Cryptocurrencies (Virtual Digital Assets): Taxation and Validity under Article 14 of Indian Constitution
Introduction
Imagine the police ring on your door and say, keeping gold assets is not legally recognised, but you will have to pay tax on it. It would be astonishing to see how an asset is not recognised but taxed. This is the prevailing regime for crypto assets in India. India taxes Virtual Digital Assets (VDAs) at 30% flat while granting them no legal recognition. Section 115BBH of the Income Tax Act, 1861 (the Act) requires that any income arising from the transfer of a Virtual Digital Asset (crypto or NFT) is taxed at a flat 30% rate (plus 4% cess and applicable surcharge), irrespective of its holding as a capital asset or business stock. Most importantly, it states that while computing this income, the assessee can deduct only the cost of acquisition and no other expenses, and no deductions, set-offs, or loss adjustments are permitted against any other income, nor can any loss from such transfer be carried forward to the future. The question this article raises is not whether the tax rate is high, but whether the mechanism denying loss relief can survive against the test of Article 14 of the Constitution.
The Evolution of India’s VDAs Tax Regime
The VDAs are defined under section 2 (47A) of the Act. The VDAs includes cryptocurrencies, NFTs, and similar digital assets. The future prospect of VDAs was sensed by RBI on December 24, 2013, it issued a covered warning to users that Bitcoin and other virtual currencies were neither approved by any central bank nor risk-free and subject to the risk of volatility and abuse. However, it refrained from terming them illegal and instead reflected a precautionary approach. These warnings were reiterated by the RBI and Finance Ministry in 2017. A major hit came on April 06, 2018, with the release of the RBI notification prohibiting all banks and financial institutions from providing any services to parties related to cryptocurrencies. To strengthen the stand of the RBI, came the Report of the Steering Committee on Fintech Related Issues in 2019 (circular). It recommended a total ban on private cryptocurrencies and strict punishments for activities related to them. It also suggested a framework for a Central Bank Digital Currency (CBDC). The comprehensive blanket ban order of 2018 faced the hammer of the Hon’ble Supreme Court in Internet and Mobile Association of India v. RBI, (2020) SCC OnLine SC 275, and was quashed. The reasoning forms the most important part, whereby the Court reasoned that the circular did not qualify the proportionality test. The Court found no evidence that cryptocurrency exchange harmed the banking system in any way. Thereafter, a structured but failed step to recognise and regulate cryptocurrencies was taken in 2021 with the proposal of the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021. However, due to the industry opposition and technological unenforceability of an outright ban, the bill never advanced to debate. Thereafter, finally, in 2022 came the Finance Act, 2022, which introduced the taxation regime for the VDAs in the form of an amendment to the Income Tax Act 1961. This introduced section 2 (47A), which defined VDAs as including cryptocurrencies, NFTs and other digital assets; section 115BBH, imposing a 30% flat taxation on VDAs gains; and section 194S, imposing 1% TDS on transfers above ₹50,000 annually. Recently, in 2025, Finance Minister Nirmala Sitaraman made a statement on stablecoins, stating that people should prepare to engage with stablecoins. This is a major shift in the crypto dealing and regulation policy of the government. The initial approach signals of being cautious and hesitation to allow cryptocurrency exchanges. However, the government is now moving towards a liberal stand. However, there is no recognition yet, but a manifestly arbitrary taxation mechanism to tax cryptocurrency transactions.
The Test of Article 14
Article 14 of the Constitution, guaranteeing equality before law, is a major test stone for legislative and executive actions. It has operated historically through the classification doctrine. A differential must be intelligible and must bear a rational nexus to the object sought to be achieved. But Indian jurisprudence has, since E.P. Royappa Vs. State of Tamil Nadu & Anr. (Supreme Court of India) – Judgment Dated 23.11.1973 – (1974) 4 SCC 3 and Maneka Gandhi Vs. Union of India (Supreme Court of India) – Judgment Dated 25.01.1978 – AIR 1978 SC 597, recognised a second and independent ground, i.e., arbitrariness itself as antithetical to Article 14, irrespective of formal classification. The Supreme Court in Shayara Bano v. Union of India, matured the doctrine to “manifest arbitration” whereby a legislation if capricious, irrational, or lacking adequate determining principle or excessive and disproportionate could be struck down. The doctrine was recently applied in landmark judgment in Association for Democratic Reforms v. Union of India, famously known as Electoral Bond judgment, whereby the court found electoral bond scheme lacking a rational basis to its claimed objective of transparency.
Is VDA a Valid Classification?
The intelligible differential is first limb of the test. It requires that VDAs be distinguishable from other capital assets on some rational basis. The liberal and literate reading of Section 115BBH, it is likely to sustain intelligible differential. VDAs tend to have price volatility, absence of intrinsic yield, and pseudonymous transfers, which are not identical to other capital assets like equity and immovable property. Therefore, an act may treat VDAs as a separate class for tax purposes.
The important consideration is the rational nexus. If the specific objective of the legislation is to deter speculative investment, it should have nexus to the mechanism chosen. The deterrence objective finds relation to taxation of lottery and game-show winnings under Section 115BB of the Act. They are similarly taxed at a flat rate without deduction, on the understanding that windfall or speculative gains require disfavoured treatment. However, this relation breaks at the point of loss treatment. The lottery winnings do not involve any similar “loss” concept requiring set-off, since a lottery ticket that does not result in a win produces no cognisable capital loss. However, VDAs transactions are structured exchanges capable of generating genuine, quantifiable losses, like any other capital asset. Therefore, use of a lottery-style flat rate logic to an asset class that behaves like a commodity or equity in a transaction shows an internal inconsistency rather than a coherent regulatory approach.
Applying the Manifest Arbitrariness Test to Section 115BBH
The another limb of the test under Article 14 is “manifest arbitrariness” as detailed in the Shayara Bano Case. The three standards of manifest arbitrariness are:
1. Irrationality: The challenge of rationality lies against the set-off bar, not the 30% taxation rate, which is a fiscal discretion. No determining principle link the deterrence rationale to a bar on set-off within the VDAs class itself. Alternatively, a ring-fenced set-off, permitting losses to offset only other VDAs gains. This would equally serve the objective while avoiding the present mechanism’s unexplained severity. Hence, the provision lacks any adequate determining principle.
2. Disproportionality: The provision needs to be measured against less restrictive alternatives available. These include ring-fenced set-off, limited carry-forward, or partial loss recognition, mechanisms used in other jurisdictions. The blanket bar is disproportionate to any articulated regulatory objective.
3. Taxed but unregulated incoherence: The state extracts revenue from an asset class it declines to formally recognise, while denying it ordinary reliefs.
In the electoral bond judgment, the Court applied manifest arbitrariness to fiscal-adjacent legislation, notwithstanding the earlier precedent of State of Andhra Pradesh & Ors. Etc. Vs. McDowell & Co. & Ors. Etc. (Supreme Court of India) – Judgment Dated 21.03.1996 – (1996) 3 SCC 709, which held that legislative wisdom could not be second-guessed absent a specific constitutional violation.
Conclusion
The detailed analyses of section 115BBH in light of the judicial precedents and practical implications, it is evident that section 115BBH’s classification of VDAs as a distinct tax category likely survives the classical differentia test. However, the loss set-off bar does not survive the stricter standard of manifest arbitrariness. There is no clear link between the provision’s deterrence rationale and its blanket denial of loss relief. When this gap is read together with the government’s continued refusal to legally recognise VDAs as a defined asset class, it makes the mechanism constitutionally vulnerable on grounds separate from any challenge to the tax rate itself.
The remedy lies not in a full, unrestricted set-off against all heads of income. However, there is an alternative in the form of a ring-fenced set-off, limited to gains and losses within the VDAs class. This would preserve the legislature’s deterrence objective while removing the present provision’s disproportionate effect. This is a tried and tested practice in other jurisdictions like the UK, where jurisdictions permitting crypto loss relief usually do so within defined limits rather than without any qualification. The correct measure is to read down rather than striking down the provision in its entirety. The Courts can employ the severability doctrine, which allows a court to remove the offending restriction. In the present case, the doctrine can be applied for the absolute bar on set-off, while leaving the flat 30% rate and the disallowance of ordinary expenditure deductions in place, since these elements do not suffer the same defect. The step to completely strike down section 115BBH as a whole would be a disproportionate response to a narrow and identifiable flaw.
Interestingly, the proposed reforms do not resolve the larger and still-unsettled question of regulatory jurisdiction over VDAs between SEBI, RBI, and the Finance Ministry. This question lies outside the ambit of the present article. The proposed reforms achieve internal coherence within the tax regime itself, regardless of how the regulatory question is eventually settled. What is less doubtful is that taxing an unrecognised asset class with unusual severity, and with no corresponding relief, is unlikely to remain undisturbed as India’s regulatory approach to digital assets continues to develop.
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