[Source: forbes.com; Authors: Justin M Bharucha, Aashika Jain]
Cryptocurrencies and non-fungible tokens (NFTs) are presently unregulated in India. While the Reserve Bank of India (RBI) had sought to ban cryptocurrencies in 2018, the Supreme Court quashed the attempted ban leaving cryptocurrencies in regulatory limbo – neither illegal nor, strictly speaking, legal. NFTs do not appear to have attracted the same level of regulatory ire as cryptocurrencies but suffer from the same uncertain legal existence as cryptocurrencies.
While there have been reports of a comprehensive Cryptocurrency Bill, no such Bill has been made public and the Government of India’s approach to cryptocurrencies remains unclear. There does not appear to be a move to substantively regulate NFTs as yet. While the Government continues to contemplate its stance on cryptocurrencies and NFTs, it has, in the interim, implemented a new tax regime aimed at taxing gains and, or, income from virtual digital assets (VDAs) – i.e. cryptocurrencies, NFTs and similar tokens, and other assets that the Government may specify. As a result, there is now a tax of 30% plus surcharge and cess on the transfer of any VDA such as Bitcoin or Ethereum under the Income Tax Act, 1961 (Income Tax Act). However, the legal position of cryptocurrencies is still unclear.
The Income Tax Act was amended with effect from April 1, 2022 to provide for the taxation of gains and, or, income derived from VDAs. Under the Income Tax Act, VDAs are:
Curiously, the Income Tax Act does not mention either blockchain or DLT in the definition of VDAs.
The Central Government has yet to notify the NFTs, tokens or other VDAs to which the provisions of the Income Tax Act will apply. While it may, therefore, be argued that no NFTs are presently covered by the new tax regime, there is a possibility that the tax authorities will elect to tax NFTs under the cryptocurrency head as the definition includes tokens and may be considered wide enough to include NFTs. It would, therefore, be prudent for taxpayers to assume that the NFTs they acquire, sell, and, or, otherwise deal with are likely to be taxable under the regime.
Under the Income Tax Act:
Difficulties may arise in determining a taxpayer’s taxable income or gains from the receipt or transfer of a VDA:
Where a VDA is received without consideration or for a consideration lower than the fair market value, difficulties may arise in determining the person’s taxable income in respect of the asset. Cryptocurrencies and NFTs are generally extremely volatile with valuations fluctuating on a regular basis. Therefore, it may be difficult to pinpoint the fair market value of the asset.
Where cryptocurrency is purchased on a crypto-exchange or an NFT is purchased on a marketplace, it may generally be argued that the fair market value is the price prevailing on that exchange or marketplace at the time of the purchase.
However, this may not hold water with the income tax authorities as fair market value under the Income Tax Act is to be determined in accordance with the Income Tax Rules, 1962 (Rules). While the Rules do prescribe mechanisms for determining the fair market value of various assets, they do not specifically deal with the valuation of VDAs, thus creating a lacuna.
Problems may also arise where a person is liable to tax on transfer of a VDA. The only deduction permitted on the income earned from the transfer of a VDA is the cost of acquisition. Where a VDA is purchased and sold for an identified amount in INR or in a foreign currency, the income and the cost of acquisition are easily identifiable. However, if a VDA is acquired using, or sold in exchange for, another VDA (example an NFT is purchased using Bitcoin), the cost of acquisition and, or, consideration for the transfer of the VDA may be difficult to ascertain as a specific INR value for the acquisition and, or, transfer will not be readily available.
The difficulties in valuing VDAs for the purpose of taxation could lead to disputes with the tax authorities.
The Government has also confirmed that expenditure incurred in mining cryptocurrency is considered capital expenditure and not a cost of acquisition. Therefore, the considerable expenditure on the hardware required to mine cryptocurrency cannot be deducted from any income derived from the transfer of cryptocurrency. While no clarification is available in respect of the deduction of costs incurred to mint NFTs, these costs will likely be treated in the same manner as mining costs for cryptocurrencies.
The Income Tax Act expressly prohibits the set-off of losses from transfers of VDAs against income or gains derived from other VDAs. Illustratively, if a person were to sell an NFT and incur a loss, the loss cannot be set-off against a gain made on the transfer of another VDA. Illustratively, if A sells an NFT artwork for a loss of INR 10,000 and then sells units of Ethereum for a profit of INR 50,000, A would be liable to tax on the entire profit of INR 50,000 from the sale of Ethereum and would not be able to set-off the loss of INR 10,000 on the NFT.
Essentially, under the Income Tax Act, gains and income from VDAs are taxable but no relief is provided in the event losses are incurred, and, to that extent VDAs are taxed differently than most other assets in India.
The Income Tax Act further complicates matters by requiring that, where a resident transfers a VDA for consideration, the person responsible for paying that consideration must deduct 1% of the consideration at source as income tax. The requirement to deduct 1% of the consideration applies irrespective of whether the consideration is in cash, partly in cash and partly in consideration for another VDA, or in consideration for only another VDA.
The obligation to withhold tax may also be imposed on the owner of the blockchain on which NFTs are traded (whether or not they are resident in India) as they may be considered e-commerce operators facilitating the trading of NFTs.
Tax does not need to be deducted where:
A “specified person” is defined as an individual or Hindu undivided family:
As a consequence, tax will generally need to be deducted at source by most persons acquiring VDAs unless they fit the criteria of “specified persons” or only make purchases of VDAs infrequently and for small amounts.
The new taxation regime introduced by the Government does not appear to take into account the nuances of cryptocurrencies and NFTs. Prior to the amendment of the Income Tax Act, experts in India and elsewhere had raised questions as to how cryptocurrencies and NFTs should be classified – capital assets, currency, securities, etc. An analysis of the nature of each category of VDAs is crucial to the formulation of a clear and effective tax regime.
Other countries, particularly, in the developed world, have adopted various approaches to the taxation of VDA. Their approach appears to be predicated on how they classify VDAs.
As NFTs are still a relatively new concept, many developed nations have yet to formulate specific policy for their taxation. At present, most developed nations, other than Malta, appear to tax NFTs in the same manner as cryptocurrencies. Malta has created a framework for DLT assets — which it categorizes as coins and tokens — and taxes coins in the same manner as fiat currencies and levies income tax on returns earned from financial tokens.
Indian legislation in respect of VDAs is clearly still evolving. While the Government has notified the new tax regime, the regime will likely be amended over time.
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