Cryptocurrency is a virtual currency based on blockchain technology, which enables a peer to peer network without the intervention of a centralized agency. Cryptocurrency gained popularity with the introduction of Bitcoin by a programmer under the name Satoshi Nakatomo. Bitcoin gained significance in light of the collapse of the financial system which culminated in the Great Recession. The reduced faith in the government, and bitcoin’s decentralized nature, gave people an avenue to place their trust in a new form of digital payment. Cryptocurrency is not backed by any asset, and its price is set completely based on the market forces of demand and supply. While the transactions are available on a public ledger, they are protected by the user’s unique key. This makes the transactions anonymous, and difficult to track. The low transaction cost, and the ease with which transactions can take place globally also makes cryptocurrency a safe haven for criminals. There has been a steady growth in the popularity of cryptocurrency with various other cryptocurrencies emerging such as Ether, Libra, Dogecoin etc. The pandemic has contributed to this surge by creating a chaos in the economy.
Despite RBI’s consistent warning and caution about the dangers of cryptocurrency, India has the largest number of cryptocurrency users in the world. In 2018, RBI prohibited all RBI regulated bodies from engaging with entities dealing with cryptocurrency. However, this ban was struck down by the Supreme Court in the Internet and Mobile Association of India v RBI case, where the court held that the ban was a disproportionate measure which could be replaced with regulatory measures. While this decision came as a relief to the cryptocurrency owners, the Indian government has maintained a negative stance on cryptocurrency. More recently, the parliament has proposed a bill to ban cryptocurrency, along with RBI’s proposal to introduce a central bank digital currency (CBDC). It is unlikely that the CBDC will replace cryptocurrency. Unlike cryptocurrency, CBDC will be a regulated fiat currency which is backed by assets. A ban on cryptocurrency is unlikely to curb its use, rather users can find relief in its decentralized, anonymous nature.
Taxation is one of the most vital sovereign functions of the state. Taxes act as a means to ensure economic stabilization, develop infrastructure, redistribute assets and act as a regulatory lever. Tax regulation of cryptocurrency has been extremely difficult due to its inherent nature. Cryptocurrency has become a major contributor to an individual’s income which is at present, is unregulated. At the same time, tax regulators must aim to strike a balance between under regulation and over regulation. While under regulation may leave many of the problems unsolved, overregulation will lead to non-compliance of the regulations. Further, it must be ensured that the cost of administration is kept at the minimum level possible. Taxation must be certain, convenient, uniform and stable. To achieve these cannons of taxation, cryptocurrency must be classified under the tax categories, which has proved to be the most cumbersome task for the regulators.
Money can be characterized as a medium of exchange, a unit of account, and a store of value. Section 2(h) of the FEMA Act defines currency as inclusive of currency notes, postal notes, bills of exchange and so on. Cryptocurrency has not been notified by RBI and cannot said to be included within the definition of its legal tender. While El Salvador has recognized cryptocurrency as its legal tender to stabilize its economy and currency, this may prove to be ineffective. Further, this approach is unlikely to be followed by other countries who have a more stabilized economy and currency. Adopting cryptocurrency as its legal currency would reduce the state’s power to regulate the market through its monetary policy and would also give rise to the crimes already prevalent in the use of cryptocurrency. On the other hand, this gives rise to the possibility of cryptocurrency being classified as a foreign currency. Section 2(m) of the Act defines foreign currency as “any currency other than the Indian currency”. In such a case, if a resident of India is earning income from El Salvador, their income will be taxed in India. If the individual is remitting funds to El Salvador, an amount exceeding Rs. 7 Lakhs will be taxed at source at a miniscule rate. This may include investment in shares, education, immovable property and so on. However, countries are likely to be reluctant in recognizing cryptocurrency as a foreign currency as well. This reduces the taxable amount and does not take into account transactions involving cryptocurrency in the home state, or other states where cryptocurrency is in use. Moreover, bitcoin forms only 40% of the cryptocurrency market, leaving other cryptocurrencies unregulated. Hence, the following discussion classifies cryptocurrency as a good for the purposes of taxation.
B. Direct Tax
Income of an individual is taxed under the Income Tax Act, 1961. Indian residents are taxed on their worldwide income, whereas non-residents are taxed on their income which accrues in India. Section 2(24) of the Income Tax Act defines income as inclusive in nature, which may be received in cash or kind, regardless of whether the source is legal. Therefore, cryptocurrency may be analyzed under two heads, that is, capital gains, and profits from business or profession.
B.1. Capital Gains
Section 2(14) of the Income Tax Act defines capital asset as “Property of any kind held by an Assessee, whether or not connected with his business or profession.” In Ahmed GH Ariff v CWT, the court held that the term ‘property’ has a wide connotation, and includes movable assets, tangible/intangible assets, incorporeal rights. It signifies every possible interest which a person can hold and enjoy. Further, in Tata Consultancy Services v State of Andhra Pradesh, the court held that a software would fall under the meaning of goods under the state sales tax law. Therefore, cryptocurrency can be classified as a capital asset under the Act. if the investment in cryptocurrency is held for more than 36 months, it would classify as a Long-Term Capital Asset. If the period of holding is less than 36 months, it would classify as a Short-Term Capital Asset. Moreover, an equalization levy of 2% may also be applicable on cryptocurrency purchased from foreign exchanges. While many countries have categorized cryptocurrency as property taxable as capital gains, there are many loopholes which loom large.
Firstly, the ‘Cost of Acquisition’ (COA) required for the computation of capital gains would be problematic. If the bitcoins have been mined, the COA becomes indeterminable, which makes the capital gains indeterminable. In CIT v BC Srinivasa Setty, the court held that if the COA is indeterminable, no capital gains would be taxed. Secondly, determining the fair market value of the cryptocurrency at the time of exchange, or sale would be very difficult due to the extreme price fluctuations. For instance, Shiba Inu which was launched as a joke rose to prominence in a very short period of time and dipped again following Elon Musk’s tweet. Further, the gains are prone to be manipulated by users. For instance, if the user bought one bitcoin at Rs. 10, another at Rs. 50, and sold it for Rs. 100, it would be in the best interest of the user to value the cost at Rs. 50 to minimize its capital gains tax. The tax authorities must regulate this practice using HIFO, FIFO or Specific Identification Method. Moreover, classifying cryptocurrency as property would burden the users to compute gains on every small transaction, such as purchasing goods and services. Lastly, to charge capital gains tax requires a record of all information and valuation to specifically calculate the tax of each transaction which is burdensome and not feasible.
B.2. Profit & Gains from Business & Profession
Section 28 of the Income Tax Act is the charging section for income of business or profession carried on by the assessee, where Section 2(13) of the Act defines business as inclusive of “trade, commerce or manufacture or any adventure or concern of such nature”. Businesses or investors engaged in the trading of cryptocurrency professionally would be included under this provision.
C. Indirect Tax
Goods and Services Tax was implemented in 2017 which regulates the tax on supply of goods and services.
C.1. Goods & Property
GST would be applicable on cryptocurrency if classified as a commodity. Exchanging cryptocurrency for other commodities would fall under a barter transaction. Section 2(31) of CGST Act lays down the definition of consideration as “any payment made or to be made, whether in money or otherwise”, which indicates that GST is applicable for barter transactions. However, this may result in double taxation, where GST would be applicable for the purchase of cryptocurrency, and its use for exchange of other commodities. Countries which tax cryptocurrency under VAT, have created an exemption for exchange of goods and services for cryptocurrency. Further, the exchange rate of the price of the other commodities into cryptocurrency may prove to be a hassle. The exchange rate of every cryptocurrency varies depending on the cryptocurrency exchange.
Cryptocurrency mining refers to the process of solving mathematical equations where the result is the creation of new coins. Section 7(1) of the CGST Act defines supply as “all forms of supply of goods or services for a consideration made in the course or furtherance of business”. Here, mining may be included as a service if it is done in the course of a business, where coins may be mined and provided to the users. However, if mining is done through an individual account, without any business or consideration, it will not be included within this ambit.
III. Comparative Analysis
In 2014, IRS issued notice 2014-2021 which classified cryptocurrency as ‘property’ for taxation purposes, and all general principles applicable to property transactions were made applicable to cryptocurrency. Accordingly, taxpayers have to account for gain or loss that they incur in every transaction, whether it is for the purchase of goods and services or cryptocurrency mining. The users are mandated to keep a record of all transactions involving cryptocurrency. However, there has been a considerable lack of certainty surrounding the notice which has led to non-compliance, and under reporting of cryptocurrencies. In 2016, the IRS issued a summons to Coinbase, the largest USA cryptocurrency exchange to disclose information on its users. The IRS’s aggressive stance was viewed as a ‘fishing expedition’, where IRS relied on unsubstantiated claims to violate the privacy of a large number of users.
Cryptocurrency has been classified as a ‘crypto-asset’ under the Payment Services Act, 2009. Any profit incurred on any transaction of cryptocurrency will be taxed as miscellaneous income under the Income tax act. The tax rate can range up to 55%, which has led to underreporting of the profits.
Cryptocurrency is treated as property for taxation purposes. Income is not taxed for investment and trade for individual accounts. Cryptocurrency is only taxable if received as wages, for professional trading or for mining of cryptocurrency. In the Zug Canton, taxes can be paid in cryptocurrency as well. Zug has been referred to as the ‘Crypto-Valley’ due to the favorable tax treatment of cryptocurrency.
China has banned all cryptocurrency transactions including services provided by offshore cryptocurrency exchanges. A system to monitor cryptocurrency transactions has also been established. However, this has not deterred cryptocurrency users with over $28 billion worth of cryptocurrency traded in the first half of 2021.
Her Majesty’s Revenue and Customs (HMRC) has noted that cryptocurrency cannot be categorized according to traditional forms of activity due to its unique nature. Every transaction of cryptocurrency is dealt on a case to case basis. VAT is applicable for sale of goods for cryptocurrency, corporate entities are taxed as per the corporate tax rules, and investments are taxed under capital gains. HMRC has also noted that underreporting at this stage may be due to lack of education of users and has started sending ‘nudge’ letters to ensure that the right tax return has been filed. Dealing with transactions on a case to case basis increases the burden of the tax regulators and creates uncertainty for the tax payers.
India has taken an aggressive stance against cryptocurrency, which may not be sufficient to curb the use of cryptocurrency. It is evident that India must attempt to regulate the virtual currency, instead of prohibiting it. Most countries have classified cryptocurrency as a property which is taxed as the income of the individual. At the same time, this approach has certain loopholes regarding the valuation of cryptocurrency which arise from the uncertain nature of cryptocurrency and, may be difficult to evade. However, at present, this is the most viable route of taxation. This may be supplemented by a ‘de minimis’ exception, where investors will only be required to disclose gains exceeding a threshold amount. This will remove the burden of calculating profit or loss on every small transaction and reduce the administrative cost as well.
 Hatim Hussain, Reinventing Regulation: The Curious Case of Taxation of Cryptocurrencies in India, 10 NUJS L. REV. 792 (2017).
 Ahmed GH Ariff v CWT, (1970) 76 ITR 471.
 Tata Consultancy Services v State of Andhra Pradesh, (2005) 1 SCC 308.
 Supra note 1.
 CIT v BC Srinivasa Setty, (1981) 128 ITR 294.
 Austin Elliott, Collection of Cryptocurrency Customer-Information: Tax Enforcement Mechanism or Invasion of Privacy?, 16(1) Duke Law & Technology Review.
 Sami Ahmed, Cryptocurrency & Robots: How to Tax and Pay Tax on Them, 69 S. C. L. REV. 697 (2018); HIFO sets the cost basis as the cost of the highest coin which results in lower capital gains, and lower taxes. FIFO sets the cost basis as the cost of the oldest coin. The Specific Identification Method identifies the exact coin being sold and sets the cost basis accordingly.
 Supra note 6.
 Supra note 1.
 Aaron Hsieh, The Faceless Coin: Achieving a Modern Tax Policy in the Changing Landscape of Cryptocurrency, 2019 U. ILL. L. REV. 1079 (2019).
 United States v Coinbase Inc., No. 17-cv-01431-JSC, 2017 WL 3035164 (N.D. Cal. July 18, 2017).
 Supra note 1.
 David McNeely, Blame the IRS: A Look at Cryptocurrency and the IRS’s Lacklustre Response to Its Rising Popularity, 14 Charleston L. REV. 513 (2020).
 Supra note 13.
 Supra note 13.