The government’s decision to tax cryptos and other virtual digital assets and lay down ground rules for the purpose in the latest Budget, is welcome on many counts. Despite repeated warnings by the Reserve Bank of India that cryptocurrencies are not recognised legal tender, Indian investors seem to be punting on these volatile and unregulated assets in large numbers. By the ecosystem’s own admission, over 10 crore Indians already owned crypto-assets by 2021, hinting at a penetration level comparable to shares (India has about seven crore demat account holders) and mutual funds (about 12 crore folios). Two, in the absence of any specific mention about crypto-currencies or other virtual assets in tax provisions, many investors have either evaded tax on their gains by not disclosing them or have opted for arbitrary classification under different heads of income. If this tax arbitrage is allowed to continue, it could lead to a flight of domestic capital from productive mainstream assets such as deposits, bonds or equities into these opaque and essentially unproductive instruments. Three, given that crypto transactions are essentially routed through unregulated local exchanges or overseas platforms, tax and central bank authorities have struggled to collect information on them in order to detect FEMA and LRS violations. The introduction of a specific provision in the Income Tax Act defining ‘virtual digital assets’ and imposing a flat 30 per cent tax rate on their transfer, and a 1 per cent TDS obligation, removes ambiguity about the tax treatment of virtual assets and establishes a money trail for the authorities to follow.

Some sections of the cryptocurrency ecosystem have cheered this announcement as the government ‘recognising’ cryptocurrencies and lending them legitimacy but this is a faulty interpretation. Any income even from illegal means is subject to tax, under Indian tax law. Besides, there are multiple aspects to the new tax provisions that signal that the authorities want to discourage punting on virtual assets. Apart from the tax and the TDS , all expenses on such assets except cost of acquisition have been disallowed, along with losses. Even crypto gifts will be taxed in the hands of the recipient.

However, clarifying the tax treatment can only be a first step in the government’s attempt to establish oversight over this unregulated ecosystem. Many cryptocurrency transactions take place on a peer-to-peer basis or on overseas platforms, and painstaking work may be required by the tax department to identify counter-parties and establish jurisdiction over such trades. It is also imperative that the Centre brings in legislation to clarify its position on the legality and regulatory status of cryptocurrencies and other virtual assets, before more investors start speculating on them.

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