Virtual Digital Asset – Taxation & uncertainties affecting it’s taxation?

What is a Virtual Digital Asset, how will it be taxed and what are the various uncertainties affecting it’s taxation?

Amidst the craze and fanfare of cryptocurrencies and NFTs, while the crypto and NFT traders, investors and enthusiasts were consumed in experiencing the daily ups and downs of the market, the Govt of India has come up with a special scheme for taxing Virtual Digital Assets (in it’s Finance Bill, 2022) something the former need to deal with in the near future.

In this article, the author will discuss below matters with regard to this new scheme proposed under the Finance Bill, 2022:

1. What is a Virtual Digital Asset and how it may cover not only cryptocurrencies and NFTs but even other commodities!

First things first- What is being proposed to be taxed is not specifically Cryptocurrencies and NFTs but a ‘Virtual Digital Asset’. So, what’s ‘VDA’ and does VDA include Cryptocurrencies and NFTs?

(For sake of brevity, virtual digital asset is hereafter being interchangeably referred to as VDA)

Here’s the definition which has been proposed to be laid down by the Lawmakers (through inserting a new section 47A in the Income Tax Act, 1961):

Provision of Section 47A	Author’s Comments
“virtual digital asset” means––	The definition is exhaustive and not inclusive in nature due to usage of word ‘mean’ hence only what is being talked about in below 3 clauses will be treated as a VDA.
Clause (a) of section 47A 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; read with Clause (b) of Explanation below section 47A– the expressions “currency”, “foreign currency” and “Indian currency” shall have the same meanings as respectively assigned to them in clauses (h), (m) and (q) of section 2 of the Foreign Exchange Management Act, 1999.’	What IS treated as VDA under clause a): Information, code, number and token whether or not generated through cryptographic means if: i) it can be transferred, stored or traded electronically AND ii) it satisfies condition a) OR condition b) Condition a) It provides a digital representation of value exchanged with the promise or representation of having inherent value i.e. the commodity being transferred should have an inherent value of it’s own. Condition b) It functions (operates) as a store of value or a unit of account and it’s use may include being used in any financial transaction or investment, but not limited to investment scheme. Hence, here a commodity operating as a store of value impliedly not necessarily of it’s own can be said to be covered here because otherwise then this phrase doesn’t really hold any specific relevance of it’s own distinct from the phrase covered in above condition a). What IS NOT treated as VDA under clause a): Currency (whether Indian/Foreign) which is legally recognised and notified by RBI is excluded from meaning of VDA and hence is not a VDA. This should be obvious as just the mere act of transferring money by one person to another person isn’t being taxed because money isn’t a commodity which is generally taxed but the underlying goods and services are. e.g. When Ajay buys a mobile through Amazon and pays Rs 25,000, he isn’t taxed for the money transferred by him. On the other hand, when Ajay sells a mobile through Amazon for Rs 25,000, he is taxed for the transfer (sale) of mobile.
Insight: Any digital commodity capable of being traded/transferred/stored electronically and deriving a value of it’s own or of another commodity can be said to be a VDA, however so it doesn’t include currencies recognized and notified by RBI.Derivations from this Insight: Below commodities can be said to be a VDA: a) Cryptocurrencies and NFTs- They are capable of being stored, traded and transferred electronically and may either derive value of their own or from any other commodity. b) Dematerialized Shares, Other Securities and Commodities- They all are capable of being stored and traded electronically, and- shares and mutual funds derive value from the assets of the ultimate underlying company, commodities derive value from the underlying physical commodities, other securities such as bonds, debentures etc derive value of their own. c) Promotional currencies introduced by different brands- There are brands which offer their own currency for promotional purposes which their customers can redeem against purchases such as The Souled Store (an apparel sale store) offers TSS, Jupiter (a Neo Bank) offers Jewels etc. These promotional currencies are capable of being stored and transferred (redeemed) electronically. d) E-books- They are capable of being stored electronically and have a value of their own. Hence, there’s a room for interpretation that not only cryptocurrencies and NFTs but even other digital commodities can be said to be a VDA.
Clause (b) of section 47A a non-fungible token or any other token of similar nature, by whatever name called; read with Clause (a) of Explanation below section 47A– “non-fungible token” means such digital asset as the Central Government may, by notification in the Official Gazette, specify	Notified NFTs shall be treated as VDA. However non-notified NFTs having similar characteristics as notified NFTs shall also be treated as a VDA. Though it should be noted that NFTs whether or not notified by Central Govt, can also be covered under clause (a) of section 47! Hence, if it is the intent of Govt to tax only certain NFTs which it would wish to, definition of VDA may need to be reworded.
Clause (c) of section 47A any other digital asset, as the Central Government may, by notification in the Official Gazette specify: Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein.	Govt may include and exclude any digital commodity within/from the definition of VDA it may wish to.

2. The way a Virtual Digital Asset will be taxed

Now that what may and may not be treated as VDA has been dealt with in this article, the next question is how is the VDA proposed to be taxed by the Govt? Well, the Govt intends to deal with this question through insertion of new section 115BBH which is explained as below:

Firstly, Taxation of VDA under the new scheme will commence from FY 2022-23. However, it should be noted that VDAs would be continued to be taxed where applicable even prior to FY 2022-23 but would be so under the normal provisions of the Indian Income Tax Legislation.

Provision of section 115BBH	Author’s Comments
Sub-section (1) of section 115BBH Where the total income of an assessee includes any income from the transfer of any virtual digital asset, the income-tax payable shall be the aggregate of–– (a) the amount of income-tax calculated on the income from transfer of such virtual digital asset at the rate of thirty per cent.; and (b) the amount of income-tax with which the assessee would have been chargeable, had the total income of the assessee been reduced by the income referred to in clause (a).	Profits from transfer of VDA will be taxed at 30% rate.
Sub-section (2) of section 115BBH Notwithstanding anything contained in any other provision of this Act,–– (a) no deduction in respect of any expenditure (other than cost of acquisition) or allowance or set off of any loss shall be allowed to the assessee under any provision of this Act in computing the income referred to in clause (a) of sub-section (1); and (b) no set off of loss from transfer of the virtual digital asset computed under clause (a) of sub-section (1) shall be allowed against income computed under any other provision of this Act to the assessee and such loss shall not be allowed to be carried forward to succeeding assessment years.	1. To arrive at profits from transfer of a VDA, only it’s cost of purchase can be deducted. Hence, other expenses such as brokerage/transaction fee on purchase and sale cannot be claimed as expense to arrive at profits. 2. This is how profits from transfer of a VDA will hypothetically be taxed as below : a) Consideration from transfer- Rs 100 b) Less: Corresponding Purchase Cost- Rs 70 c) Profits to be taxed @ 30% ((a) – b))- Rs 30 (If VDA is held for more than 3 years as investment and not as stock-in-trade, then indexation benefits may be claimed on Purchase cost and instead inflation adjusted profits may be offered for tax.) 3. Losses from transfer of commodities which are not a VDA cannot be adjusted against the above profits. Only losses from transfer of other VDAs can be adjusted against above profits. Hence, if there is another VDA transferred at a loss of say Rs 20 and few business equipment transferred at a loss of Rs 40, only the net profit of Rs 10 (Rs 30 – Rs 20) will be taxed at 30%. 4. Losses from transfer of VDAs cannot be adjusted against other incomes such as Salary, Profits from Other Business/Profession etc. 5. Unadjusted losses from VDAs will lapse and not be allowed to be adjusted against profits from VDAs of future years.
1. Even VDAs received as gifts having Fair Market Value of more than Rs 50,000 or received at below Fair Market Value by more than Rs 50,000 will be taxed. The Govt intends to tax these through section 56(2)(x) of the Income Tax Act, 1961. 2. How this Fair Market Value will be determined is something which needs to be prescribed and clarified by Govt, because for e.g. prices of cryptocurrencies such as bitcoin may be different on different exchanges. 3. Further, how should the cost of purchase be determined is also something which needs to be prescribed and clarified by Govt, because for say cryptocurrencies the most commonly used cryptocurrency tax calculation methods include highest in first out (HIFO) method and last in first out (LIFO) method- methods which are not common for valuation of securities which use FIFO/Weighted Average Cost methods.

3. Obligation of deduction of tax imposed on a person who’s looking to buy a Virtual Digital Asset

To keep a track of VDA transactions and avoid leakages in revenue, Govt has proposed to impose obligation of deduction of tax. The Govt intends to do this by way of inserting new section 194S into the current income tax legislation.

Key points to be noted in this respect are:

i. From which Date will this new obligation of deducting tax be effective from?

This new TDS obligation will commence from 01.07.2022. Till then, provisions of sections 194-O/194Q/206C(1H) will apply.

ii. Who should deduct this tax? And at what rate and on what amount will tax be needed to be deducted under this new obligation?

Tax @ 1% needs to be deducted (i.e. 1% TDS) by Buyer of VDA from consideration payable/paid to Seller of VDA, only if Seller is a Resident. Hence in case of Non-resident Sellers, TDS obligation will prevail under Section 195.

iii. How can tax be deducted and paid to Govt in case of barter/exchange transactions?

In case of barter/exchange transaction where adequate 1 % tax is not able to be deducted from monetary consideration component of total consideration, instead of deducting 1 % tax, the buyer before releasing the total consideration must ensure that applicable tax @ 30% (further increased by applicable surcharge and cess) has been paid by the Seller. In this respect, buyer can consider asking for tax payment declaration and tax payment challan from the seller.

iv. Generally for deduction of tax, a separate TAN number is required to be obtained first. Is obtaining this TAN number mandatory for fulfilling this new tax deduction obligation?

Below persons will not be required to obtain TAN for deduction of tax:

i) Any individual/HUF who has not carried out any business/profession during the current financial year.

ii) Any individual/HUF whose sales/gross receipts in preceding financial year does not exceed Rs 1 crore (in case of business) or Rs 50 lakhs (in case of profession).

v. Is complying with section 206AB of deducting tax at a rate higher than 1% mandatory?

The same above-mentioned 2 persons are also provided relief from the obligation of complying with section 206AB.

vi. Is there any threshold amount below which tax deduction obligation is exempted?

There’s no need to deduct tax by the buyer if:

i) In case he’s any of the above 2 persons, his total VDA purchases during current financial year don’t exceed Rs 10,000.

ii) In case of other persons, his total VDA purchases during current financial year don’t exceed Rs 50,000.

In case of these transactions below said thresholds, obligation to deduct tax will fall on the trading exchanges/platforms (e-commerce operators) if they are carried out through them.

vii. What will happen to tax deduction obligations stipulated under other sections already in place in view of this new tax deduction obligation? Will they need to be followed too?

Where obligation to deduct/collect tax exists under multiple sections (such as section 194S and section 206C(1H)), such obligation of tax deduction/collection under other sections shall be relieved off if 1% tax is deducted under section 194S.

Challenge in imposing TDS obligation on buyer of VDA where he makes the purchase through an exchange/platform (e-commerce operator) will be that the PAN of Seller of VDA will be very difficult to be obtained for the Buyer unless this is facilitated by said exchange/platform. Alternatively, the govt may consider imposing TDS obligation on the exchange/platform instead since it would be in a much better position to comply with it.

4. A few questions which need to be pondered upon

1. Why has the Govt considered to tax VDAs differently from other assets?

2. Will only cryptocurrencies and NFTs be taxed as VDAs or other commodities such as dematerialised securities and e-books also?

3. It is only the income from transfer of VDAs (including gifting thereof) which is taxable. Hence, this implies that there should be a permanent transfer of title which is often referred to as a sale, for VDA 30% tax to be attracted. In that case, how would interest income on lending of cryptocurrencies be taxed?

4. The new TDS obligation on VDA has been imposed from 01.07.2022 however no such specific date has been given for Charge of Tax on VDA Income but only a reference to AY 2023-24 (PY 2022-23) has been given. Hence, Tax Charge can be considered from FY 2022-23 i.e. from 01.04.2022. In such case, why is there a mismatch between these 2 dates?

5. Key Takeaways and Concluding Thoughts

To summarise, the key takeaways are:

1. There is scope for interpretation that besides cryptocurrencies and NFTs, other commodities such as dematerialised securities and e-books may also be taxed as VDAs. If this is not the intent of lawmakers, it is hoped that suitable amendments in definition of VDA are considered.

2. It is the Profits on VDAs which will be taxed at 30%. If they are held as investments for more than 3 years, inflation adjusted profits can be considered for taxation i.e. indexation benefits can be claimed.

3. Taxation of VDAs will be done in isolation from other incomes i.e. losses from VDAs cannot be adjusted against Non-VDA incomes such as salary, non-VDA related business etc and vice-versa.

4. There may be operational difficulties in fulfilling the obligation of deduction of tax on VDA purchases proposed to be imposed on buyers. In this respect, clarification is hoped from lawmakers.

Given the widely accepted view is that lawmakers have brought in the concept of ‘VDA and it’s taxation’ to tax cryptocurrencies and NFTs, it should, in the author’s personal view, certainly sit, think and deliberate more about the various unintended consequences of the provisions it has framed and rationalise the same, so that the necessary stakeholders are clear about the tax consequences it intends to have, for a more certain environment for them to operate in.

Nonetheless, crypto and NFT world is relatively new and evolving, and so would expectedly be the legislations on it. Hence, it is hoped that the lawmakers and CBDT would soon be issuing necessary clarifications, to mitigate unnecessary litigations, on this subject well before 15.06.2022 which would be when the taxpayers dealing in VDAs might be paying their 1st advance tax instalment!

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Disclaimer- Please note the views expressed herein above are basis information available upto 02.02.2022. Nothing contained in this article, including the articles and external publications herein referred to, shall be construed as a legal advice or a legal opinion rather it is hereby clarified that the article is only for general information purposes and academic discussion, and views, remarks and comments expressed in this article are author’s own personal views, remarks and comments and do not intend to represent those of taxguru and other persons, and hence must in no circumstances be used or relied upon as a legal advice or a legal opinion. Under no circumstances whatsoever, the author shall be responsible for any loss, claim, liability, damage(s) resulting from the use, omission or inability to use the information provided in the document.