Crypto taxation in the Finance Act, 2022: The Indian conundrum

Introduction

In November 2021, the government floated the idea that it was going to introduce ‘The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021’, to lay down a framework for regulating transactions involving cryptocurrency. However, come February 2022, the Budget Session did not witness the tabling of the proposed Cryptocurrency Bill, instead it was announced that cryptocurrencies will be taxable under the Income-tax Act, 1961 (‘Act’) as ‘virtual digital asset’[1]. From 1 April 2022, India will tax gains from the transfer of virtual digital assets at 30%, while TDS under Section 194-S of the Act will be deducted from 1 July 2022 at a rate of 1%, on every transaction, i.e., any buyer of virtual digital assets will have to deduct 1% of the consideration paid to the seller.

Definition of Virtual Digital Asset

The Finance Act, 2022 has inserted clause (47A) to Section 2 of the Act prescribing definition of ‘virtual digital asset’ (‘VDA’). The proposed definition appears to be very wide in nature. It emphasises on certain key features of a VDA such as it being in the nature of an information or code or number or token which has been generated through cryptographic means or otherwise; digital representation of value which is exchanged with or without consideration; transferability, storage or electronic tradability. The VDA, as defined above, also has key attributes of ‘money’ such as store of value or unit of account or having inherent value, etc. However, the proposed definition of VDA does not make reference to it being based on ‘distributed ledger technology’ or ‘blockchain’. It places key emphasis on ‘cryptography’ which is the technique of protecting information by transforming it (i.e. encrypting it) into an unreadable format that can only be deciphered (or decrypted) by someone who possesses a secret key. Cryptocurrencies such as Bitcoin, are secured via this technique using an ingenious system of public and private digital keys. The encrypted information is converted form of the original message sent by one user, in the form of number or a code or token. This converted form itself contains the information about the original message. Also, this definition is wider than the definition of digital asset expressed by FATF or OECD or UK Money-Laundering Laws.

Taxable event

The taxable event related to VDA can be either on its creation or on storage and transfer or on exchange or on evolution of token. However, the Finance Bill, 2022 has proposed to treat ‘transfer’ of VDA as the taxable event. Though in the Finance Bill, 2022 the definition of ‘transfer’ was not provided, but when FB 2022 received the assent of President, Section 115BBH, as introduced, was amended to specifically provide that the definition of ‘transfer’ as contained in Section 2(47) shall apply, irrespective whether VDA is a capital asset or not. Therefore, any transaction in VDA by which it changes hands such as, (i) disposal of VDA from one person in favour of another for a consideration; or (ii) exchange of a VDA for another VDA; or (iii) in consideration of receipt of goods or service; or (iv) gift etc., shall be treated as ‘transfer’ under Section 2(47) of the Act and accordingly, subject to taxation under Section 115BBH of the Act.

Computation of Income from transfer of VDA

The proposed Section 115BBH states that except cost of acquisition, deduction of any expenditure or allowance or set-off of any loss under any provisions of the Act, shall not be allowed. It further provides that loss from transfer of virtual digital asset computed under Section 115BBH shall not be allowed against income computed under any provision of the Act. Thus, income shall be arrived at after deducting ‘cost of acquisition’ from the consideration received on transfer of VDA. Further, if a person has acquired multiple VDAs at different points in time which are then transferred in tranches, then the proposed Section 115BBH does not provide any guidance as to how income shall be computed. That is, whether by following ‘First-in-First-Out’ method or ‘Last-In-First-Out’ method. 

Income – whether taxable as PGBP or as capital gains?

Section 115BBH only deals with the rate at which income from transfer shall be taxed. It does not provide the head of income under which income from transfer of VDA shall fall. But, in the absence of any amendment in heads of income or any express indication, it cannot be argued that income from transfer of VDA shall not be included in any head of income and be treated and disclosed separately, not falling under any head of income. Determining whether income from sale of VDAs must be charged under the head PGBP or under the head capital gains is a fact specific exercise.

India’s crypto-tax rate: Too harsh?

While several countries have chosen to specifically define cryptocurrencies either as a capital asset or currency for tax-treatment, India will treat cryptocurrency as an asset class, i.e., as a ‘virtual digital asset’, thus giving the government the power to include other (emerging) products of the block-chain ecosystem under the 30% tax rate umbrella, as it deems fit. In the wake of the announcement of taxation of cryptocurrencies, industry professionals, investors and cryptocurrency enthusiasts have expressed concerns that a 30% tax rate will increase their tax burdens and discourage trading/investing in cryptocurrencies and other digital units. In order to examine how India’s taxation regime towards crypto-currencies compares with the rest of the world, it is important to monitor the tax-treatment adopted by some countries: -

Despite the opinion that a tax-rate as high as 30% on crypto-investments is likely to disincentivise young investors and crypto-enthusiasts in the Indian market, India fares on a reasonable scale compared to countries like Australia, USA and Canada where, tax on crypto-currencies fall within a range of 37%-50%.

Taxation of income-generating transactions in the ‘Metaverse’ by India

The ‘Metaverse’ is a platform or network of virtual worlds where users can interact with each other, through a mix of virtual and augmented reality, enhanced by the purchase and trade of digital commodities. In the recent past, we have witnessed several transactions taking place in the Metaverse. E.g. Pricewater Cooperhouse Hong Kong acquired LAND, a Non-Fungible Token (NFT) representing virtual real estate in The Sandbox Metaverse. Luxury brands like Gucci, Burberry, Dolce and Gabbana have partnered with platforms like Roblox, Tencent Games to create luxury clothing items as NFTs that can be collected and owned by end users. In this backdrop, there is a greater need of clarity on how similar transactions will be taxed in India?

Recently, ITC Ltd.’s, luxury chocolate brand Fabelle promoted one of its products ‘considered as the world's most expensive chocolate, priced at INR 4.3 lakh per kg in a Metaverse wedding. ITC Ltd. distributed digital versions of Fabelle’s chocolates as gifts during the wedding and facilitated the purchase of physical versions of the digital chocolates for consumption by the attendees. This scenario could be one of many such existing or emerging transactions that are necessary to be analysed for the purpose of taxation under the Income-tax Act, 1961. In Fabelle’s case, the key issues are: - (i) the concept of ‘gift’ vis-à-vis Section 115BBH of the Act read with Sections 56(2) and 2(47A) and (ii) classification of the income generated to ITC Ltd, from the transfer of the virtual digital asset under Section 14 of the Act.

Under Section 115BBH, any gift in the nature of virtual digital asset as defined under Section 2(47A) of the Act, will be subject to tax in the hands of the receiver at 30% as provided in the Finance Act, 2022. However, it is not clear whether relaxations provided under Section 56(2) of the Act, on gifts given to or received from specified relatives on specific occasions, will also apply in the case of gifting virtual digital assets. Therefore, the gifts given by Fabelle will be liable to tax under Section 115BBH in the hands of the receiver(s) at 30% unless the relaxation under normal gifting provisions are made applicable to Fabelle’s case as well.

Taxation of crypto gains until now and the way forward

The end of the financial year witnessed several anxious queries from concerned crypto-investors and enthusiasts regarding the application of the proposed crypto-currency tax-regime. As of now, the 30% tax proposed in the Finance Act, 2022 on gains from the sale of virtual digital assets was not levied and existing income tax rules seem to have been made applicable till the end of March 2022. However, with the new law coming into effect from 1 April 2022, crypto-investors will require guidelines to conduct their business and navigate paying taxes on crypto-gains going forward. The government has announced that it is working on preparing a Frequently Asked Questions (FAQ) document regarding virtual digital assets and the taxation of it for end users, for the purposes of GST and Income-tax. The Department of Economic Affairs, the Department of Revenue and the Reserve Bank of India are jointly preparing the FAQ to provide the required clarity on the taxation aspect stated in the Finance Act, 2022, for tax offices on the field as well as crypto-dealers and investors of other virtual digital assets.

[The Author is an Associate in Direct Tax Team, Lakshmikumaran and Sridharan Attorneys, Mumbai]

[1] Section 2(47A) of the Income-tax Act, 1961.