NFT regulations in India

    By Sujata Chaudhri, Urfee Roomi and Rishikaa, Sujata Chaudhri IP Attorneys
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    Non-fungible tokens (NFTs) have been a hot topic of discussion worldwide for the past couple of years, and India has recently joined this bandwagon. Earlier this year, some of India’s biggest cryptocurrency exchanges launched their own NFT marketplaces that run on blockchains created by these exchanges. These NFT marketplaces have been created to bridge the gap between artists and buyers by providing end-to-end platforms, primarily for facilitating trade, using cryptocurrency as a medium of exchange.

    Sujata Chaudhri, Sujata Chaudhri IP Attorneys
    Sujata Chaudhri
    Founder and Managing Partner of Sujata Chaudhri IP Attorneys in Noida
    Tel: +91 88 6013 0723
    Email: sujata@sc-ip.in

    There is a lot of scepticism around the future of NFTs in India, and the validity of NFT transactions. One of the reasons is the question of the legality of cryptocurrency in the country, which remains unanswered. In 2018, the central bank, the Reserve Bank of India (RBI), had issued a circular asking banks not to deal with or provide any services to entities dealing with virtual currencies.

    However, in 2020, the Supreme Court of India struck down the 2018 circular. In early 2021, the finance minister stated that the government was not closing its options and would give room to stakeholders for experimenting with blockchains, bitcoins and cryptocurrencies. In May, the RBI issued another circular that directed all banks to carry out due diligence for transactions in virtual currencies, in line with the existing regulations pertaining to anti-money laundering, foreign exchange and combating of financing of terrorism. However, stakeholders are still waiting for more guidance on the scope and extent of legality of cryptocurrencies and crypto assets from the government, as well as other regulatory authorities.

    At this time, India does not have any law or regulation to govern NFTs. Accordingly, as far as NFTs are concerned, we must rely on the established principles of law as laid down in statute books in the country.

    Urfee Roomi, Sujata Chaudhri IP Attorneys
    Urfee Roomi
    Principal Associate at Sujata Chaudhri IP Attorneys in Noida
    Tel: +91 98 1809 8835
    Email: urfee@sc-ip.in

    It is settled that NFTs can represent various things, however their worldwide popularity, including in India, is attributed to their representation of a digital art form. Therefore, in its most popular form, an NFT is a digital copy or token of an underlying original work. Having said this, owning an NFT does not confer ownership of the underlying work that the NFT represents.

    It follows that the difference between buying an original artwork and buying an NFT is that the copyright in the original underlying work does not get automatically transfer to a purchaser of an NFT. While it is possible for a copyright holder to transfer ownership rights to the purchaser of the NFT at the time of sale, the provisions of the Copyright Act, 1957, require the contract for sale to provide for such assignment of rights explicitly, in writing.

    Once the rights are assigned in compliance with the provisions of the Copyright Act, an NFT holder would be treated as the owner of the copyrighted work. Accordingly, the rights of the parties to an NFT sale, and the extent of such rights, are determined by the governing sales contract.

    Rishikaa, Sujata Chaudhri IP Attorneys
    Rishikaa
    Associate at Sujata Chaudhri IP Attorneys in Noida
    Tel: +91 99 5881 5862
    Email: rishikaa@sc-ip.in

    Most NFT-related transactions take place through smart contracts, which may stipulate the terms of a licence, provide automatic royalties in case of resale transactions, set limits to the use of copyrights, and track subsequent purchases of an NFT. A smart contract is governed by the Contract Act, 1872, and the Information Technology Act, 2000.

    Under the Contract Act, an offer, acceptance and consideration are the cornerstones of a valid contract. While a smart contract has the offer and acceptance components of a valid contract, the consideration component may be an issue. Usually, in a smart contract governing an NFT transaction, consideration would be in cryptocurrency. However, as explained above, the legality of cryptocurrencies in India continues to be cloudy, leading one to question the validity of a smart contract and the underlying transaction.

    Given the RBI circular, which requires compliance with laws relating to foreign exchange and money laundering in all virtual currency transactions, it would not be far-fetched to state that NFT transactions would also be subject to these laws. In the absence of a legal framework, Indian legal scholars are divided on the classification of NFTs required for such compliance. This classification is key in understanding the legal implications with respect to these NFTs, and their effects on the assets they represent.

    If an NFT represents an asset that is considered a security under Indian securities laws, then it may be subject to these securities laws. According to some legal experts, NFTs are essentially derivatives under the Securities Contract (Regulation) Act, 1956 (SCRA). As per the SCRA, derivates include “a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; a contract which derives its value from the prices, or index of prices, of underlying securities.”

    Furthermore, a contract in derivatives would be valid and legal only if derivatives are traded on an authorised stock exchange in accordance with the laws of that exchange. Consequently, if NFTs are classified as derivatives, then any contract in such derivatives would be illegal because the marketplaces on which they are traded are not authorised by law.

    However, the way the current marketplaces have been set up may not require such authorisation. This is because these marketplaces have been fashioned less like exchanges and more like platforms, where a buyer purchases an NFT from the seller without any intervention from or payment to these platforms other than a nominal sales commission or gas fee (an amount paid by users towards computing energy that is required to validate NFT transactions on blockchains).

    Similarly, the popular view is that the treatment of NFTs under India’s taxation regime would depend on the nature or classification of the underlying asset. An NFT would be subject to a goods and services tax (GST), and the definition of goods under the Central Goods and Services Tax Act, 2017 includes moveable property other than money and securities, and services include anything other than goods. It is highly likely that the GST would be imposed, based on what the NFT represents.

    However, there may be additional complications in cases of cross-border NFT transactions. The Finance Act, 2020 contains provisions regarding an equalisation levy (EL), which charges a 2% fee on corporations based out of India but having operations within the country. If a marketplace is considered as an e-commerce operator under the Finance Act, then the2% EL may apply on the gross value of the NFT, or the gas fee charged by these marketplaces, or both.

    In addition, cross-border NFT transactions will also invoke provisions of the Foreign Exchange Management Act, 1999 (FEMA). Again, the treatment of an NFT under the FEMA would depend on the nature of the underlying asset. However, the situation is not as simple as it sounds, since it is almost impossible to determine the location of an NFT. This may lead NFT holders and marketplaces to avoid FEMA regulations altogether.

    The emergence of NFTs has also led to concerns regarding money laundering. NFTs are based on blockchains that provide a perfect opportunity for maintaining anonymity and privacy for parties to the transactions. Although it may be possible to trace these parties by contacting the marketplace or crypto wallet and identifying the IP address, the overall process would be slow and tedious, providing enough opportunities for such parties to evade the law, or hide from regulatory authorities.

    As is evident, there are a lot of concerns surrounding NFTs, particularly for a nation that is still struggling with the cryptocurrency conundrum. However, what started as a fad is now gaining ground in the country. One of the major reasons attributed to the rapid acceptance of NFTs is the sheer number of traditional and digital artists in India, and the benefits they can reap from NFTs.

    While speculation persists around NFTs and virtual assets, the Indian government has proposed a new law for regulating cryptocurrencies. Stakeholders and experts anticipate that this legislation will also play a role in clearing the air surrounding NFTs in India.

    New regulations are definitely the need of the hour, because current laws can only provide quick fixes to issues, whereas new regulations are capable of providing long-term solutions pertaining to this new facet of technology. Although the future of NFTs in India remains unknown, it is fairly certain that they are here to stay.

    Sujata Chaudhri IP Attorneys

    Sujata Chaudhri IP Attorneys

    1/F B-36, Sector 132
    Expressway, Noida – 201301
    India
    Tel: +91 88 6013 0723
    Email: info@sc-ip.in
    www.sc-ip.in

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