National Council of Applied Economic Research
Opinion: Sudipto Banerjee
To put the prevailing apprehensions at rest the Modi government should hold talks with all stakeholders both on the taxability of virtual digital assets and their future legal position in India
Union Budgets are known for making news. With the recent Budget announcement India joins the league of nations that have brought cryptocurrencies within the tax net. The Finance Bill 2022 has introduced a new scheme to tax cryptocurrencies. A new definition called ‘virtual digital asset’ (VDA) is to be added to the Income Tax Act 1961 (IT Act) which would include information or code or number or token (not being Indian or foreign currency) generated through cryptographic means or otherwise and non-fungible tokens.
Further the government can notify any other digital asset within the meaning of VDA. Given the burgeoning size of the Indian crypto market the definition of VDA has been kept wide enough perhaps to augment the government’s tax kitty.
Highlights of new scheme
Interestingly the definition of VDA excludes Indian and foreign currencies; this seems to signal that VDAs are different from currencies. At the best the proposed scheme allows VDAs to be treated as ‘property’ under the IT Act. However in the absence of any definition of property under the IT Act it could be construed as every possible interest a person can acquire hold or enjoy. Placing VDAs at par with gambling and betting the Finance Bill proposes to tax gains earned on the transfer of VDAs at the highest rate of 30 per cent irrespective of the holding period. Gains from transfer of capital assets are taxed depending on the duration of the holding period.
Since the Finance Bill does not classify VDA as capital assets it would be taxed at a flat rate. For computing tax an investor in VDAs cannot claim any deduction in respect of any expenditure incurred on such assets (like computing cost electricity cost) except for the cost of acquisition. Making the proposed scheme more stringent the amendment neither allows setting off the loss from the transfer of VDAs against any other income nor does it allow the loss to be carried forward to succeeding assessment years. Put differently tax is to be calculated on gross income.
From the initial reading of the Finance Bill it appears that the proposed scheme is punitive. However considering the private cryptocurrency market is fraught with speculation crypto businesses and retail investors might greet the announcements as precursors to regulation. But just because an item is getting taxed does not ipso facto make it legal. This position was reiterated by the CBDT chairman in his recent interview after the Union Budget. Moreover tax can be imposed even on illegal activity. The Supreme Court [CIT v Piara (1980)] had allowed the assessee to claim expenses in a smuggling transaction which was subject to income tax. Also the Budget made an announcement on the introduction of the Central Bank Digital Currency but was silent on the position of private cryptocurrencies.
While the Budget announcements aim to bring clarity on the tax treatment of crypto apprehensions and conjectures prevail. Following a consultative process would have been a better approach. The thrust of this post is the adoption of a participative approach in designing the crypto tax and highlights some of the apprehensions that arise from the proposed taxation scheme.
Why is public consultation necessary?
Public consultation is the cornerstone of sound and transparent rulemaking. It avoids the surprise element and brings clarity confidence and legitimacy. Consultations are not uniformly adopted in state interventions in India. At present the rationale behind the proposed scheme of crypto taxation can be found in the Budget speech which states that owing to a phenomenal increase in transactions in virtual digital assets a specific tax regime is being introduced.
In countries like the US UK and Australia there is a statutory duty of the government to conduct public consultations before implementing an intervention. For instance when the UK government decided to tax crypto assets the HM Revenue and Customs released a policy paper for consultation. While most statutory regulators in India have a legal obligation of public consultation it is not clear whether there is a similar mandate for the government. In February 2014 the Ministry of Law and Justice issued a circular necessitating that all departments and ministries put out draft legislation along with the rationale for it in public for minimum 30 days and take steps to ensure that it reached a wider public. In practice the situation is not followed uniformly. Moreover this pre-legislative consultation policy allows ministries to opt out if they think the exercise is not feasible or desirable.
Past experience shows a mixed track record of deliberation with the stakeholders. When the Supreme Court ruled against the income tax department in the Vodafone judgement in the Union Budget of 2012 the government introduced several retrospective amendments to the IT Act [Sections 2(14) 2(47) and Section 9] to levy a capital gains tax on transactions done outside India’s borders but for assets that were situated in India. No consultation process was followed. Little did the government realise that such a decision could have repercussions in the future. After suffering two consecutive setbacks in international arbitration proceedings initiated by Vodafone Plc and Cairns Plc in August 2021 the government amended the law [The Taxation Laws (Amendment) Act 2021] to withdraw the retrospective nature of the indirect transfer tax amendment.
Impact assessment
An essential component of public consultation is doing impact assessment of a decision. Conducting this exercise helps to determine the possible costs and benefits associated with a decision and identify benchmarks for its future evaluation. While the cryptocurrency market is still evolving in India it has a wide range of stakeholders including many retail investors. Did the proposal undertake an assessment of the possible impact (like cost of doing business investment) both on the supply and demand side? Did we contemplate its impact on retail investors? Can the steep rates nudge them towards traditional modes of investment?
The Finance Bill says that the person paying the consideration to the resident seller for transfer of VDAs will be responsible to deduct 1 percent tax at source (TDS). Usually the intra-day traders and market makers engage in low mark-up and high volume transactions. Can the proposed 1 percent TDS reduce their profitability and impact the volume of transactions on the Indian exchanges? Can this affect the price competitiveness of the exchanges in the international market?
Moreover what could be the rationale of a tax proposal when there is an absence of clarity on the legal status of VDAs? Is the proposed tax scheme an interim arrangement where the government first wants to garner revenue by tracking the volume of transactions and then decide on the ban or regulate debate? At present we are constrained to make only surmises.
Unanswered questions
Tax experts have already flagged several concerns with the proposed scheme. Some of these are listed here.
First the proposed scheme aims to tax the event of a transfer of VDAs. At present it is not clear whether the tax will be applicable when a cryptocurrency comes into existence through processes like mining or airdrop.
Second since the new regime kicks in from 1 April 2022 what would be the tax treatment of gains earned from crypto till 31 March 2022? Questions like whether deductions can be claimed or set-offs to be allowed in the transition period can arise.
Third crypto exchanges/platforms facilitate matchmaking where the buyer does not know the identity of the seller. In such a scenario will the crypto exchange be liable to discharge the TDS liability?
Fourth TDS obligation is applicable when consideration is paid in kind or in exchange of VDAs. Does it mean when A and B exchange cryptocurrencies as consideration both would have to discharge the TDS liability? Further the valuation of the cryptocurrency is not uniform and fluctuates between exchanges as a result calculating the TDS amount could be complicated.
Fifth TDS obligation is applicable to peer-to-peer VDA transactions. When such a transaction happens outside the exchanges as per the proposed law the buyer will be required to discharge the burden of TDS compliance. Whether buyers would meet this obligation and how would the government enforce the TDS compliance remains a question. Also there is no clarity on TDS obligation for trades carried out on international exchanges.
Sixth the Finance Bill exempts ‘specified persons’ (individual or HUFs) having turnover/gross receipts within a specified threshold from the obligation of TDS. Looking at past evidence of benami transactions this exemption might be abused if ‘specified persons’ are used as a facade for the transfer of VDAs.
Seventh so far there is no announcement on the treatment of VDAs under the GST laws. Will it be subject to GST? If yes will it be classified as a ‘sin item’ and subject to the highest rate of tax?
Lastly the fundamental question remains whether taxation classifies crypto as a legal asset?Global experience suggests that consultation has played a constructive role in shaping the tax policy of cryptocurrencies which has developed because of the evolving nature of the underlying technology. Despite the grey areas the recent Budget announcements are laudable as they attempt to provide clarity on the tax treatment of VDAs. However to put the prevailing apprehensions at rest the government should engage in meaningful deliberations with the stakeholders both on the taxability of VDAs and their future legal position in India.
The writer is a public policy consultant at NCAER a Delhi-based think tank. Views expressed are personal.