Taxation of Virtual Digital Assets

Date:

VIRTUAL DIGITAL ASSETS

In 2009, Satoshi Nakamoto, a supposedly pseudonymous inventor, invented Bitcoin, the world’s first decentralized cryptocurrency. Since then, cryptocurrencies have drawn investors from all demographics. The economic and central bank conflict with cryptocurrencies is well-known. In India, the Supreme Court of India removed the Reserve Bank of India’s (RBI) prohibition on cryptocurrencies on 4 March 2020.

The judgement did not provide regulatory guidance but merely rejected the RBI circular on the grounds that it violated the basic rights of persons involved in virtual currency-related companies without offering an appropriate justification. Since then, India’s growing investment base has not looked back. According to industry estimates, India has between 15 million and 20 million

cryptocurrency investors, with total crypto holdings of roughly 400 billion rupees ($5.37 billion). Given the enormous number of players in this field, the clarity on cryptocurrency taxes is a positive step.

BUDGET 2022 AMENDMENTS

1. THE MEANING OF THE TERM “VIRTUAL DIGITAL ASSET” [SECTION 2(47A)].

In simple terms, the term “virtual digital asset” refers to a cryptocurrency, a non-fungible token, or any type of virtual digital asset as determined by the Central Government. It excludes subscriptions to any over-the-top (OTT) platform, mobile applications, or e-commerce platforms.

2. CLASSIFICATION OF DIGITAL ASSETS IN THE VIRTUAL WORLD

The government has not specified whether the virtual digital assets would be classified as a money, commodity, or security. If no such clarity is forthcoming, the virtual digital asset should be classed as a capital asset. According to Section 2(14) of the Income Tax Act, a capital asset is any property owned by an individual, whether or not it is related with his company or profession. Although the term ‘property’ has no legal definition, it encompasses all potential interests that a person might acquire, own, or enjoy.

As a result, cryptocurrencies or NFTs should be treated as capital assets if they are acquired for investment purposes by taxpayers. As a result, any gain on the disposition of such assets will be taxed as capital gains. However, if the taxpayer engages in considerable and frequent transactions in such assets, it should be determined that the taxpayer is trading in such assets. Income from the sale of such assets should be taxed as company income in this scenario.

3. CAPITAL GAINS TAXATION [SECTION 115BBH]

I. The Characteristics of Virtual Digital Assets

If profits on the transfer of virtual digital assets are recognized as capital gains, they are further classified as short- or long-term gains depending on the time of ownership of such assets. If a virtual asset is kept for more than 36 months from the date of purchase, it is classified as a long-term capital asset; if it is retained for less than 36 months, it is classified as a short-term capital asset.

II. Capital gains computation

There will be no deduction for any expense or allowance. Section 115BBH(2)(a) specifies that the assessee shall not be permitted to deduct any expenditure (other than cost of acquisition) or to allow or set off any loss in computing the income referred to in Section 115BBH (1) (a). In other words, no other deduction or exemption must be permitted for computing short- or long-term capital gains, save for acquisition costs.

III. Capital gains tax rates

According to Section 115BBH (1), revenue derived from the transfer of virtual digital assets is taxed at a rate of 30%. Thus, both short- and long-term capital gains are taxed at a single rate of 30%. Additionally, no deduction or exemption under Chapter VI-A or Section 54F shall be permitted on such capital gains. However, remedy according to Section 87A may be sought.

IV. Rates of surcharge

The surcharge rate that will be applied to short- and long-term capital gains on the transfer of virtual digital assets.

FAIR MARKET VALUE DETERMINATION OF VIRTUAL DIGITAL ASSETS

The virtual digital asset’s fair market value for purposes of determining its taxability under Section 56(2)(x) shall be established in accordance with Rule 11UA.

I. If obtained from a licensed dealer

If the virtual digital assets are acquired from a registered dealer on the valuation date, their invoice value shall represent their fair market value.

II. If the message is received in another mode

If the virtual digital assets are acquired by another means (e.g., mining), their fair market value must be evaluated to be the price at which they would sell in the open market on the valuation date. If the assessee’s asset is valued at more than Rs. 50,000, the assessee may seek a report from a registered valuer indicating the amount the asset would receive if sold in the open market on the valuation date.

TAXATION OF BUSINESS INCOME UNDER THE HEAD BUSINESS INCOME

If the taxpayer engages in considerable and frequent transactions in virtual digital assets, it should be determined that the taxpayer is trading in such assets. Income from the sale of such assets should

be taxed as company income in this scenario. Gains (net of any expenses or allowances) must be taxed at a flat rate of 30% plus the surcharge (as described above) and cess.

NO SET-OFF OR CARRY-FORWARD OF LOSSES ON VIRTUAL DIGITAL ASSETS IS PERMITTED.

Section 115BBH(2)(b) specifies that no set-off of loss from the transfer of the calculated virtual digital asset against income computed under any other provision of this Act must be permitted to the assessee, and such loss shall not be carried forward to successive assessment years.

It is self-evident that capital losses incurred through the transfer of virtual digital assets cannot be offset against other capital gains subject to intra- and inter-head adjustment laws. In other words, the short-term capital loss associated with the selling of a cryptocurrency cannot be offset against the short-term capital gain associated with the sale of listed securities. Similarly, long-term capital losses on NFTs cannot be offset against long-term capital gains on mutual fund sales.

However, losses on one virtual digital asset should be permitted to be offset against profits on another. Section 115BBH(2)(b) makes it unlawful to set against losses on virtual digital assets determined pursuant to Section 115BBH(1)(a) against income computed pursuant to any other provision of this Act. Because capital gains from the transfer of other assets are computed and taxed separately from income from the sale of all virtual assets, such set-off of loss from one virtual asset against revenue from another virtual asset is permitted. This set-off is subject to the existing intra- and inter-head adjustment regulations.

SECTION 194S-TAXES DEDUCTED AT SOURCE (TDS)

To broaden the tax base derived from these transactions, it is suggested to amend section 194S of the Act to provide for the deduction of tax on payment for the transfer of a virtual digital asset to a resident at the rate of 1% of such sum. However, no deduction will be necessary if the consideration paid during the fiscal year does not exceed Rs. 50,000/- (in the case of a specified person) or Rs. 10,000/- (in the case of a non-specified person) (in any other case).

GIFTS OF VIRTUAL DIGITAL ASSETS ARE TAXABLE

In Section 56(2)(x), the term “property” must encompass virtual digital assets. Thus, income derived from gifts or transfers of virtual digital assets for insufficient compensation will be taxed in the recipient’s hands.

FINAL COMMENTS

To minimize misunderstanding and litigation, the Finance Ministry is going to provide a clear set of rules for authorities on the tax handling of crypto transactions. While addressing the foregoing areas of ambiguity, it is envisaged that the recommendations would help clarify the situation in the past, when assessees took diverse positions—some treating crypto transactions as capital gains, others as business income, and still others as not income at all. The recommendations are expected to follow a consistent approach with regard to treatment under Indian goods and services tax regulations.


Edited By: Khushi Thakur

Published By: Bhavya Dedhia

Sahiti Annam
Sahiti Annam
Sahiti is a Law student pursuing BBA.LLB at Symbiosis International University, Pune. She also holds a Diploma in International Business laws & Indian Corporate Laws. Her primary interest areas are Bankruptcy Laws, Company laws, Blockchain & Data Protection Laws, Banking Laws, and Laws relating to Intellectual Property Rights. Having been a professional lawn tennis player and an avid sports enthusiast, she is capable of handling her wins and losses well. Her adaptability makes her an excellent team player.

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