The Income Tax Act, 1961: A New Chapter for Virtual Digital Assets
The Finance Act 2022 marked a watershed moment for the taxation of VDAs in India, introducing a specific and stringent tax regime. While providing much-needed clarity, this move has also sparked considerable debate among investors, industry stakeholders and tax professionals.
Defining Virtual Digital Assets
The Income Tax Act, through Section 2(47A) insertion, provides a broad and inclusive definition of a Virtual Digital Asset. It encompasses:
- 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 that can be stored, traded or transferred electronically.
- A Non-Fungible Token (NFT) or any other token of similar nature, by whatever name called.
- Any other digital asset as the Central Government may, by notification in the Official Gazette, specify.
- Any crypto-asset that is a digital representation of value relying on a cryptographically secured distributed ledger or similar technology to validate and secure transactions (w.e.f. A.Y. 2026-27)
This definition is intentionally wide to capture the entire spectrum of existing and future digital assets, ensuring that the law remains relevant in a rapidly evolving information technological landscape.
The Charging Section: Section 115BBH
The key features of this section are:
- Flat Tax Rate: A flat tax of 30% (plus applicable surcharge and cess) is levied on any income arising from the transfer of a VDA. This rate is applicable irrespective of the holding period of the asset, thus eliminating the distinction between short-term and long-term capital gains that applies to other asset classes that can be categorised as capital assets.
- No Deductions: No deduction in respect of any expenditure (other than the cost of acquisition) or allowance or set-off of any loss is allowed to the taxpayer while computing the income from the transfer of a VDA. This means that expenses such as internet charges, electricity costs for VDA mining, or fees paid to crypto exchanges cannot be claimed as a deduction.
- No Set-Off of Losses: Any loss arising from the transfer of a VDA cannot be set off against any income under any other head of the Act. Neither can losses arising from any other heads of income be set off against income arising from transfer of a VDA. Furthermore, such losses cannot be carried forward to subsequent assessment years.
Tax Deducted at Source (TDS): Section 194S
To ensure a clear audit trail and to widen the tax net, Section 194S was introduced, mandating the deduction of tax at source (TDS) on the transfer of VDAs by any person responsible for payment to any resident any sum by way of consideration for transfer of VDA. The key aspects are:
- Rate of TDS: TDS is to be deducted at 1% of the consideration payable for the transfer of a VDA.
- Threshold Limits: The TDS provision is triggered if the aggregate consideration payable by a specified person during the financial year exceeds ₹50,000. For any other person, the threshold is ₹10,000 for the financial year. A “specified person” is an individual or a Hindu Undivided Family (HUF) whose total sales, gross receipts, or turnover from business do not exceed ₹1 crore or from a profession do not exceed ₹50 lakh in the immediately preceding financial year.
- Responsibility of Deduction: The person responsible for paying the consideration for the transfer of the VDA is liable to deduct the TDS. In cases where the transaction takes place on a cryptocurrency exchange, the exchange is typically responsible for the deduction.
Taxation of VDA Gifts
The receipt of VDAs as gifts has also been brought under the tax net. An amendment to Section 56(2)(x) of the Income Tax Act now includes VDAs in the definition of “property.” Consequently, if a person receives a VDA as a gift without consideration, and the aggregate fair market value of such VDA exceeds ₹50,000, the entire fair market value will be taxable in the hands of the recipient under the head “Income from Other Sources.” However, gifts received from specified relatives are exempt.
Classification Dilemma: Business Income or Capital Gains?
A significant point of discussion and intense debate revolves around the appropriate classification of income from VDAs. The current law seems to be unclear as to its appropriate classification. It fails to answer the question as to whether it should be treated as “Profits and Gains from Business and Profession” or as “Income from Capital Gains”?
While the introduction of Section 115BBH has, to an extent, rendered this debate academic and somewhat redundant from a tax rate perspective (as the 30% flat rate applies in either case), the classification still holds relevance for other provisions of the Income Tax Act, such as the requirement to maintain books of accounts and the applicability of tax audit.
Case for “Income from Capital Gains”:
- Nature of Asset: Proponents of this view argue that for most individual investors, VDAs are held as a form of investment, similar to stocks, mutual funds, or real estate. The intention is to hold the asset for a period and benefit from its appreciation in value.
- Judicial Precedent: Even before the introduction of the specific VDA tax regime, the Income Tax Appellate Tribunal (ITAT) in certain cases had held that gains from the sale of virtual digital assets should be taxed as capital gains. (Refer ANNEXURE I)
- Definition of Capital Asset: The definition of a “capital asset” under Section 2(14) of the Income Tax Act is wide and includes property of any kind held by an assessee. VDAs can be considered a form of intangible property and thus, a capital asset.
Case for “Income from Business and Profession”:
- Nature of Assessee and Investment Intent: For salaried individuals or professionals whose primary source of income is not trading but to hold such assets as investments for capital appreciation, VDA transactions are more likely to be treated as investments.
- Frequency and Volume of Transactions: Where an individual engages in frequent and high-volume trading of VDAs, it can be argued that such activity strictly constitutes a business. The intention is not long-term investment but to profit from short-term price fluctuations.
- Organised and Systematic Activity: If a person sets up an infrastructure for trading, devotes significant time and resources, and conducts transactions in a systematic and organised manner in furtherance of profit earning, it is undoubtedly indicative of a business activity.
Rationale and Opinion:
In my professional opinion, the classification should be determined on a case-by-case basis, based on the principles laid down by judicial precedents for distinguishing between investment and business activity. For a casual or long-term investor, treating the income as capital gains appears more apt. Conversely, for a frequent trader, classifying it as business income would be more accurate. But once a stance has been taken to classify the income under either of the two heads of income, the assessee should not be given the opportunity to change his stance in the following financial years.
However, the current tax regime, with its flat 30% tax and denial of most deductions, significantly blurs the practical distinction. The government’s intention seems to be to tax VDA income at a high rate, regardless of its classification, to discourage speculative trading while capturing revenue from this new asset class. A more nuanced approach, perhaps with different tax rates for short-term and long-term holdings, as is the case with other capital assets, could foster a more mature and stable VDA market in the long run.
Goods and Services Tax (GST) on Virtual Digital Assets:
The application of GST to VDA transactions is another area that requires careful consideration. The GST Council is yet to issue specific guidelines on the matter, leading to some ambiguity. However, based on the existing legal framework, the following interpretations can be made:
- VDA as “Goods”: The definition of “goods” under the GST Act is broad and includes every kind of movable property other than money and securities. As VDAs are not legal tender and are generally not classified as securities in India, they are likely to be treated as “goods” for GST.
- GST on Trading: The direct sale and purchase of VDAs between individuals are generally not subject to GST as of now, as this would be akin to trading in goods, and GST is typically levied on the value addition by a registered person.
- GST on Services by Exchanges: Cryptocurrency exchanges provide services such as facilitating trades, wallet services, and processing transactions. These services are subject to GST at 18% on the fees or commissions charged by the exchanges.
- GST Rate and HSN Code: The seller of crypto or digital assets needs to pay GST and collect from their buyer, irrespective of whether the sale is executed through exchanges or any other means, at 18% under the HSN Code 960899 – Other Miscellaneous Articles.
- Input Tax Credit: GST levied on the purchase of crypto or digital assets or any other goods or services like broker commission, consultancy services, software, the cost to generate digital assets, etc., used for dealing in crypto or digital assets can be used as an ITC.
- GST on Mining: If mining of VDAs is undertaken as a business activity and the aggregate turnover of the miner exceeds the prescribed threshold limit of 40 Lakhs for GST registration, the activity could be considered a supply of service (or goods) and would be subject to GST.
The lack of explicit clarification from the GST Council on the valuation and place of supply for various VDA transactions remains a challenge for the industry. A clear and comprehensive framework is essential to ensure compliance and avoid future litigation.
Conclusion: A Tax Regime in Evolution
The current scheme of taxation of Virtual Digital Assets (VDAs) under the current direct and indirect regime of taxation is characterised by its simplicity in application of a flat, high tax rate with minimal deductions. While this approach ensures revenue collection and may deter speculative behaviour, it is overly stringent and for not distinguish between different types of VDA activities and provide a detailed framework for various other VDA transactions. A balanced tax regime that encourages investment while ensuring compliance and mitigating risks needs critical formulation in India.
ANNEXURE I: Precedent Setting Case
Background of the Case
The assessee, Mr. Raunaq Prakash Jain, had purchased Bitcoin during the F.Y. 2015-16 for approx. ₹5.05 lakhs. He held this investment for over three years and sold it in the Financial Year 2020-21 for a substantial sum of around ₹6.69 crores. In his income tax return for the Assessment Year 2021-22, Mr. Jain declared the profit as Long-Term Capital Gains (LTCG). He also claimed an exemption under Section 54F of the Income Tax Act, 1961, for reinvesting the capital gains in a new residential property.
The Assessing Officer (AO), however, disputed this classification and contended that cryptocurrencies were not explicitly defined as a “capital asset” under Section 2(14) of the Income Tax Act. As such, the AO treated the entire profit as “Income from Other Sources,” which is taxed at the applicable slab rates and does not allow for the exemptions available for capital gains, such as those under Section 54F. The CIT (Appeals) upheld the AO’s order, prompting the assessee to appeal before the ITAT.
Key Arguments and ITAT’s Verdict:
The ITAT, after hearing both sides, delivered a landmark ruling in favour of the assessee. The tribunal’s decision was based on a thorough interpretation of the existing provisions of the Income Tax Act.
Key observations and the rationale behind the ITAT’s decision include:
1. The ITAT emphasised the wide and inclusive definition of a “capital asset” under Section 2(14) of the Income Tax Act. This section defines a capital asset as “property of any kind held by an assessee, whether or not connected with his business or profession. The tribunal noted that the definition is not exhaustive and that cryptocurrency, being a form of intangible property in which the assessee has rights, squarely falls within this definition.
2. The tribunal took into account the intention of the assessee, which was evident from the long holding period of the Bitcoin (over 36 months). Holding the asset for more than 36 months made it eligible to be classified as a long-term capital asset. This long-term holding indicated that the assessee intended to invest in an intangible virtual asset and did not intend to engage in speculative trading or business in Virtual Digital Assets in any explicit or tacit manner.
3. The transaction was treated as a clear case of investment in a long-term capital asset, the gains from which are appropriately classified as capital gains. The assessee could therefore compute the income from long-term capital gains by availing the benefit under Section 48 of the Indian Income Tax Act, 1961, which allows the cost of acquisition of an asset to be inflated using the Cost Inflation Index (CII), accounting for the effects of inflation over the holding period.
4. By classifying the income as Long-Term Capital Gains, the ITAT also held that the assessee was eligible to claim the exemption under Section 54F of the Act for the reinvestment of the sale proceeds in a residential house built within three years from the date of sale or bought within one year before or two years after the date of sale. This deduction is available subject to the satisfaction of other conditions. This was a significant relief for the taxpayer.
5. The ITAT took cognisance of the prospective Nature of the VDA taxation regime, and the ruling pertained to an assessment year before the implementation of the new VDA taxation regime (Section 115BBH) from 1st April 2022. The decision of the tribunal, therefore, provides crucial guidance for the tax treatment of cryptocurrency gains for the period before the provisions of section 115BBH came into force, i.e. for the period pertaining before F.Y. 2022-23.
Implications of the ITAT Ruling
In my view, the ruling in the case of Raunaq Prakash Jain has had significant implications for cryptocurrency investors in India, particularly for those who had transactions before the financial year 2022-23:
- It provided much-needed clarity on the tax treatment of crypto gains during a period when the law was silent on the matter and the taxation of VDAs fell into the grey area. There were and still are no specific laws or regulations governing the trading and mining of VDAs, and the Reserve Bank of India (RBI) has time and again cautioned against their use.
- Classification as long-term capital gains, especially for assets held for more than 36 months, allowed investors to benefit from a lower tax rate (20% with indexation benefits and benefits of deductions under sections 54F and 54EC) compared to the slab rates that could go up to 30% (plus surcharge and cess) if treated as income from other sources or business income.
- Eligibility for Exemptions: It opened the door for investors to claim various exemptions available under the head “Capital Gains,” such as those under Sections 54F and 54EC, for reinvesting their gains in specified assets into construction or purchase of residential property or purchase of bonds of NHAI, REC, PFC and IRFC, subject to certain conditions.
The ITAT’s proactive and interpretative approach in cases like Raunaq Prakash Jain vs. ITO has played a pivotal role in settling the tax position for a nascent asset class in the absence of specific legislation, providing a fair and legally sound basis for the taxation of cryptocurrency gains as capital gains for the era before F.Y. 2022-23
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Author: Atith Sinai Amonkar – Financial Practitioner | Author & Blogger
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