#TaxmannPPT | Demystifying Taxation of Virtual Digital Assets (VDAs)

Demystifying taxation of Virtual Digital Assets May 2022

Demystifying Taxation of Virtual Digital Assets PwC

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01 Background

Demystifying Taxation of Virtual Digital Assets PwC

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Fundamental technology powering digital assets Blockchain A blockchain is a decentralized ledger of all transactions in a network. Using blockchain technology, participants in the network can confirm transactions without the need for a trusted third-party intermediary. Powerful applications include fund transfers, voting, and many other uses.

Demystifying Taxation of Virtual Digital Assets PwC

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Fundamental technology powering digital assets How Blockchain works?

Distributed ledger

Every participant in the network has simultaneous access to a view of the information without any scalability issues

Demystifying Taxation of Virtual Digital Assets PwC

Cryptography

Consensus

Smart contracts

Integrity and security of the information on the Blockchain are ensured with cryptographic functions

Verification is achieved by participants confirming changes with one another, replacing the need for a third party to authorise transactions

The ability to run additional business logic means that agreement on the expected behaviour of financial instruments can be embedded in the Blockchain

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Lifecycle of digital assets STAGE 1

STAGE 2 Issuance of Tokens

Idea/ concept/ underlying purpose

Miners earn reward in form of cryptos upon solving the puzzle (other forms of issuance – ICOs/ Direct listing, airdrops,etc)

STAGE 3 Users and Stakeholders

Decentralised Application

Cryptocurrency

Smart Contracts (NFTs)

Bitcoin Ether

STAGE 3A Cryptocurrency Exchanges/ NFT marketplaces

Facilitates trading

Means of exchange, store value, smart contracts

Set-up of ecosystem (developers, PoC, etc.)

Demystifying Taxation of Virtual Digital Assets PwC

Miners validate transaction before adding it to the Blockchain

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Types of digital assets Payment tokens A Payment Token is a medium of exchange accepted by the public, as payment for goods or services or for the discharge of a debt which is not denominated in any currency and is not pegged by its issuer to any currency and can be transferred, stored or traded electronically.

Example - Bitcoin

Demystifying Taxation of Virtual Digital Assets PwC

Utility tokens Utility tokens provide value to investors in different ways. They give users access to a future product or service and offer users the right to a service or product.

Example – Basic Attention Token rewarded to users for using Brave browser and viewing advertisement on the browser.

Security tokens Security tokens derive their value from an external, tradable asset. For example, stocks or real estate.

Example – PAXG Token is a cryptocurrency which is backed by Gold. Each PAXG Token is backed by 1 troy ounce of Gold (which is stored in a vault by the company issuing these tokens).

Asset tokens An asset-backed token is a digital token that signifies and derives its value from an non-fungible underlying asset.

Example - Non-fungible tokens (NFT) representing artwork or used in gaming could be a type of asset token.

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Journey of cryptocurrency in India so far…

2013-17

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Central Bank issues a circular that bars banks and other financial institutions from facilitating transaction involving cryptocurrencies

Central Bank cautions public against dealing in virtual currencies via a press release

2018 -19

2020

Apex Court quashes Central Bank circular on the grounds of disproportionality

The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 is reported to be tabled, but has been delayed

2021

2022

India Annual Budget Introduction of Digital Rupee, taxation of Virtual Digital Asset

Government institutes a high-level InterMinisterial Committee to report on issues pertaining to the use of virtual currencies

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Regulatory stance across the globe REGULATED (DIRECTIONNALY)

UNREGULATED

RESTRICTED

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El Salvador (legal tender)

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India

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China

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UK

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Kenya

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Qatar

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Japan

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Saudia Arabia

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Bangladesh

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Australia

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Vietnam

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US

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Egypt

Key considerations – 3I framework – Innovation, Integrity and Investors •

Licensing framework

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Classification or specific categorization

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Financial Crimes

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AML/CFT compliance

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Investor protection

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Access to international markets

Impact on financial and banking system

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Effect on the environment

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Examples of taxation of Virtual Digital Assets around the world The United Kingdom

The United States

While no specific tax legislation is in place regarding the taxation of cryptocurrencies, Her Majesty's Revenue and Customs ("HMRC") issued Cryptoassets Manual ("CM") on 30 March 2021, which provides guidance on how HMRC is going to treat a transaction/business associated with the crypto assets. However, the CM is not legally binding on taxpayers, but it

USA’s Internal Revenue Service (IRS) states that buying and selling crypto is identified as property, not currency, for tax purposes. Hence, virtual currency is taxed in the same way as any other assets, like stocks, gold etc.

Tax tax treatment of all types of tokens is dependent on the nature and use of the token.

Importantly HMRC does not consider crypto assets as currency or money but more equivalent to a commodity.

Selling crypto for cash, paying crypto for goods and services, buying one crypto with another, receiving mined crypto, being paid in crypto by an employer and receiving crypto rewards are the crypto transactions taxable.

India

However, buying crypto with cash and holding it, transferring crypto between wallets and donating crypto to a qualified taxexempt charity will not be taxable.

Crypto assets received as employment income it is treated as ‘money’s worth’ and are subject to Income Tax and National Insurance contribution based on the value of assets converted into sterling pounds.

A Demystifying Taxation of Virtual Digital Assets

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Examples of taxation of Virtual Digital Assets around the world Canada

Australia

The Canada Revenue Authority (CRA) generally treats cryptocurrency like a commodity for purposes of the Income Tax Act.

Under the Australian income tax rules, cryptocurrency is not viewed as money or foreign exchange but rather a capital gains tax (“CGT”) asset or as a revenue asset, like shares or property, with the character of the asset depending on the intention of the holder.

Any income from transactions involving cryptocurrency is generally treated as business income or as a capital gain, depending on the circumstances.

Where cryptocurrency is held on capital account, a CGT event is triggered when cryptocurrency is sold or exchanged for AUD or other cryptocurrencies or used to obtain goods and services (unless it is considered a personal use asset).

India

Taxpayers have to establish if a cryptocurrency activity results in income or capital because this affects the way the revenue is treated for income tax purposes.

If more than one type of cryptocurrency is held in a digital wallet, each type of cryptocurrency is considered to be a separate digital asset and must be valued separately.

A Demystifying Taxation of Virtual Digital Assets

In certain circumstances, a 50% discount of the taxable gain can apply where the cryptocurrency has been held by an individual or trust for a period in excess of 12 months.

Where a cryptocurrency investor holds cryptocurrency as an investment or hobby, they may not be subject to capital gains tax on the disposal of a cryptocurrency. This will depend on whether it can be demonstrated that the cryptocurrency is a ‘personal use asset’ valued at AUD10,000 or less.

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OECD – Crypto Asset Reporting Framework (‘CARF’) CARF •

The OECD on March 22, 2022 released a public consultation document regarding the CARF— a new global tax transparency framework on the development of automatic information exchange with respect to crypto-assets — as well as proposed amendments to the existing Common Reporting Standard (CRS).

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CARF would require emerging digital market intermediaries, such as crypto-asset exchanges and wallet providers, to apply due-diligence procedures to identify their customers and to report annually customers’ aggregate exchanges and transfers to their respective tax administration. CARF has been designed as a response to challenges that the growing crypto-assets market is considered to pose for tax administrations’ visibility to taxpayer information and taxpayer compliance.

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The OECD requested public comments with regard to the consultation document by April 29. The OECD is expected to consider this feedback and provide an update to the G20 meeting in October 2022.

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So far, crypto has not been the focus of CRS and the automatic exchange of information regimes. This will change with the OECD’s newly released plan. Banks and other financial market participants that are classified as reporting financial institutions under CRS likely would be heavily impacted by this new framework and should take steps to prepare for its implementation.

Demystifying Taxation of Virtual Digital Assets

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Central Bank Digital Currency (CBDC) CBDCs are a digital form of a paper currency and unlike cryptocurrencies that operate in a regulatory vacuum, these are legal tender issued and backed by a central bank.

Recently, in 2022-23 budget, the Government of India announced that Central Bank will issue a digital currency as early as 2022-23.

The main objective is to mitigate the risks and trim costs in handling physical currency, costs of phasing out soiled notes, transportation, insurance and logistics.

Demystifying Taxation of Virtual Digital Assets

Present

Future

Central bank

Fiat currency

CBDC

Bank

Bank’s settlement + services

Services

End user May 2022 5

02 Global perspective

Demystifying Taxation of Virtual Digital Assets PwC

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03 Indian taxation provisions for Virtual Digital Asset

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Definition of Virtual Digital Asset Section 2(47A) – Virtual Digital Asset means: •

any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;

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a non-fungible token or any other token of similar nature, by whatever name called;

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any other digital asset, as the Central Government may, by notification in the Official Gazette specify:

Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein.

Explanation.—For the purposes of this clause,— (a) "non-fungible token" means such digital asset as the Central Government may, by notification in the Official Gazette, specify;

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Key issues Section 2(47A) •

Terms such as “information”, “token”, “code”, “number” can have very wide import. Generated through cryptographic means “or otherwise” can potentially include wide ranging technologies. Can reward points, coupons, etc issued in online gaming, payment systems, credit card or debit card, etc. on usage of the platform or app also falls under the definition of VDAs.

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The definition of VDA also seeks to cover assets which are digital representation of inherent value. Can this include dematerialized shares or securities?

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NFTs are a title record of ownership of an underlying asset on the blockchain without any independent existence of their own. Will transfer of NFT’s create a separate taxable event?

Demystifying Taxation of Virtual Digital Assets PwC

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Taxability on transfer of Virtual Digital Asset Section 115BBH •

Gains arising on transfer of VDA taxable at 30% (plus applicable surcharge and education cess) without any deduction except for cost of acquisition.

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Set-off of loss arising on sale of VDA not permissible against any other income; no carry forward of loss arising on sale of VDA.

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Any loss arising from any other source cannot be set off against income from transfer of VDA.

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For the purpose of section 115BBH, the word "transfer" as defined in clause (47) of section 2, shall apply to any virtual digital asset, whether capital asset or not.

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Taxability of gift of Virtual Digital Asset Section 56(2)(x) •

S.56(2)(x)(c) provides for taxation of income where property is transferred for NIL or inadequate consideration as compared to fair market value (FMV). The difference between FMV and consideration in excess of Rs. 50,000 is considered as income in hands of recipient.

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Section 56(2)(x) of the Act is amended to expand the definition of the term ‘Property’ as defined therein, to Include VDA as a new category of property.

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Key issues Section 56 and 115BBH •

Can loss incurred on transfer of VDA be set-off against income from transfer of other VDA’s? – Hon. Minister of State for Finance informed the Lok Sabha that loss from the transfer of VDA will not be allowed to be set off against the income arising from transfer of another VDA

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Can income from transfer of VDA be classified under any head of income?

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Transactions not regarded as transfer to be governed by section 47.

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Section 115BBH or 56 does not provide method of computation of fair market value of consideration.

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Cost of acquisition in case of mining - Hon. Minister of State for Finance has clarified in Lok Sabha that infrastructure costs incurred in mining of VDAs will not be treated as cost of acquisition.

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Method for determination of cost of acquisition of VDAs (FIFO, weighted average)

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Rebate under section 87A of the Act from the total tax payable under section 115BBH of the Act.

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Is minimum exemption limit available for income from transfer of VDA?

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Withholding tax on transfer of Virtual Digital Asset Section 194S •

Person responsible for paying any sum to any resident in respect of transfer of a VDA, is required to deduct tax at 1% on such sum.

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Where payment is wholly or partly in kind, the person responsible for paying such consideration shall ensure that tax has been paid, prior to releasing such consideration.

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Threshold amount triggering TDS deduction is an aggregate amount of INR 50,000 in case specified persons make payment, else it is INR 10,000.

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In case of specified persons, the requirement to obtain a TAN as per section 203A of the Act and the requirement to deduct tax at higher rates as per section 206AB of the Act, not applicable.

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Where tax deducted under 194S of the Act then no tax required to be deducted/ collected under 194O.

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Key issues Section 194S •

Determination of person responsible for paying for transactions carried through various crypto exchanges.

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TDS in case of presence of other intermediaries such as brokers or payment gateways.

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Valuation methodology if transfer of VDA is in exchange of another VDA.

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TDS in case of receipt of VDA in considerations of services.

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Practical aspects around how the person responsible for paying consideration shall ensure payment of TDS before releasing consideration.

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Ambiguity on applicability of section 194S of the Act, if either the credit or payment to transferor is before 1 st July 2022.

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Interplay with other provisions of Chapter XVII-B.

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Applicability of section 194-O before 1st July 2022.

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