How Cryptocurrencies Are Taxed In India
[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.
How The New Tax on Income from Virtual Digital Assets (VDAs) Works
Assets Subject to the New Tax
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:
- Cryptocurrencies not being Indian or foreign currency (the proposed digital Rupee would seemingly be exempt as a result) – the specific terminology used under the Income Tax Act is “…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…”;
- NFTs or similar tokens as the Central Government may notify; and
- Such other digital assets as the Central Government may notify.
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.
When does Tax Liability Arise?
Under the Income Tax Act:
- Where a person receives a VDA without consideration and the fair market value of that VDA exceeds INR 50,000 – the entire fair market value of the asset is considered taxable income in the hands of the person who received the VDA. The applicable rate of tax will depend on the income tax bracket within that person ordinarily falls;
- Where a person receives a VDA for consideration lower than the fair market value, and the fair market value exceeds the consideration by more than INR 50,000 – the difference between the fair market value and the consideration paid is considered taxable income in the hands of the person who received the VDA. The applicable rate of tax will depend on the income tax bracket within that person ordinarily falls;
- Where a person earns income from the transfer of a VDA – the income earned by that person less the cost of acquisition, if any, is subject to tax at the rate of 30%. Additionally, an equalization levy of 2% will be levied on the non-resident owner of the blockchain on which NFTs are traded.
Difficulty in Determining Fair Market Value and, or, Gains
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.
No Set-Off or Carry Forward of Losses
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.
What Is Tax Deducted At Source For Cryptocurrencies
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:
- The consideration is paid by a “specified person” and the aggregate value of the consideration being paid does not exceed INR 50,000 during the financial year; or
- The consideration is paid by a person other than a “specified person” and the aggregate value of the consideration being paid does not exceed INR 10,000 during the financial year.
A “specified person” is defined as an individual or Hindu undivided family:
- whose total sales, gross receipts or turnover from the business carried on by him or profession exercised by him does not exceed INR 1 crore in case of business or INR 50 lakhs in case of profession, during the financial year immediately preceding the financial year in which such VDA is transferred;
- that does not have any income under the head “profits and gains of business or profession”.
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.
Key Concerns With Tax On Cryptocurrencies
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.
- At present, the Income Tax Act treats cryptocurrencies, NFTs and other VDAs homogeneously. While both cryptocurrencies and NFTs use DLT and blockchain technology, the similarities end there. Cryptocurrencies are, by their very nature, fungible while NFTs are not. Cryptocurrencies have limited application. NFTs, on the other hand, can be deployed in a number of ways – as art, instruments, certificates of ownership, etc.
- The fact that the Income Tax Act does not address the characteristics of VDAs and how they can be acquired and utilized could lead to confusion. Illustratively, if cryptocurrency is acquired through mining, is it considered to have been transferred to the recipient and, therefore, subject to the 30% tax? Alternatively, is it considered a receipt of a VDA without consideration making the fair market value of that VDA taxable in the hands of the miner? While experts have differing views on how the receipt of VDAs pursuant to mining will be taxed, the fact remains that the law does not address or clarify the position.
- The new taxes imposed on VDAs appear to be aimed at discouraging investment in such assets. The tax rate of 30% – applicable irrespective of the income bracket of the taxpayer – is similar to that imposed on other assets of which the Government appears to disapprove such as lottery winnings. The refusal to permit any deductions other than cost of acquisition, or to permit the set-off of losses, and the requirement to deduct tax are further evidence of the intention to discourage investments in VDAs.
- The Government has not prescribed the manner in which VDAs ought to be valued despite linking the imposition of tax in certain cases to the fair market value of the relevant asset. This will invariably lead to disputes and further reduce faith in the Indian tax regime.
- Finally, the decision to tax VDAs is not indicative of the legalization of cryptocurrencies or NFTs in India. In India, assets acquired through the proceeds of crime are subject to tax. Similarly, assets acquired in an illegal fashion (benami property or undisclosed foreign assets) are also taxed. The mere incidence of taxation cannot be interpreted as legitimization or legalization of VDAs.
Examples of How Cryptocurrencies are Taxed Outside India
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.
- Certain countries such as the U.S. consider cryptocurrencies to be property and tax gains derived from transfers. The fair value for the purposes of determining such gains is the price at which the cryptocurrency was trading on the exchange when the transaction was completed.
- In Canada and the UK, although the two countries classify cryptocurrencies differently (as commodities and capital assets, respectively), they may be subject to both income tax and capital gains tax depending on the relevant facts and circumstances – example, whether the cryptocurrency was acquired through professional mining or hobby mining).
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.
What Should Investors Do?
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.
- For the present, residents looking to invest, or trade, in VDAs must familiarize themselves with the new tax regime and, ideally, consult a tax advisor before commencing such activities. Ideally, to the extent that persons would like to trade in VDAs, they should do so on exchanges or marketplaces rather than through off-market transactions. This could help substantiate the fair market value of the VDA absent guidance from the Government.
- Taxpayers should also bear in mind the fact that their losses cannot be set-off against gains from another. Additionally, capital expenditure such as the cost of mining cryptocurrency or the cost of minting NFTs cannot be reduced from the gains made on VDAs.
- Persons seeking to acquire or deal in NFTs will also need to be vigilant and track the Government’s actions to determine whether the relevant NFTs are considered VDAs for the purposes of the Income Tax Act.