Tax Collector’s Crypto Conundrum

From the announcement of the Reserve Bank of India’s (RBI) central bank digital currency to the proposal of taxing income from the sale of virtual digital assets at 30% and tax deduction at source (TDS) at 1%, the Centre made it clear in the Union Budget 2022 that it is set to heavily focus on digitisation in the finance space. While the cryptocurrency industry in India has construed these moves as major steps towards regulatory recognition of cryptocurrencies in India, the government has been quick to clarify that taxation and legality are two different realms.

When it comes to regulation of cryptocurrencies, India’s approach finds its bearings in a 2013 RBI press release that had cautioned users, holders and traders of virtual currencies about the potential financial, operational, legal, customer protection and security-related risks that they were exposing themselves to. Next, in April 2018, an RBI circular said that the entities regulated by the RBI should not deal in virtual currencies or provide services to facilitate any person or entity in dealing with or settling virtual currencies. The circular, however, was set aside by the Supreme Court in its judgment in the Internet and Mobile Association of India vs RBI case in 2020. In 2021, the Cryptocurrency and Regulation of Official Digital Currency Bill was to be tabled in Parliament during the winter session but did not see the light of day.

In the meanwhile, cryptocurrency exchanges in India have only soared higher over the last one year. Various industry estimates and cryptocurrency exchanges reckon that about 20 million people in the country dabbled in cryptocurrencies in 2021, pegging the total value of crypto assets held by Indians at around $5.3 billion. Add to this the hectic activity being witnessed in the non-fungible tokens market following endorsements by celebrities and big brands, and we have a thriving industry.

Against this backdrop, finance minister Nirmala Sitharaman, in her budget speech, proposed to tax any income from the transfer of virtual digital assets at a flat rate of 30% topped up with a surcharge, if applicable, and education cess. There is neither any deduction allowed other than the cost of acquisition nor any set-off permitted against other income. Further, a 1% tax deduction at source is mandated in case the transferor is a resident of India, subject to a few exceptions. The presumption here is that the tax deduction at source on payments to non-residents will continue in the normal course.

While the virtual digital assets would include any information, code or token generated through cryptographic means (or otherwise) providing a digital representation, the proposal allows the government to notify exclusion of any digital asset from the ambit of the definition of virtual digital assets.

Given these announcements, questions surrounding cryptocurrencies and non-fungible tokens have now increased manifold from a tax and regulatory perspective. For instance, let us say an Indian resident ends up buying a non-fungible token and decides to sell it for a consideration at an international non-fungible token exchange. The seller is now looking to repatriate the gains to their bank account in India.

In this scenario, how does one define gain? Apart from the delta price of the sale consideration and the purchase price, how would the exchange rate(s) play a part in determining income? Even if that is somehow sorted, it raises doubts about how one would substantiate to the tax authorities that the said proceeds have been from the sale in question as the identity of the buyer and seller could be anonymous in international exchanges.

Further, it also leaves a question mark dangling over how the gains will be repatriated to an Indian bank and ascertained whether they are in compliance with the requirements of the regulatory regime in the country. Also, would they be considered as goods or services when it comes to indirect tax?

There is also the possibility of an intellectual property rights quicksand being created if the owners of the physical asset on which the non-fungible token was minted claims that the income realised from the trade has violated their intellectual property rights. What would happen in that case?

Taxation of cryptocurrency will open up a whole new Pandora’s box. In terms of any cryptocurrency sale or gifting, how will the asset be valued? What if the consideration is in kind or is insufficient? Does one assess the base value for tax deduction at source? In case of a non-resident, how will a tax event be triggered? How does one identify the situs of such assets? Is intra-head set-off feasible and are any deductions available under Chapter VI-A of the Income Tax Act? The list of questions does not end here.

For now, more guidance is required on the mechanism of tax deduction at source, categorisation for taxation purposes, a comprehensive view on what will be considered as virtual digital assets, transitional provisions between the previous positions adopted by taxpayers and the new regime, a method to determine the location of seller/service provider and buyer/service receiver, among other aspects.

There needs to be a focused and consolidated dialogue between the government and the industry on these matters to ensure that there is clarity and a structured approach is devised to deal with cryptocurrencies, non-fungible tokens and the like. If history is any indicator, similar instruments based on this underlying technology will emerge in the future. It is, therefore, extremely important that all virtual digital assets are subjected to proper regulation with adequate safeguards for retail investors and that exchanges operate within the framework of law.

(The authors are partners in Deloitte India)