• Rav P. Singh


Updated: Feb 27

India’s Finance Minister in the Budget Speech of 2022 announced her intent to tax cryptocurrency gains. While a novelty in India, various countries such as US and UK have already subjected cryptocurrency to tax by equating it to property and gains from it as capital gains. India has adopted a somewhat similar approach but with greater restrictions for taxpayers. In part one of this two-part article, I elaborate on the direct tax implications of transactions involving cryptocurrency. In part two, I will focus on indirect tax – more specifically GST – implications.

Virtual Digital Asset

Finance Bill, 2022 proposes to include definition of ‘virtual digital asset’ in Income Tax Act, 1961. It, inter alia, defines virtual digital asset as:

(a) any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;

(b) a non-fungible token or any other token of similar nature, by whatever name called;

(c) any other digital asset, as the Central Government may, by notification in the Official Gazette specify:

Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein. (emphasis added)

As is evident, the definition includes within its scope cryptocurrency and non-fungible tokens but specifically excludes Indian currency or foreign currency. The Revenue Department has chosen not to define cryptocurrency as a foreign currency but as a distinct form of asset, a common practice in various jurisdictions which levy tax on cryptocurrency gains. The concerning part is the open-ended nature of the definition which empowers the Central Government to notify any NFT or digital asset to include or exclude it from the definition of virtual digital asset thereby rendering the definition open-ended. This is not the ideal approach to draft a tax statute which demands more precise drafting.

The tax treatment of cryptocurrency gains is analogous to tax treatment of winnings from gambling under Sec 115BB, IT Act, 1961. The gains from both sources will now be taxed at a flat rate of 30%, and the restrictions on taxpayers with source of income from both these sources are equally constricting. As far as cryptocurrency gains are concerned, some of the restrictions are:

First, tax slab of the assessee is inconsequential for determining tax rate on virtual digital assets. Though for income from other sources the tax slabs will be relevant.

Second, it appears that the classification of long term and short-term capital gains is not applicable to virtual digital assets, though the Rules may clarify this further; the tax rate is same irrespective of the duration of investment.

Further, no deductions will be available against cryptocurrency gains, losses cannot be set off or nor can loss be carried forward to any subsequent years. The only deduction available is cost of acquisition. This is unlike any other capital gains where certain expenses and cost of transaction are allowed to be deducted from the gains.

Question of Legality

While some taxpayers were flummoxed that cryptocurrency gains are being subject to tax without conferring legality on cryptocurrency per se, it is important to view issues of legality and taxability in the context of IT Act, 1961.

First, it is important to disabuse oneself of the notion that taxation of an income or transaction confers legality on it. IT Act, 1961 only levies tax on gains or income of an assessee, it has no bearing on the legality or illegality of a transaction.

Second, IT Act, 1961 is blind as to the source of income. Income, legal or illegal, is subject to income tax and law on this point has been elaborated in various judgments. In fact, the disallowance of deductions and expenses makes cryptocurrency gains not only comparable to gambling winnings but also income from illegal sources.

Finally, any attempts to read into the Union of India's 'crypto tax' proposal an intent to bestow legality on cryptocurrencies per se is inaccurate. In fact, the disallowance of any deductions and a 30% tax rate irrespective of your income slab suggests that the Union is not inclined to encourage transactions in cryptocurrency, but only wishes to tax the cryptocurrency gains at high rates to discourage investment and speculation.

While a law regulating and legalizing cryptocurrency may still be passed by the Parliament, it is vital to disentangle taxability from legality. Latter does not have a bearing on the former under IT Act, 1961.

Loose Ends

First, while the proposed provisions of Finance Bill, 2022 would be applicable only from 1 April 2022 it is uncertain at what rates should taxes be paid for gains realized before the end of this current financial year, i.e., 31 March 2022. Prudence suggests that current tax rates for capital gains tax and/or business income will be applicable but CBDT could clear this issue by way of abundant caution.

Second, the proposed changes in the Finance Bill, 2022 largely addressed tax anxieties of investors and traders. There is little to take home for the cryptocurrency community which may develop new virtual digital assets, mine these assets, trade in these assets or otherwise receive them through airdrops, because of hard forks, or otherwise. Tax consequences of aforementioned transactions are uncertain.

Thirdly, while IT Act, 1961 will be suitably amended via Finance Act, 2022 to ensure that gifts of cryptocurrency are taxable in the hands of recipients it is unclear if this would also apply to employer-employee relations and more pertinently how the fair market value would be determined. Finally, another related issue is how would value of cryptocurrencies typically traded in foreign currencies be determined?

It is likely that a some of these and additional issues will be clarified through Rules; but these issues are certainly indeterminate after a bare perusal of the provisions of Finance Bill, 2022. Numerous direct tax issues surrounding cryptocurrency gains require greater clarity. Hopefully the Rules will bring the much needed clarity.

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