In her 2022 Budget speech delivered on 1 February, Finance Minister Nirmala Sitharaman announced that virtual digital assets, including cryptocurrencies, will be covered by a taxation scheme. Though the scheme is new, the principles that it relies upon and the issues that are likely to arise from its implementation are fairly conventional.
The first principle at play is ensuring that no earnings from virtual digital assets (VDAs) escape the tax net. The new tax scheme attempts to do this by defining VDAs very broadly. The definition is agnostic in form as well as the technological underpinnings of VDAs. Illustratively, VDAs can be “any information, code, number, or token (that is not foreign or domestic fiat currency)” generated through “cryptography or other means and provide a digital representation of value”.
The definition of VDAs also includes assets that are transferred for no monetary consideration. Such transactions include gifts as well as peer-to-peer exchanges of VDA. Such a definition also attempts to extensively cover VDA functionality. It recognises that they can have inherent value, resemble money, and operate as commodities. VDAs that fall beyond the ambit of this expansive definition are also covered because the Narendra Modi government is empowered to notify any digital asset as a VDA.
This definition of VDAs also covers any token, including non-fungible tokens (NFTs). For the uninitiated, NFTs are non-interchangeable pieces of information on a blockchain. Furthermore, the government will now specify the NFTs that qualify as VDAs, which raises some ambiguity about the tax status of the income earned from their transfer. However, it may be the case that the Modi government will release more comprehensive provisions for different classes of NFTs in the coming months.
It’s disincentivising for some
The second principle is to use a high tax rate as a disincentive for individuals with low incomes from investing in VDAs. Income earned from these is taxable at 30 per cent – the same rate at which Short Term Capital Gains above Rs 10 lakhs are taxed.
Third, to deploy a tax-deductible-at-source (TDS) mechanism to understand the extent of activity in the VDA market. The Finance Bill 2022 introduces a Section 194S into the Income Tax Act, 1956, under which the person paying for the VDA must deduct income tax at the rate of 1 per cent from the transaction amount. The TDS is also applicable to transfers of VDAs where there is no cash component, such as a VDA to VDA exchange, or a peer-to-peer transfer. In such cases, the person must ensure that they have paid the tax for such a transaction.
The implementation of Section 194S will be riddled with complexity, particularly in scenarios where there is no fiat currency used for transactions. How will an assessee calculate the tax deductible if the prices for VDAs are not standardised? It is well established that VDA pricing varies from country to country and exchange to exchange. According to a report, on 24 November 2021, Bitcoin was priced at 33.5 lakhs on Wazirx and 41.94 lakhs on Binance. The differences in pricing are a function of several factors, including liquidity and transaction costs. Moreover, in such transfers, the person using non-cash means of consideration is responsible for paying the tax. Thus, in VDA to VDA exchanges, both parties have a tax liability.
The Finance Bill states that if any difficulties arise in the implementation of Section 194S, the Central Board of Direct Taxes (CBDT) will issue guidelines to ameliorate the situation. However, the Section’s complexity points to an intent to discourage unsophisticated investors from interacting with VDAs as well as peer-to-peer transactions and VDA swaps. An unintended consequence of the provision may be that an increasing number of people may resort to using anonymity-centric VDAs that are hard to trace.
Where the loopholes are
Fourth, to carve out exemptions to reduce the enforcement and implementation burden of the tax scheme. Two classes of persons are exempt from the TDS requirement for VDAs — those who pay a total of Rs 10,000 for VDAs in a financial year and a special class known as specified persons. The latter is an individual or a Hindu Undivided Family (HUF) whose total turnover/receipts from business does not exceed Rs one crore (or 50 lakh, in case they are professionals). This category also includes individuals/HUFs who do not have any profits or gains from their business or profession. Specified persons who pay a total of under Rs 50,000 for VDAs in a financial year will be exempt from the TDS requirement under Section 194-S.
Like all exemptions, the carve-outs under Section 194S create a loophole that is likely to be misused. For instance, a person may trade through several individuals who fit the description of specified persons, similar to how benami transactions are conducted in the case of immovable properties. Depending on how the situation evolves, the government may need to supplement this requirement with some provision for the identity of the ultimate beneficiary to check abuse.
Fifth, to make it clear to anyone investing in VDAs that they cannot be relied upon as a tax evasion instrument. Assessees cannot claim any deduction for expenditure, allowance, or set-off on income earned from VDAs other than the cost of acquisition. Moreover, losses incurred on VDA transfers cannot be used to diminish tax liability under other income slabs. Assesses will also not be allowed to carry forward such losses to succeeding assessment years.
The VDA tax scheme aims to ensure that all VDA transfers are taxable, create a mechanism to gather information on all such transactions in the country, discourage those in lower-income brackets from engaging with VDAs, and put up disincentives to VDA swaps and peer-to-peer transactions. While the 30 per cent income tax provision comes into effect on 1 April 2023, the one per cent TDS will be effective from 1 July 2022. The scheme is ambitious in both scope and design and is likely to face some hiccups during implementation.
Why tax when India is still debating legality?
On the tax scheme’s position about the legality of VDA transfers in India, the commentary is mixed. Those who say it does nothing to clarify the legality of VDAs cite the fact that proceeds from illegal activity are also taxable. However, even illegal activity is not recognised under the tax law. The Income Tax Act does not specify a tax rate for smuggling or extortion, though income earned from these activities is taxable.
Conversely, the Finance Bill creates a specific tax rate for VDAs, which indicates that the government may allow this activity in the long run. This position is also somewhat affirmed by a recent statement made by the Principal Economic Advisor, Sanjeev Sanyal, who suggested that the government was looking to take a balanced view on cryptocurrencies. The extent of what will be permitted and what will not shall be introduced in legislation specific to cryptocurrencies. On the linkage between privately-issued cryptocurrencies and Central Bank Digital Currencies — these are distinct constructs and commentators would do well to refrain from conflating them.
Meghna Bal is a Fellow at the Esya Centre and a consultant for Koan Advisory, a technology policy consulting firm. Views are personal.
This article is part of ThePrint-Koan Advisory series that analyses emerging policies, laws and regulations in India’s technology sector. Read all the articles here.
(Edited by Humra Laeeq)