Taxing virtual digital assets is hard 

Over the past few years, speculations were rife that cryptocurrencies will be banned in India. Investments in crypto have seen a huge surge. The Finance Bill 2022 that was tabled in the Parliament a few days ago did not make any official announcement about legalising it, however, it has promulgated a new taxation regime for the class of “virtual digital assets” (VDA) including cryptocurrencies and non-fungible tokens (NFTs).

The proposed taxation regime is similar to that of speculation income. The gains arising from the transfer of VDA are proposed to be taxed at the rate of 30 per cent, without any option of set-off of losses. Furthermore, no deductions would be allowed in computing the gains arising from such assets, other than the cost of acquisition.

The Finance Minister has also announced the launch of the digital currency based on blockchain technology by the Reserve Bank of India (RBI), which is a welcome step in the right direction as it would yield a cheaper and more efficient currency management system and also foster adoption of the digital ecosystem.

However, CBDC would see the light of the day, only after the passage of the crypto law in Parliament. Also, it would require amendments to the RBI Act, the Coinage Act, the FEMA, and the Information Technology Act since these laws were drafted with paper currency in mind.

Also read

Today, Cryptos are Legal, Unregulated and Taxable

Challenges and questions

The proposed section 115 BBH does not explain the connotations of the term “cost of acquisition” for a VDA. Necessarily, it means the cost at which the VDA was purchased by the investor. However, for a miner, the digital asset will be a self-generated asset having no cost of acquisition, whether expenses incurred in setting up the mining equipment and other incidental expenses should be construed as “cost of acquisition” – only time will tell.

In the absence of a specific definition of cost of acquisition, there would be more ambiguity than clarity for determining tax implications in the case of a transaction involving VDA. Besides, valuation of such assets for ascertaining income chargeable to tax in the hands of a recipient of a gift will also be challenging in view of the volatile nature of virtual assets and the absence of valuation guidelines.

Furthermore, the proposed tax and the liability to withhold taxes are sought to be invoked at an incidence of “transfer” of VDA. Under the Income Tax Act, the term “transfer” includes a sale, exchange or relinquishment of assets or the extinguishment of any rights therein.

The proposed provisions in respect of withholding of tax also explicitly envisage circumstances of barter or exchange where consideration is discharged either partly or wholly in kind. Therefore, the law suggests that withholding tax requirements will be applicable even in a situation where cryptos are used to purchase a commodity or when one crypto is traded for another.

In a typical scenario, the liability to withhold tax at source at one per cent while making payment of the consideration would be on the buyer of the VDA. However, where the buyer is a non-resident, how would the tax authorities trace and track the buyer for non-compliance.

The provisions of the proposed section 115 BBH also contain restrictions in respect of setting-off of losses from the transfer of a virtual digital asset. The wording of the provisions implies that the restriction of setting off of losses arising from the transfer of a VDA is only against income computed under any other provisions of the Income Tax Act.

Hence, set-off of losses arising from one class of VDA against gains from another class of VDA should be allowed in a particular financial year, however, clarity is awaited, since the Income Tax Authorities may contend that any loss from the transfer of a VDA will be a sunk cost and tax liability would be determined on every profit made on transfer of a VDA.

In a case where an employer or start-up pays a portion of the remuneration as VDA, whether the same shall be taxable as salaries? Hong Kong, for instance, provides that VDA’s received as employment income should be reported at their market value and subject to the same salaries tax treatment as regular remuneration. With the current legislation, such a salary in the form of VDA are most certainly to be treated as a perquisite under section 17 of the Act, however, clarity would certainly help.

Other nations’ stance

The governments across the world have taken differing views towards crypto assets. Some countries such as China have banned digital assets altogether. On the other hand, countries like El Salvador have embraced the new technology and declared it as their legal tender. Countries that are in favour of crypto assets are either incorporating amendments to their existing tax codes or enacting a standalone law for addressing questions pertaining to such assets.

For instance, in Singapore, the Payment Services Act of 2019 legalises crypto and sets provisions to prevent illegal activity. From an income tax standpoint, businesses engaged in buying and selling digital tokens are taxed on the profit derived from trading in digital token. Pertinently, no taxes are levied if gains accrue from disposal of digital tokens held as long-term investments. So, Singapore has given VDA the status of a capital asset, unlike India.

The US and Canada also construe cryptocurrency as a capital asset. Any income accruing from these assets is subjected to tax. The Canada Revenue Agency also has a system in place that tracks crypto investments and ensures accurate reporting of crypto investments and resulting tax liability. The UK levies capital gains tax or income tax on crypto gains depending upon the nature of the transactions. Likewise, the Australian government primarily considers crypto as an asset for capital gains tax purposes.

On the other hand, countries like Germany and Portugal have slightly relaxed taxation rules in place for cryptocurrencies. In Germany, cryptocurrency is deemed to be a private asset attracting an individual Income Tax rather than a Capital Gains Tax only if it is sold in the year it was bought.

In Portugal, crypto income is only taxable if it accrues from professional trading activity. Further, no tax is levied on the exchange of cryptocurrency for other currency which implies that buying or selling cryptocurrencies would not be subject to capital gain taxes or Value-Added Tax (VAT).

As discernible from past deliberations, India is likely to enact a standalone law to regularise digital assets by way of a “Crypto Bill”. Pertinently, no regulated entity will be able to deal with cryptocurrencies unless a Crypto Bill allows them to do so.

Back in 2021 when China banned cryptocurrencies, there was a shift of investors to countries like Singapore and the US resulting in huge losses of crypto mining revenues. As crypto may render itself as future of currencies across the globe, well-calibrated clarifications would help in precluding any adverse impact on trading and investments in VDA in the country.

The authors are Chairman and Director, respectively, of Nangia Andersen India, a law firm

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