The Budget 2022 has witnessed a renewed push for digital India – be it digital rupee, e-passport, e-Vidya, digitization of land records, digital banking, digital universities, the Government has laid out a digital vision towards new India. The Government has rightly always sought to immerse technology in the optimum manner in it’s pursuit towards ease of doing business et al. Digital Rupee is proposed to be introduced by the Reserve Bank of India (RBI) as a Central Bank Digital Currency using block chain and other technologies in FY22-23. This move certainly marks the Government’s endorsement and a paradigm shift towards digital currency. A Block chain technology is commonly understood as a distributed ledger that is recorded on a network of computers. Transactions in digital currency are recorded on respective blockchain ledgers and cannot be tampered with in any manner. The complete audit trail for every transaction is an effective tool to discern any modification taking place within the block-chain environment.
Digital currencies like Bitcoins, Tether, Ethereum, Dogecoin and others have gained an immense popularity globally however not yet legalised in India. These digital currencies use encryption techniques, rather than a central bank, to generate, exchange, and transfer units of currency and are highly volatile in nature.
In the Indian context, the Crypto currency and Regulation of Official Digital Currency Bill, 2021 is yet to be blessed by Loksabha. This bill facilitates RBI to create its official digital currency and seeks to prohibit all private cryptocurrencies in India with certain exceptions to promote the underlying technology and its uses. Presently, there is no clarity on taxation of such cryptos namely Bitcoins, Non-Fungible Tokens (NFTs). RBI had previously put in place measures that effectively outlawed the use of virtual currencies. The Supreme Court ruled out these measures noting that in absence of any legislative prescription, trading should be considered as legitimate trade.
Increasing volumes in crypto currencies has alerted government to initiate regulation of the crypto currencies by levying tax even if the same is not acceptable as a legal tender. The moot question remains to be addressed is by just taxing the transfer of crypto currency whether all cryptos or certain cryptos are legalised? While this does not seem to be the intention of the Government at this stage; however laying down a taxation framework to encompass the same itself is an important step forward.
From a global lens, cryptos are legalized in United States, United Kingdom, Canada, Australia, Netherlands and other industrialized countries. Countries like China have not legalized cryptocurrency. Whilst Russia has legalized it but there is a ban on payments. The US classifies cryptocurrency as a ‘property’ and thereby levies capital gains tax. Likewise, Canada as well as UK attract capital gains tax or income tax. The Dutch system levies wealth tax unlike capital gains tax by most of the countries. In Australia, the cryptos held as stock-in-trade are subject to tax as business income instead of capital gains. In essence, the taxability of virtual currencies broadly occur at creation stage and/or disposal stage. Globally, NFTs are still non-taxable.
In nutshell, most countries have treated all forms of virtual exchanges of digital currencies as generating a taxable event and have considered virtual currencies as property and have taxed in the same way as other intangibles, income from ‘mining’ or exchanges are taxed as capital gains or as a form of capital or miscellaneous income. Notably, the Organisation for Economic Co-operation and Development (OECD) has also issued a report on Taxing Virtual Currencies – An overview of tax treatments and emerging tax policy issues [1] which explains the concept of virtual currencies, legality and taxable events in various jurisdictions.
The Indian Government has now proposed through the Finance Bill 2022 to tax certain digital currencies as one of the key constituents of Virtual Digital Assets (VDA) as under:
- Income from transfer of VDA will be subject to a steep tax of 30% w.e.f FY 22-23 without any deduction of expenditure or allowance of set off / carry forward of loss
- Definition of VDA ~ 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, non-fungible tokens (NFT). Other digital assets to be notified by the central government.
- Payment of consideration, whether in cash or kind to a resident on the transfer of virtual digital assets shall be subject to tax deduction at source at one percent from 1 July 2022 . Absence of PAN will attract higher withholding tax rate of 20%
- Withholding provisions not applicable on payment to specified persons (being individuals and HUF not subject to tax audits) up to Rs. 50,000, and payment to other than specified persons less than Rs. 10,000 during the financial year.
- Gift of VDAs is taxable in the hands of the recipient.
The contours of the proposed definition of VDAs is of wide import and inclusive to cover not only crypto currencies but any form of digital asset fulfilling the stated conditions above. It will be interesting to watch out the Government’s prescription in the coming days to this effect. While the proposed VDA regime has provided for taxation of existing and budding digital assets like NFT, using cryptographic technology. It could also include future and evolving digital assets..
Importantly, NFT has non-fungible tokens that can be used to represent ownership of unique items and they can be used to tokenise / authenticate transfer of art, collectibles, even real estate and gaming. Likewise, metaverse projects on blockchain networks are powered by fungible tokens – tokens that are divisible and can be mutually exchanged. These tokens are used to purchase digital assets like virtual land or digital avatars. They can also be traded for other crypto or fiat currencies.
The typical lifecycle of a unit of virtual currency includes (i) Creation (includes stages such as Airdrops, Initial Token Offering, Mining and Forging) (ii) Storage and (iii) Transfer and Exchange. The proposed VDA tax regime seeks to tax the last stage of this digital life cycle i.e. transfer and exchange.
With an impetus to digitization in one hand and a tad high crypto tax on the other may be seen as a dampner to the crypto investor and innovators, it is well understood that the evolving economy required regulation too. Some of the unintended interpretation anomalies necessitating deeper evaluation and CBDT clarifications emanating from the proposed tax regime could be:
- Whether crypto currency is a currency or an asset? In absence of legal santity, it may be considered as an asset.
- Ambiguity on the characterization of income earned on transfer of VDAs as to whether taxable as ‘busines income’ or ‘capital gains’;
- Loss from transfer of one crypto asset cannot be set off against gain from another crypto asset
- Digital gold, RBI’s digital currency are not excluded from the ambit of VDA
- Practical challenges in deducting tax at source because the buyer is not aware about the whereabouts of seller, and hence, the role of crypto platforms will be really become relevant in near future i.e. the TDS might have to be collected via electronic platforms dealing with cryptos.
- Withholding tax provisions to be applied from 1 July 2022 while the proposed taxability on income from cryptocurrency is from 1 April 2022. Accordingly, there would be ambiguity around determining the threshold for the purposes of tax deduction at source.
- Also, what about the taxation of cryptos till 31 March 2022, can losses upto 31 March 2022 be carried forward in absence of any law prohibiting the same?
- Non-resident taxation with respect to VDAs
- In a case where crypto currency is generated through mining (i.e. computation of complex mathematical algorithms to create a virtual coin) what would be the cost of acquisition in such a case?
- Taxability of crypto swaps
While there is a buzz at this initial stage about taxation of crypto currencies as a form of Virtual Digital Asset, the intent of not squarely covering only the crypto currencies needs closer evaluation as the ramifications in the digital businesses of today and tomorrow may be impacted. Careful description and legal contours of digital assets and their usage and accounting require a revisit by concerned businesses to ensure optimum compliance with law. The interplay between equalisation levy on e-commerce transactions, significant economic presence and now the VDA tax would be an interesting study for researchers and experts. The CBDT would do well to release clarifications and circulars sooner than later to ensure that the businesses in the digital space do not get tentacled by protracted litigation in India. While ease of doing business in India and the Digital India are being stressed upon by the Government, counter productivity by way of tax uncertainty may be sensed as a deterrent by the digital community at large.
[1] 12 October 2020
Authors : Mansi Mehta, Senior Manager and Ruchi M Shah, Manager with Deloitte Haskins & Sells LLP
