Lack of clarity over future legitimacy and plans to levy hefty taxes threaten to clip the wings of jittery cryptocurrency investors. Freny Patel reports
Among many things, the ongoing Russia-Ukraine war has put the spotlight on cryptocurrency. It is gaining global acceptance based on the sheer volume of donations flooding into war-torn Ukraine in the form of cryptocurrency, largely to finance military support. The virtual digital asset class is no longer seen as a shady “black-market” transaction owing to reliance upon it in this geopolitical and humanitarian crisis.
Despite concerns raised by a few central banks that cryptocurrency could be used by Russia to evade economic sanctions imposed by the US and the EU, many crypto exchanges across the world have strictly adhered to the economic sanctions and blocked many Russian accounts. This to an extent dismisses the industry perception that cryptocurrency is “politically neutral”.
Back at home, the Indian government is mulling over whether cryptocurrency needs to be regulated, but this is for different reasons, none of which have anything to do with the ongoing conflict in Eastern Europe. After all, India has abstained from voting against Russia in the UN.
There has been a lot of speculation on whether the Cryptocurrency and Regulation of Official Digital Currency Bill would ban cryptocurrency. And if the government chose not to impose a ban, then the next question was how cryptocurrency would be defined. Given the apprehensions publicly voiced by the Reserve Bank of India, cryptocurrency is unlikely to be considered a currency or a financial asset. At best, it may be defined as an electronic code with no intrinsic value, according to the central bank general manager, Anuj Ranjan.
Since 2013, the central bank’s stance has remained unchanged, having issued several advisories to banks urging caution, questioning the financial stability of cryptocurrency, and warning that the volatility of the assets could see investors making huge losses.
Subhash Chandra Garg, a former secretary of the Department of Economic Affairs within the Ministry of Finance, does not expect the government to pass any cryptocurrency bill. “It is simple as well as complex,” he tells India Business Law Journal.
Simple because the digital currency part of the bill has been dealt with separately with the amendment of the Reserve Bank of India Act that empowers the central bank to regulate everything in relation to digital currencies.
Complex because for the remaining crypto businesses and crypto assets, the government does not seem to have any clarity on what to do, Garg explains. This from the man who headed the inter-ministerial committee constituted in 2017 to study issues related to virtual currencies to propose an action plan. Nakul Batra, an associate partner at DSK Legal in New Delhi, anticipates the crypto bill would not make dealing in virtual digital assets illegal, but “stricter laws to ensure traceability, transparency and disclosures are very likely”.
“The government cannot afford to ignore the country’s exposure to cryptocurrency, which has increased significantly since March 2020, after the lockdown,” says Batra. India ranked second globally, behind Vietnam and ahead of Pakistan, in terms of adoption of cryptocurrency in 2021, according to the Chainalysis’ Global Crypto Adoption Index 2021. In 2020 India ranked 11th globally.
Finance Minister Nirmala Sitharaman had previously told the media that a decision on the cryptocurrency bill would be taken after consultation with stakeholders. But while the fate of the bill hangs in abeyance, the minister unexpectedly announced a tax on virtual digital assets in her budget address on 1 February.
Come 1 April, India will join several of its global peers to impose a tax on income from cryptocurrencies and other virtual digital assets.
At first sight, the imposition of the tax was heralded as validating cryptocurrency. And although the levy of 30% on income generated and a 1% tax deducted at source are on the higher side, at least the finance ministry had provided the much-needed guidance on the tax treatment of cryptocurrency.
The government has set out specific tax rules for cryptocurrency and given tax certainty, which it need not have done in the case of an unlawful business, says Gouri Puri, a partner with the tax practice group at Shardul Amarchand Mangaldas & Co (SAM) in New Delhi. This leads to “an inference that in due course it intends to allow and regulate crypto,” she notes.
Investors rushed to crypto exchanges following the budget announcement, says Vikram Sobti, a partner at Chandhiok & Mahajan in New Delhi, adding, “whether that’s to settle their accounts before the financial year 2022-23 kicks-in, only time will tell”. The finance minister’s statement made it clear that it was the intent of the government to tax gains from crypto assets, which were thus far treated under different accounting categories such as business income or capital gains.
Although the initial reading of the Finance Bill 2022 gives Indian investors and crypto exchanges hope that the government has legitimised the asset class, and that there is a future in cryptocurrency, the finance minister shot down industry aspirations, clarifying that the tax levy should not be misconstrued that India has legalised cryptocurrencies.
“Many Indians have seen a future in crypto, therefore I see a possibility of revenue in it,” Sitharaman recently said at the India Global Forum in Bengaluru.
Tax provisions do have a tendency of creating an air of acceptance and legitimacy, but there is no direct nexus between tax paid and the legitimacy of cryptocurrency, says Garg. Tax is also payable on incomes earned on illegitimate business, he points out, adding that the imposition of tax does not debar the government from banning all or some use of crypto-currencies/assets.
Section 115BB of the Income Tax Act, 1961, provides for tax on income accrued from gambling or betting of any form or nature whatsoever. Merely taxing an instrument does not hint towards its legality, says Sobti.
When the Supreme Court lifted the ban on cryptocurrency trading in March 2020, investors and crypto exchanges had pinned hopes on the government adopting a more flexible approach.
While the Reserve Bank of India and other government agencies battle it out on whether to legalise cryptocurrency, taxing income even from illegal transactions or assets is fairly low hanging fruit, says Meyyappan Nagappan, leader of the international tax practice at Nishith Desai Associates in Mumbai. “No government agency would object to such a transaction being taxed, and some regulators may even see the entire industry being taxed out of existence as a positive outcome,” he tells India Business Law Journal.
Although the crypto tax is seen as a step forward towards providing much-needed clarity when it comes to taxation, many issues remain unaddressed. The 1% tax deducted at source is going to be destructive if it is passed without a rate reduction, says Nagappan. Advocating that the 1% tax rate should be rationalised, he suggests that it should be reduced in the range of .0125% to 0.05%, similar to the securities transaction tax. “Otherwise, it is an industry killer,” he points out.
The mandate of 1% tax deducted at source before the payment is made on the purchase of virtual digital assets from resident sellers will introduce a massive compliance burden and might not be practical to administer, adds Garg. “It may not kill the crypto-assets market, but would certainly diminish the enthusiasm for holding crypto assets, especially in the current global environment of shrinking liquidity and risk-off,” he adds.
The 30% tax rate without deductions or set-off or carry forward of losses is equally steep, most lawyers believe. Business profits are currently taxed at 25% to 30% after setting off all expenses and carrying forward losses. Long-term capital gain is taxed at 20%. “It’s a prohibitive regime, and we are hearing anecdotal evidence that many crypto and blockchain founders have exited their positions and shifted business offshore,” says Nagappan.
Sobti agrees that the levy would seriously impact investors, as well as other stakeholders including exchanges and third-party service providers. “The proposal to impose 1% tax deducted at source on each crypto transaction would significantly impact the business models of digital asset service providers,” he says. Additional clarity is required, he adds, on issues such as set-off for losses and barter transactions.
Nagappan suggests that the government should allow deductions and carry forward losses. Eventually, the trades will go underground/off exchange or outside India, say both Garg and Nagappan. This will defeat the purpose of the amendment, which was to track such transactions. The government may also end up losing revenue once these transactions go off platform or offshore, says Nagappan.
Transactions in cryptocurrency are disadvantaged in comparison to other investment assets such as shares and securities, says Puri at SAM. “The underlying policy intent does not look to incentivise transactions or savings in crypto among the masses,” she points out.
DSK’s Batra feels otherwise, and says that the crypto tax will not discourage investment in virtual digital assets, but rather will enable the government to encash on the profits made. The flat and high tax rate of 30% will not act as a deterrent when it comes to trading and investment in crypto, although the same argument may not hold for gifting, he says. “At least the government now recognises cryptocurrencies as an asset class for the purposes of taxation.”
Broadly worded definition
Although the Finance Bill has provided guidance on the tax treatment for cryptocurrency, the widely worded definition of virtual digital assets is broad enough to cover any code or number or tokens generated through cryptographic means or otherwise. The term “virtual digital assets” would not be limited to digital assets and businesses created on blockchain-cryptography technology, lawyers fear.
The tax authorities would interpret many other businesses as possessing them, says Garg, citing reward programmes and online gaming apps. “There is a tough legal battle ahead for not only crypto-businesses and assets, but also centralised databases based on digital assets and businesses,” warns Batra.
Nagappan agrees and tells IBLJ that apart from gaming or online apps, even demat shares could get caught if securities are not excluded. “Demat shares, being a digital representation of shares, could get covered within the expansive definition,” he explains, adding the government needs to clarify and narrow the scope to virtual currencies, which is what they intended to cover.
EQX Business Consultancy’s founder and director, Nemin Shah, cites a major loophole in the definition of virtual digital assets, which was not rectified before the passage of the Finance Bill on 25 March.
Critics of cryptocurrencies often argue that there is no inherent value and that cryptocurrencies are akin to Ponzi schemes. Shah highlights a contradiction in the definition of virtual digital assets under the Finance Bill, which need to be transacted with a promise of having inherent value.
In the absence of any inherent value, the seller of these assets cannot provide any promise or representation of inherent value to the buyer, Shah tells IBLJ.
Furthermore, cryptocurrencies cannot function as the store of any value, contrary to what has been defined in the Finance Bill, Shah says. “Given the contradictory position of the central bank and the Ministry of Finance with respect to VDAs, an Indian court may take a liberal view that cryptocurrencies do not fall within the definition of VDA,” he points out.
“The biggest irony is that many commodities or assets that are not intended to be included in the definition of VDAs (such as loyalty points, and gift cards) would satisfy the above condition related to inherent value, and fall within the definition of VDA whereas cryptocurrencies would escape,” he says.
“The entire exercise of defining VDA directly in the Income Tax Law without regulating the same is an incorrect chronology,” says Shah, adding that the government has put the cart before the horse.
As the government can notify any digital asset or token as a virtual digital asset, the 1% tax deducted at source would result in an increase in compliance costs, says Sobti. As issues like set-offs would require clarification, “as and when clarity is provided … the true nature of tax burden would be better understood,” he tells IBLJ.
With a 30% tax on gains arising from virtual assets without any exemptions or deductions, the logical question remains: “to invest or not to invest?”.
Several exchanges have said that the charm to hold onto cryptos has not worn off despite the tax. The advice given by them is that new investors should adopt a systematic investment plan by staggering investments periodically to maximise profits and protect themselves against the volatility of the asset class.
Governments capitalise on crypto profits
The crypto industry had urged the Indian government to introduce “reasonable crypto tax policies” with a petition going around signed by almost 100,000 individuals asking the finance minister to reduce the proposed 30% tax rate and drastically bring down the one percent tax deducted at source. As one investor said “30% tax is not relevant because we do not earn profits all the time, and have seen major losses in the past three months.”
According to the petition being circulated, the majority of the investors in India are in the age bracket of 17 to 27 and they are small investors though collectively they have reportedly invested close to USD6 billion in cryptocurrency with the intention of diversifying their respective portfolios.
While Finance Minister Nirmala Sitharaman in her budgetary address announced the tax on virtual digital assets, regulations and legal clarity are awaited. The Finance Bill was tabled and approved by the Parliament on 25 March. Even before the official cryptocurrency tax kicks off from 1 April, the local media reported that the income tax department has threatened to issue notices and impose penalties on around 700 individuals for failing to file tax returns or declare profits earned from cryptocurrency gains.
India however, is not alone when it comes to imposing a tax of 30% on cryptocurrency and other virtual digital assets. As individuals find new ways to make money from cryptocurrency, governments are tapping into this revenue source to boost their state coffers. Many countries the world over have or are in the process of rewriting their tax laws as the market value of cryptocurrency and other virtual digital asset classes has ballooned.
The US for instance imposes a tax of up to 37% as cryptocurrency is considered a property and not a currency. The UK imposes capital gains tax on the sale of cryptocurrency, which varies from 10% to 20% depending on taxable income, profits earned and deductibles allowed. Australia equally imposes a capital gains tax.
Closer to home, while Hong Kong does not have capital gains tax, and nor do investors have to pay tax on the sale of cryptocurrency, the trading of the asset is treated as income and accordingly taxed up to a cap of 16.5%.
Singapore took the industry by surprise when it announced on 11 March that income generated from the trading of non-fungible tokens would be taxed under the existing income tax rates. The Monetary Authority of Singapore had previously stated that while cryptocurrencies needed to be monitored to ensure it did not provide an avenue for money laundering and other illegal activities, it did not wish to stifle innovation.
Japan has seen cryptocurrency exchanges leave on account of hefty corporate tax and individuals paying up to 55% on capital gains. In comparison, a 20% capital gains tax is imposed on securities. This grouse is similar to what India faces come 1 April.
Then there are a few countries that have opted to ease the tax liability on earnings from cryptocurrency. Earlier this month, South Korea’s new President Yoon Suk-yeol has promised to relax the crypto taxation policies by increasing the threshold for taxing crypto assets. Last November South Korean legislators deferred plans to tax cryptocurrency until 2023 in a move to appease young voters. It had initially proposed to levy a 20% tax on earnings from cryptocurrency effective 1 January 2022.
Similarly in February this year, Thailand decided to scrap the 15% withholding tax on cryptocurrency transactions following heavy opposition. However, unlike India, the relaxation in the rules will allow Thai traders to offset their annual losses against profits earned during the year.
Cryptocurrency trading is legal in Indonesia but at the moment no tax has been imposed. Talks are on with industry associations and exchanges as the government considers imposing a tax given the rising number of crypto investors in the country. Against the 0.1% tax on stock trades, talks are on to impose a 0.05% tax on cryptocurrency trades and impose an income tax of 0.03% for investors.