Taxing virtual digital assets: towards a progressive era

Introduction of a new tax regime for virtual digital assets alongside the launch of a virtual Rupee backed by the RBI in the Union Budget has flummoxed people. There has been uncertainty with the ban the on use of cryptocurrencies by the RBI, followed by Supreme Court lifting such ban and pending regulation on their use case by the legislature. Hitherto, there was no guidance on taxation of gains derived from transactions in cryptocurrency, due to which such income would largely go undisclosed and outside the tax net. Meanwhile the market capitalization of cryptocurrency transactions has been growing exponentially and is expected to cross $240 million in India by 2030. And, while the final verdict on the regulation of cryptocurrency is still not out, Union Budget, 2022 clarifies that nonetheless taxes must be paid.

Notably, the tax regime for virtual digital assets is not limited to cryptocurrency. Virtual digital assets are defined widely to mean any information or code or number or token (not being Indian currency or any foreign currency), generated through cryptographic means or otherwise, and include non-fungible tokens notified by the Government. Therefore, the new tax regime is likely to have broader ramifications than just cryptocurrency. 

Unexpectedly, the government has chosen not to extend capital gains tax treatment to virtual digital assets ending debates around characterization issues. Gains from transfer of virtual digital assets will be taxed at a flat rate of 30 per cent (plus applicable surcharge and cess) in the hands of the transferor. No deductions other than the cost of acquisition of such virtual digital asset will be allowed. Losses from transactions in virtual digital assets cannot be set off against any other income nor can they be carried forward for future set-off. Separately, the gift of virtual digital assets will be taxable in the hands of the recipient as ordinary income.

Additionally, a new tax withholding provision has also been proposed, which requires any person making payment for a virtual digital asset (either in cash or kind) to an Indian resident to withhold tax at 1 per cent. The underlying policy intent for such withholding tax provision is to track transactions in virtual digital assets. Such withholding tax provisions should apply in transactions of cryptocurrency against cash, cryptocurrency to cryptocurrency transactions and purchase of goods and services against cryptocurrency. Certain exemptions have been provided for low value transactions and for individuals and HUFs. 

While the Government has taken a conservative policy stance on taxation of virtual digital assets (in comparison to other countries), it is a step in the right direction in that it looks to accord tax certainty. There remain some open issues around valuation of cryptocurrency, taxation of miners, interface of equalization levy, and implementation of withholding tax provisions in barter transactions. Such issues are likely to be addressed by the Government in due course as the tax regime is fleshed out in the future. 

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The Digital Rupee Needs More Thought, Less Haste

Gouri Puri is Partner and Suyash Sinha, Principal Associate at Shardul Amarchand Mangaldas & Co 

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