India’s Crypto Conundrum: Of Regulation, Taxation And Ban

As the decentralised financial system of cryptocurrency and digital currency finds swathes of enthusiastic takers across the globe, the Indian government seems to be on the fence about the rising online phenomenon.

In its first term, the BJP-led central government had formed a high-level inter-ministerial committee in November 2017 and its purpose was to study virtual currencies, the problems related to the sector and suggest ways to deal with it. The committee, which submitted its report in February 2019, had recommended policymakers to keep an open mind about introducing an official digital currency, observing its advantages.

Also Read: India Has A Crypto Dilemma

Three years later, Finance Minister Nirmala Sitharaman, in her Union Budget speech for 2022-23, announced that the government would be launching one soon. She also announced a 30% tax on income from cryptocurrencies.

Why taxation? As per the government, the gains from trading used to be taxed under different heads for different categories of people earlier. Some paid long-term capital gains tax while the others paid windfall gain tax or it was considered business income, depending on the nature of gain. A 30% tax clears that ambiguity and would be levied uniformly.

To that, Rohinton Sidhwa, partner, Deloitte India, raises a pertinent question—what happens to profits of the past years? “The gains from crypto have always been income and were taxable. In the absence of specific provisions, it was left to the taxpayers to decide under which head of income and at what rate the tax was to be paid. Even though these provisions are not retrospective, taxpayers may seek to apply them retroactively to pay tax for the past years in case they have not already done so,” says Sidhwa. The tax would be applicable to all Indian taxpayers even if the income arises from a cross border transaction, he adds.

During the Budget Session in Parliament, Sitharaman had said that the government had the sovereign right to tax the profits generated from cryptocurrency transactions and that a decision on the ban would be taken after adequate consultations. By doing so, she effectively ruled out the tabling of the long-pending crypto bill in the session.

While the government seems to have made a decision regarding taxation, it is still struggling to formulate a policy for the sector. Since the time the government started studying the sector seriously, there have been reports of its plans of banning cryptocurrencies.

The sector saw quick popularity in the country, especially among the young, because of high returns owing to the volatile nature of its trade. As more and more people got interested, several exchanges dealing with crypto trading have sprung up across India in the last few years.

The cynicism about the sector, however, is not limited to the government. Former Reserve Bank of India (RBI) chief Raghuram Rajan has been vocal about his reservations, stating that most cryptocurrencies lack permanent value and that only one or two out of the many would ultimately survive.

The government’s delay in formulating a policy also mirrors this skepticism. In a post-budget interaction with Outlook Business, expenditure secretary TV Somanathan had said, “Should cryptocurrency be banned, regulated, remain unregulated or not be banned—all possibilities are open. It can be banned, it can be regulated or it can be left neither regulated nor banned but taxed. That is a separate discussion and [its outcome is] yet to be decided.”

The industry has been looking forward to the bill in order to get some clarity on how the government looks to treat crypto in India as there is still no clarity on the same. “There has been much discussion around the crypto use cases that will be permitted. The government has, on several occasions, indicated that it is not headed towards a complete ban, but that crypto will be permitted to be traded as an asset. Crypto will be treated like an asset similar to a security or a commodity,” says Shilpa Mankar Ahluwalia, partner and head, fintech, Shardul Amarchand Mangaldas & Co.

The policy dilemma is also stemming from the discrepancy between the government’s own stand on crypto and that of the RBI’s. While the RBI has consistently batted for a complete ban, the government has always maintained that it was keen on regulating the sector instead of an outright ban.

In December last year, it was reported that the RBI had told its central board that it favoured a complete ban on the trading of cryptocurrencies. After its Monetary Policy Meeting in February this year, RBI governor Shaktikanta Das cautioned investors against putting money in crypto trading. “Private cryptocurrencies, or whatever name you call it, are a threat to our macroeconomic stability and financial stability. They will undermine the RBI's ability to deal with issues of financial stability and macroeconomic stability," Das had stated, while cautioning investors by saying that such assets do not have any underlying, “not even a tulip"—referring to a 17th century Dutch tulip price bubble.

The government does hold the power to enforce a complete ban on private crypto trading. However, until it comes up with the crypto bill that would outline the final crypto regulation, its position on the sector’s legality is uncertain.

“It seems more likely that the legal framework will seek to regulate the crypto economy, tax gains on crypto trading (which has already been announced) and the ecosystem via licensed intermediaries. The challenge will be to ban certain use cases (crypto as a medium of exchange) while allowing others (crypto as an asset), given that technology may potentially blur the lines between the two,” says Mankar Ahluwalia.

In November last year, Prime Minister Narendra Modi held a meeting with the sector’s stakeholders to discuss its future. The industry wants cryptocurrency to be treated like an asset—just like gold. “We are still not sure about how to call something that has no underlying value an ‘asset’. That is primarily why regulation is taking so long. This sector is completely new to us and it will take us more time to understand it,” said a senior government official, on condition of anonymity.

“What is it? Is it a commodity? Is it a stock? Is it a currency? We still don’t know how to define it. And the failure to define it means that one can’t point to who the regulator would be in such a case,” the official adds.

According to the official, the sector is volatile which makes it open to high gains and even higher falls. It is also heavily dependent on technology. In such a scenario, it becomes difficult to assign responsibility.

Data security and protection become key to creating a safe crypto ecosystem given that it is a digital asset. Not only are all transactions concluded digitally, even the underlying ownership and the title is evidenced via a digital private key. The legislation is expected to highlight a baseline data security architecture that would have to be complied with by intermediaries in the crypto economy.

The legislation is also expected to include a framework for licensing of intermediaries such as crypto exchanges and wallet providers that operate in the crypto economy. But it is not clear yet as to which intermediaries will need to obtain a license.

“The regulatory framework will also include requirements in respect of the KYC onboarding procedures and reporting of transactions by licensed intermediaries,” says Mankar Ahluwalia.

As the crypto economy has no geographical borders, a coordinated global approach to crypto regulation is critical to developing an effective regulatory framework. That said, the international community itself has not yet agreed upon a uniform approach to regulating cryptocurrency. While some countries have banned crypto trading entirely, some have accepted certain cryptocurrencies as legal tender. Many large economies are still mulling a legal framework.

“India is one of the first large economies to announce the roll-out of a central bank digital currency (CBDC) by 2023. While a CBDC is legal tender and, in that sense, will operate in a completely different space from private cryptocurrency, the framework for India’s CBDC is likely to become a benchmark for many other jurisdictions,” says Mankar Ahluwalia.

Today, policymakers are faced with a two-pronged challenge—how to define cryptocurrency and who should regulate the sector. The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, was listed for introduction in the Lok Sabha in the last winter session. It was also listed for last year’s Budget Session. Since the government decided that it wanted to rework it, it wasn’t tabled.

With another Budget session down, India still awaits a crypto bill and with that, clarity.