Taxmann's Taxation of Virtual Digital Assets

Acknowledgement We thank the following individuals for their contribution: CA Naveen Wadhwa, Adv. Poonam Harjani, CA Dipen Mittal, CA Sunil Kumar, CA Rahul Singh, CS Rachit Sharma, CA Karishma Malhan The authors have taken immense efforts and devoted considerable time and resources to share their vast knowledge and experience.

I-5

Chapter-Heads

PAGE

Acknowledgement

I-5

Contents

I-9

CHAPTER 1 : CONCEPT OF VIRTUAL DIGITAL ASSET (VDA)

1

CHAPTER 2 : MEANING OF VIRTUAL DIGITAL ASSET (VDA)

9

CHAPTER 3 : SCHEME OF TAXATION OF VDA ON OR AFTER 01-04-2022

14

CHAPTER 4 : TRANSFER OF VDA WITHOUT OR FOR INADEQUATE CONSIDERATION ON OR AFTER 01-04-2022

37

CHAPTER 5 : DEDUCTION OF TAX AT SOURCE UNDER SECTION 194S

42

CHAPTER 6 : SCHEME OF TAXATION OF VDA BEFORE 01-04-2022

50

CHAPTER 7 : TAXABILITY OF CRYPTOCURRENCY UNDER THE GST LAW

64

APPENDIX

83

: RELEVANT SECTIONS OF INCOME-TAX ACT, 1961

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Contents PAGE

Acknowledgement

I-5

Chapter-Heads

I-7

1 CONCEPT OF VIRTUAL DIGITAL ASSET (VDA) 1.1

Historical Background of development of cryptocurrencies

1

1.2

Key concepts

2

1.2-1

Crypto Assets

2

1.2-2

Distributed Ledger Technology (DLT)

3

1.2-3

Blockchain

4

1.2-4

Non-Fungible Tokens

4

1.3

Need for Blockchain Technology

4

1.4

How does Blockchain technology work?

5

1.5

Lifecycle of virtual currencies

5

1.5-1

Creation

5

1.5-2

Storage

6

1.5-3

Transfer

6

1.6

Government of India’s stand on Cryptocurrency

7

1.7

Judiciary’s stand on Cryptocurrency

8

2 MEANING OF VIRTUAL DIGITAL ASSET (VDA) 2.1

Meaning of VDA as per section 2(47A)

2.2

Inclusions in VDAs

9 10

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CONTENTS

I-10 PAGE

2.3

2.2-1

Information or code or number or token generated through cryptographic means 10

2.2-2

Non-Fungible Tokens (NFT)

11

2.2-3

Any other digital asset

11

Exclusions from VDAs

11

2.3-1

Indian Currency

11

2.3-2

Central Bank Digital Currency (CBDC)

12

2.3-3

Foreign Currency

12

2.3-4

Notified Digital Assets

13

3 SCHEME OF TAXATION OF VDA ON OR AFTER 1-4-2022 3.1 3.2 3.3

3.4 3.5

3.6

3.7

New section 115BBH introduced by the Finance Act, 2022 Chargeability of VDA Classification of VDA 3.3-1 Taxable under the head of PGBP 3.3-2 Taxable under the head of Capital Gains 3.3-3 Taxable under the head of other sources Scheme of taxation of VDA Transfer of VDA 3.5-1 Transfer by way of exchange 3.5-2 Transfer by way of conversion into stock-in-trade 3.5-3 Lending of cryptocurrencies 3.5-4 Transfer in a mode specified under section 47 3.5-5 Mining of VDA 3.5-6 Transfer without consideration 3.5-7 Transfer by way of donation of VDAs 3.5-8 VDAs lost or stolen Computation of Income taxable under section 115BBH 3.6-1 Full value of consideration 3.6-2 Cost of acquisition of VDA

14 15 17 18 18 19 19 20 21 21 21 22 22 23 24 24 25 26 28

Tax to be levied at 30%

32

3.7-1 3.7-2 3.7-3

Benefit of maximum exemption limit Rebate under Section 87A Deduction under Chapter VI-A

32 33 33

3.7-4

Rates of surcharge and cess

33

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CONTENTS PAGE

3.8

No deduction for expenditure or allowance

34

3.8-1

Treatment of expenditure or allowance

34

3.8-2

Treatment of loss

35

4 TRANSFER OF VDA WITHOUT OR FOR INADEQUATE CONSIDERATION ON OR AFTER 1-4-2022 4.1

Scheme of taxation on the transfer of VDA without or inade- quate consideration 37

4.2

Taxability under section 56(2)(x)

37

4.2-1

Benefit arising from movable property

37

4.2-2

New entry inserted by the Finance Act, 2022

38

4.2-3

Exemption from taxability

38

4.3

Taxability under section 28(iv)

39

4.4

Determination of Fair Market Value of VDA

39

4.5

Tax rates

39

4.6

Cost of acquisition of VDAs received as a gift

40

4.7

Comprehensive Example

40

4.8

Overview of taxation of cryptocurrencies

41

5 DEDUCTION OF TAX AT SOURCE UNDER SECTION 194S 5.1 5.2

5.3 5.4 5.5 5.6 5.7

Introduction Deductor 5.2-1 Over-The-Counter (OTC) deal 5.2-2 Dealing through the exchange platform 5.2-3 Consideration in kind Deductee Rate of TDS Time of deduction Amount on which tax is to be deducted Exemption from deduction of tax at source 5.7-1 Consideration is below Rs. 10,000 5.7-2 Consideration is below Rs. 50,000

42 42 42 42 43 44 44 44 45 46 46 46

CONTENTS

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5.8

Overriding effect of provision

48

5.8-1

Multiple TDS provisions applicable to payer

48

5.8-2

TDS provisions applicable to both payer and payee

48

5.9

TAN is not mandatory

48

5.10

No TDS on gift or lending of VDAs

49

5.11

Others

49

6 SCHEME OF TAXATION OF VDA BEFORE 1-4-2022 6.1

Introduction

50

6.2

Classification of VDA

50

6.3

Computation of capital gain from transfer of virtual assets

50

6.3-1

Period of holding of virtual assets

50

6.3-2

Computation of capital gain from virtual assets

51

6.3-3

Full Value of Consideration

52

6.3-4

Cost of Acquisition

52

6.3-5

Cost of Improvement

53

6.3-6

Benefit of Indexation

53

6.3-7

Expenditure on transfer

53

6.3-8

Tax rates on capital gain from virtual assets

54

6.4

6.5

Computation of business income from transfer of virtual assets 54 6.4-1

Speculative or Non-speculative

54

6.4-2

Method of Accounting

55

6.4-3

Audit of Accounts

57

6.4-4

How to compute turnover from virtual assets?

57

6.4-5

Valuation of virtual assets held as stock-in-trade

58

6.4-6

Computation of business income

59

6.4-7

Tax rates on business income from virtual assets

61

Loss from the transfer of virtual assets before 1-4-2022

61

6.5-1

Loss from the transfer of virtual assets held as a capital asset 61

6.5-2

Loss from the transfer of virtual assets held as stock- in-trade 62

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CONTENTS PAGE

6.5-3 6.6

Carry forward of loss from virtual assets to the assessment year 2023-24 62

TDS or TCS provisions applicable on transfer of virtual assets before 1-4-2022 63

7 TAXABILITY OF CRYPTOCURRENCY UNDER THE GST LAW 7.1

Introduction

64

7.2

Cryptocurrency - Is it Goods or Services?

64

7.2-1

Meaning of Goods

64

7.2-2

Meaning of Services

72

7.3

Supply of cryptocurrency - Whether covered under Schedule III? 73

7.4

GST implications on transactions of various crypto - Assets

74

7.4-1

GST implications on the trading of cryptocurrency

74

7.4-2

GST implications on Mining

74

7.4-3

GST implications on Airdrop

75

7.4-4

GST implications on the exchange of cryptocurrency with other goods 75

7.5

Exchange services by foreign crypto exchanges - Is it OIDAR services?

75

7.6

Crypto exchanges - Are these intermediaries?

77

7.7

International practice on the taxability of cryptocurrency

78

7.8

Open points relating to taxability of cryptocurrency under GST 78

7.9

Our recommendations

APPENDIX :

Relevant sections of Income-tax Act, 1961

79 83

3

SCHEME OF TAXATION OF VDA ON OR AFTER 1-4-2022

3.1 New Section 115BBH introduced by the Finance Act, 2022 The Finance Act, 2022 has inserted a new Section 115BBH with effect from 01-04-2022 to tax the income arising from the transfer of virtual digital assets. The Section 115BBH reads as under: 1. Where the total income of an assessee includes any income from the transfer of any virtual digital asset, notwithstanding anything contained in any other provision of this Act, the income-tax payable shall be the aggregate of– (a)

the amount of income-tax calculated on the income from transfer of such virtual digital asset at the rate of thirty per cent; and

(b)

the amount of income-tax with which the assessee would have been chargeable, had the total income of the assessee been reduced by the income referred to in clause (a).

2. Notwithstanding anything contained in any other provision of this Act,– (a)

no deduction in respect of any expenditure (other than cost of acquisition, if any) or allowance or set off of any loss shall be allowed to the assessee under any provision of this Act in computing the income referred to in clause (a) of sub-section (1); and

(b)

no set off of loss from transfer of the virtual digital asset computed under clause (a) of sub-section (1) shall be allowed against income computed under any provision of this Act to the assessee and such loss shall not be allowed to be carried forward to succeeding assessment years.

3. For the purposes of this section, the word “transfer” as defined in clause (47) of section 2, shall apply to any virtual digital asset, whether capital asset or not.

14

15

CHARGEABILITY OF VDA

Para 3.2

Before discussing the computation of income from the transfer of VDA and levy of tax on such income, it is essential to examine the chargeability and classification of income arising from VDA.

3.2 Chargeability of VDA Section 115BBH only provides for the tax rate and the manner in which income from the transfer of VDA shall be computed. It does not provide for the chargeability of such income to tax. The income arising from the transfer of VDA shall be chargeable to tax as per extant provisions of the law, i.e., section 4, section 5, section 9 and section 14 of the Incometax Act. Indian taxation is based on the principle of the residence of the person and the source of income. The worldwide income of the Indian residents is taxable in India. Non-residents, however, are subject to source-based taxation. Only amounts received or accrued from a source or so deemed to accrue or arise in India are subject to income tax in India. Section 9 contains provisions as to when certain income shall be deemed to accrue or arise in India. Section 9 enumerates various categories of income under clauses (i) to (viii). Income falling under each of the clauses shall be deemed to accrue or arise in India. However, the ultimate tax liability of a non-resident person shall depend upon the Double Taxation Avoidance Agreement (DTAA) that India has entered into with various countries.

To determine whether the income arising to a non-resident from the transfer of VDA shall be taxable in India, among other factors, one needs to identify the situs of VDA. If the situs of a VDA is situated in India, the income arising to a non-resident on its transfer shall be taxable in India subject to the provisions of Section 9(1)(i) and DTAA. The situs/ location of an asset matters only for non-resident assessees and not ordinarily resident assessees. In the cases of these assessees, if an asset located outside India is transferred outside India and sale proceeds are received outside India, no taxability arises in view of section 5 of the Act [except in the case of shares/interest as referred to in Explanation 5 to Section 9(1)(i)]. Such assessees will be liable to be taxed under section 9(1)(i) of the Act in respect of income accruing or arising through the transfer of any property, asset or capital asset situated in India.

Currently, Income-tax Act does not contain any explicit provision to identify the situs of VDAs. VDAs being an intangible property, the judicial pronouncements on the situs of intangible property may be referred to determine the situs of VDA. In the case of CUB Pty. Ltd. v. Union of India [2016] 71 taxmann.com 315, the Delhi High Court held as under:

Para 3.2

SCHEME OF TAXATION OF VDA

16

(a) The issue of situs of an intangible asset is indeed a tricky one.

Insofar as the tangible assets are concerned, there is absolutely no difficulty. They exist in physical form and their existence is at specific locations. Thus, fixing their situs does not pose any problem. (b) An intangible asset, by its very nature, does not have any physical form. Therefore, it does not exist in a physical form at any particular location. The legislature could have, through a deeming fiction, provided for the location of an intangible asset but, it has not done so insofar. With regard to a share or interest in a company registered/incorporated outside India, Explanation 5 has been added to section 9(1)(i) by virtue of the Finance Act, 2012 with retrospective effect from 1-4-1962. (c) Thus, the legislature, where it wanted to specifically provide for a particular situation, as in the case of shares, where the share derives, directly or indirectly, its value substantially from assets located in India, it did so. There is no such provision with regard to intangible assets. Therefore, the well-accepted principle of ‘mobilia sequuntur personam’ have to be followed. The situs of the owner of an intangible asset would be the closest approximation of the situs of an intangible asset. This is an internationally accepted rule, unless it is altered by local legislation. There is no such alteration in the Indian context.

Earlier it was held that income arising on transfer, outside India, of an intangible asset such as technology, designs or drawings, would not be taxable in India (Pfizer Corpn., In re [2004] 141 Taxman 642/271 ITR 101 (AAR - New Delhi), CIT v. Davy Ashmore [1991] 190 ITR 626 (Cal.), Union of India v. Azadi Bachao Andolan [2003] 132 Taxman 373/263 ITR 706 (SC) and CIT v. Maggronic Devices [2010] 190 Taxman 382/329 ITR 442 (HP). But a specific amendment by virtue of Explanation 5, enabled the tax authorities to tax income on the transfer of shares/interest if they derived, directly or indirectly, their value substantially from the assets located in India. However, no provision has been inserted in the Act to tax income arising on the transfer of other intangible assets whose owner is a resident of another country.

There are several kinds of intangible properties. The situs of these properties may vary according to their nature and obligations attached to them. The general law is that the situs of an intangible would be according to the law of the State which created the intangible property and interest therein. However, various parameters involved in deciding situs may create conflict and confusion and thereby pose problems in deciding the taxability of income arising therefrom.

17

CLASSIFICATION OF VDA

Para 3.3

If there are several criteria on the basis of which situs of intangible property can be decided, and there is no definite basis that would attribute situs to India, the courts would always lean in favour of the taxpayer. It has already been held in Vodafone International Holdings B.V. v. Union of India [2008] 175 Taxman 399 (Bom.) and Azadi Bachao Andolan’s case (supra) that if the owner of the property is not a resident of India and the property is transferred outside India then income arising on its transfer cannot be taxed in India. Explanation 5 to section (1)(i) alters the situation only to a limited extent in the case of shares and interest in a company, and their locations will be deemed to be in India if substantial assets of the company are in India. In the case of other intangible assets, there are no such provisions in the Income-tax Act. Therefore, even if an intangible asset is developed, used or commercially exploited in India, income arising from their transfer outside India cannot be taxed in India. It would clearly be a case of profit shifting. Therefore, if revenue leakage is sought to be plugged in, the amendment must be brought into the Act. In the absence of any provision in the Act, the situs of the intangible property can only be decided based on the domicile of the owner of such property, and if the owner of the intangible property is not a resident of India, then income on their transfer outside India cannot be taxed in India. Therefore, if the government intends to prevent the shifting of revenue, an amendment by way of expanding the operation of Explanation 5 to other intangible assets would be necessary.

3.3 Classification of VDA Before discussing the computation of income arising from the transfer of VDA, it is essential to identify the nature of income arising from the transfer of VDAs, particularly cryptocurrencies.

The total income of any assessee is computed under the five heads of income, the provisions of which are contained in Chapter IV computation of total income (section 14). The income so computed is taxed at normal rates specified in Part III of the First Schedule to the Finance Act and special rates specified in Chapter XII (Determination of tax in certain special cases), which includes Section 110 to Section 115BBI1. Chapter XII shall follow Chapter IV. Unless the nature of an income is classified under the relevant head of income specified in Chapter IV, the special rates specified in Chapter XII cannot be applied.

The income arising from the transfer of VDAs can be classified under any of the following heads of income: 1. Section 115BBH and Section 115BBI have been inserted by the Finance Act, 2022.

Para 3.3

SCHEME OF TAXATION OF VDA

18

(a) Profits and gains from business or profession (PGBP); (b) Income under the head of capital gains; or (c) Income from other sources.

3.3-1 Taxable under the head of PGBP When an entity holds VDAs for sale in the ordinary course of business (i.e., trading asset), the profits arising therefrom should be taxed under the head PGBP. This would apply in particular to traders of cryptocurrencies.

Whereas, if the VDAs are held as a capital asset, the income shall be taxed under the head of “capital gains”.

When a person holds virtual assets for sale in the ordinary course of business (i.e., as a trading asset), the profits arising therefrom should be taxed under the head of PGBP. Business income arises when a person carries on business, commerce or adventure in the nature of trade.

A person is said to be carrying on a business if he carries on some activities continuously and systematically by the application of his labour and skill to earn an income. If the virtual assets are held for investment purposes, the income shall be taxed under the head of “capital gain”.

3.3-2 Taxable under the head of Capital Gains As per Section 2(14), ‘capital asset’ means property of any kind held by an assessee, whether or not connected with his business or profession.

The word ‘property’ is of the widest amplitude, including the right and interest of a person in a particular asset. Every possible interest that a person can hold or enjoy in an asset can be termed as ‘property’ within the definition of a capital asset1. Any right which can be called property will be included in the definition of ‘capital assets’2. It would comprise a bundle of rights and interests that a person may conceivably hold and enjoy. It includes such rights that a person may lawfully exercise to the exclusion of others or entitled to use and enjoy as he pleases, provided he does not infringe any law of the State3. It is also defined as an aggregate of rights having monetary value. It includes money and all other property, real or personal, including things in action and other intangible property4.

1. Nila V. Shah (Mrs.) v. CIT [2012] 21 taxmann.com 324/51 SOT 461 (Mum.) 2. CIT v. Tata Services Ltd. [1980] 122 ITR 594 (Bom.) 3. Indian Aluminium Cables Ltd. v. Dy. CIT [2000] 73 ITD 109 (Delhi - Trib.)

4. Shakti Insulated Wires Ltd. v. Jt. CIT [2003] 132 Taxman 171/87 ITD 56 (Mum. - Trib.)

19

SCHEME OF TAXATION OF VDA

Para 3.4

A VDA has all elements a capital asset has. Thus, if the VDAs are not held as stock-in-trade in the books of account or the assessee is not engaged in the business of (or adventure in the nature of trade) dealing in VDAs, the resultant gains should be taxable under the head of the capital gains.

Though the tax rates are the same and notwithstanding the income is taxed under the head of business or profession, capital gains or other sources, this classification is essential for computation of interest under Section 234C. If a shortfall in payment of advance tax happens on account of underestimating or failure to estimate the accrual of capital gains, then such shortfall shall be ignored while computing interest under Section 234C. 3.3-3 Taxable under the head of other sources As per Section 56(1), any income shall be chargeable to tax under the head “Income from other sources”, if it is not chargeable under any other heads. Therefore, the classification of such income should be tested first under the head of business income or capital gains. Only on unsuccessful classification it can be taxed under the head of other sources [see Nalinikant A Mody v. S.A.L. Narayan Row, CIT [1966] 61 ITR 428 (SC) & CIT v. Smt. T. P. Sidhwa [1981] 6 Taxman 91/[1982] 133 ITR 840 (Bom.)].

3.4 Scheme of taxation of VDA The taxation under section 115BBH shall be as under: (a) There should be a transfer of any VDA, whether held as a capital asset or not [see Para 3.5]; (b) The transfer of VDA should result in income which should be included in the total income [see Para 3.6]; (c) The tax on the income from the transfer of such VDA shall be calculated at the rate of 30% [see Para 3.7]; (d) No deduction in respect of any expenditure (other than the cost of acquisition, if any) or allowance or set-off of any loss shall be allowed in computing such income [see Para 3.8-2]; (e) No set-off of loss from the transfer of a VDA shall be allowed against income computed under any provision of this Act [see Para 3.8-2]; and (f) Such loss shall not be allowed to be carried forward to succeeding assessment years [see Para 3.8-2].

Para 3.5

SCHEME OF TAXATION OF VDA

20

3.5 Transfer of VDA The income from VDA shall be taxable under Section 115BBH only if it arises on the transfer of VDA. The word ‘transfer’ is defined under section 2(47) of the Act in relation to capital assets.

As VDA can be held as a trading asset or capital asset (as discussed earlier), it could be argued that section 115BBH would apply only in the case of transfer of VDA held as a capital asset. To avoid any controversy on this aspect, sub-section (3) of section 115BBH provides that the definition of transfer shall apply to any VDA, whether a capital asset or not. Thus, income from VDA shall be computed and taxed as per Section 115BBH irrespective of the fact whether it is covered under the head business or profession, capital gain, or other sources.

The term ‘transfer’ has been defined under Section 2(47) in an inclusive manner. This means that the term shall be deemed to include all transactions prescribed below besides what is otherwise understood as transfer in common parlance: (a) Transfer by way of sale; (b) Transfer by way of exchange [see Para 3.5-1]; (c) Transfer by way of relinquishment; (d) Transfer by way of extinguishment of rights; (e) Transfer by way of compulsory acquisition; and (f) Transfer by way of conversion into stock-in-trade [see Para 3.5-2].

However, the transactions listed below are not regarded as a transfer to compute the capital gains. Therefore, any profit or gain arising from these transactions is not chargeable to tax under Section 115BBH: (a) Lending of virtual digital assets [see Para 3.5-3]; (b) Any distribution of assets in kind by a company to its shareholders at the time of liquidation is not treated as a transfer of an asset by the company. However, in this case, the shareholders are liable to pay tax if any capital gain arises therefrom [Section 46]; (c) Transfers in a mode listed in Section 47 [see Para 3.5-4]; (d) Mining of VDA [see Para 3.5-5]; (e) Transfer of VDA without consideration [see Para 3.5-6]; (f) Transfer by way of donation of VDAs [see Para 3.5-7]; (g) VDAs lost or stolen [see Para 3.5-8];

Taxation of

Virtual Digital Assets AUTHOR PUBLISHER DATE OF PUBLICATION EDITION ISBN NO NO. OF PAGES BINDING TYPE

: : : : : : :

TAXMANN TAXMANN APRIL 2022 1ST EDITION 9789356221741 110 PAPERBACK

Rs. : 250 | USD : 34

Description This one-of-a-kind book provides a complete analysis (from an Income-tax & GST perspective) of the new scheme of taxation of Virtual Digital Assets (VDAs), which includes Cryptocurrencies and Non-fungible Tokens (NFTs).

This book helps the reader to understand the following: u

Basic Concepts & Ecosystem of VDAs

u

Difference between the New & the Old Scheme of taxation of VDAs

u

GST Implications on VDAs

u

Current Tax Challenges

This book also explains the essential taxonomy of the following: u

Crypto Assets

u

NFTs

u

Blockchain Technology

u

Distributed Ledger Technology

u

Airdrop

u

Mining, etc.

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