BUSINESS AND FINANCE

MOMENT OF GLORY?

The announcement of a tax slab on virtual digital assets has been welcomed by the crypto industry, even though taxation does not necessarily mean legalisation.

SYNERGIA FOUNDATION

RESEARCH TEAM

As the 2022 Union Budget was presented in the Indian Parliament, the focus on digitisation was apparent. While many significant announcements were made, what captured global attention was the proposed taxation scheme for digital assets, including cryptocurrencies and non-fungible tokens (NFTs). According to Union Finance Minister Ms. Nirmala Sitharaman, there had been such a phenomenal increase in the magnitude and frequency of virtual asset transactions in India that it was imperative to provide for a specific tax regime.

Accordingly, the government declared a flat 30% tax on income from digital assets, with an additional one per cent TDS (tax deducted at source) on payments made using such assets. Ms. Sitharaman clarified that no deductions in respect of any expenditure or allowance would be permitted while computing the income, other than the cost of acquisition. Moreover, any loss incurred during transfer could not be set off against other income.

Despite the imposition of such a steep levy, much of the crypto industry welcomed this move. This is because the government had hitherto been ambivalent about the future of digital assets in India. It was generally feared that a prohibitive bill would be introduced in Parliament.

Now, by bringing it under the umbrella of taxation, there is much optimism that the government has effectively legitimised the trade in private cryptocurrencies and NFTs. Only time will tell if the new tax indeed implies regulation of crypto, as opposed to a blanket ban that was proposed earlier.

UNPACKING IMPLICATIONS

While cryptocurrency investors and coin exchanges have hailed the taxation measure as the first step towards legitimising the digital asset class, Finance Minister Nirmala Sitharaman has been quick to clarify that this is not necessarily the case. According to her, the Crypto bill is still under consultation with various stakeholders, and any inference about the legal status of cryptocurrencies would be premature at this stage. All that the Budget has sought to do is recognise the peer-to-peer (P2P) nature of crypto, taxing it like any other source of income.

Indeed, taxability and legality have no direct connection. Merely because something is taxed does not make it legal. There are a number of court judgments that buttress this principle. For instance, in the 2008 case of Commissioner of Income Tax v. K Thangamani, the Madras High Court had confirmed that income from illegal activities could be taxed. The income tax authorities were not necessarily concerned with the manner or means of acquiring income in order to bring it within the ambit of taxation.

Given this reality, the proposed 30 per cent tax does not automatically translate to legal recognition of digital asset transactions. The same will be left to the provisions of the upcoming ‘Cryptocurrency and Regulation of Official Digi-

Contrary to popular opinion, the introduction of a hefty taxation scheme may actually prove to be punitive in the long run. It could act as a deterrent in trading, with many people disincentivised from investing in virtual digital assets.

tal Currency Bill, 2021’.

However, if such legitimisation and mainstreaming of the virtual asset class indeed comes to pass, it will be a major shot in the arm for the Web 3.0 start-up ecosystem in India. It will also be a major source of encouragement for millions of cryptocurrency investors in the country, who have staked around $10 billion in digital currencies, according to the Credit Rating for Exchanges Blockchains and Coin Off erings (CREBACO).

Moreover, the levying of TDS has been projected as a ‘masterstroke’, as it will help the government to keep track of transactions. As opposed to relying on exchanges for securing data about crypto investors, it can obtain the necessary information about transactions from the reporting of TDS for each trade.

TEMPERING EXPECTATIONS

Contrary to popular opinion, the introduction of a hefty taxation scheme may actually prove to be punitive in the long run. It could act as a deterrent in trading, with many people disincentivised from investing in virtual digital assets. The higher tax rate could bring down the net gain in the hands of investors, thereby reducing the appeal of cryptocurrencies and NFTs. Moreover, the restrictions on setting-off losses and deducting transactional expenses could motivate them to look for greener pastures, as it is a signifi cant deviation from existing tax principles pertaining to business income and capital gains. Similarly, the TDS provision is perceived as an impediment to trading, as it can erode capital and discourage traders and market-makers. The position on levying TDS for trading in international exchanges also remains unclear. In this context, the volume on exchanges is expected to diminish, with the Budget provisions heavily dampening day-to-day transactions and trading.

As articulated by Harish Prasad, the Head of Banking with FIS fi ntech -“The position of the government is clearly to minimise the attractiveness of crypto-assets, and this is evident from the highest slab tax rate of 30 per cent”. The mere fact that the administration has acknowledged the digital asset class by providing tax guidance should not blind the industry to this reality.

ASSET VERSUS CURRENCY

One signifi cant stride made by the 2022 Budget, however, is that it has settled the long-standing debate on the classifi cation of private crypto. The Indian Finance Minister has confi rmed that cryptocurrencies will be treated as digital assets, as opposed to currencies. According to her, the Reserve Bank of India (RBI) will issue an offi cial digital currency, and everything that prevails outside of it will be assets created by individuals – “Currency rests only with the RBI, everything else is crypto-assets.” This means that if cryptocurrencies are introduced as fi nancial assets, they cannot be used to make payments but will have to be held like shares or gold.

Such a position is in line with the long-standing view of the Indian establishment that crypto cannot be treated as legal tender. In other words, one cannot compel a cryptocurrency to be accepted by another person in the absence of an identifi ed issuer. As per many experts, crypto-assets like bitcoin, for example, cannot be treated as currency, as they do not depict a stable source of value. Rather, they are highly speculative instruments that one can trade like commodity assets in the hope that their value increases.

In fact, the Finance Bill has introduced a new defi nition for ‘virtual digital assets’, covering any information or code or number or token that provides a digital representation of value exchanged. In doing so, it has also lumped cryptocurrencies and NFTs under the same category. According to some experts, it would be more prudent to treat crypto tokens separately from digital NFT tokens, as they are fundamentally diff erent. Since NFTs are still classifi ed as non-taxable assets worldwide, it is argued that industries like gaming, interactive immersive museums or other edutainment platforms should be free from tax burdens.

For now, however, the higher tax rates on private crypto, coupled with the government launching its own Digital Rupee, could portend a diffi cult few years for trading volumes.

HOW GAINS FROM SALE OF CRYPTOCURRENCY TAXED?

Classification of Nature of crypto-transaction

Volume - frequent Purpose - short term trading

Business Income

Taxable at slab rates (GST applicability to be examined) Volume - low Purpose - long term investment

Capital gains

Holding <=3 years

STCG Holding >3 years

LTCG

Taxable at applicable slab rate

20%

with indexation

Assessment

While the proposed tax scheme does remove some ambiguity around digital assets, its steep rates can discourage people from investing. The government’s enthusiasm for blockchain-powered technologies appears limited to the Digital Rupee. In all likelihood, the upcoming bill will enact strict regulations in relation to private cryptocurrencies, citing national security and fi nancial stability concerns.

At the same time, the government’s move to issue a central bank digital currency may familiarise reluctant investors and non-investors with virtual currency. It remains to be seen if this will build an appetite for the entire asset class, irrespective of whether it is private or sovereign-backed.