Taxation of Cryptocurrencies & NFT – Assets of next generation

Cryptocurrency, Nonfungible tokens (NFT) or legally known as Digital Assets are the new and the fastest upcoming modes of investment which have taken the world by storm. During the past few years there are multiple platforms from which one can invest in such digital assets in India and everyone is attracted towards this new form of assets owing to the huge returns these assets offer. There has been a discussion since long whether trading and investment in such new forms of digital assets is legally allowed in India or not, specifically after the RBI Circular of 2018 which banned banks not to facilitate transactions for crypto. However subsequently the Hon’ble Supreme Court set aside this circular giving a second life to the digital currency. The discussion regarding whether the government would ban or regulate crypto would always make the news each time parliament was in session. There have been speculations that the government might not ban the cryptocurrencies but might regulate it. However, no such formal bill was ever laid before the Parliament leaving the investors guessing over its validity. Despite this skeptical cloud over the validity of the cryptocurrencies, today India has the fifth largest owners of cryptocurrency as a percentage of the population estimated more than 100 million users. This number is only increasing on quarterly basis given the supernova like returns the Assets present.

It was about time the taxation authorities took a stand for the taxation of these assets. Possibly the biggest announcement by the Hon’ble Finance Minister in the Union Budget of 2022 was relating to taxation of Digital Assets. Before we jump onto the taxation provisions let us understand what does this mean to the public at large. It obviously means that the Government would not ban trade of Cryptocurrencies, however it is likely that in the times to come there would be regulation to the trading of crypto markets. Now let us understand the taxation provisions which would apply to trading in such digital assets.

The Hon’ble Finance Minister in her budget speech for 2022 introduced the provisions of Section 115BBL wherein the profits from transfer of Cryptocurrencies or NFT better known as virtual digital assets would be taxed at flat rate of 30% (Plus Cess and surcharge in applicable cases). Further the only deduction which would be allowed to the holder of such assets would be the cost of acquisition of these virtual assets. In case of losses on transfer of such digital assets that would be allowed as a set off only in the year in which the loss was incurred against gains from transfer of the same type of assets.

Let’s say an Assessee incurred losses on transfer of Ripple Coin in AY 2022-23 then such loss would be allowed to be set off only against any gains the Assessee has incurred on transfer of some other digital assets falling in AY 2022-23 only. Such losses cannot be carried forward to subsequent years nor such losses can be adjusted against gains under any other head.

This would mean that in case an Assessee has incurred huge losses in one year and huge gains in the subsequent year, then the Assessee is expected to pay taxes @ 30% on such gains and the losses incurred in the previous year cannot be carried forward. The view taken by the Hon’ble Finance Minister is uncalled for and is a bit stringent, the losses should have been allowed to be carried forward to subsequent year though set off should be allowed against income from such head only. This is similar to the view adopted under the provisions of Section 72A of the Income Tax Act, 1961 (“the Act”) wherein the losses on owning and maintaining of horses is allowed to be carried forward for 4 Assessment Years from the year wherein they are incurred but can only be set off against income from owing and maintaining of horses. This goes on to reflect that the government is not open to the new category of assets and plans to tax the Assessee’s at large for the profits generated from the trading of cryptocurrencies however when it comes to allowing losses to be set off against future profits, it takes a view that such profits cannot be allowed. Let us understand the taxability and the set off provisions better by way of an example.

1. In Year 1 no losses would be allowed to be set off against the income from Virtual Digital Assets.

2. The losses incurred under any business (Speculative or non-speculative) would not be allowed to be set off against income from transfer of Digital Assets.

3. The Assessee isn’t allowed any basic exemption limit in case the only income during the year is from the transfer of the Virtual Digital Assets.

4. In Year 2, the losses of 85,000 in Virtual digital assets would not be allowed to carried forward to subsequent years.

It is obvious to state that in case the funds are not withdrawn by an Assessee from the aggregator then also such income would be taxable.

Now let us take a case that an Assessee who transfers these virtual digital assets at a value less than a value than the fair value of the asset the differential value would be taxable in the hands of the recipient as per the provisions of Section 56(2)(x) of the Act.

It is pertinent to note that the Hon’ble Finance Minister introduced the new law taxing the transfer of virtual digital assets under the taxation laws however under which head of income would such income be taxed has not been stated. We would need to wait for the detailed ITR form to determine under which head the income from such assets would be taxed.

The Hon’ble Finance Minister in her budget speech also introduced the provisions of Section 194S to the Act wherein the person making the payment for the transfer of virtual digital asset shall at the time of the transfer of the virtual digital asset deduct TDS at the rate of 1% of the consideration. Now it is important to understand that the TDS would be applicable whether the seller of the asset transfers by way of cash or through kind or partly in cash and in kind. However, no TDS would be deducted in case the value of the transfer does not exceed fifty thousand rupees during the financial year wherein the transfer is made by a specified person being an Individual or HUF which subject to monetary limits would be required to deduct TDS or in case of any other person the value of the transaction does not exceed ten thousand rupees during the financial year.

Let us understand this better by way of an example, now say in case a resident individual sells Bitcoin on WazirX worth Rs.8,000/- and also sells Ripple worth Rs.25,000/- then WazirX would be required to deduct TDS @ 1% on the total value of the transaction in excess of Rs.10,000 being Rs.23,000/-. Now, it does not matter whether the Assessee converts the sum in cash or transfers the sum to purchase any other assets. Now in case that the person selling the asset is a person as per the provisions of Section 206AB of the Act then TDS would be deducted as per the higher rate specified in the Section, however such higher rate would not be applicable in case the transfer is made by an Individual or HUF subject to the limits specified under the provisions of Section 194S.

The government after much anticipation has taken some a stand on the Cryptocurrencies and NFT. Also, it would not be wrong to say that income generated from Metaverse would also be taxable under this head.

While this is a first good step, there are still multiple shortcomings to the new law which needs to be addressed. However one positive thing which has emerged from this new provision is that the government has finally considered Cryptos and NFT as an asset class paving the way for the future of this class of assets.

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Author: Sanket Bakshi, Partner Sahil Rao & Associates | Vadodara