DECRYPTING TAXATION CHALLENGES OF CRYPTOCURRENCY IN INDIA

INTRODUCTION

The advent of cryptocurrency has sparked a shift in financial systems globally. Regardless of the government’s acceptance of this new monetary system, cryptocurrencies have managed to capture the attention and approval of the common man. The entry of these digital assets into India’s burgeoning digital economy brings with it a multitude of challenges including that of taxation. The lack of a regulatory framework coupled with the rapid evolution of blockchain technology and varying interpretations associated with these digital assets compound the challenge of addressing the issue.

 CRYPTOCURRENCY AND TAXATION

While the term cryptocurrency has no unified definition, the Oxford Dictionary defines it as “a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.” It is a virtual currency that uses cryptography for security and is transferred directly between users on a peer-to-peer network. The primary defining features of cryptocurrency are decentralization and the absence of intermediaries. These cryptocurrencies can be traced back to the 2010s, with the growing popularity of Bitcoin. These cryptocurrencies can be used for payments, foreign exchange, and cross-border payments and transfers. In the passage of a few years, cryptocurrency became a global phenomenon, gaining media attention and the support of enthusiasts.

This paradigm shift in user preference represents a significant potential tax base. Currently, this financial base does not fall within the government’s purview. Taxation would enable usage monitoring, curbing not just illicit activities but also market volatility, ensuring financial stability. The discourse on taxation of cryptocurrencies is an ongoing one. In 2018, the Reserve Bank of India issued a ban on banks dealing with cryptocurrencies. Later, this ban was overturned by the Supreme Court in 2020, leading to a surge in crypto trading. Policymakers have subsequently been exploring regulatory measures to address the challenge of cryptocurrencies.

CURRENT LEGAL LANDSCAPE

The sporadic legislative response to cryptocurrency has not been entirely accepting of this new-age digital money. Cryptocurrency has not yet been recognized as a legal tender, rather classified as a virtual digital asset (VDA). The Income Tax Act, 1961 was amended in 2022 following the Union Budget to introduce cryptocurrency taxation provisions:

• 2(47A) – defines VDAs as any information or code or number or token (not being Indian 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. It also includes non-fungible tokens and any other digital asset that may be notified by the Central Government.
• 115BBH – deals with taxation of income from VDAs, imposing a flat 30% tax, with no permissible deductions except the cost of acquisition. Losses cannot be set off against the gains from any other head.
• 194S – deals with Tax Deducted at Source (TDS) for virtual digital assets, imposing a 1% TDS on transfer of VDAs above Rs.50,000 for individual tax payer and R.s 10,000 for specified individuals and entities.
• 56(2)(X) – includes VDAs within the definition of property.

Another interesting aspect is the applicability of GST to cryptocurrencies. GST is generally payable on:

• sale of goods or provision of services within one state in India;and
• sale of goods or provision of services from one state to another state in India.

While it may be interpreted that exchange services operating within India should be subjected to 18% GST, the applicability to cryptocurrency assets themselves depends upon their classification as a “good” or a “service.” The Government has remained silent on this dilemma and hence, GST has not been implemented broadly or enforced on end-users or investors.

HURDLES TO TAXATION

The exigencies surrounding cryptocurrency taxation are multifaceted, exacerbated by the evolving nature of digital currency.

1. Classification of Cryptocurrency: While someview them as an asset or currency, others view it as a commodity to be bought and sold like any other property. This complicates the formulation of an adequate tax policy.
2. Valuation and Price Volatility: Unlike traditional assets, the value of cryptocurrency can fluctuate wildly in the span of a short period. This complicates determining a fair market value for taxation purposes as it may change at any moment. For instance, the value of Bitcoin in April 2021 was $64,000, which quickly plummeted to $30,000 by July of the same year.
3. Identification and Tracking Transactions: Cryptocurrencies operate on decentralized networks or peer-to-peer networks, transcending traditional financial institutions. These pseudonymous transactions are recorded on blockchain ledgers, which create obstacles in tracking and taxing these transactions, as seen in the 2021 Wazir case. It becomes imperative to establish AML and KYC rules for cryptocurrency transactions and exchanges.
4. Absence of Reporting Standards: The registered exchanges comply with basic Indian norms and regulations. However, many users resort to international or unregulated platforms that do not share their data with the Indian government. This allows for a large number of transactions to go unreported, enabling tax evasion and other illegal activities like money laundering or terror funding.
5. High Tax Rates: The current taxation rates of 30% on gains from cryptocurrency and 1% TDS are inordinately high and has been criticized for driving the industry underground. The unfriendly tax rates may discourage compliance and prompt tax evasion. Despite India’s potential to become a cryptocurrency powerhouse, the excessive tax rates have encouraged crypto enthusiasts to take their business elsewhere, with almost a 90% decrease in trading volumes.
6. Lack of specialized Infrastructure and Technology: Cryptocurrency operates entirely on blockchain technology. The government would require superior technology and technical understanding of the workings of cryptocurrency transactions to trace them back to taxpayers. Lack of such tracing might also result in double taxation. The knowledge gap is further intensified by the ever-evolving technology and market practices.

 WAY FORWARD

The widespread public acceptance and interest in cryptocurrency makes it essential to streamline the taxation of cryptocurrency in India. The primary step would be to clearly demarcate the boundaries of cryptocurrency, classify their use cases and formulate a unified valuation method. Further, policymakers could leverage blockchain technology itself to ensure tax compliance and monitor real-time transactions. This would however require proper data protection and upholding privacy laws.

Bridging the gap between technology and policymaking would require developing extensive training programs for tax officers and specialized software. Exploring international knowledge-sharing opportunities might be advantageous. Additionally, collaborating with technology experts is crucial in creating a robust monitoring and taxation framework for cryptocurrency.

 Cryptocurrency usage is transborder and requires international cooperation. The nations of the world might consider devising a strategy to ensure cross-boundary cooperation and avoidance of double taxation. Treaties targeted at managing digital assets would not only address taxation challenges but also enhance jurisdictional challenges and promote compliance.

 CONCLUSION

Taxation of cryptocurrency undoubtedly faces a myriad of challenges, from legal ambiguities to complexities in tracking pseudonymous transactions. However, cryptocurrency is here to stay and indispensable to our collective progress. The nations of the world have recognized the importance of cryptocurrency in the changing fintech landscape and taken measures to adapt their tax regimes to include this new digital currency. For instance, the U.S.A. requires individuals to report cryptocurrency as property subjective to capital gains tax while Japan enforces strict KYC requirements on exchanges in addition to tax rates up to 55%. 

While our present taxation system offers a foundation for future advancements, India could take inspiration from global standards and develop its own legal code tailored to our needs, setting an example to countries world-wide. The establishment of a transparent, consistent and holistic tax policy specific to cryptocurrency is crucial to the amelioration of India’s financial system.