The Finance act 2022 introduced section 115BBH and it will be applicable from AY 2023-24. The section provides that the income on the transfer of the virtual digital asset (VDA) will be taxable at the rate of 30 percent. The taxpayer cannot take the deduction in respect of any expenditure other than the cost of acquisition. The loss from the transfer of VDA will not be allowed to set off against any other income (such as capital gain, profit from the business, profession, salary, or any other income from other sources) and such loss cannot be carried forward to the succeeding assessment years.
The Finance act 2022 also provides the mechanism to deduct the TDS on the transfer of VDA under section 194S. The threshold limit is Rs 50,000 and it has to be seen on the aggregate value of the consideration payable on the transfer of VDA.
Section 56(2)(X) of the IT act would be also applicable to Virtual digital assets. This means that receiving the VDA without consideration will invite the gift tax in the hands of the recipient if the fair market value of the assets exceeds fifty thousand rupees.
The imposition of such taxes on virtual digital assets has been done to regulate this dynamic and sophisticated market. Such action of the government invites both negative as well as positive views from the crypto community but many professionals in the crypto community believe that the introduction of taxation on the transfer of Virtual digital assets is an excellent move and will provide clarity to the investors on how their income would be taxed which is the most disputed and controversial before the budget’s announcement. But We still need clarity as most of the things are vague.
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Taxability of Airdrops
Usually, when any new cryptocurrency comes into the market, they are freely distributed among the users. It is done to promote (making the people aware of the new cryptocurrency or token) and make the initial market for the coins. This free giveaway can be of coins or tokens. The new coins or tokens are directly transferred to the wallets of the recipient. It can be offered for free or for a small amount of consideration or participation in the crypto community or return of any small service. Sometimes, these coins are also offered for undertaking marketing activities such as posting on social media, conducting seminars or workshops, or making other crypto enthusiasts participate in the project. In short, the consideration paid by the recipient for receiving such tokens or coins is mostly non-monetary. Mostly, the recipients provide their time and mind for the benefit of the whole project. Here, the question arises that how this will be taxable at the time of receipt and sale.
Sec 56(2)(x) will be applicable in the hands of the recipients at the time of receipt from the issuer of the coins or tokens. It is because recipients have not provided any monetary consideration to receive such coins or tokens. After that, if the recipient sells the same tokens or coins received in Airdrop to someone else, the normal tax rate of 30% would be applicable on such a sale.
As per sec 56(2)(x), The coins or tokens received till the fair market value of Rs. 50000 shall not be taxable but excess of it would be wholly taxable in the hands of the recipient. However, as per industry norms, getting free coins or tokens is not easy. The users have to participate in a lot of projects and might need to incur certain costs such as gas fees, account fees, and listing fees.
Hence, the questions arise that what could be considered as consideration for receiving such tokens or coins. Whether the non-monetary services provided by the recipient can be considered as ‘consideration’ for the purpose of section 56(2)(x). How will we evaluate the fair market value of the new coins at the time of free distribution? Here, we can’t take the value from the open market as these coins or tokens would be at their initial level and taking the open market price might lead to absurdity. In various instances, the courts have held the non-monetary benefit as ‘consideration’ for the purpose of section 56 and decided that no gift tax would be chargeable on such transactions. The legislature will have to provide the proper mechanism to calculate the fair value otherwise it would lead to confusion and a breakdown of the structure.
Taxability of Gas fees
The gas fee is paid at the time of acquisition of any token or smart contract on the Ethereum network. The gas fee is like the transaction fee charged by the banks or any other financial institution to carry out the activity or transaction on our behalf. The gas fee directly goes into the pocket of the miners as they are the ones who are constantly employing their computing power to mine the smart contract on the block. Therefore, the gas fee is paid by the users to compensate for the computing power incurred by the miners. The longer the smart contract, the more gas would be required to validate the contract in the block. It fluctuates from time to time depending on the traffic on the network as the miner will validate the smart contracts of the users first, who will offer more gas prices as compared to other users.
The gas fee is a very major cost which might cost something around 10 dollars to 16 dollars for only a single NFT (non-fungible token) or fungible token or smart contract. The gas fee is unrelated to the price of the NFTs or any other assets. The price of one gas is equivalent to 70 to 200 gwei (gwei is the unit of measurement) and to purchase the NFT, the minimum gas limit is 21,000 gas. Thus, the total cost for purchasing an asset will be 4200000 gwei (21000 gas * 200 gwei). One gwei is equal to 10-9 Ethereum. Therefore, the total gas fees for purchasing the NFT will be 0.0042 Ethereum (4200000 * 10 -9), which is something around 14 to 17 dollars. The gas price increases as the gas limit to validate the contract increases.
There is no doubt that any payment made for the purchase before the sale of the coins or tokens to the other person would be considered as a “cost of acquisition”, but can the gas fee be included in the cost of acquisition? It should be but still, there is no clarity, and the legislature has not provided the proper framework to calculate the amount on which the tax has to be imposed. Similarly, doubt can be raised about the Account fees and listing fees.
The account fee is mainly charged by the NFTs’ marketplaces such as Open Sea and Binance etc. The listing fee is charged at the time of the listing of NFTs. Such fees are integral and if such fees are not incurred, the NFT would not be formed in the first place. It is difficult to hold that such costs would not form part of the cost of acquisition. The position will become clear as time will pass.
Taxability regarding lending/borrowing and pledging of VDA
The TDS will not be deducted on lending/borrowing and pledging of the VDA as per section 194S of the IT act. The lending/borrowing and pledging of the VDA cannot be considered a “Transfer “as the ownership or title of the VDA is not transferred to the borrower. The same has also been confirmed in CIRCULAR NO. 751, DATED 10-2-1997. As per the circular, the transaction of lending and borrowing cannot be considered as an ‘exchange’ of an asset.
The extract of the circular which discusses this issue – “The transaction of lending shares of some distinctive numbers and receiving back shares of some other numbers is not “exchange” of assets within the meaning of “transfer” as defined in section 2(47) of the Income-tax Act. The meaning of the word “exchange” necessarily involves exchange of two different assets. The asset received back in the aforesaid type of transaction is no different from what was lent so long as it represents the same fraction of the ownership of the company. At no stage, the lender or borrower intended to “exchange” different assets. Hence, the transaction of lending of shares or any other security under the securities lending scheme would not result in “transfer” for the purpose of invoking the provisions relating to capital gains under the Income-tax Act.”
The same ratio can be adopted in this case as well.
The meaning of exchange as per the Black’s Law Dictionary is – “the act of transferring interests, each in consideration for the other”. Hence, once the transaction is not “transfer”, the transaction will not come under the ambit of section 194S of the income tax act. Therefore, no TDS has to be deducted on lending/borrowing and pledging of the VDA.
This question becomes very important as the new virtual economy is getting created around the blockchain in the form of Decentralized apps (DAPPs), metaverse, Decentralized Autonomous Organizations (DAOs), etc. Various known liquidity pools such as Aave, Bancor and Uniswap, etc. provides facilitation service for lending and borrowing of crypto assets. The Government has to clarify this position otherwise it will cause huge hardship to Defi liquidity pools discussed above as it will hamper their basic activity of lending and borrowing.
Initial Coin Offering
Initial coin offering is the most fascinating concept in the world of crypto and the most misunderstood concept by the novice. Initial coin offering is just a glamorous name for “token sale” or “token offering”. In the Initial coin offering, the person has to pay the price for the purchase of the tokens, initially generated by the promoter of the project. It is very different from airdrop as discussed in the above para, as in airdrop, the recipient doesn’t incur any monetary cost apart from his/her time and energy.
The Initial coin offering is available to the public at large against the airdrop, where only a small group of people are enjoying the privilege. It is not like the Initial public offering in the case of the primary market for the company’s shares, where coins are sold like shares of the company. The token sale is mostly conducted by the promoters who are developing new projects or platforms, as most of the activities (buying and selling) on the platform will be carried out by using the tokens issued by the promoters. It is like going to a food stall, where the shop owner Exchanges your fiat currency with the food token and then you can exchange your food token for your favorite food. Let’s take a real-world example – brave browser. The browser provides BAT (Basic attention token) to the users when they open advertisements in the brave browser. The BAT can be used to purchase advertisement space on web pages. The BAT is like the unit of currency for undertaking any transaction in the brave browser. If you don’t need BAT, you can also convert it into Ethereum afterward. The token sale helps the promoters to establish their basic market (creating the demand and supply), indirectly financing their working capital needs. Nowadays, the tokens are generated on the Ethereum blockchain following the ERC-20 standard.
Applying for ICOs is not as easy as we might think. The whole transaction can be divided into two legs. On the first leg, we have to convert our fiat currency into the other cryptocurrency i.e., Ethereum or bitcoin and on the second leg, we are supposed to purchase the tokens from the coins purchased in the first leg. On the second leg, we can see that one virtual digital asset is exchanged for another virtual digital asset. Here, two parties are involved. One party is providing Ethereum and receiving tokens and another party is providing tokens and receiving Ethereum.
Section 194S is not very clear on how the TDS has to be deducted when one VDA is exchanged for another VDA. Circular no. 13/2022 provides that in a situation where one VDA is being exchanged with another VDA, both the persons are buyer as well as seller. Thus, both need to pay tax with respect to transfer of VDA and show the evidence to the other so that VDAs can then be exchanged. This would then be required to be reported in the TDS statement along with the challan number. This year Form No. 26Q has included provisions for reporting such transactions. For specified persons, Form No. 26QE has been introduced. Thus, TDS has to be deducted by both parties in the second leg.
But the circular has not made it clear how TDS would have to be deducted in the case where the project lies completely outside India. As per DTAA, there should be no TDS liability in such cases but it still needs further clarification & discussion and it might differ from country to country.
The same problem also arises in the NFTs, as to purchase the same, the Ethereum coins have to be transferred to the meta mask (meta mask is the special wallet for holding the NFTs) and then the Ethereum coins in the wallet are used to purchase the selected NFT. Here, also one VDA (Ethereum) is transferred to purchase another VDA (NFT). Various platforms from where one can purchase NFTs lies completely outside India.
To deal with such a problem, a very careful interpretation of sec 194S and DTAA is required, and the legislature will have to issue proper notifications and guidelines in this regard otherwise, the government might lose huge revenue concerning this. There is also no proper mechanism on how the non-residents will deduct TDS if the consideration is received from a resident for buying the VDA from them.
CONCLUSION
Taxing cryptocurrencies and other related financial instruments pose a huge challenge for the government. As this technology is very dynamic, it facilitates the formation of more sophisticated financial instruments, and dealing with it in the real world would be more challenging. The government has to choose the mid-way as they also know that the blockchain is the technology of tomorrow and if they prevent it, it might hamper the technological growth of the country. The government has to elaborate and will have to issue clarifications and notifications otherwise it would lead to confusion and suffering for the taxpayers.
Author Bio
I have sold NFTs in Assessment Year 2022-23 and received cryptocurrency. Now, I have used that cryptocurrency in Assessment Year 2023-24 for various expenses related to business like marketing, payment of tax, professional fees etc. What will be the tax impact?