TAXING REGIME FOR VIRTUAL ASSETS

Authored By: Akshat Jain Designation: Law Student { Institute of Law, Nirma University}

ABSTRACT

Cryptocurrency is a virtual or digital currency. Robust security is provided by cryptography, and using cryptocurrency makes it nearly impossible to double spend or counterfeit. A decentralised network based on the Blockchain idea underlies a cryptocurrency (Distributed Ledger). Cryptocurrency exchanges take place between willing parties without the assistance of brokers or regulatory bodies. Due to the rising popularity of cryptocurrencies, the Indian government has begun taxation on cryptocurrencies.

Nirmala Sitharaman, the finance minister of India, recently declared that the government would impose a 30% tax (the highest tax bracket in India) on revenue derived from cryptocurrency. A tax on digital assets is imposed as of the Financial Bill of 2022 to profit from their higher potential future appreciation. Additionally, there is significant potential for future growth regarding cryptocurrencies. The tax on cryptocurrencies in India creates an actual transaction since investors are maximising their investment in purchasing and selling digital assets to generate profits.

Through this research article, an attempt has been made to understand the new tax regime on virtual assets, i.e., cryptocurrency in India. We first understood what cryptocurrencies are and what their objectives are. We discussed the new tax regime and compared it to the taxation policy globally. This article critically analysed the new tax regime and discussed alternate taxation regimes that could have been adopted.

KEYWORDS: Cryptocurrency, Union Budget, Taxation.

INTRODUCTION

Cryptocurrency is described by its promoters as “an innovative payment network and a new kind of money,”¹ Cryptocurrency is any digital or virtual money that employs encryption to safeguard transactions. Cryptocurrencies lack a central issuing or regulating body and rely on a decentralised system to record transactions and issue new units.

As a financial invention, it has gotten much attention.² This interest stems less from cryptocurrency’s capabilities as a digital medium of exchange and a store of wealth and more from the decentralised character of Cryptocurrency transactions. Unlike traditional currency and financial products, Cryptocurrencies are not issued by a central bank. Instead, anybody may attempt to “mine” Cryptocurrencies by utilising computers built to predict answers to a computational problem. Thus, cryptocurrency is neither a commodity currency (backed by gold or another commodity) nor a fiat currency (used by convention as a result of a legal edict).

Cryptocurrencies operate on the blockchain, a distributed public database that keeps track of all transactions that are updated and retained by currency holders. Mining is a technique that uses computing power to solve complex mathematical problems that generate cryptocurrency units. Users may also purchase the currencies from brokers and then store and spend them using encrypted wallets. A person who owns cryptocurrency does not possess anything physical. They hold a key that lets them transfer a record or unit of measurement from one person to another without the assistance of a trusted third party.

Taxation is the imposition of mandatory taxes on persons or companies by governments in practically every country worldwide. Taxation is primarily used to raise revenue for government expenditures, but it can also be used for other purposes.³

Tax fulfils various government requirements, including but not limited to revenue generation, regulation of consumption and production, stimulating investment, reducing income inequalities,

and promoting economic growth. Taxation occurs when a government or other authority requires that citizens and corporations pay a fee to that authority. The fee is involuntary and, as opposed to other payments, not linked to any specific services that have been or will be provided.

According to the Internal Revenue Service (IRS), most cryptocurrencies are convertible virtual currencies. This implies they may be used as a medium of exchange, a store of value, a unit of account, and can be used in place of actual money.⁴

This also implies that any earnings or revenue generated by cryptocurrencies are taxed. However, there is a lot to unpack regarding cryptocurrency taxation because you may or may not owe taxes in specific scenarios.

OBJECTIVE AND A BRIEF EXPLANATION OF THE MARKET OF CRYPTO ASSETS

Crypto Assets are a form of digital currency formalised from the decentralised process of Blockchain Technology. Crypto assets are differentiated from other digital assets as they are decentralised and have no government backing. Also, the Crypto Assets are transacted between two anonymous parties as Blockchain Technology transactions are permanently anonymous. Crypto assets have gained prominence recently as they have faced a seismic shift in the financial markets.

A crypto asset is an intangible digital asset because it lacks physical substance (intangible), but it is digitally identifiable (digital) and is held in anticipation of future economic benefits (asset).

A crypto asset does not meet the definition of cash or a financial instrument under current standards because it does not represent a claim or contractual relationship that results in monetar y or financial liability on any identifiable entity. Crypto assets’ underlying technologies have come a long way and could change and disrupt the financial system. A crypto asset is an intangible digital asset whose issuance, sale, or transfer is encrypted and shared electronically through a distributed ledger. A distributed ledger (blockchain) contains issuance and transaction records.⁵ In

order to implement its consensus protocols, the first cryptocurrency, Bitcoin, was built utilising blockchain architecture in 2009. A blockchain is a continuously expanding chain of records of transactions that have been cryptographically safeguarded. When the remote computers have finished cryptographically protecting the data, blocks are formed. When a new block arises, the opportunity to receive cryptocurrency incentives motivates anonymous global actors to work on preserving and protecting the data.⁶

Since Bitcoin’s inception, the cryptocurrency market has evolved erratically and at an unprecedented rate. Cryptocurrency is not a stock in which to invest. It should not be analysed in this manner. The stock market is scrutinised. The market’s volatility is high, and it is difficult to predict which factors will influence it. Because cryptocurrencies are not restricted within borders, they can influence how much at any time.⁷

The Market of Crypto Assets is where the crypto assets are transacted and regulated. In the current scenario, India does not have enough technological advancement to regulate the crypto assets market due to the decentralised mechanism involved in transacting them. Since it is impossible to bring a uniform code for the transactions of Crypto Assets, much has not been done to regulate the same. An unregulated system will attract many problems like money laundering and fraud.

THE TAXATION REGIME ON CRYPTOCURRENCIES INTRODUCED IN 2022

Finance Bill 2022 and other provisions and changes also imposed new taxation rules for digital assets such as cryptocurrencies. This application of taxation is merely two-fold at the face, but it is to resolve these multi-faceted problems related to cryptocurrency from a deeper level. This new regime seeks to decrease the increasing popularity of crypto and start regulating aspects of such income and transfer. It also helps to build a concrete transaction and not just a regulatory check; this way, the government can earn more revenue. Before the bill, such transactions were not observed or scrutinised, and income was not taxed at such high rates, but now they are.

The Finance Bill 2022 also defines Virtual Digital Assets under Section 3, which enlists the amendments for the Income Tax Act, for an easement for taxation purposes which includes cryptocurrency under 3(b) with an insertion in Section 2 with clause (47A).

Now, cryptocurrencies are termed digital capital assets for taxation purposes in India. Therefore, this virtual asset comes under the head Capital gain, and the income under this gain will be a transaction on the same.⁸

To understand taxation on cryptocurrencies, we must look at the same, that is, by dividing it into parts such as: –

1. Direct Tax Rate

In the 2022 budget, Section 115BBH was added, which dictates the taxation of profits earned from cryptocurrencies which were hiked to 30%. For example, if crypto is bought at 10,000 Rs and sold at Rs. 20,000, the profit of 10,000 Rs will be taxed at 30%, which will be 3000Rs directly as tax. It also Enlists that only profit and loss emerging from the same cryptocurrency can be set off against each other.

Such tax shall only arise at the time of the sale of such asset. In case of loss, the assesses will not be held liable for taxes.

• TDS on Transactions

New Rules also impose a 1% amount as TDS which will be deducted at the source. The said deduction will be made by the crypto exchanges used in a transaction.

The TDS amount is the deduction from the actual transaction value of cryptos. For example, if you bought a cryptocurrency for ₹ 10,000 and sold it for any profit, you will get Rs. 9900. Then again, if you invested this amount in any other digital asset and sold it with a loss, the 1% TDS will then also get deducted, and you will get Rs. 9801.

Additional Rules and Provisions

1. No deduction for any expenditure is allowed except the cost of acquisition.

• Loss from the transfer of virtual digital assets cannot be set off against any other income.

The gift of a virtual digital asset is also to be taxed in the hands of the recipient.

TAXATION POLICY GLOBALLY

Companies can make a significant contribution to society all around the world by paying taxes. Governments must ensure that taxation is transparent and non-discriminatory as the business expands internationally for everyone to benefit from free trade and investment.

Taxation is an essential instrument for national governments, but it can be challenging tocoordinate across different nations worldwide. However, international cooperation is crucial if businesses want to invest abroad and participate in global trade.

In almost every nation, taxes are the government’s most significant source of income. The International Centre for Tax and Development’s most current estimates show that tax collections make up more than 80% of total government income in almost half of all nations and more than 50% in virtually all of them.

A notable economic development during the past two centuries, shown historically, is the expansion of governments and the degree to which they can raise money from their constituents. The long-term data demonstrate that states have raised tax levels while also altering taxation patterns during development, primarily by emphasising broader revenue bases.

Today’s global taxation practices show significant cross-country disparities, particularly between industrialised and developing nations. Mainly, rich nations today collect far more taxes than developing nations as a percentage of their national GDP, and they frequently rely more on income

taxation to accomplish so. In contrast, developing nations place a greater emphasis on consumption and trade taxes.⁹

Even after accounting for underlying variations in economic activity, the data reveals that wealthy countries collect substantially more tax income than developing countries while having comparable statutory taxation rates. This shows that variations in tax compliance and the effectiveness of tax collection methods account for a considerable portion of cross-country heterogeneity in fiscal capacity. The effectiveness of political institutions appears to impact each of these variables.

While it is true that taxes have a significant redistributive impact, it is also crucial to consider how they alter economic incentives, which in turn change how people behave.

In recent years, countries have discussed significant adjustments to the international tax laws that apply to multinational corporations. Over 130 OECD member countries approved the general framework for new tax regulations last October due to deliberations at the organisation.

Large corporations would pay more taxes in the nations where they have clients and less in the nations where their offices, personnel, and operations are located. The pact also specifies a 15 per cent global minimum tax, which would raise taxes on businesses with earnings in low-tax areas. The agreement is currently being turned into legislation as governments create implementation strategies.

GLOBAL TAX PROGRAM

The Global Tax Program (GTP) supports technical assistance and consultancy services to enhance tax administrations and raise funds fairly and effectively internationally and domestically.

A vital component of the worldwide 2030 Financing for Development strategy is domestic revenue mobilisation (DRM), which reflects the funding required in many developing nations to achieve Sustainable Development Goals (SDGs).

A crucial tool for implementing the Bank’s domestic revenue mobilisation (DRM) Approach is the Global Tax Program. This strategy focuses on helping nations raise more and better revenues to fulfil the SDGs by (i) fostering equity, fairness, and inclusive growth and (ii) fostering a stable, predictable, and sustainable fiscal environment.

Considering the COVID-19 crisis and through initiatives like greening tax systems, reducing consumption of unhealthy products, promoting gender equality, and combating tax evasion and avoidance, taxes have a crucial role in ensuring sustainable, inclusive growth and equity.

THE WORLD BANK’S GLOBAL TAX PROGRAM UMBRELLA¹⁰

• The Global Tax Program (GTP), housed at The Fiscal Policy and Sustainable Growth Unit of the World Bank, was launched in June 2018.

• GTP portfolio consists of bank-executed advisory and technical assistance projects.

• The DRM Pillar helps countries strengthen their tax systems.

• A temporal GTP Fiscal Policy Pillar was launched in 2021 to support governments in mitigating the social and economic impact of the COVID-19 pandemic.

• The gender Equality and Tax Reform Workstream helps countries achieve gender equality goals.

• Health Tax Workstreams supports countries in reforming excise taxes on tobacco, alcohol and sugar-sweetened beverages (SSBs).

A CRITICAL VIEW ON THE POLICY

The taxation on virtual assets brings legitimacy to the industry, but the quantum of tax imposed is discouraging. The finance minister declared the tax rate at 30% on income from crypto-related transactions and equated it with the tax on gains from speculative activities such as lotteries, gambling and other gambling activities.

Crypto can be classified as an asset class and an investment product. Trading crypto assets requires specific skills and cannot be compared to gambling. The tax rate should have been on par with other asset classes to foster the industry’s growth.

Moreover, while profits from crypto trading will be taxed at 30%, losses cannot be set off against or carried forward. Like any business or asset, the crypto industry also experiences vicissitudes. Being able to carry forward losses would reduce the tax burden on investors. The government allows share investors to carry forward their losses, and crypto trading should have been treated similarly.¹¹Making income tax return filing mandatory, even if the annual income is less than Rs. 5 lakhs, will lead to unnecessary work for both assesses and the tax department.

Moreover, there is a lack of clarity on classifying cryptocurrencies in GST. Further, the provision of services outside India and getting paid in cryptocurrency is not to be classified as export as one of the conditions for classification according to GST provisions is that the “payment must be received in convertible foreign exchange or Indian rupees, whenever permitted by the RBI.” Since crypto is not a legal tender, it fails to fulfil this condition of export. The government may consider such service supply as domestic supply and tax it accordingly. As of now, no legal clarification is present in this respect. One can only think of possible implications under GST on transactions connected in addition to that.¹²

PURPOSE OF CRYPTOCURRENCIES

Cryptocurrency is a digital currency that uses cryptography to regulate the creation and transfer of money. The cryptocurrency was created to enable anonymous wire transfers. Further, it can now be employed as a potent investing tool to generate income. Cryptocurrencies, like fiat money, are universally accepted currencies that may be used as a standard when dealing in the market.

By eliminating the need for institutional arbitrators to oversee transactions, such as banks, cryptocurrencies help streamline money. Under this type of mechanism, it is implausible for a financial crisis—like a recession—to develop because of a single point of failure.

In recent years, Bitcoin has also developed into one of the most lucrative—though risky— investments. The following are the significant subheads explaining the purpose of cryptocurrencies. They are as follows:

1. Autonomy

When cryptocurrencies were intended for online transactions, their primary goal was to design a system that made it possible to send payments to decentralised intermediaries. In the end, a centralised authority was not required to oversee business dealings between two parties.

While using a digital currency to do business between two parties is viable, the centralised institution oversees the monitoring of these transactions and has the power to ignite a global crisis.

You are the only person who has access to the cryptocurrency. Since cryptocurrencies are decentralised and stored in a distributed ledger, no authority can ban them. This indicates that there is no central organisation in charge of managing cryptos.

• Cryptocurrency Is Almost Impossible to Forge:

The distributed ledger, or blockchain, is the platform on which cryptocurrency runs. If someone wanted to alter just one block of data on the chain, they would have to change every block going forward and update every machine with a copy of the blockchain ledger. Although

it is technically possible, the number of resources required to accomplish it would make any effort impossible.

• Cryptocurrency Transactions Are (Mostly) Confidential

Government-issued conventional currencies allow for private transactions or in-person payment of goods and services. Large cash withdrawals are rapidly noted and examined by central authorities, such as banking system regulators or governments.

The flexibility of cryptocurrency to carry out peer-to-peer transfers anonymously is a significant advantage. This makes it possible for assets and money to be transferred without government intervention. Along with becoming more consistent in price over time, it has expanded the range of transactions for which it can be utilised.

• Protection Against Inflation

Inflation has caused the value of several currencies to decline. Almost all cryptocurrencies have a fixed starting balance. The amount of each currency, such as the 21 million Bitcoins, is displayed in the source code. Its price will rise together with demand, keeping pace with the market and preventing inflation.

TAXATION OF CRYPTOCURRENCY: WHETHER A REGULATORY OR MORE THAN THAT

The budget 2022 introduced the norms of taxation on cryptocurrencies—the players in the market’s long-awaited cryptocurrency tax. The finance bill cleared the way to implement a tax on Virtual Digital Assets, i.e., crypto. In essence, any one of the Digital Assets (Virtual Digital Assets) cannot be made up for by a loss in another Digital Asset. In other words, you will be required to pay tax if you have profited from digital assets.

The amendment defined what cryptocurrencies are, the classification of digital assets and the process of taxation on cryptocurrencies as per the IT act. The Bill’s Section 115BBH addresses taxation on virtual and digital assets. According to clause (2) (b), losses from digital trading assets cannot be offset against earnings under “any other provision” of the IT Act.

The term “other” is removed following the amendment. The amendment prohibits offsetting losses from crypto assets against profits in such assets. It is now evident as a result of this amendment that neither cryptocurrency losses nor other provisions may be combined with the gains of any other cryptocurrency. While the profit must be taxed, the investor will be responsible for the loss.

Governments are concerned about using cryptocurrency because it is not regulated. The legislation resulted in stricter regulations for cryptocurrencies. It can be seen that the legislation wanted this amendment to be more than just a mere regulation.

ALTERNATIVE TAXATION REGIMES THAT COULD HAVE BEEN ADOPTED

The anonymity associated with cryptocurrency transactions is often identified as a fundamental roadblock in effectively regulating the sector. This feature also differentiates cryptocurrencies from other more traditional financial instruments and may affect the efficacy of any tax enforcement measures. However, as far as bitcoins and many existing cryptocurrencies are concerned, this issue has recently been established as being relatively less complicated. “Contrary to common perception, most existing cryptocurrencies do not provide complete anonymity.” bitcoin is a pseudonym. Therefore, Bitcoin transactions are typically linked to the wallet address instead of the holder’s name.” bitcoin transactional records are kept on a public blockchain.

While a holder’s name may not be directly connected to a bitcoin transaction, the public network allows people to see everyone’s public address, and it “does not take much to pair an identity to a public key.” as a result, regulators can often “track crypto asset transactions by using metadata stored on the related blockchain and applying pattern analysis.”

In the future, taxpayers involved in the cryptocurrency ecosystem may be subject to monitoring and reporting frameworks by introducing new tax returns. Taxpayers should be able to classify their units as capital assets or stock-in-trade based on the nature of the holding with such returns.

Alternatively, if the government adopts the new income-tax regime of treating cryptocurrencies as a separate class of assets, the tax implications at the time of mining and staking must be explained. As explained in the previous sections of the working paper, the taxability of cryptocurrency creation is currently ambiguous due to a lack of clarity on whether the term ‘transfer’ includes the

activity of mining and staking of cryptocurrency. Further, because the new income-tax framework provides for a withholding obligation, taxpayers, especially cryptocurrency traders, may face specific practical challenges, such as keeping a record of sellers’ identity or tax residence, etc. A detailed assessment of the withholding obligation should be done to address these concerns.

CONCLUSION

Unfortunately, as they currently stand, these regulations discourage investors, especially novices, from entering and researching the market. Regulations and tax laws must be written to keep complexity and compliance minimum.

Sadly, if they do not change, the nation’s ability to innovate in cryptocurrencies will be severely hindered. We might also miss the opportunity to turn India into a leading cryptocurrency centre. There are already many worthwhile initiatives and a vast talent pool in the nation that can make this happen.

To draw people and businesses to their shores, several governments, including Singapore and Dubai, have already taken steps to be viewed as crypto-friendly.

Anyone considering entering this market should not be discouraged by the rules and tax laws as they currently stand or doubt its long-term potential. These issues will probably be seen as mere setbacks on the way to one of the most significant technological advancements of our time as the crypto space develops.

In India, the cryptocurrency industry is still in its infancy. There may be no stopping us once we find it and can strike the ideal balance between regulations that promote investment and aid in raising money for the government.

Reference

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⁶ Wulf A. Kaal and Craig Calcaterra, Crypto Transaction Dispute Resolution, Vol. 73, The Business Lawyer, 109, 111, (2017).

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¹⁰ SMARTER TAXATION CAN HELP BOOST GOVERNMENT REVENUE AND HEALTH OUTCOMES, 2022.

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