Taxmann's Analysis | Bitcoin ETFs – Can You Escape the 30% Tax Rate?

Contents Section 115BBH:

Tax on income from virtual digital asset

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Section 50AA:

Tax on capital gains from specified mutual funds

Section 112:

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Tax on long-term capital gains

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Conclusion

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Bitcoin ETFs Can You Escape the 30% Tax Rate?

Bitcoin is again the talk of the town.

To provide some context, Bitcoin is a cryptocurrency known for its vulnerability, encryption, anonymity, and assets without intrinsic value.

Until January 10, 2023, investors had a singular option to invest in Bitcoin: a direct investment through various unregulated or semi-regulated exchanges. A notable development has occurred recently, presenting investors with two alternatives: direct investment and investment through Bitcoin Exchange-Traded Funds (ETFs). This anticipation surrounding the latter option has generated excitement in the crypto market, leading to a significant surge in Bitcoin’s price by over 150% in the last 12 months.

This anticipation materialised when the US Securities and Exchange Commission (SEC) approved the inaugural list of Bitcoin ETFs. This approval follows previous rejections primarily due to market immaturity, vulnerability, and manipulation concerns. Notably, the SEC has given the green light to 11 applications, including those from BlackRock (BLK.N), Ark Investments/21Shares (ABTC.S), Fidelity, Invesco (IVZ.N), and VanEck. This approval by the SEC followed an appeal filed by the Crypto Asset Manager, Grayscale, before the US Court.

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Bitcoin ETFs Can You Escape the 30% Tax Rate?

It is worth noting that Bitcoin ETFs are not a recent development.

Previously, the SEC approved Bitcoin futures ETFs. The recent announcement is specific to Bitcoin Spot ETFs. In this scenario, the ETF will directly purchase Bitcoin, distinguishing it from the earlier futuresbased ETFs. The Bitcoin Spot ETF allows investors to take Bitcoin exposure without possessing the cryptocurrency directly in digital wallets or hard disks.

This will eliminate the concerns about potential cyber hacks and the intricacies of managing complex passwords when stored on hard disks.

The Bitcoin ETFs will be listed on Nasdaq, NYSE and the CBOE. In the context of an Indian resident individual investing in Bitcoin ETFs in the US market, a crucial question arises regarding the tax implications.

The issue is whether the long-term capital gains arising from the sale of Bitcoin ETFs should be subject to taxation under Section 115BBH, Section 50AA, or Section 112.

Section 115BBH is a special provision to tax income derived from transferring Virtual Digital Assets (VDA), including cryptocurrencies.

Section 50AA is a special provision to tax the income from specified mutual funds that do not allocate more than 35% of their total proceeds to equity shares of domestic companies. Section 112 operates as a residual provision, encompassing the taxability of long-term capital gains from any capital asset not covered by the special provisions.

Let’s evaluate each provision separately.

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Bitcoin ETFs Can You Escape the 30% Tax Rate?

Section 115BBH:

Tax on income from virtual digital asset This provision provides that the income from virtual digital asset transfers shall be taxable under Section 115BBH at 30%. The definition of “virtual digital asset” is outlined in Section 2(47A) and encompasses three classes of VDA: information, code, number, or token generated through cryptographic means; non-fungible tokens (NFTs); and any other digital asset as notified.

The first class represents cryptocurrencies like Bitcoin. However, it is essential to note that units of Bitcoin ETFs may not fall within this class for taxability in the hands of investors because investors have not invested directly in the cryptocurrency. Instead, the Asset Management Companies (AMCs) may be taxed under this provision. Given that these USA AMCs are not subject to taxation in India, investors are not obligated to pay tax under Section 115BBH in this scenario. However, if the government notifies Bitcoin Spot ETF as VDA in the third class mentioned above, the resultant gains can be taxable under this provision. Until that happens, this provision may not apply.

Section 50AA:

Tax on capital gains from specified mutual funds Section 50AA contains provisions for the computation capital gains arising from transferring units of a Specified Mutual Fund (“SMF”). The specified mutual fund means a mutual fund (including ETF) where not more than 35% of its total proceeds are invested in the equity shares of domestic companies.

The term “mutual fund” is defined in Regulation 2(q) of SEBI (Mutual Funds) Regulations, 1996. It means a fund established in the form of a trust to raise monies through the sale of units to the public under one or more schemes for investing in securities, money market instruments, gold or gold-related instruments, silver or silver-related instruments, real estate assets and such other assets and instruments as may be specified by the Board from time to time.

Given that the SEBI does not approve investments in Bitcoin by Mutual Funds, and the Bitcoin Spot ETFs are neither registered nor approved by SEBI, they should not be classified as mutual funds. As a result, these Bitcoin ETFs should be excluded from the purview of taxability under Section 50AA.

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Bitcoin ETFs Can You Escape the 30% Tax Rate?

Section 112:

Tax on long-term capital gains Section 112 is a residuary provision to tax long-term capital gains arising from transferring any capital asset. This provision applies when other special provisions are not invoked to tax long-term capital gains. According to Section 112, long-term capital gains are subject to a tax rate of 20%. Additionally, the benefit of indexation is available in computing the amount of long-term capital gain.

In the context of Bitcoin ETFs, the units should be regarded as long-term capital assets when held for a period exceeding 36 months before the date of transfer.

Conclusion Section 50AA may not apply to tax gains arising from the transfer of such units, given the absence of SEBI approval for Bitcoin investments and Bitcoin Spot ETFs. The approval from SEBI serves as a crucial determinant in this context. Similarly, Section 115BBH may only apply if the CBDT issues a notification explicitly including Bitcoin ETFs within the definition of Virtual Digital Assets (VDAs).

Consequently, the taxation of long-term capital gains from transferring units of Bitcoin Spot ETFs should be covered under the residuary provisions of Section 112.

Regarding short-term capital gains resulting from the transfer of units within 36 months or less, taxation should follow the applicable tax rates for the assessee.

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CA Naveen Wadhwa Vice President - Research and Advisory, Taxmann

Naveen holds expertise in advisory and litigation related to Income-tax and International Tax matters. Extensive experience of working with diversified industries like real estate, technology, publication, education sector, hospitality, manufacturing, etc. He writes and speaks regularly on Income-tax issues for renowned media houses.

Highlights 

Chartered Accountant (All India 24th Rank)



13+ Years of Experience in Income-tax and International Tax

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Previously worked with Grant Thornton

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Experience in Real Estate, Technology, Publication, Hospitality, etc.

Bitcoin ETFs Can You Escape the 30% Tax Rate?

Our Associations

Income-tax Department

Indian Institute of Banking & Finance

Income-tax Appellate Tribunal

National Institute of Securities Markets An Education Initiative of SEBI

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Bitcoin ETFs Can You Escape the 30% Tax Rate?

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Bitcoin ETFs Can You Escape the 30% Tax Rate?

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