in most cases. However, there may be issues in complying with the withholding obligation in absence of knowledge of identity of the counter party. Further, the Budget also mandates withholding in cases where transactions are undertaken in kind. This seems to be an onerous condition for investors and may create cash flow issues. Apart from this, withholding tax provisions is also likely to block capital of the users till the end of the financial year, which may hamper trading volumes in this upcoming industry.

There are also instances, especially in the tech sector, wherein employers pay salary in form of tokens to their employees. In such cases, an issue may arise on whether the employers are liable to withhold taxes as per section 192 as salary payment or under section 194S as consideration for transfer of VDAs. While this may be tricky for employers, from employee’s perspective, it may not make much of a difference as both salary income and income from transfer of VDAs are taxable at 30% without any deductions. Similar issues may also arise in cases where consideration for services rendered is discharged in crypto currency. In such cases as well, it will be important to analyze applicability of section 194S versus 194J on the service provider as it may be considered to be discharging consideration for transfer of VDAs by the service recipient. Similar conflicts may also arise where winnings from gambling or gaming is paid out in tokens or crypto where section 194B or 194S may apply. Clarity on such issues would be welcome, particularly since the government has expressed its willingness to address any potential gray areas due to the introduction of this amendment.

What next?

As the crypto industry matures and, it is expected that more issues are likely to arise in future. To this extent, the amendments in the Budget are just the beginning of clarifications on taxation of income from VDAs. Reports suggest that income-tax returns from next year will have separate column for disclosing crypto income.[3] Individuals, employees, consultants, fund managers, artists, actors and others who are receiving consideration or payments in the form of tokens, cryptos or NFTs should watch the final wording of these proposals closely to assess their tax exposures under various sections of the proposed law.

India’s Approach to Taxing Cryptocurrencies

The Indian Government has usually been averse in allowing the Cryptocurrencies to become a mainstay in India. With unclear laws to bans by RBI on payments for purchase of digital currencies, the Government has tried it all to not let these digital currencies grow. But, the budget of 2022 is a clear indication that the Government has realised that despite any action, they can't just wish Cryptos away. In this Budget, the Finance Minister has announced measures which in a way legitimize these cryptocurrencies and yet, add more roadblocks to these transactions possibly to still discourage the average investor. Let's discuss the changes below in detail.

1. Virtual Digital Assets – Cryptocurrencies defined

The Finance Bill, 2022 has coined the term ‘Virtual Digital Assets’ which is used to represent all types of cryptocurrencies, crypto tokens and includes non-fungible tokens (NFTs). It includes all current cryptocurrencies such as Bitcoin, Ethereum, Ripple, Tether or any other cryptocurrency which may be evolved in the future.  The definition has been kept open ended to capture each and every type of such cryptographic tokens in any form whatsoever. The Government has also been given the power to include any digital asset as a ‘Virtual Digital Asset’ or to exclude one. The latter possibly being given to exclude the proposed token to be issued by RBI.

2. Income from transfer of cryptocurrencies to be taxed at a flat rate of 30% plus surcharge and cess.

This budget for the first time has clearly specified a rate for taxation of cryptocurrencies putting to rest the speculation on how exactly they should be taxed. The Finance Bill provides that income on transfer of cryptocurrencies would be taxed at 30% after adjusting only the cost of acquisition of such cryptocurrency. No deduction is going to be provided for any other expenditure or allowance.

The tax rate proposed here is the highest tax rate applicable currently to any resident taxpayer. The rate is almost akin to the tax applicable on gambling or lottery. The rate of 30% would be applicable irrespective of the slab of an individual taxpayer, or even if the taxpayer is a corporate enjoying the tax rate of 22% or even 15%. Surcharge and cess would also be applicable on the total tax amount.

While the introduction of this tax has provided some certainty of taxation, the fact that only cost of acquisition would be deductible has still left multiple challenges for the taxpayer. Further, the term cost of acquisition has also not been defined adding to the confusion. Costs such as exchanging fees, wallet charges, etc which are commonly incurred while trading of cryptocurrencies would not be deductible. Where cryptocurrencies are acquired by way of mining, it could be debatable whether cost of equipment, electricity and other allied costs would be considered as part of cost of acquisition or not.

3. TDS to be applicable at the rate of 1% on purchase of Cryptocurrency

The Finance Bill has introduced a TDS rate of 1% on the purchase of any Cryptocurrency if the total purchase exceeds Rs.50,000 (for individual/HUF buyers)/Rs.10,000 (for other buyers) from a seller. The primary purpose of introducing this nominal rate seems to be to collate all the data in respect of the trading of cryptocurrency. However, the implementation of this provision is not as straightforward as it seems. 

First, this is a very difficult step to implement on the Crypto Exchanges. These exchanges work in a manner similar to stock exchanges and the buyer and seller don’t have the visibility to each other’s information, let alone PAN. Current regulations do not mandate that each seller furnish its PAN on these exchanges.  In case of non-availability of PAN, the higher rate prescribed under Sec 206AA would become applicable. Further, if the seller has not filed its return, an even higher rate under Sec 206AB would be applicable.  Even if a transaction is entered into between two cryptocurrencies without involving actual Rupee or any other regular currency, TDS is still required to be deducted on such transactions. Live trading on a cryptoexchange makes it virtually impossible to comply with these norms.

To add to this complexity are decentralised exchanges, which conduct the transaction without the help of any central server across the globe capturing the barest of information possible.  It is also important to know that the people buying crypto currencies today are from all walks of life and not established businesses. They don't always have a TAN and will have no clue on how to go about fulfilling compliances above.

The difficulty in complying with this TDS provision would only lead to high default rates and the possibility of significant penalties for non-compliances. The better approach, at least initially, would have been to set a regulation for these cryptoexchanges and to have them report the transactions in the annual SFT report already furnished by banks and stock exchanges. The Government would have been able to capture a significant amount of data on trading of the cryptocurrencies which could be compared with the annual returns to determine whether appropriate tax is being paid on such income or not.

4. Profit on sale of Cryptocurrencies is not capital gains

Income from Cryptocurrencies has been dealt by in the Finance Bill in a separate section (115BBH) of the Income Tax Act and hence it is not being considered as capital gains. This is important for all those investors who are holding significant value of cryptocurrencies as individuals. Not only the highest rate of tax would be applicable on such income, but there will be no restriction of the highest rate of surcharge. If an individual has an income of more than Rs. 5 Crores from sale of cyrptocurrencies, then the highest surcharge of 37% will apply and the effective tax rate would become 43% on such crypto without any provision of indexation.

But, these provisions come into effect from April 1, 2022 and an individual can book profit on cryptocurrencies held for a period of more than 3 years in the current financial year and treat it as long term capital gains and enjoy the reduced tax rate of 20% and indexation. However, one should be ready to expect some challenges by the tax authorities on this treatment.

5. Loss from Cryptotrading not to be adjusted with any other income or being carried forward

This is going to be another pain point for small investors and traders. Most of them see Cryptocurrencies as another form of investment just like stock markets and commodity. The proposed law disallows set-off of loss from trading of cryptocurrencies with any other type of income. Further, the law also proposes to disallow any carry forward of such losses to any subsequent financial years.

Both these proposals are a big discouragement to the investors or traders of cryptocurrency and might even lead to unnecessary volatility at year end where such persons would try to square off their holdings to minimise their losses in an year.

5. More clarity needed for FEMA/GST

While the budget has tried to bring certainty around tax on cryptocurrencies, there are still issues under Foreign Exchange Management Act (FEMA) and Goods and Services Tax (GST) which need to be addressed.

Current FEMA laws require that all residents undertake all transactions outside India through a bank in India. These transactions are strictly governed and monitored by the Reserve Bank of India and even minor infractions are dealt with a heavy hand. However, the transactions in cryptocurrencies happen electronically and it is virtually impossible to draw a national border around these transactions. The buyer and seller can be sitting in absolutely two different countries and trade cryptocurrencies in any volume at the click of button without the intervention of any bank or authorised dealer. The Government needs to prepare a detailed framework on how to handle these international transactions with the people of India having clear certainty on how to handle these transactions. One suggestion could be to setup a large bank like organisation who could be the intermediary to undertake all such transactions legally.

The treatment of sale of cryptocurrencies under GST is also net clear. As per the current provisions any good or service, unless specifically exempted or excluded, are taxable under GST. List of exclusions covers ‘money’ which covers Indian or foreign currency and even promissory notes or bills of exchange. And while cryptocurrencies also want to be recognised as a legal tender, the current laws do not recognise them as one. So, there is still doubt in the mind of all professionals, whether GST would be applicable on the sale of all cryptocurrencies. 

While the lure of taxing these transactions to augment revenue would be fairly high, a more growth-oriented approach can be to exempt these transactions under GST and to levy a tax equivalent to Securities Transaction Tax. This will enable Government to augment revenue without adding significant complexity to the growth of cryptocurrencies.

Conclusion

While we can continue to debate on how to best regulate cyptocurrencies, the proposed law is a welcome step for all cryptocurrency enthusiasts. We all need to acknowledge now that cryptocurrencies are here to stay, and it is best that we figure out a way on how to regulate them in a constructive manner instead of trying to curtail them. The Government may not allow their use as a legal tender. However, just like stocks, commodities and derivatives, cryptocurrencies have showcased their utility in an electronic world over the last decade or so. With deep technical expertise available in our country, India is rightly poised to take advantage of this crypto revolution and become a leader in this domain. The Government just needs to keep the dialogue open and allow the growth in a regulated manner protecting the interests of the small people.

Virtual Digital Assets – A Special Tax Regime

This article has been co-authored by Nikhil Shah (Manager, Direct Tax, Nexdigm)

BACKGROUND

India has become one of the largest market for Cryptocurrencies. Indians have parked nearly $ 6.6 billion[1] in cryptocurrencies until May this year, as compared to $ 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 remained always unclear and ambiguous. Reserve Bank of India (RBI) in its Financial Stability Report in the year 2013 warned the public against banking on Cryptocurrencies as they posed challenge to the economy in the form of regulatory, operational, and legal risks. Later, RBI in its circular "Prohibition on dealing in Virtual Currencies” dating 6th 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 4th March 2020, the Supreme Court has given its landmark judgement 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.

While the legality of crypto currencies is still not certain there were also issues on classification of crypto currencies on the tax side and overall tax implications on the same. Accordingly, a separate scheme of taxation is proposed in the Finance Bill 2022 for Digital Assets.

SCHEME FOR TAXATION OF VIRTUAL DIGITAL ASSETS

Taxation of virtual digital assets:

• Finance Bill 2022 proposes to insert section 115BBH to Income-tax Act, 1961 (‘Act’) to provide for taxation of income from transfer of any virtual digital asset. The applicable tax rate shall be 30% plus applicable surcharge and cess. There would not be any benefit of income slabs or minimum exemption limit.

• Under section 2(47A) of the Act, definition of virtual digital assets has been included. The definition is wide enough to cover cryptocurrencies, Non-Fungible Tokens (NFT) or any other type of digital assets.

• It is also proposed that no deduction in respect of any expenditure (other than cost of acquisition) shall be allowed. Further, no allowance / set off of any loss on transfer of digital assets shall be allowed under any provision of the Act to the taxpayer. Such loss shall also not be allowed to be carried forward to subsequent years for set-off.

Taxation on gift of virtual digital assets:

• It is also proposed to amend deemed gift tax provisions under section 56(2)(x) of the Act to provide for taxation of the gifting of virtual digital assets in the hands of the recipient. However, gifts from relatives would continue to enjoy the exemption like other gifts/assets.

• Thus, in case of gift, the fair market value shall be deemed to be the income of the recipient of these assets. However, how to arrive at the fair market value needs to be examined and it is better that Government provides some clarity here.

• Also, in case of gift there could be double taxation – once when the receiver receives digital asset as a gift and again once he sells the digital assets on the full sales value as for that taxpayer the cost of acquisition is zero. The Government should clarify on this aspect also.

Withholding tax:

• It is proposed to insert section 194S to the Act to provide for deduction of tax of 1% on payment for transfer of virtual digital asset to a resident. Where such payment is in kind or in exchange of another virtual digital asset or cash is not sufficient to meet the liability of deduction of tax, the person before making the payment for such transfer shall ensure that the tax has been paid in respect of such consideration.

• This withholding tax is to be deducted and paid by person responsible for making payment to taxpayer who has transferred digital asset.

• It is also proposed that no tax deduction is to be made if:

o   Consideration payable by specified person does not exceed INR 50,000 during the financial year

o   In any other case, the consideration payable does not exceed INR 10,000 during the financial year.

Specified person means:

-  Individuals and HUF having income other than business or professional income

-  Individuals and HUF having business or professional income where the gross receipts / turnover/ sales does not exceed INR 10 million (in case of business) and INR 5 million in case of profession in the immediately preceding year

• In case of tax to be deducted by specified persons, there would be no requirement of obtaining Tax Deduction Account Number (TAN) as also of deducting tax at higher rates where the income recipient has not filed income tax return for the prior year.

NEXDIGM VIEWS

A specific taxation scheme is certainly a welcome move as it is expected to provide much required clarity on the taxation of transactions in digital assets and is also expected to increase the tax base. However, it appears that the provisions are adverse in comparison to other investment class / assets.

One will also have to see how the norms for determination of fair market valuation get prescribed considering the peculiar nature of these assets.

Also, while the taxation appears to be simple for residents, it would be interesting to understand the taxation in hands of non-resident. Whether such income would deem to accrue or arise in India would be dependent on situs of the virtual digital asset and finding the situs would be next to impossible.

With the introduction of withholding tax provisions, it appears that crypto exchanges may have to carry out the compliances.

It would be pertinent to note that Government has a right to tax any income (whether its legal or illegal) and hence merely introduction of tax provisions for Digital Asset would not make them legal.

Cryptocurrency Regulations – Lessons from the US

Co-authored by Ms. Aasawari Kadam (Advocate), Ms. Anushka Mehta & Ms. Garima Sisodia (Law Students)

Introduction

India is now one of the largest cryptocurrency markets in the world, however, investment in cryptocurrencies like Bitcoin, Eretheum, etc is heeded with a word of caution. An unofficial

The USA has came up with the Amendment to Infrastructure Investment and Jobs Act, where it has defined cryptocurrency and issued new reporting regulations for those engaging in holding or dealing in cryptocurrency. The amendment intends to introduce reporting regulations with respect to declaration of income arising from dealing in cryptocurrency, which is dealt with below, along with emphasis on relevant takeaways for India.

Present Regulatory Framework Governing Cryptocurrencies in USA

In the USA, cryptocurrencies are not considered legal tender, however, trading in cryptocurrencies or virtual currencies is permitted. In accordance with the FAQs on the website 

Most states have legislation in place to regulate the transfer and taxation of digital assets. The state of Wyoming has passed a law for the creation of a special type of depository, which shall act as the custodian of the digital assets maintaining safety. The state of Ohio has even started accepting taxes in the form of cryptocurrencies. On the other hand, states such as Iowa, Maryland and Hawaii have issued warnings against the use of cryptocurrencies.

The main legislation regulating cryptocurrencies in the USA is the Bank Secrecy Act, 1970 (“BSA”). The BSA is an anti-money laundering regulation, under which the Financial Crimes Enforcement Network (“FinCEN”) acts as the regulatory body against financial crimes. Earlier this year the National Defense Authorization Act was passed which includes within it the Anti-Money Laundering Act, 2020 (“AML Act”) to amend the BSA to include virtual currencies within its ambit. Under the BSA, financial institutions and other “money transmitters” who deal in “values that substitute currency”, are required to implement anti-money laundering programs and comply with record keeping and reporting requirements, including suspicious activity

Under the relevant securities regulations, the Securities and Exchange Commission (“SEC”) treated cryptocurrencies as securities, since they can be issued as tokens in an Initial Coin Offering (“ICO”) and thus, have utility, satisfying the “Howey Test”. Howey test states that an investment contract is a transaction, scheme or contract where a people invest their funds in a common enterprise and expect profits solely from the efforts of a third party or promoter. Thus, the issuer of the cryptocurrency would be required to register the issue with the SEC, unless exempt under SEC Rule 501(a)(5). Further, brokers dealing with or facilitating the sale of tokens must be registered with the SEC as well as Financial Industry Regulatory Authority (“FINRA”). Such tokens can only be traded on licensed security exchanges.

On the aspect of taxation, the Internal Revenue Service of the United States (“IRS”) has maintained that virtual currencies would be taxed as property and post 2018, requires individuals filing returns to recognize taxable gains or losses anytime a cryptocurrency is converted to another form.

Lastly, the Commodities Futures Trading Commission (“CFTC”) has adopted a friendlier, “do no harm” approach, recognizing Bitcoin and Ethereum as commodities and allowing other virtual and cryptocurrency derivatives to trade publicly on exchanges that it regulates or supervises.

Impact of amendment to Infrastructure Investment and Jobs Act

The most recent attempt of the United States Senate to regulate cryptocurrencies finds mention in the presently under consideration, Infrastructure Investment and Jobs Act (H.R. 3684) (“US Bill”). The Bill aims to provide for reporting of 'digital assets’' by amending the Internal Revenue Code, 1986 (“Revenue Code”). As on the date of publication of this article, the Bill has been passed by the Senate and is pending approval before the House of Representatives. The Bill, if passed, shall be applicable to federal tax returns to be filed from 2024 onwards, pertaining to transactions undertaken since 2023.

The Bill defines “digital assets” broadly as “any digital representation of value which is recorded on a cryptographically secure distributed ledger or any similar technology as specified by the Secretary.” This would, therefore, include cryptocurrencies within the ambit of the definition. The US Bill defines “brokers” as “any person who (for consideration) is responsible for and regularly provides any service effectuating transfers of digital assets on behalf of another person.” Such broad language leaves the provision susceptible to wide interpretation, including even miners, stakers and software developers, who may not have any customers leading to a reporting requirement of information which is not in their possession.¹ On the other hand, the position of certain other crypto-operators, such as broker-dealers, prime brokers, asset managers, and exchanges remains unchanged given that they carried out know-your-customer (“KYC”) compliances and reporting even prior to the consideration of such an amendment. Thus, we note that the US Bill effectively places an unfair higher burden of compliance on a class of people who do not conventionally have any interaction with the end users of cryptocurrencies.

Section 6045(g)(3)(B) of the Revenue Code shall subsequently be amended to include digital assets under the definition of “specified security”. This shall ensure that a broker has to file a return on the transfer of any digital assets from an account maintained by such broker to another account, from January 01, 2023 onwards.

Developments around Cryptocurrencies in India

The very first-time cryptocurrency was officially acknowledged in India was through the press release in 2013 and subsequently in 2017 by the RBI cautioning investors of the risks associated with Cryptocurrencies (Press Release: 2013-2014/1261 dated: 24/12/2014). Thereafter the RBI issued “Statement on Developmental and Regulatory Policies” on April 5, 2018, which expressly prohibited banks from dealing in cryptocurrency or providing any services to market participants in support thereof. This made it practically impossible for the market participants to regularly engage in trading of cryptocurrency. This statement of RBI was set aside by the Hon’ble Supreme Court in its landmark judgement in March, 2020 in the case of Internet and Mobile Association of India v. RBI (supra). On a similar note, in consonance with the attitude of RBI, the legislature introduced the Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019 which sought to prohibit mining, holding, selling, trade, issuance, disposal or use of cryptocurrency in the country. Cryptocurrency was defined as any information, code, or token which has a digital representation of value and has utility in a business activity, or acts as a store of value, or a unit of account. Under the draft Bill, mining, holding, selling, issuing, transferring or use of cryptocurrency was punishable with a fine or imprisonment of up to 10 years, or both, however holders of cryptocurrency were given a window of 90 days to declare and dispose any such cryptocurrency in its possession. It also hinted at a RBI backed digital rupee as legal tender. However, the Bill couldn’t make its place owing to the prevailing movement of cryptocurrency.

The prayer for relief was considered and the new bill titled Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 (“Cryptocurrency Bill, 2021”) is expected to be tabled during the winter session of the Parliament. Instead of completely banning trading in cryptocurrency and declaring the same to be illegal in the 2019 Draft Bill, the Government via the Cryptocurrency Bill, 2021 may impose a ban only on dealing in “private cryptocurrencies” in India. What is a private cryptocurrency remains to be seen, since the bill is not available in

Likely taxable implication of Cryptocurrencies in India

Under the direct tax regime, cryptocurrencies may be taxed as income, under Entry 82 of the Union List of Schedule VII of the Indian Constitution, which allows the Centre to legislate and levy tax on incomes. The income generated through cryptocurrencies can be classified under the heads of Profits and gains of business or profession, Income from Capital Gains or Income from other sources based on its designation as determined by the Government of India.

The possible Income tax implications could be classified into various heads of Income:

1. Profits and gains of business or profession

The “miner” who would facilitate the entry of new cryptocurrency are subject to income tax under this head of income. However, the determination of the status of the cryptocurrency, i.e., its place of origin and subsequent taxation could be challenging. This would directly impact the taxability of the cryptocurrency with respect to issues in international taxation and recourse may be required to resources of international taxation like double taxation, avoidance treaties. The miner has to make investments in the form of computing resources and electricity etc. into the mining activity and therefore can claim the computer resources deployed towards mining as a Capital “Plant and Machinery” while the electricity bill and other expenses including the bandwidth charges may be claimed as revenue expenditure.

The second side of the coin as far as profits from gains and professional income is concerned is the treatment of the income earned from trading of cryptocurrency. Trading however, brings with it a high chance of cross border element, given the virtual nature of cryptocurrency and its ambiguous geographic location. Hence issue of international taxation issues could come in place like Permanent Establishment (PE) or interpretation of relevant tax treaties.

The introduction of the “Equalization Levy” also brings the possibility of taxation for the purchase of cryptocurrency that is purchased from abroad: Section 164(cb)(i) has the potential of being squarely applicable to the trading of cryptocurrency while section 164(ca) has the possibility of being directly applicable to the cryptocurrency exchanges/institutional sellers as well as individual sellers etc. that are selling cryptocurrency online.

2. Capital Gain

The definition of “capital assets” is contained within the Act and includes “property of any kind held by a person whether or not connected with his business or profession”. The term “property”, though has no statutory meaning, yet it signifies every possible interest that person acquires or enjoys in a property. A cryptocurrency would therefore fall under the definition of “capital asset” as defined under the Act. Accordingly, if a person is involved in the business of trading in cryptocurrency and the gains made therefrom could be taxed as “business income”. On the other hand, if a person holds the same as investments and the frequency of the transactions is not regular, then the gain from the same will be taxed under the head “capital gain”. If the cryptocurrency held by the person for less than 36 months, then the gain from the same will be taxed as short-term capital gain and it is held for more than 36 months, then the gain therefrom will be taxed as “Long term Capital Gain”.

3. Income from Other Sources

Section 56(1)(ib) makes “any winnings from lotteries, crosswords puzzle, races including horse races, card games and other games of any sort or gambling, betting of any form or nature whatsoever “as an income from other sources. It is no news that cryptocurrency is highly volatile in nature as its value is dependent on what investors are willing to pay for it. Thus a pragmatic view can be taken that the taxation of cryptocurrency may move beyond the realm of business profit and capital gain and move into the realm of “income from other sources” .

Key Takeaways for India

1.  Taking cue from the US Bill as well as existing regulations, Indian legislation on regulation  of cryptocurrencies should contain a comprehensive yet exhaustive definition of cryptocurrencies. The erstwhile Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019 defined cryptocurrency under section 2 sub-section (1) as “Cryptocurrency, by whatever name called, means any information or code or number or token not being part of any Official Digital Currency, generated through cryptographic means or otherwise, providing a digital representation of value which is exchanged with or without consideration, with the promise or representation of having inherent value in any business activity which may involve risk of loss or an expectation of profits or income, or functions as a store of value or a unit of account and includes its use in any financial transaction or investment, but not limited to, investment schemes;” .

2.   Just like the amendment by the US, Bill will primarily result in making subsequent amendments to the Revenue Code, introduction of the Cryptocurrency Bill, 2021 in India will necessitate changes to be made to primarily the Income-tax Act, 1961 for reporting of income from dealing in cryptocurrency and other legislations like the Prevention of Money Laundering Act, 2002, The Foreign Exchange Management Act,1999 as well as procedural legislations such as Criminal Procedure Code, 1973 will be required to be amended in order to avoid misuse of Cryptocurrency for funding criminal & terrorist activities.

3.  The US Bill provides a wide definition for crypto-brokers while excluding a class of people who do not engage in crypto-currency for trading purposes. Thus, care must be taken that people are not un-justly taxed due to erroneous classification.

4.   On the other hand, the position of certain other crypto-operators, such as broker-dealers, prime brokers, asset managers, and exchanges remains unchanged given that they carried out know-your-customer (“KYC”) compliances and reporting even prior to the consideration of such an amendment. In India too, the RBI has advised banks to continue with the earlier prescribed KYC norms.

5.  As per the proposed amendment in the American Revenue Code, which considers crypto-currency as a specified security, there might be possibility of crypto-currency being recognized as “security” globally. Accordingly, the Securities and Exchange Board of India (“SEBI”) has to take necessary measures to regulate the trading of Crypto-currency such as mandatory compliance on reporting of exchange by brokers or intermediaries dealing with crypto-currencies will be required to safeguard the interest of the investors.

6.  Move of the US Treasury towards framing the Cryptocurrency Anti Money Laundering Rules, gives a clear indication for the necessity of bringing crypto-currency within the ambit of Anti Money Laundering legislation in India as well. At present, the Prevention of Anti Money Laundering Act, 2002 is silent about these aspects.

Conclusion

While the Central Government has made it abundantly clear that cryptocurrencies shall never replace nor form a legal tender, one will have to wait for clarity once the proposed bill becomes law. Till then the crypto market in India remains unregulated and one has to exercise caution while dealing in it. The only clarity that one can expect is with regard to the creation of a CBDC as hinted at by the RBI.

Taking a cue from other jurisdictions will definitely help in framing a regulatory framework in India, until then a wait and watch policy will help!

Cryptocurrency & CBDC - Regulations & Tax: India vis-à-vis Other Countries

This article has been co-authored by Krunal Vora (Deputy Manager, Deloitte Haskins and Sells LLP).

Business models are changing at a rapid pace today, especially in view of the exponential changes in the digital economy. A lot has been said and written about cryptocurrency, including the recent freefall. Who would have imagined that such cryptocurrencies can be donated to support COVID-19 relief work in India? Crypto Covid Relief Fund has been set up to mobilise donations in cryptocurrencies. We are seeing many globally recognised companies accepting cryptocurrency payments in some form.

Having said that, the high volatility of crypto assets, instances of fraud and lack of regulatory framework, consumer protection, market integrity and money laundering have underlined serious concerns for the Reserve Bank of India (‘RBI’) and the government for accepting cryptocurrencies in India.

Through a Circular dated 6 April 2018, RBI prohibited financial institutions regulated by it not to deal in virtual currencies or provide services for facilitating any person, in dealing with its settlement. However, the Supreme Court on 4 March 2020[1] has set aside RBI’s Circular.

Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019

The Inter-Ministerial Committee constituted in 2017 with the mandate of studying various issues related to virtual currencies, including its legal framework, submitted a Report and draft bill titled 'Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019' (‘the Bill’), in 2019. 

In the report, the Group has highlighted the positive aspect of distributed ledger technology (‘DLT’) and suggested various applications, especially in financial services, for use of DLT in India. The DLT-based systems can be used by banks and other financial firms for processes such as loan-issuance tracking, collateral management, fraud detection and claims management in insurance, and reconciliation systems in the securities market. As for private cryptocurrencies, given the risks associated with them and volatility in their prices, the Group has recommended banning of the cryptocurrencies in India, and imposing fines and penalties for carrying on of any activities connected with cryptocurrencies in India. The Group has also proposed that the government keeps an open mind about the official digital currency. 

The Bill prohibits mining, holding, selling, trade, issuance, disposal or use of cryptocurrency in India. It separates cryptocurrency from digital rupee and digital foreign currency, and provides that the central government, in consultation with the RBI, may issue “digital rupee” as legal tender and appropriate regulatory framework will be laid out for this purpose. It has also empowered the RBI to notify a digital currency recognised as legal tender in a foreign jurisdiction, as a foreign digital currency. 

Cryptocurrency has been defined in the Bill to mean, any information or code or number or token not being part of any Official Digital Currency, generated through cryptographic means or otherwise, providing a digital representation of value which is exchanged with or without consideration, with the promise or representation of having inherent value in any business activity which may involve risk of loss or an expectation of profits or income, or functions as a store of value or a unit of account and includes its use in any financial transaction or investment, but not limited to, investment schemes.

The Bill allows a person using technology or processes underlying any cryptocurrency for the purpose of experiment or research, including imparting of instructions to pupils, provided that no cryptocurrency shall be used for making or receiving payment in such activity. Further the Bill allows the use of DLT for creating a network for delivery of any financial or other services or for creating value, without involving any use of cryptocurrency, in any form whatsoever, for making or receiving payment. So blockchain technology without use of cryptocurrency is proposed to be permissible.

The Bill prohibits any person from directly or indirectly using cryptocurrency in any manner, including, as (a) a medium of exchange; and/or (b) a store of value; and/or (c) a unit of account. Cryptocurrency shall not be used as legal tender or currency at any place in India.  No person shall directly or indirectly use cryptocurrency for activities including - (a) as a payment system, (b) buy or sell or store cryptocurrency; (c) provide cryptocurrency related services to consumers or investors which includes registering, trading, settling, clearing or other services; (d) trade cryptocurrency with Indian currency or any foreign currency; (e) issue cryptocurrency related financial products; (f) as a basis of credit; (g) issue cryptocurrency as a means of raising funds; and/or (h) as a means for investment.

Any attempt to commit offences, abetting and contravention of provisions of the Bill on enactment, is proposed to be penalised and will be punishable.

For the existing holders of cryptocurrencies, it is proposed in the Bill, that the person must declare and dispose of any cryptocurrency in his possession, within 90 days from the commencement of the Bill on enactment.

The Ministry of Corporate Affairs (‘MCA’) on 24 March 2021[2] has made it mandatory for companies to disclose profit /loss and holding etc. of crypto trading/investments in their financial statements and has amended the Schedule III to the Companies Act, 2013 effective from 1st April, 2021.

Regulations in some of Asia Pacific jurisdictions

(i)  Hong Kong

In November 2019, the Hong Kong Securities and Futures Commission (‘SFC’) has introduced regulatory framework for the licensing of virtual asset service providers. SFC has allowed licensing of virtual asset trading platform under type 1 license (dealing in securities) and under type 7 license (automated trading services)[3]. The license regulates the activities of the operator of crypto exchanges in Hong Kong which provide trading of atleast one security token. The SFC announced that it has granted the first licence to a virtual asset trading platform in Hong Kong.[4]

Joint statement on the Multiple Central Bank Digital Currency (‘m-CBDC’) Bridge Project - The Hong Kong Monetary Authority (‘HKMA’), together with the Bank of Thailand (‘BOT’), the Central Bank of the United Arab Emirates (‘CBUAE’) and the Digital Currency Institute of the People’s Bank of China (‘PBC DCI’), announced on 23 Feb 2021, the joining of the CBUAE and the PBC DCI to the second phase of Project Inthanon-LionRock, a central bank digital currency project for cross-border payments initiated by the HKMA and the BOT.  This joint effort is strongly supported by the Bank for International Settlements Innovation Hub Centre in Hong Kong and the project has been renamed as “m-CBDC Bridge”.

(ii)   Singapore

In January 2020, the Payment Services Act (‘PSA’) came into effect to regulate traditional as well as cryptocurrency payments and exchanges. Under PSA, a license is required to be obtained from Monetary Authority of Singapore (MAS)[5] for providing digital payment token services. Such license generally covers the provision of services facility allowing purchase and sale of any digital payment token in exchange for money or other digital payment token.

MAS also made the Securities and Futures Act (‘SFA’) applicable for public offerings or issues of digital tokens and in May 2020, released a new Guide to Digital Token Offerings. Offers or issues of digital tokens to the public will be regulated by MAS if the digital tokens are "capital market products". MAS will determine whether a digital token, its characteristics and the rights attached to it, is a type of capital markets products.

First use of automated market making in m-CBDC experiment[6] - The MAS and Banque de France (BdF) announced on 8 July 2021 the successful completion of a wholesale cross-border payment and settlement experiment using central bank digital currency (‘CBDC’). The experiment, supported by J.P. Morgan’s Onyx, simulated cross-border transactions, involving m-CBDC on a common network between Singapore and France. This is the first m-CBDC experiment that applied automated market making and liquidity management capabilities to reap cross-border payment and settlement efficiencies.  

(iii)  China

Recently, three financial industry associations in China has directed institutions, including banks and online payment channels, not to provide saving, trust or pledging services of cryptocurrency, nor issue financial product related to cryptocurrency. It also made clear that institutions must not accept virtual currencies or use them as a means of payment and settlement nor can institutions provide exchange services between cryptocurrencies and the yuan or foreign currencies. This is not the first time that China has banned cryptocurrency. In June 2019, the People's Bank of China issued a statement saying it would block access to all domestic and foreign cryptocurrency exchanges and Initial Coin Offering websites, to put a hold on cryptocurrency trading.

China is at the forefront and is expected to become the first major economy to launch a CBDC. Its sovereign digital currency program, Digital Currency Electronic Payment (‘DCEP’), has launched one of the largest real-world trials in several cities over the last few months. Recently, the HKMA has informed that the first phase of tests for use of the digital yuan across borders has been successful.

(iv)  Bank for International Settlement (BIS)

CBDCs have the potential to enhance the efficiency of cross-border payments, as long as countries work together. This is the main conclusion of a joint report released on 9 July 2021 by the Committee on Payments and Market Infrastructures, the BIS Innovation Hub, the International Monetary Fund (IMF) and the World Bank.[7]

Interest in CBDC has grown in response to changes in payments, finance and technology, as well as the disruption caused by Covid-19. A 2021 BIS survey of central banks found that 86% are actively researching the potential for CBDCs, 60% were experimenting with the technology and 14% were deploying pilot projects.[8]

Tax Treatment of Cryptocurrency Transactions

The Organisation for Economic Co-operation and Development (‘OECD’) on 12 October 2020 published a report on “Taxing Virtual Currencies, An Overview of Tax Treatments and Emerging Tax Policy Issues”.

The report has been prepared with the participation of over 50 jurisdictions, Taxing Virtual Currencies is the first comprehensive analysis of the approaches and policy gaps across the main tax types (income, consumption and property taxes) for such a large group of countries. This report also considers the tax implications of a number of emerging issues, including the growing interest in stable coins and CBDC; as well the evolution of the consensus mechanisms used to maintain blockchain networks and the dawn of decentralised finance.

As per the Report, key tax questions raised on crypto-assets to be considered by governments may include: How should the income created by crypto-assets be treated for direct and indirect tax purposes?

• If considered to be property, should the stock of crypto-assets be included in countries’ net wealth taxes (where they exist) or other capital taxes? If so, how should they be valued?
• How should VAT systems treat the creation, acquiring, holding and transfer of these assets?
• What are the policy implications of the different tax treatments available?
• How can governments effectively detect and address the risks of tax evasion and other financial crimes posed by crypto-assets, including what are the existing legal frameworks and tools that tax administrations can use?
• How to improve tax transparency, including what information tax administrations need to know about transactions for purposes of compliance and enforcement? In addition, the OECD is addressing the need for greater tax transparency in this area, in particular in light of the tax compliance risks posed by crypto-assets. In this respect, the OECD is currently developing technical proposals in order to ensure an adequate and effective level of reporting and exchange of information with respect to crypto-assets.

This OECD report was prepared for presentation in the October 2020 meeting of G20 Finance Ministers and Central Bank Governors. It provides key insights and a number of considerations to help policymakers wishing to improve their tax policy frameworks for virtual currencies.

Income and gains arising from cryptocurrency or crypto assets, whether legal or illegal, should be taxable. The taxation should be looked at the time of creation of the crypto asset, storage, use and transfer, exchange and disposal of the asset.

Way Forward

Reporting under company law and the proposed Bill should help track such transactions from regulatory and income-tax perspective.  Should income-tax authorities also seek reporting of such transactions by Indian traders, crypto exchanges in India and outside India?

A global framework to regulate, report and tax the cryptocurrency and central bank digital currencies for consistencies across countries is the need of the hour.

[1] [LSI-128-SC-2020(NDEL)]

[2]http://www.lawstreetindia.com/news/7398/MCA-Substantially-amends-Companies-Act-Schedule-III-Mandates-several-additional-disclosures-under-financial-statements

[3]https://www.sfc.hk/web/files/ER/PDF/20191106%20Position%20Paper%20and%20Appendix%201%20to%20Position%20- Paper%20(Eng).pdf

[4]https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=20PR127

[5]https://sso.agc.gov.sg/Acts-Supp/2-2019/Published/20190220?DocDate=20190220

[6]https://www.mas.gov.sg/news/media-releases/2021/monetary-authority-of-singapore-and-banque-de-france-break-new-ground-in-cbdc-experimentation

[7] https://www.bis.org/publ/othp38.htm

[8] https://www.bis.org/about/bisih/topics/cbdc.htm

Exit Tax on Reconstitution of Firms - An Illustrated Analysis

This article has been co-authored by Meet Thakkar (Chartered Accountant) & Virtue Jain.

Background:

One of the traditional methods resorted by the taxpayer to structure or plan taxation on gains from sale of capital assets was through the medium of a partnership firm, LLP or an Association of Persons (AOP) or a Body of Individuals (BOI), by transferring their individual assets to such entities at cost or at a price lower than the fair market value and later on, withdrawing themselves from the said partnership or such entity by taking only the balance in their capital accounts and allowing other partners to continue to hold these capital assets. 

Section 45(4) was introduced to tax the profits or gains arising on transfer of asset or consideration on dissolution[1] by a partnership firm /LLP /AOP /BOI will be taxable in hands of such entity. Some of the major unanswered issues are as under:

Whether “dissolution of the firm or otherwise” includes ‘reconstitution’ of the firm?

Whether money /property received by an outgoing partner from the firm would be chargeable to tax in his hands / in the hands of Firm?

• Case 1: In Settlement of Existing Capital Balance.

• Case 2: By Revaluing the intangible factors, giving credit to Partners’ account as per his share and then distribution of Asset in settlement of revalued capital balance.

Whether sum payable/paid to an outgoing partner could be taxed in the hands of the firm?

Whether transfer of property (in form of stock-in-trade / capital asset) by a firm to its partners is taxed in the hands of firm?

What is the mode of computation of income in all the above-mentioned situations?

Finance Act, 2021 inserted section 9B and made consequential amendments in section 45(4) and section 48(iii) in Income Tax act,1961 with aim to resolve these questions. It is important to understand that when a partner disassociates from the partnership firm and receives any Asset / property, there are two taxable transactions.

• Transaction 1: Qua Partner - Receipt of asset by partner as consideration to reconstitution (Section 45(4) applies)

• Transaction 2: Qua Firm - Transfer of capital asset or stock in trade by firm to partner on reconstitution. (Section 9B applies)

Certain terms to be understood from Section 45(4) and Section 9B:

Specified entity is a firm, LLP, Body of Individuals or AOP, however, it specifically excludes company or co-operative society.

Specified person means a person who is a partner or member of specified entity in any previous year.

Reconstitution of entity means:

• One or more Partners /members (not all) cease to be its partner/s or member/s; or

• One or more new partners or members are admitted to the existing entity where one or more partners / members continue to remain even after addition; or

• Modification of share in profit ratio (whether changes in partners or not).

(For the analysis on Section 45(4) and Section 9B ahead, Partnership Firm is referred as ‘Specified entity’ and Partner is referred as ‘specified person’ for better understanding.)

Analysis of relevant amendments in Finance Act, 2021:

Similarity of provisions in Section 9B and Section 45(4):

Exclusion:

• Capital Withdrawal from their respective capital accounts during business shall not attract 45(4) or 9B.

Exclusivity of Section 9B:

Exclusion:

• Doesn’t deal with situation partner is distributed only cash at time of Dissolution/ reconstitution.

Exclusivity of Section 45(4):

Exclusion:

• Doesn’t deal with situation partner is distributed Asset/ cash at time of Dissolution.

• Doesn’t deal with situation partner is distributed Stock in trade at time of reconstitution.

• Cash Withdrawal from their respective capital accounts during business shall not attract 45(4).

Summary - Applicability of Section 45(4) and 9B under certain cases:

Quick view - Determining taxability for capital asset or stock-in-trade transferred to Partner by Firm

Illustration[2]:

Question: Mr. C, D and E are partners in a firm ‘IT’ having one third share each. Each partner has capital of INR 20 Lakhs. The firm owns three lands in Thane, Mumbai and Pune. All lands were acquired 4 years ago. Partner C exits from firm with consideration of INR 22 Lakhs and land in Pune. Details of lands is tabulated below:

What are the tax implications in the above situation?

Hint: Let’s discuss the implications of above transfer considering section 45(4) & section 9B is shown below:

Computation of Capital gain as per Section 9B in hands of firms:

Calculation of Net Profit & gains in books of accounts:

Computation of tax under Section 45(4) in hands of firm:

Further, the income of 80L will be attributed to land in Thane and Mumbai equally and would be reduced from sale consideration when remaining land are sold by virtue of section 48(iii).

Different practical situations to be analyzed from given illustration:

1.  What if, in above case, the land is sold to external party instead of transfer to partner and the consideration received from external party is paid to Mr. C?

Our View:

If the Pune land is sold to external party, then capital gains will be computed as per normal provisions of the Act i.e., Full value of consideration less indexed cost of acquisition/improvement under 48. Section 9B won’t apply in case of transfer to external party. However, the impact of tax amount would remain same in 45(4).

Computation of tax under Section 45(4) in hands of firm:

2.  What if the firm has self-generated/ intangible assets like patents and goodwill? Will Section 48(iii) still apply?

Our View:

Yes, the income from Section 45(4) will be apportioned to the intangible assets/self-generated assets/goodwill in proportion of valuation by registered valuer.

In case of self-generated assets such as goodwill, the cost would remain Zero (Sec. 55(2)(a)). However, the sale consideration of self-generated Goodwill would be reduced by amount of gain attributed as per operation of Section 48(iii).

3.  What if the firm has no capital assets left post transfer of Pune land to Mr. C, is benefit under Section 48(iii) be available?

Our View:

If it is temporary phase, and afterwards, any Capital asset is acquired, benefit of Sec. 48(iii) can be availed. But, if the firm is left with no capital asset, then forever, provisions of Section 48(iii) won’t be available to the firm.

4.  In case of loss under Section 45(4), what will be corresponding impact under Section 48(iii)?

Our View:

If the outcome under Section 45(4) is loss/negative, then value computed by section 45(4) shall be deemed to be Zero. In short, Sec. 48(iii) operates only if firm has gain u/sec. 45(4). As per Section 48(iii), loss under Section 45(4) can’t be apportioned to any leftover assets.

5.  What if the amount of debit capital balance of Mr. C after tax adjustment is 40 Lacs, Calculate Income under section 45(4)?

Our View:

• As per principal of judicial pronouncement[3], if the net worth is negative same shall be considered as zero while computing capital gains under Section 50B. Simple logic applied was Capital Gain can never exceed Sales Consideration.

• However, as understood from plain reading of Section 45(4), if the capital balance is negative, the same shall be added back to the computation as per the formula. Therefore, in the above illustration the income under Section 45(4) for the firm would be 162L (22L+ 100L - (- 40L)). There is rational of addition, as the retiring partner is getting over and above his capital which is overdrawn.

Frequently Asked Questions (FAQs):

1.  Why does Section 45(4) does not apply to dissolution of firm?

• Section 9B provides for taxability arising at the time of dissolution or reconstitution whereas Section 45(4) deals with the taxability at the time of reconstitution only.

• Where any asset or money is transferred to partner or member at the time of dissolution, same amounts to extinguishment or relinquishment of rights.

• Term “Transfer” as defined under section 2(47) covers extinguishment or relinquishment of rights within its ambit. However, since such rights are not extinguished or relinquished in favour of another person in case of dissolution, no one derives any benefit from the same. Thus, section 45(4) does not apply at the time of dissolution.

2.  In case of reconstitution of firm, is Section 45(4) or Section 9B is applicable?

It is clarified that the provisions of section 45(4) shall operate in addition to the provisions of section 9B and when a capital asset is received by a partner from a firm in connection with the reconstitution of such firm, the provisions of both the sections may operate independently in order of sequence given above.

3.  In case of Piecemeal distribution/ installment basis, whether section 9B applicable on yearly basis or in year of transfer?

Section 9B will be applicable in different years in case of piecemeal settlement on receipt basis (in connection with reconstitution of firm).

4.  What is the impact in hands of partner?

• No tax implications in hands of partner on reconstitution. In case of consideration received, the same is not taxable in hands of partner as the amount is already included in total income of the firm and in respect of asset transferred, when the partner sells the asset, capital gains will attract considering his cost as FMV on date of receipt by him.

• Period of holding would be from date on which the asset was transferred to partner by the firm until the date of transfer of such asset to any other person.

5.  Will the amount taxed under Section 45(4) will be attributable to block of assets?

Amount taxed under Section 45(4) will be attributable to capital gain on transfer of block of assets as per Rule 8AB.

6.  Will amount of benefit under Section 48(iii) be added to WDV of asset or will be deducted while computing capital gains on sale of such asset?

Income under Section 45(4) will not be added to WDV of asset but instead amount will be deducted while computing capital gains on sale of such asset from the block as per provision of Section 50(1)/(2).

7.  Will benefit under Section 48(iii) be available to stock-in-trade?

Benefit under Section 48(iii) is only applicable to capital assets defined u/sec.2(14), as stock-in-trade is not a capital asset.

8.  What if asset transferred to partner on reconstitution is non-capital asset (as defined under Section 2(14)) held by the firm?

• In provisions of Section 9B as well as 45(4), no separate definition of capital asset is mentioned and hence, general definition shall be considered as per provisions of Section 2(14).

• Transfer of non-capital asset as per Sec.2(14) like Rural Agricultural Land or Crypto Currency like Bitcoins etc, however, held as Investment will not be covered under the ambit of Section 9B. However, as Section 45(4) operates only when partner is receiving consideration towards relinquishment of his rights in favour of other/s on account of reconstitution, and consideration settled in ‘money terms’ is subject to tax. On similar lines, Taxman can have probable argument to consider FMV of ‘so called non-capital asset’ for tax purpose in lieu of money. In our view, the issue is not free from litigation.

Conclusion:

Blockchain and Transfer Pricing: From possible to plausible

This article has been co-authored by Gopal Agarwal & Dhiman Parekh.

Blockchain is a ubiquitous term in our everyday parlance made popular by the wildly hyped cryptocurrency Bitcoin. It promises to disrupt the manner in which the world conducts business, and consequently the taxation aspect of such businesses. In this article, we explore whether Blockchain technology can traverse the distance of ‘possible’ to ‘plausible’ in connection with its application in TP.

What is Blockchain

To understand its application in TP, we must first understand the technology. Blockchain, a part of a suite of technologies known as Distributed Ledger Technologies (DLT), in which a transaction is stored as ‘block’ and linked to each other via ‘chains’. To approach it differently, this ledger of information is replicated and distributed across computers that are joined over a peer-to-peer network. Result? That single transaction, known as a ‘block’, serves as a permanent record, maintained in a single, shared digital ledger, ‘chains’. Any related new transaction can be added on top of that original records, creating an interconnected blockchain of complex transactions and counterparties, mapped in the single digital ledger shared by all parties involved.

Like any other disruptive technology, blockchain aims to replace traditional models, by offering an alternative that is devoid of the weaknesses that would have crept into these models over time, which are:

• Consensus: Information can be added onto a Blockchain only if all, or a defined number of participants in the network agree on the correctness of information.
• Immutability: The ‘Blocks’ are cryptographically locked into a ‘Chain’, meaning that it is impossible to delete or alter the information stored in the block.
• Chronological and time-stamped: Blockchain is a chain of blocks, each one storing data on a wide range of information. Each one is linked to the previous block, forming a chronological chain of the data uploaded onto the Blockchain.

The implications: recordkeeping in a decentralized, time-stamped, tamper-proof (to the extent that it is near impossible to alter or overwrite without the other party’s tacit approval), quick and cost effective manner. The identification of new instruments to improve the efficiency of TP and its control is a priority on the international tax law agenda.

Thus, there is a need to explore the applications of Blockchain technology in real world scenarios. A couple of examples include:

Smart Contracts

‘Smart Contracts’ are programs stored on a block, that execute when predetermined conditions are met. Smart contracts can be used to automate the execution of an agreement, so all parties can be certain of the outcome, without any intermediary’s involvement or loss of time. Smart contracts are finding applications in a wide array of businesses, especially in the Financial Services Sector, for trade clearing and settlement (managing approval workflows between parties, calculation of trade settlement amounts, and automatic transfer of funds), coupon payments (calculation and payment of periodic coupon payments and returns of principal upon expiration of period), calculation and distribution of royalty payments, apart from other sectors such as Life Sciences, Healthcare, Supply Chain, Logistics and public authorities.

Digitization of assets

‘Digitization of Assets’ is a process wherein the rights to an asset are converted into a digital token (on a blockchain). Ownership rights are transmitted and traded on a digital platform, and the real-world assets on the blockchain are represented by digital tokens.

Digital Tokens can be created for tangible or intangible assets, fungible or non-fungible assets. Once created, the Digital Token can be traded freely, and royalties arising from rights to use such tokens can be automated using Smart Contracts for further ease of business and accuracy.

Adoption of Blockchain Technology

As per a Deloitte’s 2020 Global Blockchain Survey, the Telecom, Media, Telecommunications industry along with Financial Services are the early adopters of Blockchain technology.  Approximately 36% of the respondents to the survey reported that their organization planned to invest at least US$5 million in the next 12 months in Blockchain. As can be expected, the top three barriers felt by organizations in adopting blockchain technology is Implementation: replacing or adapting existing legacy systems, potential security threats and concerns of sensitivity of information.

At this juncture, it would be pertinent to mention the discussion paper released by the NITI Aayog: Blockchain: The India Strategy – Part 1. This discussion paper released in 2020 signals both India’s eagerness and trepidations in adopting Blockchain technology. The three case studies that the NITI Aayog has explored use of Blockchain technology are: (i) Land Records, (ii) Pharmaceutical drugs supply chain and (iii) SuperCert: anti-fraud identity intelligence blockchain solution for educational certificates. The NITI Aayog is also working on part II of the paper, which will cover specific recommendations on the growth and expansion of use of Blockchain ecosystem in India.

Further, both the Organisation for Economic Cooperation and Development (‘OECD’) and United Nations (‘UN’) have taken note of the potential of Blockchain and its applications. The OECD has constituted the Blockchain Policy Centre in 2018, which intends to work as an international reference point for policy makers on Blockchain technology. The OECD also recently released a discussion paper on ‘Draft OECD high-level guidance regarding policy considerations on responsible innovation and adoption of distributed ledger technology (DLT)’, with a view to providing high-level, non-sector-specific guidance on responsible innovation and adoption of Blockchain, to all stakeholders involved in the development and use of blockchain, including but not limited to governments. Further, the UN has also responded positively, particularly in the areas of humanitarian cause, fight against climate change, disbursing funds to refugees using blockchain-verified iris scans instead of ID cards etc.

Blockchain and TP

Blockchain has the power to disrupt and strongly reorganize accounting and the way tax payments are processed. It particularly is attractive since it will reduce administrative burden, cost of tax collection, and reduce data gap / data corruption, for both taxpayers and tax administrations.

Focusing on TP, blockchain technology promises to be a boon, rather than a bane in the following scenarios:

- Standardized ‘Decentralized’ Data: Large MNEs often have decentralized operating structures and multiple corporate units, with decision making individuals located in multiple jurisdictions (often in the form of Regional Headquarters). This often leads to data being stored on local servers in varying formats. This leads to the MNE embarking on a data centralizing exercise, which is cumbersome and costly. Blockchain technology is well suited for merging data (and possibly processes) in the case of a decentralized organization structure. Visualize an ERP system based on Blockchain with standardized data formats across the globe, with TP and arm’s length calculations (on pre-determined rules which can be updated time-to-time). Further visualize such an ERP system that can be used as an interface to funnel data into pre-defined TP formats (for statutory compliances, including CbCR, Master Files, Local Files, or internal management reporting / tracking). 

- Audit Readiness: Blockchain, by default, undertakes archiving of audit data, since inter-company transactions are mapped in a standardized format and available for dissemination to tax authorities on an almost real-time basis. Further, the efficacy of the data using Blockchain will be beyond question / challenge, as it is near impossible to manipulate / edit data once stored.

- Smart Intercompany Contracts: Tracking and maintaining physical intercompany contracts is cumbersome and smart intercompany contract can displace the physical one. As discussed above, a smart contract is an agreement or set of rules that governs a transaction and is coded into the blockchain network. If the pre-defined conditions are satisfied, the transaction is executed. For example: a smart intercompany contract may define contractual conditions under which a cash pooling arrangement works, trading of commodities at pre-determined arm’s length prices etc. Further, Blockchain reduces the risk of loss of data. Visualize, inter-company securities transactions being executed at prices which satisfy the requirements under Comparable Uncontrolled Transaction (CUT), on a real time basis, with such data being maintained and recorded instantaneously. Further, implementation of prices / methodology determined under Advance Pricing Agreements (APA) can also be made instantaneous and in accordance with the APA, especially beneficial for bilateral and multilateral APAs and questioning the need for audits post signing an APA.

- Smart Contracts in Intra-Group Services: In our TP world, the correct transfer price calculation is the first stage to be mandated. The mechanism involves a situation in which there is a ‘green light’ for validating the transaction any time the transfer price of an intra-group transaction is within the range of prices calculated by the smart contract. The second stage is focused on transaction validation and determines the corresponding actions from MNE entities that operate as nodes of the network. Once there is a green light for an intra-group transaction, MNE entities, have the right to validate that transaction allowing the adding of a new block to the blockchain. Therefore, as transfer price calculation and transaction validation become a fully automated process, there is no longer a need for dedicated reporting activities from MNEs.

- Performance of DEMPE Functions: Blockchain technology could be used to identify where a related-party transaction originated, exactly when it occurred, and the terms under which it occurred. Thus, it provides the hope that blockchain will clearly show the development, enhancement, maintenance, protection, and exploitation of intangibles by creating a trail back to the location(s) of value creation. In application of Profit Split Method, the first hurdle is the determination of profits to be split. Blockchain will enable the MNE to collate the data effectively, as it will capture the entire supply chain in an efficient manner. Further, implementation of results of the contribution analysis can also be standardized and made real-time, rather than a post-facto exercise. Blockchain will also assist in identifying where the actual substance lies in a transaction over its legal structure.

- Country-by-Country Reporting (CbCR): CbCR poses added risk and administrative burden for finance and tax departments of MNEs. Use of blockchain technology may provide potential ability to access aggregated CbCR information from a single distributed ledger source available for review and approval by all parties. The ability to validate and share secure data between parties on the blockchain will redefine how CbC reporting is done.

- Pillar 1&2: Since Blockchain works on pre-defined rules, it may provide ease in the implementation of Pillar 1 principles – agreed upon allocation of profits between entities. Without the need for manual intervention, it can enforce trust into conduct of parties and make work easier. Blockchain may enable tax authorities to implement the global minimum tax rule across countries and organizations in an efficient and cost-effective manner.

- Interplay with other laws: Since data stored on Blockchain is standardized, the format can be made such that the data can be used for other laws / purposes with ease (GST Laws, Customs, Cost Audits) without having the need for customizing the same for different applications. It can also facilitate capturing data in a format desired by organizations to ensure accurate reporting for business decision making.

As is with any emerging technology, there certainly are drawbacks to Blockchain, the biggest being scalability, since it generates a large amount of data, being based on a P2P network, it requires constant computing power, reliance on the private key of users. The decentralized nature of Blockchain is a double-edged sword for organizations, since the centralized data management is a security feature, which also leads to single-point of failure. Further, since the record is permanent, accuracy of data being fed into the system is of paramount importance.

Thoughts to ponder

Cryptic Taxation of Cryptocurrencies in India

This article has been co-authored by Yash Goenka (Manager, TMSL).

Cryptic Taxation of Cryptocurrencies in India

Regardless in which part of the world we are today, unless it is under a rock, one fact that remains communal across is the virtual ecosystem that we live in. While we exist in this virtual world, there is no reason for currency to not go virtual too. Cryptocurrency is the digital or virtual currency which is used in place of normal currency (also known as fiat currency). While the cryptocurrency dates back to 1980s starting with e-cash, the crypto concept became popular much later. Although, the initial models of cryptocurrencies may not be called successful, but they certainly laid down a strong foundation for the upcoming storm of alternate currency. The first cryptocurrency which took the world by rage was Bitcoin. However, at present there exists multiple currencies which are serving the purpose of a cryptocurrency such as Ethereum, Ripple, Dogecoin etc.

How does it work?

The process of transferring Bitcoin is very complex and the above diagram is not the actual representation of it. However, as we attempt to understand the GST implications on cryptocurrencies vide this article, we have summarized and simplified the process for a better understanding.

Global coverage and taxation system[1]

The countries across the globe are divided on the treatment of cryptocurrencies. Nevertheless, the increasing use and popularity of cryptocurrencies have obligated the nations to give a serious thought to the currency and its use. Some countries like Japan, UK, Mexico have dedicated laws and regulations for the use of cryptocurrencies. There is also a gamut of countries like Vietnam, Ecuador and Indonesia which do not treat it as a currency but permit the trading of it. Countries like Saudi Arabia, Bangladesh, Bolivia, Morocco, Russia, have made possession of cryptocurrencies illegal. Moreover, there are countries like China, Thailand, Qatar, Kuwait have prohibited the regulated financial institutions like banks, NBFCs etc. from directly or indirectly participating with individuals or businesses who engage in cryptocurrencies.

From a Direct Taxation perspective, only a handful countries consider a virtual currency to be money. Most countries consider it a type of asset or property including intangible asset or financial asset. Thus, in these countries the income tax treatment is similar as given to any other asset.

From an Indirect Tax outlook, again the approach of countries is divided. UK, Germany, Sweden, Ireland etc. do not tax the mining fees. However, the same is taxable as supply of service in France. In Australia, prior to 2017, transactions in cryptocurrencies were treated as taxable barter event. However, this was amended to hold that purchases of goods and/or services with cryptocurrency would not be a barter event. Additionally, exchange of virtual currency and/or fiat currency is now exempt being a financial service. Similarly, in Singapore prior to 2020, exchange of virtual currency was subject to GST and transactions in cryptocurrencies were treated as barter. Later, it was included in the definition of exempt financial services and no GST was levied.

Status of Cryptocurrency in India

In India, cryptocurrency is not recognized by the Reserve Bank of India (RBI) as a currency and thus remains unregulated currently. The RBI’s approach towards cryptocurrencies was made clear in 2018 when vide a circular the regulator directed all financial institutions which it regulates to stop providing any services to any individual or business dealing with or settling digital currency. However, this circular has been set aside by the Supreme Court in 2020. Despite the Court’s order, the RBI has instructed banks to stay away from crypto exchanges. These exchanges have petitioned the Government to not ban cryptocurrencies completely, instead appoint a new or a hybrid regulator other than RBI for its regulation and clear the air around its taxation; even if that means taxing crypto in the highest tax bracket. This request comes as the Government is ostensibly evaluating the crypto bill.

In 2021, a question was posed before the finance ministry in the parliament – ‘whether the earnings from cryptocurrencies is being subject to tax’? To which the ministry replied that any income irrespective of where it is derived from should be offered to income tax; hence, any profits or gains from dealing in cryptocurrencies should be subject to income tax. The ministry added, that any supply of goods or service which has not been exempted would be liable to GST; no supply in relation to crypto currency has been exempted from GST specifically. Thereby clearing the air around taxability of cryptocurrency.

In July 2019, a press note was released by the Ministry of Finance which stated that a draft law on cryptocurrencies is pending before the Government for discussion and final decision.

Income Tax Issues

The Income Tax Act, 1961, (IT Act) will govern the taxability of cryptocurrencies in India. Although, there is no clear guideline or principle for taxability of these currencies, one may only anticipate. The IT Act does not levy any tax on transactions in money. Therefore, if virtual currency is held to be money or currency, there would be no income tax implications. On the contrary, if virtual currency is not considered as ‘money’ or ‘currency’, two views are probable. As discussed above, a view has been adopted at various places which cogitates virtual currency as an intangible asset. This would lead to an interpretation that the income from such currencies could be taxable under the head ‘Income from capital gains.’ Hence, any profits realized on sale of cryptocurrencies could become taxable as capital gains. Another school of thought has emerged, is for a person who is engaged in the business of trading cryptocurrencies. For such person, cryptocurrencies become inventory and profits from such business would be taxable under the head of the ‘Income from Business and Profession’.

Possible GST implications

For simplifying the subject, let us understand the GST implications on two most common types of scenarios that occur in crypto:

1. Using crypto as a consideration to pay for supply of goods and/or services; and
2. Trading of crypto (similar to securities or bullion)

Let us discuss these two scenarios and possible tax implications in details below:

1. Scenario 1: Using crypto as a consideration to pay for supply of goods and/or services

In the first scenario, we can take the recent example of Tesla. In February 2021, Tesla mentioned that it may start accepting Bitcoin as a payment against the sale of its cars. Thus, instead of fiat money, a car buyer could make payment in Bitcoins. If a similar transaction were to happen in India, how would it become taxable is the question?

As per Section 7 of the CGST Act, 2017, supply includes ‘all forms of supply of goods or services or both such as sale, transfer, barter, exchange, licence, rental, lease or disposal made or agreed to be made for a consideration by a person in the course or furtherance of businesses.’ Consideration under GST has been defined as ‘any payment made or to be made, whether in money or otherwise….’. Moreover, the CGST Act, 2017 (the Act) defines money as ‘Indian legal tender or any foreign currency, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveler cheque, money order, postal or electronic remittance or any other instrument recognized by the Reserve Bank of India when used as a consideration to settle an obligation or exchange with Indian legal tender of another denomination but shall not include any currency that is held for its numismatic value.’

In light of the above definitions, it is clear that Bitcoin would not qualify as consideration in ‘money’ as it is not recognized by the RBI. Therefore, it may be called a supply against another supply or a barter. With respect to taxing a barter transaction under GST, there are two underlying supplies attracting tax within the same transaction i.e. supply of car and supply of Bitcoin, in the above example. There are multifold issues in this case such as whether both supplies which are part of essentially a single transaction would attract GST? If yes, whether the recipient of supply would be eligible to avail credit of input GST? How would the supply of Bitcoin be classified and valued for GST purposes?

2. Scenario 2: Trading of cryptocurrencies

Trading in crypto is a common phenomenon. Since it is being considered as a modern-day investment option, people buy crypto for trading purposes, similar to securities and bullion. Consideration for such transactions is made in fiat currency. Thus, it is a normal supply transaction wherein crypto is supplied against consideration in money. However, the issue that crops up here is whether supply of crypto is supply of goods or services. 

The Act defines goods as ‘every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply.’

The Act directs us to peruse the definition of securities as given under (h) of section 2 of the Securities Contracts (Regulation) Act, 1956[2].

Moreover, services have been defined as ‘anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged;

In terms of the definitions cited above, it can be said that unless a tender is recognized by the RBI, it cannot be called money under GST law. Nor can they be termed as securities in light of the cited definition. Additionally, goods or services include anything other than money or securities. This gives rise to an interpretation wherein any trading or dealing in cryptocurrency can be termed as ‘goods’ or ‘service’ under GST law as the same is not money or securities. Considering that it has been established that virtual currency is taxable under GST since it’s not money. Further, let us move to analyze whether it is goods or service. This is important because the HSN or SAC code will be determined basis such grouping, thereby determining the tax rates on cryptocurrencies.

The given definition of goods under GST aims to include movable property. Movable properties under General Clause Act, 1847 and Transfer of Property Act 1882, has been defined in a wide manner to say that movable property is anything except for immovable property. With such an extensive definition, it is quite possible that the Government would classify virtual currencies as goods. This explanation also applies to Scenario 1 where crypto is supplied in consideration for another supply.

The above view also concurs with Central Economic Intelligence Bureau (CEIB) proposal which has been sent to the Central Board of Indirect Taxes & Customs (CBIC). The said proposal has anticipated that the cryptocurrency market in the country would reach at about Rs 40,000 crore. The proposal further suggests to classify bitcoins as ‘intangible asset’ and levy GST @ 18% on margins made while trading in such currency. However, there are no concrete steps taken by the CBIC in this regard.

With the above in perspective, the three transactions cited above could have the following GST implications:

1. Validation by miners: The transaction fees paid to the miners to validate the transfer of a cryptocurrency would be subject to GST, irrespective of whether the consideration is received in money or cryptocurrency. Therefore, miners would be required to discharge GST if their turnover exceeds the prescribed GST registration threshold.
2. Valuation and liquidity by cryptocurrency exchange: The exchange performs the function just like any other securities exchange wherein valuation, trading and transaction of cryptocurrencies can take place. It also charges a fee for such function which could be in fiat currency or in cryptocurrency. Such fees would be subject to GST.
3. Payment for supply: This is a usual transaction for supply of goods and/or services leviable to GST. Therefore, B would levy GST on the supply made by it.

While all three transactions would attract GST, their valuation could prove to be challenging if the consideration is received in cryptocurrency as valuation rules under GST do not cover valuation of cryptocurrencies. The obvious option which appears here is very homogeneous to current treatment with USD; to convert the virtual currency into fiat currency by using the conversion rate as applicable in the market and apply GST thereon.

Also, in case where virtual currency is received as a consideration for export of goods and/or services, one may have to determine whether the conditions for being qualified as export would be met. More specifically, the condition of realizing proceeds in convertible foreign exchange. Can cryptocurrency be called convertible foreign exchange? Convertible foreign currency is defined to mean foreign exchange which is treated as convertible foreign exchange in terms of Foreign Exchange Management Act, 1999 by the RBI. It appears that it may be difficult for a cryptocurrency to qualify as convertible foreign currency, unless the RBI amends the FEMA provisions.

How does the future look like for Crypto?

It is undeniable that the popularity of cryptocurrency is touching the roof. While everyone is dubious of the currency and its future, the truth is that it has the potential to become the most prevalent and widely used currency across the globe. Recently, Tesla Inc announced that it would not accept bitcoins against the sale of its vehicles. This announcement alone dropped the valuation of bitcoin by 17%. This indicates the volatility of value of cryptocurrency. The capricious nature of the currency and its lesser known underlying value also makes it a good contender for another Tulip Mania.

Irrespective of that, the Indian taxation authorities have identified a golden goose and soon we shall be witnessing some clarity on the taxation of cryptocurrency transactions. Though, the path ahead is a long one as there are plenty of open questions that need answering; key ones being –

• Is cryptocurrency money?
• Is cryptocurrency intangible asset?
• Would transaction in cryptocurrency be called as barter?
• What would be the taxation of validation fee paid in cryptocurrency to miners for validating a cryptocurrency transaction?
• Whether gains from trading of cryptocurrency would qualify as capital gains or income from business and profession?
• Whether virtual currency will satisfy the requirements of being called a convertible foreign exchange in export cases?
• What is cryptocurrency – goods or service?
• What is the classification and rate of GST, if applicable?
• How can one value cryptocurrency? Will it be similar to stock exchange?

The above list is not exhaustive. The Government needs to give the concept a deep thought before acting on the draft law. It may not be long before RBI actually considers the recognition of virtual currency as money. Notably, the crypto exchanges in India want Securities and Exchange Board (SEBI) as its regulator. The rationale behind the appeal being that crypto assets are closer to commodities than to currency. Therefore, the Government needs to draw a clear-cut demarcation to classify whether crypto is a currency or a commodity. Till the time that does not happen, the industry might be treading a precarious territory. Whatever the future may hold, the industry deserves clear guidelines on the taxation of their transactions.

[1] https://www.oecd.org/tax/tax-policy/taxing-virtual-currencies-an-overview-of-tax-treatments-and-emerging-tax-policy-issues.pdf

Cryptocurrency: Key GST Aspects in India and Path Ahead

This article has been co-authored by Onkar Sharma (Principal Associate, Khaitan & Co).

1.       Background 

The conversation around cryptocurrency in India is expected to gain significant impetus now, with Coinbase Global Inc., the largest Bitcoin exchange in the US, having gone public this week at a staggering valuation of around one hundred billion US dollars. 

India has had a complicated relationship with cryptocurrency. The Reserve Bank of India (RBI) initially reacted with effectively a ban on cryptocurrency trading in India vide circular dated 6 April 2018 which was overturned by the Supreme Court of India in March 2020. In the last few months, there has been a lot of conversation around potential introduction of a new law which envisages issuance of an ‘official’ digital currency by the RBI and, more importantly, prohibition of all other forms of cryptocurrency. However, more recent news reports indicate a possible softening of stand with statements being made about the government keeping an ‘open mind’ and adopting a ‘calibrated approach' towards digital assets[1]. 

This uncertainty, however, does not seem to have dented India’s enthusiasm for cryptocurrency. As per a report from Reuters of March 2021[2], “In India, despite government threats of a ban, transaction volumes are swelling and 8 million investors now hold 100 billion rupees ($1.4 billion) in crypto-investments, according to industry estimates”. 

It is in this backdrop that it becomes imperative to examine the key GST aspects of cryptocurrency transactions. 

2.       Key GST aspects 

A.                Nature of cryptocurrency?

Unlikely to qualify as ‘Security’: Securities are specifically excluded from the definitions of both ‘goods’ and ‘services’ under GST. Section 2(101) of Central Goods and Services Tax Act, 2017 (CGST Act) read with explanation to section 2(h) of the Securities Contracts (Regulation) Act, 1956 defines “securities” as:

“Securities include-

(i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;

(ia) derivatives;

(ib) units or any other instruments issued by any collective investment scheme to the investors in such schemes;

(ii) government securities;

(iia) such other instruments as may be declared by the Central Government to be securities; and

(iii) rights or interest in securities.”

While the definition begins with ‘include’, given the very specific enumerations thereafter, it appears that the word ‘securities’ has to be understood in light of the specific categories mentioned above. All these categories, stripped to their bare essence, envisage certain rights that the recipients obtain over the issuer of ‘securities’. Given that cryptocurrencies do not have a centralized issuing authority who undertakes to repay the value represented by a unit of cryptocurrency, cryptocurrencies are unlikely to qualify as ‘securities’ and thus get excluded from GST. 

Unlikely to qualify as ‘actionable claim’: Schedule III of the CGST Act specifies “Actionable claims, other than lottery, betting and gambling” as “Activities Or Transactions Which Shall Be Treated Neither As A Supply Of Goods Nor A Supply Of Services” and thus not be liable to GST. Section 2(1) of the CGST Act read with section 3 of the Transfer of Property Act define ‘actionable claim’ to envisage two scenarios: (i) an enforceable claim to an unsecured debt, and (b) an enforceable claim to a beneficial interest in a movable property which is not in possession of the claimant. 

Given that cryptocurrencies do not have a centralized issuing authority which undertakes to repay the value represented by a unit of cryptocurrency, cryptocurrencies clearly do not fall under (i) above. Further, given that cryptocurrencies are themselves likely to qualify as ‘movable property’ (which would typically be in ‘possession’, in the relevant cryptocurrency ‘wallet’), it would be difficult to argue that cryptocurrencies represent claim to a beneficial interest in a movable property which is not in possession. Thus, cryptocurrencies are unlikely to qualify as ‘actionable claim’ either. 

‘Goods’ or ‘Services’? - Section 2(52) of the CGST Act defines ‘goods’ to mean “….every kind of movable property other than money and securities but includes…..”. Section 2(36) of the General Clauses Act defines ‘movable property’ in a rather catch-all manner - “movable property shall mean property of every description, except immovable property”. The word ‘property’ has also been interpreted in a wide manner by courts in various contexts to be a bundle of rights which the owner has over or in respect of a thing, tangible or intangible, or the thing itself over or in respect of which the owner may exercise those rights. Given the foregoing, cryptocurrencies are likely to qualify as ‘goods’ under GST laws in India, albeit intangible ones. 

B.        Using cryptocurrency to pay for goods/services? 

The term ‘consideration’ has been defined under Section 2(31) of the CGST Act to include “...any payment made, whether in money or otherwise, in respect of the supply of goods or services...”. Here, it would be necessary to make a reference to the definition of the term ‘money’ as provided under Section 2(75) of the CGST Act. 

As per the definition money means “…the Indian legal tender or any foreign currency,….or any other instrument recognised by the Reserve Bank of India…”. Thus, it can be stated that a currency would qualify as ‘money’ under the CGST Act only if the said currency has been recognised by the RBI. While the initial ban by RBI was overturned by the Supreme Court, the RBI has obviously not recognised cryptocurrency (like Bitcoin etc) in any manner. Therefore, as on date, ‘cryptocurrency’ cannot be classified as ‘money’ under the CGST Act. 

At this juncture, it may be noted that the phrase “or otherwise”, which is occurring in the definition of the term ‘consideration’, would include situations / transactions like ‘barter’. This is because typically in ‘barter’, the recipient of supply does not make payment to the supplier by paying ‘money’; instead, the ‘consideration’ is paid by the recipient in ‘kind’. Meaning thereby, that the supply is received either in lieu of some other specific goods or services. Thus, using cryptocurrency to pay for goods/services may lead to the transaction being treated as if it’s a barter transaction (supply of goods/services against receipt of intangible goods ie., cryptocurrency) and accordingly, be made liable to GST. 

GST law in India is not quite settled apropos certain aspects of barter transactions. Accordingly, if a transaction qualifies as a ‘barter’ under GST, following issues may require greater analysis: 

a.         Which leg of the transaction would qualify as a ‘consideration’ and which leg of the transaction would qualify as a ‘supply’? Ambiguity in this regard may lead to a scenario where GST authorities in India may argue that transfer of / payment in cryptocurrency  received by Indian parties is a separate ‘supply of intangible goods’, thereby, making the parties (located in India) liable to deposit tax / GST[3].

b.        If payment through cryptocurrency is construed to be the ‘consideration’, how will value be ascribed to such ‘consideration’ for the purpose of levying GST?

Practically, if an Indian customer uses cryptocurrency to pay for goods/services, GST can apply at two levels – (i) GST borne by the customer for acquiring cryptocurrency upon payment in money; and (ii) GST applicable on the purchase of goods/services which have been paid for using cryptocurrency. 

Impact on ‘export’ position under GST: One of the key conditions for availing the benefit of ‘zero rating’ for exports under GST is the receipt of the consideration in ‘convertible foreign exchange’. The term ‘convertible foreign exchange’ will have to be interpreted in light of the provisions stipulated in Indian foreign exchange laws. As the laws stand today, it would be difficult for cryptocurrency to qualify as a ‘convertible foreign exchange’ thereby jeopardizing the tax benefits of ‘export’ transactions under GST. 

C.        Relevant references from Australia and the United Kingdom (‘UK’) 

Australia: Till July 2017, the position in Australia was similar to what has been discussed above. As per the ruling no. GSTR 2014/3 from the Australian Tax Office (ATO), using cryptocurrency to pay for goods/services would have led to the transaction being treated as if it’s a barter transaction. GST was to be paid on the value of the cryptocurrency in Australian dollars, at the time of the transaction. The problem of dual-level taxation (as mentioned above in the Indian context) was identified in Australia too and the position was reviewed. 

From 1 July  2017, the guidance note provided by ATO[4] states that: “Sales and purchases of digital currency are not subject to GST from 1 July 2017. This means that you do not charge GST on your sales of digital currency and similarly, you are not entitled to GST credits for purchases of digital currency.”  Basically, a treatment comparable to ‘exempt supplies’ under Indian GST laws have been prescribed. 

The note further prescribes: “…..No GST consequences arise when you use digital currency to pay for goods and services in your business. Digital currency is a method of payment and the consequences of using it as payment are the same as the consequences of using money as payment…..If you receive digital currency as payment for your sales of goods and services normal GST rules apply.” 

UK: The UK HMRC has recently released its internal Crypto-assets Manual[5], to provide guidance for tax treatment of crypto-assets for its staff and to assist professional advisors and customers in understanding HMRC’s interpretation of law. 

The manual clarifies: “VAT is due in the normal way on any goods or services sold in exchange for cryptoasset exchange tokens. The value of the supply of goods or services on which VAT is due will be the pound sterling value of the exchange tokens at the point the transaction takes place……no VAT will be due on the supply of the token itself”. Effectively, the position seems similar in UK and Australia today. 

D.        Recent proposals in India 

Media reports suggest that the Central Economic Intelligence Bureau (CEIB) has raised a proposal to the Central Board for Indirect Taxes and Customs (CBIC) to bring cryptocurrency exchanges and platforms under the GST purview. The salient features of CEIB’s proposals in this regard, as available in public domain[6], are excerpted below: 

• The act of cryptocurrency mining could be treated as a supply of service as it generates cryptocurrency and charges transaction fees, and as such, should classify as an intangible asset and attract a GST of 18%

• Taxpayers operating as cryptocurrency miners will be required to register under GST if their annual revenue exceeds ₹20 lakh. GST will be liable on the transaction fee and/or the reward viz. currency mined. 

• Consider bringing wallet service providers under the GST purview.  

• Trading of cryptocurrency and other related transactions like transfer, storage, accounting etc are also likely to be considered as an act of supply and could be taxed.  

• The transaction value in INR or an equivalent freely convertible foreign currency will be used to determine the value of cryptocurrency and thereby the transaction and subsequent tax liabilities.  

• In cases where the buyer and seller are registered as Indian residents and operators, the transaction should be treated as a supply of software.  

• International cryptocurrency transactions by companies registered in India will be treated as import or export of goods and as such will be liable to IGST. Another major reason to consider bringing cryptocurrencies under the GST purview is to curb money laundering and undermining of legitimate currencies. 

Some of these proposals do not seem to be in sync with the global best practices and would hopefully be reconsidered. 

One hopes that, like in Australia and UK, clear and progressive guidelines will soon be issued in India apropos GST (as well as in general vis a vis various other aspects of crypto-currency) so that India becomes well-placed to ride the ‘cryptocurrency wave’ in the coming days. 

The views of the authors in this article are personal and do not constitute legal / professional advice of Khaitan & Co. For any further queries or follow up please contact us at editors@khaitanco.com.

[1] See: https://www.livemint.com/news/india/will-ensure-interest-of-crypto-investors-is-protected-anurag-thakur-11618215067597.html

GST on Bitcoin

This article has been co-authored by Swati Ghoshal (Partner, AMRG & Associates).

Cryptocurrencies like bitcoin are decentralized digital currencies relying on a peer-to-peer network that operates without the need for a third-party intermediary like the Reserve Bank of India. Tied with a lack of governing guidance, its exceptional technical aspects create difficulties in its taxation. One key advantage of using cryptocurrency is that it is almost impossible to counterfeit. This is due to cryptography being used as part of transactions, ensuring everything is safe and sound.Bitcoin was the first-ever cryptocurrency created in the year 2009 by “Satoshi Nakamoto”.Successively, there has been a rapid increase in the number of cryptocurrencies that have been formed some of which are Litecoin, Ethereum, Zcash, Dash, Ripple, etc.

India has one of the largest economies in the world, would always fear something which has the potential to replace the fiat currency primarily because it does not have the know-how to curb the wrong practices which can result from crypto trading. The establishment and transfer of bitcoins are based on an open-source cryptographic convention that is being managed in a decentralized manner. Bitcoin network shares a public ledger, which is called “blockchain”. This ledger encloses information of every transaction administered, thereby, allowing the user’s computer to verify the soundness of each transaction. The authenticity of each transaction is protected by digital signatures, permitting all users to have a complete mechanism over sending bitcoins from their bitcoin addresses. This whole process is known as “mining”.

In the Year 2018, the Reserve Bank of India (RBI) imposed a ban on the dealings of Virtual Currencies through the medium of the financial institution. The main argument for banning financial institutions dealing with Cryptocurrencies is that it has no certified form of virtual currency. In the Year 2020, the Indian Supreme Court reversed the 2018 ban through a judgment on banks and other financial institutions from offering their funding, support, and services for cryptocurrencies. This was a welcome relief for many. However, this is now being re-evaluated, putting the future of many crypto businesses at risk.

Wherever there is a business, the role of taxation cannot be underplayed. Whether legal or illegal, Bitcoin is playing a role in India, which is bound to catch fire in the next years. It is crucial to understand various aspect of the atxation of this currency legally as well as pratcically.

GST applicability on Bitcoins

Everyone is aware of GST and the vagueness created by it. A layman or a proficient, no one is left intact by its impact, not even our economy and business.

The bitcoin trade varies from country to country. For example: In the USA it is treated like an asset having the nature of fixed or an inventory asset. While in the UK it is a `private currency'. In Singapore, Bitcoin is known as a valid currency, while in Japan Bitcoin is calleda commodity.

As per a proposal raised by Central Economic Intelligence Bureau (CEIB), Cryptocurrencies like bitcoin can be categorized into intangible assets and GST can be levied on the same at the rate of 18% GST. 

Legally speaking as per the provisions of GST, the classification of cryptocurrencies can be done as follows:

·         Goods:As per Section 2(52) of CGST Act, 2017, Goods are be defined as “every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply”.

·         Services:As per Section 2(102) of CGST Act, 2017, Services are defined as “anything other than goods, money, and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged.

Explanation.—for the removal of doubts, it is hereby clarified that the expression "services" includes facilitating or arranging transactions in securities.”

·         Money: As per section 2(75) of CGST Act, 2017, Money will be defined as “the Indian legal tender or any foreign currency, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, travellercheque, money order, postal or electronic remittance or any other instrument recognised by the Reserve Bank of India when used as a consideration to settle an obligation or exchange with Indian legal tender of another denomination but shall not include any currency that is held for its numismatic value;”

·         Securities: As per Section 2(h) of Securities Contract Regulation Act, 1956, securities include “shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;”

GST is leviable on the supply of goods or services or both only. If Bitcoin falls under the scopeof Goods or Services, then GST will be applicable on trade of bitcoins otherwise; not. However, there is one major challenge in the taxation of Bitcoin. Whether it would be treated as Goods or services? What would be the HSN? What would be the tax rate? These all are open issues that have never been dealt uptill now by anyone. There seems to be neither any discussion nor any deliberation in GST council on this topic. We are far from a formal determination of taxes in the case of cryptocurrency.

If,However Bitcoin is approved by RBI as “legal currency,” then like any other currencies INR, USD, payment to wallets etc. it will not be chargeable to GST per se.

If law declares the same as security, then also no GST would be applicable on trading of such securities like listed shares, unlisted shares, debentures etc.

Tax authorities

Now the moot question remains, what will happen till any formal decision is taken by law on this aspect. How will grass-root tax officials behave when they unearth a transaction in cryptocurrency.

For practical purposes, if any person is caught trading in cryptocurrency, GST authorities may not let it go unnoticed. They would initiate some action to keep the case alive. There is a Heading 9997 in the case of supply services, which intends to tax any service which is “nowhere else classified,” and the tax rate would be 18%. Similarly, there is a residuary entry no. 453 also in the classification of Goods, which taxes all other classes of goods @18%.

Meaning thereby tax officials will initiate action on the transaction with cryptocurrency and are also expected to press for recovery of such computed taxes. 

Conclusion

CEIB has pegged the value of bitcoin transactions in the country at INR 40,000 crore annually. Also, as we understand, a study is planned on implementing GST on cryptocurrencies.

The cryptocurrency market is very immature in India, and the taxpayers dealing in such trades are unaware of the real treatment in accounts and tax. Therefore, it isvital for the officials to come out with some transparency in the system & regulation of bitcoins in India. Delaywould lead to different treatments being given by varioustaxpayers. Even though the success of bitcoins as a medium of exchange is not genuine, it seems highly promising and innovatory and therefore requires serious opinions. Sooner or later, government will define the provisions of Bitcoin for the proper implementation of Cryptocurrency in India. However, tax authorities should have a framework ready for the appropriate taxation and administration of Bitcoins.

Technology in Tax - Fall in Line or Fall Behind: Part 2

This article has been co-authored by Nishant Verma (Manager, Ernst & Young LLP).

Part 2 of our series comes at the heels of the recently launched Transparent Taxation - Honouring the Honest platform seeking complete objectivity and boosting quality of the revenue audits undertaken riding high on technology initiatives already undertaken by the Indian Income-tax authorities. The natural by-product of dealing with a fresh tax collector (with the backdrop of revenue targets as discussed in the earlier article) would be comprehensive and high quality data furnished as part of compliances, further elaborated through suitable backup reports.

In part 1 of this article, we discussed what the prime disruptor in the current age is as well as how it's bringing about the disruption and associated challenges to the tax function. We will now see where the same disruptor may be used as an opportunity and why it's gaining significance and importance for application.

Avenues for tax automation in Indian context

Undoubtably, it is the augmented use of data which has brought about a wide range of issues ranging from compliance management to risk management and to assessment readiness. However, and as acknowledged by our Finance Minister, it is indeed data which is powering the renewed approach of the tax authorities and efficient management of the same by organisations may serve to address the problem. Some probable answers for businesses embracing automation in tax function could be:

• One of the most fundamental problems that businesses face today is lack of a common source of information that is consumed, analysed and submitted by their tax function.  Therefore, what businesses need is to first get the basics right by creating a data lake cohesively linked with the ERP and other digital platforms, which forms the single source of information for all facets of the businesses, including tax.
• Effective management of various tax compliances as well as litigation, along with tracking of the multitude of department communications and institutionalisation of such data could also be achieved through digital enablement.
• On the indirect tax front, the arrival of GST has already triggered a major shift towards digital adoption with e-invoicing being touted as the next big step towards transparency powered by automation. Nonetheless, incremental technological enablement can further automate the entire compliance process by evaluating invoices at a granular level to monitor the input credit as well as determine the liability and support in determination of liability payable as well as preparation of returns.  Technology may further be applied for tracking GST credits arising from a vast multitude of airline and hotel bills arising during the regular course of business with near perfect accuracy, permitting mental bandwidth to be channelized towards more meaningful activities. Greater efficiencies through automation may further be introduced for management of exports and imports, with assistance ranging from customs document preparation, export-linked incentive application and tracking, HSN classification and computation of the various duty drawbacks.
• Coming to Income-tax, the multiple revisions brought about to the tax audit report [such as clause 34(a)] have long since plagued the tax teams for collation of suitable data and comfort of the same, such issues, along with multiple issues surrounding TDS such as withholding rate determination, PAN validation and monthly liability quantification can be suitably addressed by adopting a combination of digital tools. Likewise, with modification in the Income-tax returns requiring taxpayers to report the TDS credits brought forward, utilized and carried forward, the authorities expect the taxpayers to maintain reconciliation income and TDS credit, as per taxpayer records vis-? -vis Form 26AS.  Automation can enable timely reconciliation of the large volume of tax credits data of the company with the revenue earned for the year and understanding the gaps for taking corrective action.
• Transfer pricing is another field which has evolved over the past decade or so with tax authorities seeking new ways to evaluate fulfilment of arm's length price criteria. Obtaining adequate documentation to substantiate benefit test requirements as regards intra-group transactions can be addressed through application of technology. Furthermore, the adherence and monitoring of operations to ensure compliance with transfer pricing policies and objectives can also be enabled through appropriate use of technology. Segmental differentiation and tracking of results therein have long since been a time-consuming process for many and can also be addressed by suitable automation measures.
• While the compliances and activities may be supplemented by use of technology solutions, the same may further be applied through data analytics for effective tracking and presentation of relevant data through interactive and customisable dashboards which would be scalable as per different levels in the management hierarchy ranging from the CFO and department heads down to functional staff.

What are the different enablers to start along the digitisation journey?

The applications of digital enablement in the tax function are virtually limitless and it's a just a blank canvas with endless possibilities in terms of applicability. For ease of understanding, certain key enablers which facilitate to bring about digital enablement are elaborated below:

• Building capabilities into the ERP system: The ERP system of a company serves as its operational database, storing details of all transactions which it may be involved in. In many cases, the tax function, being the largest consumer of data within the organization, still spends substantial time formatting and linking additional data points to reports generated from the ERP, resulting in time lags and risk of human error.  Activating some additional functionalities to the ERP system in a manner such that various tax focused touch points may be addressed, is a very potent manner to tackle issues on obtaining quality and reliable data. This 'tax-sensitisation' of the ERP, which have traditionally been implemented without focussing on the requirements of tax function, may be an ideal starting point in the journey of automation.
• Robotics Process Automation ('RPA'): Arguably the most popular tool used as part of the digital agenda. RPA or a 'bot' basically refers to a computer program coded to take on tasks which are repetitive in nature, have a fixed process flow and require processing of a very large number of transactions. Ambit of RPA's utility is extremely wide, with very high levels of accuracy and seeks to eliminate issues relating to human error and runs along in the background of a regular computer system.
• Focussed and coded digital assets:  These may be web based solutions or tools which serve to address identified issues with the objective of high efficiency for the intended purpose as well as effective management of underlying data in this regard. These may also help in end-to-end management of the issue it seeks to address and are generally scalable as per the needs of the customers.
• Machine Learning: This is a predictive technique based on data which helps in building models for tasks where you learn by example.  Digital assistants, facial recognition while tagging photos on social media, recommendations on a Netflix, etc are some of the most prominent examples on machine learning.  Using Machine Learning to predict applicable tax rates on a transactional level (be it for GST or TDS) based on strong layers of coding and past trend could be a game changer.
• Data analytics: Analytics typically involves the processing of vast amounts of data into simpler and summarised illustrations providing relevant insights basis the need of the user and helps in keeping an overall control as well as better decision making.
• Blockchain: Blockchain may be best known today as the technology that underpins the digital currency bitcoin, but it can also be used for a host of other purposes that involve transmitting data securely.  Some say that blockchain represents nothing less than second generation of the internet and is going to be the most disruptive technology in the coming decades in the tax world.  It holds vast promise for various functions of businesses as well as the society.

Tax function 2.0: What is being future-ready like?

In today's day and age of data security, transparency and technological advancement, tax functions across need to evolve. But when you imagine a tax function of the future, what do you picture? Surely one would imagine a well-oiled machinery automating the entire tax function lifecycle with intelligent dashboards providing high quality insights and tax optimisation inputs for strategic decision-making built upon an unprecedented control on facts and figures. This would be possible because of reduced human intervention for menial but otherwise time-consuming tax processes like collating segmental data and TDS management, or efficient reconciliation of data relating credits on the TDS and GST front and so on powered by automation. Audit and assessment readiness for collating requisite benefit test documentation on transfer pricing, corporate tax and GST front at a click of a button would further enhance the productivity.

Summarily, a team whose priorities and bandwidth have shifted from collation and verification of data to processing the same and putting it to constructive use.  Believe it or not, such capabilities are a lot closer in the horizon than one may think, with some teams well on their way to the path of automation.

Contrary to the common belief, digitization measures do not necessitate contracting the existing function but rather requires suitable upskilling so that one may be able to process and utilise the data to fulfil the intended objective. It fosters an environment of growth and development, which as clearly elaborated above, is the theme in this age of disruption.

Concluding thoughts

The age of disruption has brought with it an abundance of digital possibilities to make work easier and improve one's efficiency and there is no reason for such tools to not find application to the tax function as well. 

The need for the right tools to do the right job is ever increasing, with the tried and tested methods of the past such as use of excel templates becoming increasingly redundant. This need has only been amplified with the unexpected disruption brought about by Covid-19, bringing about a 'new normal' in more ways than one and making various companies relook at the available resources with a fresh perspective, ease and efficiency of compliance management being one of them.

In a world where the quality of data is supreme and the regulators are concocting up to the developments to stay ahead in the digital race, businesses can't afford to let the guard down.  More so, with emergence of complex business models, unprecedented changes in the global tax environment, sharp focus on transparency, the time for a digitized tax function has arrived and the time is NOW. 

Views expressed are personal

Blockchain and supply chain security

Blockchain technology has become a rapidly growing industry. Although commonly associated with Bitcoin, blockchain can be used for many different purposes that go way beyond digital currencies. It has three key characteristics - transparency, disintermediation and immutability - that can produce numerous benefits and cost reductions in various areas, providing efficient alternatives for many traditional processes. In this contribution, the author discusses the potential use of blockchain to warrant supply chain security.

Over the last years, trade has been growing exponentially and this trend is certain to continue. To meet the needs of customers who expect online-ordered items to be delivered next day, the speed with which goods are moving along the supply chains has increased. Growing trade volumes (especially the increasing number of imported low value consignments) imply a higher workload for the customs administration.

One of the main tasks of customs administration is to ensure security of cross-border supply chains. Customs authorities should prevent dangerous and counterfeit goods from entering a country's territory and, in doing so, they should interfere as little as possible with the flow of commerce. Examples of traditional measures to address the issue of supply chain security are: the submission of pre-arrival information for all goods imported into the European Union, the concept of trusted entities (e.g. Authorized Economic Operator, C-TPAT), and the US Container Security Initiative.

Another area of customs administration where security issues are paramount is the trade in dual-use goods that pose a risk of being diverted from legal trade for illegal misuse. The European Union and many other jurisdictions control the export, transit and brokerage of dual-use items by requiring traders dealing with these items to obtain authorizations and to keep records of how these goods are used across the supply chain. Dual-use export controls affect a wide-range of industries (e.g. energy, aerospace, telecommunications and information security, life sciences, chemical, and electronics).

In the area of customs administration, blockchain technology would permit tracing the origin and flow of (high-value) goods to their final destination by means of tokenized assets (which are digital representations of real assets). When a high-value product is manufactured, a corresponding digital token would be created by a trusted entity that would authenticate the origin of the product. A digital 'certificate of origin' would be more difficult to forge or falsify than one issued in a paper form. Any movements of the product across the supply chain and changes of ownership would be recorded in the blockchain. By recording all data in one register that would be shared among various stakeholders, efficient control over the movement of goods would be possible. One central register would eliminate inefficiencies related to storing and processing the same information by different bodies, duplication of processes and manual data entry. By being able to trace the origins and pathways of goods they procure, distributors and retailers would be sure that there are no illegal labor or environmental practices involved at any stage of the supply chain. The main difficulty of using blockchain for customs purposes is that the participation of a large group of stakeholders (traders, brokers, ports, customs authorities) would be necessary make the system fully operational.

However, although blockchain applications uses pre-programmed alghoritms and computational logic, it cannot be assumed that they will always produce legally correct records. Just like any software application, blockchain faces the inherent problem of the interface between the digital and physical world: someone must prorgam the distributed ledger and make sure that proper entries are made. As input needs to be provided by people, what enters the blockchain can be subject to manipulation. For example, two related parties may agree to include fictitious transactions or fictitious prices in the ledger. If these entries are validated by the network, blockchain is technically correct but not legally correct. There are many ways in which validators who digitally sign the blocks they create in a private blockchain can manipulate the database contents. If enough validators collude maliciously, they can prevent a particular transaction for being confirmed.

Blockchain is frequently praised as a technological innovation that can be the cure-all panacea for all world's problems. To its enthusiasts, it has the potential to make a similar impact to the one the internet has made, revolutionizing human interactions and business processes. This contribution has shown that although blockchain could be a useful tool in supply chain management, it will not be a perfect solution for all problems that we are currently facing.

Bitcoin - Concept and taxation aspects: Part 2

This article has been co-authored by Neeraj Sharma (Chartered Accountant).

Indirect Tax implications

On the indirect tax front, merely because consideration has been made in the form of Bitcoin, the transaction will not be exempted from Goods and Services Tax (GST). Section 7 of the Central Goods And Services Tax Act, 2017 (CGST Act) provides that supply includes all form of supply of goods and services such as barter, exchange made or agreed to be made for a consideration. Consideration has been defined to include any payment made in money or otherwise (section 2(31) of the CGST Act). The Valuation Rules (section 15 of the CGST Act read with Determination of Value of Supply, CGST Rules, 2017) prescribe that where consideration for supply is not solely in money, the taxable value has to be determined as follows: (i) Open market value of such supply; (ii) Monetary consideration plus money value of the non-monetary consideration; (iii) Value of supply of like kind and quality; (iv) Value of supply based on cost, i.e., cost of supply plus 10% mark-up; or the Best Judgement method.

Income Tax Act

Under the Income-tax Act, if Bitcoin is used as a medium of exchange for transacting in goods and services, the value of Bitcoin received on the date of transaction should be considered as business receipt. Income Computation and Disclosure Standard (ICDS) IV on revenue recognition provides that 'revenue' is the gross inflow of cash, receivables or other consideration arising from the sale of goods or rendering of services. Later, there may be change in the value of Bitcoin when it is exchanged for fiat currency or otherwise transferred. Such change in value should be treated as capital gain of the assessee and be taxed accordingly. If Bitcoin is not currency but an asset, its use may result in capital gain/ loss (not 'Profits and Gains of Business or Profession', because Bitcoin is not part of the seller's inventory if seller is not engaged in trading of Bitcoins) if it has enhanced/ reduced value at the time of usage as compared to its value at the time of acquisition.

However, issues may arise in computation of capital gains. Price discovery is a challenge - Bitcoin price varies across exchanges. Also it may be practically impossible to compute capital gain/loss on each and every conversion of Bitcoin to that currency. 

Further, the following provisions of the Income-tax Act may raise issues in claiming allowance for expenses, when paid for in Bitcoin:

·       Section 40A (3) of the Income-tax Act that provides that if any expenditure is incurred in respect of which a payment is made otherwise than by an account payee cheque drawn on a bank or account payee bank draft, or use of electronic clearing system through a bank account (hereinafter referred as banking channels) exceeds INR 10,000, no deduction shall be allowed in respect of such expenditure.

·      The second proviso to section 43(1) of the Income-tax Act provides that where the assessee incurs expenditure on acquisition of asset in respect of which payment is made otherwise than through banking channels, such expenditure shall not be included in the cost of acquisition. Consequently, depreciation will not be allowed on expenditure incurred using Bitcoins to acquire assets.

·     Section 269T of the Income-tax Act prohibits repayment of loan in any mode otherwise than through banking channels. Correspondingly, section 269SS of the Income-tax Act prohibits acceptance of loan, deposit or other sum otherwise than through banking channels. Failure to comply with these provisions entails penalty of equivalent amount of loan/deposit so repaid or so accepted u/ss. 271E and 271D of the Income-tax Act respectively.

·      Another aspect requiring consideration is the applicability of section 269ST of the Income-tax Act, which prohibits receiving an amount or INR 2 lakh or more otherwise than through banking channels.

Thus India's Income-tax Act as it stands today is not conducive to using Bitcoin as a routinely used method of transacting.

RBI has been repeatedly cautioning everyone about the usage of cryptocurrencies[1]. Recently, the hon'ble Supreme Court has issued notice to the Ministries of Finance, Law and Justice, Information Technology, SEBI and RBI, on the plea, which also sought setting up of a panel to frame a mechanism to regulate the flow of bitcoin [2].

Income from and expenditure incurred on business of Bitcoin/ crypto-currency mining

Mining of crypto-currency is a growing business. China is the largest location for Bitcoin miners. Under the Income-tax Act, the definition of business is a very wide and inclusive one, to encompass within its ambit any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. Profession has been defined to include vocation too. Hence, it may be strongly argued that Bitcoin mining is a business and/ or profession. The income from mining may be computed by following the provision of computation of income from business or profession. General principles of computing income from business or profession may be followed.

A miner receives income from two sources on successful completion of a transaction: first, from the system by way of newly generated Bitcoin; and second, from the person who undertakes the transaction by way of fee. It is relevant here to examine the nature of such fee earned (from person undertaking the transaction) and tax deduction at source (TDS) obligation of the payer. The fee earned by way of mining activity should not be considered fees for technical services (FTS) or royalty under the Income-tax Act. When any technology or machinery operates automatically, without much human interface or intervention, the usage of such technology cannot, per se, be held as rendering of technical services as contemplated under the Income-tax Act.[3] The mining fees payable cannot be considered as royalty either. The only limb that can be discussed is whether the payment can be considered for the use or right to use any industrial, commercial or scientific equipment; however, persons undertaking transactions do not have any right or control to use the equipment. Pursuant to the 2012 amendment to Income-tax Act,[4] this may be 'royalty. But taxability under the tax treaties may be different. In case one still considers that the fee payable to miner is FTS under the Income-tax Act, the additional argument for not having TDS obligation in case of resident payees is that since the payment made is in kind (Bitcoin being property), the TDS provisions of section 194J of the Income-tax Act are not applicable.[5] It is to be noted that if FTS is payable to non-resident in kind, TDS would be applicable.[6].

However, there may be cases in which mining is performed as a hobby or incidental activity. In such cases, the income from mining may be considered as income from other sources and may be computed accordingly. As mentioned above, there may be change in the value of Bitcoin when it is exchanged for fiat currency or otherwise transferred. Such change in value should be treated as capital gain of the assessee and should be taxed accordingly.

The mining activity may be considered as provision of services and may be considered as taxable services for the purpose of GST and accordingly, the GST obligation would arise on miners in respect of transaction fee earned by them.

Bitcoin and buying/ selling on exchanges

Exchanges buying and selling Bitcoin are considered as carrying on business activity and would be assessed to income tax accordingly.

The assessee engaged in the buying and selling of Bitcoin may earn income on account of increase in the price of the Bitcoin. The guiding principle by the Central Board of Direct Tax (Circular #4 of 2007) on when shares are treated as held as investment or stock-in-trade may be applied to determine if the income from such Bitcoin transactions is capital gains or business income of the assessee, and accordingly, the Income-tax Act tax provisions may be applied. A clarification from tax department may be required to deal with losses from Bitcoin buying selling transactions.

Although, as discussed above, some guidance may be taken from existing tax law framework on how to deal with transactions involving Bitcoin, it is always desirable that specific clarifications/guidance is issued by the tax department.

III - Bitcoin and money laundering

Section 3 of Prevention of Money Laundering Act 2002 (PMLA) defines the offence of money-laundering thusWhosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property shall be guilty of offence of money-laundering.

Section 2(u) of PMLA defines proceeds of crime which means any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence or value of such property or where such property is taken or held outside country, then the property equivalent in value held within the country.

The PMLA Act has a Schedule which covers all major offences punishable under various penal laws.  The definition of the property is given in Section 2(v) of PMLA which means any property or asset of every description whether corporeal or incorporeal, movable or immovable, tangible or intangible and includes deeds and instruments evidencing title to, or interest in, such property or assets, wherever located;

Explanation: For removal of doubts it is hereby clarified that the terms property includes property of any kind used in commission of an offence under this Act or any of the scheduled offences.

It is clear from the above that if any property, including virtual currencies, is derived by committing any offence in India or any of the treaty country, it will amount to offence of money laundering.

Bitcoin - Concept and taxation aspects: Part I

This article has been co-authored by Neeraj Sharma (Chartered Accountant).

I. Bitcoin: What, when, why and how

Bitcoin is not simply a digital currency. Its underlying network-centric architecture is a cryptographic, shared and open, borderless ledger. Bitcoin does not need financial intermediaries such as PayPal and Visa, it is protocol-based form of programmable peer-to-peer money, with every participant using the same protocol. In this article, we use 'Bitcoin' interchangeably with the term, 'crypto-currency', of which class Bitcoin is the most prominent member.

Bitcoin obviates the need have an independent assurance provider to ensure there is no cheating, by distributing the ledger among all users. Every transaction in the Bitcoin economy is registered in a publicly distributed ledger, known as the Blockchain, and new transactions are checked against the Blockchain to eliminating possibility of the digital equivalent of 'counterfeiting'. Every participant validates transactions and authenticates their source by checking whether the bitcoin complies with well defined and established consensus rules and public key cryptography respectively. All transactions are time-stamped and stored in blocks in realtime on the Blockchain, and replicated on thousands of computers around the world.

Currency Issuance limits: Though theoretically, Governments can issue currency without limits, in practice, increase in money circulation is permitted by Governments, but within limits that are related to economic value created in the economy. If money supply within an economy rises beyond this figure, prices of goods and services tend to rise (which is called inflation), reducing the value of each unit of the currency. For the same reasons, any digital currency (Bitcoin is a genus of this species) also needs to have inbuilt control over the currency supply.  This function is performed by the mechanism of mining. Mining in the digital sphere is a task that is commonly acknowledged as difficult and costly (in terms of time, computing power and resources), which alone can result in creation of brand-new units of a crypto-currency. Usually, a function of diminishing returns kicks in, and sets an absolute limit to the activity of, and incentives for, mining.  The best analogy in the real world is the cost and difficulty of mining gold in the gold standard era (pre-Aug 1971). Blockchain blocks for each unit of new currency have to comply with distributed consensus rules that need validation by all network participants. This becomes progressively costlier, more difficult, or less rewarding, and it is expected that the supply of Bitcoins will be capped at 21 million units.

The central bank of every country backs each currency note with a promise to provide value. This is called 'fiat' and hence currencies issued by Governments are called 'fiat money'. Bitcoins and other crypto-currencies, in contrast, are secured by a decentralized trust mechanism in the form of an open, distributed ledger, called Blockchain.  Each transaction in each unit of currency is 'time stamped' and this cannot be changed.  Transaction costs are expected to fall sharply in the Bitcoin economy, in the absence of for-profit agencies charging fees for providing its services. This is likely to make small transactions and micropayments economical and viable. Also, a crypto-currency is by design almost inflation-neutral (except for permitted mining), whereas Governments all over the world tend to overspend, and tend to be inherently inflationary.

Concerns around crypto-currencies: Governments around the world (India is no exception) have been, and continue to be, wary of Bitcoins and other Blockchain based crypto-currencies, because of the anonymity surrounding the transactions and players. However, Blockchain is purpose-agnostic. It doesn't differentiate between good and bad participants. However, sophisticated Blockchain analysis tools have emerged that can allow law enforcers to trace transactions and unmask parties to the transaction.  Also, by design, when a user tries to convert bitcoin into cash, the anonymity disappears.

One big concern of governments arises from the ability of crypto-currency users to flout capital control laws.  Yet another concern is the extremely high volatility of value of Bitcoins. Risk is very high since no legal framework is in place to control its volatility.

Another disadvantage of crypto-currency systems is that if you forget the private key, the currency is lost forever. Another practical disadvantage is that peer-to-peer validation by network members will slow down the validation process and increase inconvenience to users. Sometime it may take hours to validate transaction.

II- Regulation and Taxation of Crypto-currencies

As bitcoins and other crypto-currencies are meant to be a medium of exchange, the question is whether they may be treated as currency for tax purposes, or whether they are assets having value as investment.

Bitcoin - Is it 'currency'? 'Currency' has not been defined in the tax laws. Guidance may be taken from the Foreign Exchange Management Act, 1999 (FEMA), which defines currency, as including all currency notes, postal notes, postal orders, money orders, cheques, drafts, travellers cheques, letters of credit, bills of exchange and promissory notes, credit cards or such other similar instruments, as may be notified by the Reserve Bank of India (RBI). So far RBI has not recognised Bitcoin or any other crypto-currency as a currency. Hence, it is not currency.  They cannot be treated 'foreign currency' either. Under FEMA, foreign currency means any currency other than Indian currency, and Indian currency has been defined to mean currency that is expressed or drawn in Indian rupees but does not include special bank notes and special one rupee notes issued under section 28A of the Reserve Bank of India Act, 1934. Thus, Bitcoin or any other crypto-currency is neither an Indian currency nor foreign currency. 

Bitcoin is money-equivalent, but not money and the Supreme Court of India in the matter of Kasturi & Sons[1] has held that the word money cannot be interpreted as money's worth.

Bitcoin as asset or property/ store of value: Capital asset has been defined in section 2(14) of the Income-tax Act, 1961 (Income-tax Act) to include property of any kind held by the assessee. 'Property' is understood in a wide manner for tax purposes. The Kerala High Court, in the case of Syndicate Bank,[2] while analysing the definition of capital asset,  has thrown light on the concept of property as follows: The terms 'capital asset' has an all-embracing connotation and includes every kind of property as generally understood except those that are expressly excluded from the definition. So too, the meaning of the expression, 'property'. It includes every conceivable thing, right or interest or liability. In addition, for property, the emphasis is on holding and enjoying, and not on ownership - this is explained by Madras High Court in the case of Madathil Brothers,[3] that the definition of capital asset under the Income-tax Act, referring to property of any kind carries no words of limitation. The definition includes every possible interest that a person may hold and enjoy. The definition of capital asset refers to property of any kind held by an assessee, in contradistinction to the word owner, or owned. Based on the above, Bitcoin is 'property', as the holder has exclusive right to spend/ access the Bitcoin he holds.  Once Bitcoin is considered property, the general tax principles applicable to property transactions apply to transactions using Bitcoin. Below is a discussion of how existing general tax principles could apply to Bitcoin transactions.

Bitcoin/ crypto-currency transactions in business

A Public Interest Petition (PIL) (Writ Petition (Civil) no. 406 of 2017), was filed under Article 32 of the Constitution of India in the Supreme Court, against Union of India, Ministry of Home Affairs, Ministry of Finance and Reserve Bank of India, against the use and business of  illegal cryptocurrencies or Decentralised Digital Currency or Virtual Currency (VCs), such as, Bitcoins, litecoins, bbqcoins, dogecoins etc. During the course of hearing on 14th July 2017, the Bench of Hon'ble Chief Justice of India J.S. Khehar and Hon'ble Mr. Justice D. Y. Chandrachud, while disposing off the PIL, gave four weeks to the Reserve Bank of India to examine all security related issues about virtual currency, including Bitcoin, and respond to the Petitioners[4]. The report is still awaited.

The discussion that follows assumes that there is no blanket ban on use of crypto-currencies, or other restrictions imposed on use of crypto-currencies by Indian taxpayers. Tax law does not currently bar acceptance of consideration in kind (which is what payments in crypto-currency will in all likelihood be treated as).

Bitcoin, crypto currency and block chain - the next industrial revolution- the new gold

Imagine going back to the stone ages; back to a basic unit which helps attribute value and facilitates transactions.Direct peer to peer - no interference of Governments, central authorities and banks - direct peer to peer.  

Welcome to the wonderful world of bit coin, ethereum and crypto currencies; a whole parallel world of virtual currencies, coins and listing. 

My quest of searching e-currency usage in India led me to Khavda, Kutch.

Ravji Bhai,was an MSC in computers and after 4 years on a salary of INR 10,000 per month and barely making ends meet he quit his job.He took a loan from bank, bought a computer, started ethereum mining and bitcoin trading. Today, he converts just enough to INR to meet his household expenses and the rest of his assets are in Bitcoins and other crypto currencies.  

He estimates that with 4 hours of work a week, he makes upto INR 80,000 a month!  He also does freelancing software development and prefers to be paid in bitcoin, ethereum, etc.He is now designing his own coin and preparing for his ICO listing.  He eagerly gives me the details and I promise to attend and subscribe at the launch.  

Fascinating but how did all of this start?  

In the late 1990s, hackers started working on a project to decentralize money and facilitate internet transactions.Internet transactions required a merchant, an intermediary, for example, PayPal, a bank, and your credit card details.All this also had a security risk, your card could be hacked.There were numerous attempts at digital cash and there were many failures, a) reliance on a merchant/bank for acceptance b) there was the issue of creating money out of thin air?

To create a free-floating digital currency that is likely to attain a real value, one had to do something that was scarce by design.  Scarcity is the reason that gold and diamonds have been used as a backing for money.  

To achieve this in the digital realm, minting money required solving a "puzzle" which takes a while to crack.  This is called "Mining".

Another key feature of bitcoin and crypto currencies is the block chain.  Blockchain is a ledger in which all transactions are securely recorded. This literally has blocks of information stacked up like blocks and linked together with a chain.  Events are kept by a series of nodes and stored by miners. Anyone can become a miner by solving computational problems to create blocks. There is no one trusted server.  Every minor keeps track of blocks.  

This technology cannot be hacked and it has immense uses in all fields like education, land registries, etc.  It may very well be the technology to revolutionize the world. 

In essence, Bitcoin combines the idea of using computational puzzles to regulate the creation of new currency units with the idea of secure time stamping to record a ledger of transactions to prevent double time spent.  

Who invented bitcoins?

Bitcoins were invented by a person or group of persons under the pseudonym Satoshi Nakamoto in 2008.  There were many attempts at e-currency and many failures. Satoshi combined many technologies of that time to create bitcoin.He stuck around for 2 years, was on numerous blogs, created patches and then disappeared.The success of Bitcoin is remarkable, as its notable innovations - block chain and decentralized model support user to user transactions.  

To understand bitcoins,let us look at its history:

October 2008 - White paper

Satoshi Nakamoto releases his white paper on the P2P Version of electronic cash.   He manages to solve the problem of money being copied providing a vital foundation for bitcoins.  

January 2009 - First mining

The first block called "genesis" is mined and the first transaction happened.  

October 2009 - First value  

Bitcoin receives its value in traditional currency.  The initial equation was USD 1 = 1,309 BTC.  The equation was derived as to the cost of electricity to run the first computer who created bitcoin.   

February 2010 - World's first bitcoin market is launched  

May 2010 - First and most expensive pizza bought in bitcoins  

A programmer Laslo paid a volunteer 10,000 BTC.  The volunteer paid USD 25 to order a pizza for him.Today that pizza is valued at GBP 1.9 m!!

August 2010 - Bitcoin hacked and value crashes  

November 2010 - Bitcoin reaches USD 1 m.  

Based on demand and supply, the valuation leads to a surge in bitcoin value to 0.5/BTC.  

January 2011 - the Silk Road  

An illicit drug market is set up using bitcoin as an untraceable way to buy and sell drugs online  

February 2011- BTC reaches parity with the USD.  

By June each BTC is worth USD 31 giving it a market cap of USD 206 million.  

June 2013 - security breach and the value plummets to 0.01 BTC  

March 2013 -First guidance note

The US FINCEN releases a guidance report for persons exchanging, administering or using virtual currency.  This sparked the debate on regulation.

March 2013 - BTC achieves a market cap of USD 1 billion  

August 2013 - US Judge declares that

 “Bitcoin can be used as money. It can be used to buy goods and services."Bloomberg begins bitcoin data on its terminal  

November 2013 - US senate first hearing on e-currency  

BTC climbs to USD 700 as the US senate holds its first hearing on the e-currency.  The Fed Reserves chairman Bernanke states that "bitcoin may hold long term promise, particularly if the innovations promote a faster, more secure and more efficient system of payment." 

December 2013 - China Central Bank bans financial institutions from handling bitcoins.  

They stated that it was not a currency with real meaning and does not have the same status as fiat money.The ban reflects the risk that bitcoin poses to China capital controls and financial stability.  

That being said, China is the world's largest bitcoin trader with 80 percent of the world's bitcoin transactions being processed there.

January 2014 - First insured bitcoin vault for institutional investors  

February 2014 - The taxing event!  Bitcoin taxation.  

The HMRC classifies bitcoins as assets or private money.  No VAT to be charged on mining or trading.  

June 2014 - Silk route closed and their bitcoins auctioned by the US Government  

This enhances the legitimacy of bitcoin.  From this point onwards bitcoin can no longer be used as a currency for criminals.  The use of blockchain means that the identity of users can be established. 

July 2014 - First fund and regulations  

-  First regulated bitcoin fund GABI launched   

- "Bit license" rules proposed for regulating bitcoin launched in the US  

- European banking authority launches its opinion on virtual currencies.   European regulators consider declaring virtual exchanges as obliged entities to comply with AML regulations.  This report acts as a catalyst to launch bitcoins into the mainstream by highlighting the fact that virtual currencies need a regulatory approach to strive for international coordination to achieve a successful regulatory regime.

August 2014- Chancellor of the Exchequer buys bitcoin

George Osbourne, Chancellor of the Exchequer buys GBP 20 worth of digital currency,

showing his support.  He announces HMs call for digital currencies.  The report was later published on March 2015. 

October 2014 -the first bitcoin derivative transaction on a regulated exchange  

December 2014 - Microsoft starts accepting payments in bitcoins   

Looking at the history, what lies ahead for bitcoins, crypto currencies and block chain?  

Ravji bhai in the tiny hamlet of Khavdas cracked the crypto currencies, which shows that it has already made its way into rural India.

 With the acceptance by international regulators it is likely to enter the financial mainstream.  It solves many payment problems making transacting more efficient and more secure.With the emergence of AEOI, loss of confidence in Governments crypto currencies has seen a surge, despite glitches.

 A currency which transcends borders, languages, ethnicity, unifies the online world, decentralized, secure and more efficient - peer to peer!  

For more information on how you can get started with bitcoins and other currencies, start your own coin, list it, trade, exchange and regulations surround it look out for the next article. 

Part 2 coming shortly.

Bits and pieces on Bitcoins

In recent years there has been an exponential increase in advancement of technology.  The way the internet effects business, communication, education and entertainment is profound.  The combination of internet and mobile phone is like a powerhouse of possibilities.  We are living in times where the world seems to have shrunk enough to fit into a palm-sized smart phone.  People of all age groups are getting hooked to gaming, shopping and social networking on their smart phones and tablets.  Few are also busy collecting their rewards by way of digital coins for the activities on the digital platforms.

Bitcoins - Very briefly

We are seeing a virtual currency - Bitcoin much in the news these days.  Bitcoin[1]  is an internet currency that has been growing in popularity and prominence in this digital age.  It is a distributed peer-to-peer digital currency that can be transferred instantly and securely between any two people in the world.  It is like electronic cash that can be used to pay friends or merchants.  Since it is peer-to-peer, there is no central bank or government regulating this as yet.  Bitcoin users can store their currency using software on their computer or use a web-based service to hold the coins in an account known as a 'wallet'.  There are varieties of other ways to acquire Bitcoins.  Bitcoins can be acquired by accepting them as payment for goods or services.  These can also be acquired through 'mining' process or be bought through the Bitcoin Exchange.  According to media reports Bitcoin, started gaining momentum after the banking crisis in Cyprus pushed depositors there to find creative ways to move money. The use of online and mobile technologies is driving the proliferation of such virtual currency.  The value of Bitcoin is not backed by any government or organization. Like other currencies, it is worth something partly because people are willing to trade it for goods and services.  The value of Bitcoin has soared from USD 1 in early 2011 to about USD 1,000 by the end of the year 2013. Bitcoin might well be a bubble; but considering the momentum and the wider acceptance that it is gaining, the regulatory authorities around the world are keeping a close watch on it.

Bitcoins - Tax Conundrum

Albert Einstein admitted that, the hardest thing to understand in the world is the income tax - the hardest thing just got harder in this dynamic era where things seem to change faster than ever.  As per the conventional tax rules Income is income, whether one receives it in cash or in kind. Anyone providing a service or selling goods for Bitcoins in exchange will have income just as in the case of barter.  However, there are questions and issues that needs deeper understanding and research so as to address them -

• Whether Bitcoin is a currency or commodity?  
• Whether Bitcoin can be regarded as an 'intangible personal property'?
• In a transaction involving Bitcoin, what is the trigger event for the taxability?

Applying conventional tax principles to transaction involving Bitcoins

Assuming transaction involving Bitcoins are regarded as legal, then going by conventional tax principles; let's see how such transactions can be treated for tax purpose in India. If Bitcoins are received as a consideration for sale of goods or services, the income so generated will be a taxable business income unless it is specifically exempted under the provisions of the Income Tax Act. Bitcoin is not recognized as a currency in India and there isn't any notified or recognized Bitcoin Exchange in India; therefore there will be some level of subjectivity while adopting a particular value for Bitcoins and rate of foreign exchange for the purpose of determining consideration in INR.

If a person earns income through the activity of buying and selling Bitcoins, it needs to be seen whether the person is trading in Bitcoins or is he holding Bitcoins as an investment. Income from trading of Bitcoins should be business income; however, where trading is done without actual transfer of Bitcoins and the transaction is settled for value differential, then any income from such trading could be regarded as speculative in nature. In case Bitcoins are held as an investment, the income could be treated as Capital Gains.

Bitcoins are generated through mining operations. A Bitcoin miner is like a manufacturer who generates Bitcoins. Generally speaking, revenue from Bitcoin mining operations should be taxable only after considering deduction for allowable expenses. However, if the Bitcoin miner does not sell all his Bitcoins, then logically he should be taxed on the excess of the closing value recorded for Bitcoins over the expenditure incurred in generating the same. 

Answers to the questions above are not always clear.  It is worth pondering to see if there is sufficient guidance from the world's tax research organizations and Revenue authorities as to how Bitcoins will be subject to local and cross-border taxation. Unfortunately there is hardly any official guidance available on this subject.   Based on media reports it is learnt that the Inland Revenue Authority of Singapore (IRAS) has started giving advice regarding tax-related issues on transactions involving Bitcoins.  The IRAS has issued tax advice regarding the purchase, sale and exchange of Bitcoins in response to queries from Singapore based Bitcoin brokering service 'Coin Republic' (http://coinrepublic.com).  Coin Republic has posted on its website very useful excerpts of the response received IRAS - http://coinrepublic.com/singapore-tax-authorities-iras-recognize-bitcoin-and-gives-guidance/

Going by the excerpts posted, the guidance from the IRAS is that, if a company is in the business of buying and selling Bitcoins, it will be subject to taxation on the gains made on the sale of Bitcoins. However, if the Bitcoins form part of the investment portfolio of a company, then gains from the sale will be capital in nature.  The GST treatment of Bitcoins will depend on the contractual arrangement between the parties.  Selling Bitcoins in return for goods or services will be subject to GST; however, the GST treatment will have to be examined based on the conduct of the parties involved.  The GST treatment of the supply of Bitcoins will depend on whether the company is acting as an agent or principal in the transaction.

The misty road ahead

In India, the RBI has issued an advisory in December 2013 cautioning general public against use of bitcoins and other virtual currencies.  The RBI has also stated that it is presently examining the issues associated with the usage, holding and trading of Virtual Currencies under the extant legal and regulatory framework of the country.  The full text of the RBI press release can be read at - http://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=30247 . 

The Internal Revenue Service (IRS) of the United States federal government is studying the matter but is yet to issue any guidance.  HMRC, the UK government's tax-colllecting body, is also reviewing the tax treatment of virtual currency Bitcoin.  After a parliamentary inquiry, Germany has clarified its position on Bitcoin by considering it as private money . The world's first Bitcoin ATM was launched in Canada in October 2013 and more Bitcoin ATMs are likely to open in Hong Kong and Taiwan.

Rapidly growing popularity of Bitcoins has garnered enough attention of the tax and regulatory authorities world over.  While some countries have started recognizing Bitcoins, many other countries are threading the path cautiously before forming a view on this subject.   Given the risk of money laundering, cyber security and possible use Bitcoins for illegal trades, it is quite possible that few countries may want to pull the plug on Bitcoins.  However, for all we know, Bitcoins may just be an emergence of the new wave of digital currencies.  There is a need for some serious and well-directed effort on the part tax and regulatory authorities to clarify its stand on Bitcoins and formulate ways and means of administering and regulating transactions involving digital currencies.