Indian Regulation regarding the Taxation of Virtual Digital Assets

Given the ever-growing popularity of the crypto space, it was natural for governments all around the world to eventually step in and start rolling out tax legislation in order to get their cut. In the Indian context, the Finance Act 2022 has introduced provisions to address the taxation of transactions of “Virtual Digital Assets” (VDA). This is a catch-all term used for cryptocurrencies, Non-Fungible Tokens (NFTs), etc. The provisions under this act aim to change the taxation system and formulate a new policy to tax income from virtual digital assets.

Policy Summary

In the recent budget, the Finance Minister announced that no deduction in respect of any expenditure or allowance should be allowed while calculating income, aside from the cost of acquisition. Furthermore, the loss from the transfer of Virtual Digital Assets cannot be set off against any income. She also proposed to provide for TDS on payment made in relation to the transfer of virtual digital assets at the rate of 1% of such consideration above a monetary threshold.

Legislative Background

Proposals from the Union Budget presented through the Finance Bill, 2022 have been enacted accordingly, and the Income-tax Act, 1961 has been amended. After being enacted as a part of the Income Tax Act, 1961, these proposals have come into force from April 1, 2022, except for provisions for tax withholding, which came into force from July 1, 2022.

What does the Government consider a Virtual Digital Asset?

Before discussing the legislation in detail, it is important to understand what the government considers to be a Virtual Digital Asset. According to Clause 47A, Section 2 of the Income Tax Act, the following items are considered as VDAs.

It is essential to elaborate on the first definition. The government is defining any information or code or number or token (not being Indian currency 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 functioning as a store of value or a unit of account, including its use in any financial transaction or investment, but not limited to investment schemes; and can be transferred, stored, or traded electronically.

Summing up the aforementioned definition, the government aims to tax any cryptographically generated instrument that may have any possibility of acting as a financial instrument in a decentralised financial system where it is transferred, stored, or traded through electronic means.

In the case of NFTs, the Central Government specifies a token which qualifies to be a virtual digital asset as a non-fungible token within the meaning of sub-clause (a) of clause (47A) of section 2 of the Act but shall not include a non-fungible token whose transfer results in the transfer of ownership of the underlying tangible asset and the transfer of ownership of such the underlying tangible asset is legally enforceable. Do note that sub-clause (a) here refers to the first definition of cryptographically generated instruments.

The primary implication here is that NFTs that confer legally enforceable ownership on a tangible asset, such as, say, land records which are sold as NFTs, are not taxable as Virtual digital assets. They will be taxed as a normal land sale provided it is legally enforceable (meaning that the transfer of land is duly registered with the sub-registrar office).

Exceptions

The legislation makes a special note to specify items that are not considered Virtual Digital Assets:

1) Gift Cards: Vouchers and e-Cards for purchasing any items or services

2) Mileage Points, reward points of loyalty cards: Any such record given that does not imply a direct monetary benefit. Provision of such items under an award, reward, benefit, loyalty, incentive, rebate or any promotional program is not considered a Virtual Digital Asset.

3) Subscriptions to any websites, platforms, or applications.

Overview of the Taxation Components

According to the primary legal instrument governing VDA taxation, there is a Tax Deducted at Source (TDS) component (TDS is a form of advance tax and will be reduced from tax payable) and a direct 30% (plus surcharge and cess) tax on income from transfer of VDA.

Income Tax

“Section 115BBH” has been inserted into the Finance Act, 2022, which provides for taxation on income from virtual digital assets. It consists of two subsections.

The first subsection seeks to provide that where the total income of an assessee includes any income from the transfer of Virtual Digital Assets, the tax payable shall be calculated on the income from the transfer of VDA at a rate of 30%.

The subsequent subsection states that notwithstanding anything contained in any other provision of the act, no deduction in respect of any expenditure, other than the cost of acquisition of the Virtual Digital Asset, will be allowed in computing the taxable Income. Also, no offset will be allowed in the context of the transfer of the Virtual Digital Asset at a loss as well.

Tax Deducted at Source

Upon the purchase of a Virtual Digital Asset, the purchaser is required to deduct 1% of the amount as income tax deducted at the source and make the balance payment to the seller. It is required to be deducted at the time of credit of the amount or at the time of payment to the seller.

However, there are a couple of limits at play.

TDS will be applicable only and only if the amount paid by the buyer, a.k.a. a ‘specified person’, exceeds Rs. 50,000 during the financial year.

For other than a specified person, the same condition is pegged at Rs. 10,000 during the financial year.

A couple of filing-related caveats exist as well:

If the PAN number of the resident seller is not available, then the tax at the time of transfer of Virtual Digital Asset will be deducted at the rate of 20%. Further, if any person has not filed the income tax return and TDS/TCS of 50,000 or more has been deducted/collected, then TDS will be deducted at a higher rate of 5% as compared to 1% if the payer is not a specified person.

A specified person, according to the law, is someone who : (a) is an individual or an undivided Hindu family, whose total sales, gross receipts or turnover from the business carried on by him or the profession exercised by him does not exceed one crore rupees in the case of business or fifty lakh rupees in case of the profession, during the financial year immediately preceding the financial year in which such virtual digital asset is transferred; (b) being an individual or an undivided Hindu family, not having any income under the head “Profits and gains of business or profession”.

What happened to the taxability of Digital Virtual Assets before the law came into force? (Pre 1st April 2022)

As is with any financial instrument, people handle crypto in different ways, per their financial restraints and appetite for risk. In some cases, income was taxed as “Income from Business and Profession”, where the VDA was held as a business commodity. Some individuals treated it as a capital asset and consequently were taxed on capital gains.

If a taxpayer was trading cryptocurrencies, the income was often categorised as “business income”. Other than that, income from VDA was often reported under the residuary head of the “Income from other sources”.

Thus, in almost all the above cases, income was taxed at normal slab rates or specific rates for capital gains. Depending on the holding period, gains were classified as Long Term (more than 36 months) or short-term (less than 36 months). Long-term gains were taxed at 20%, subject to indexation benefits, while short-term benefits were taxable at normal applicable rates.

While this specific legislative framework did not exist before April 01, 2022, the income therefrom was still subject to tax, even prior to the date of the law’s coming into force.

In conclusion, the new law aims to create a comprehensive tax base aimed at all subsectors of the crypto space. It aims to target all transactions at all stages of the supply chain, with the TDS and Income Tax-based provisions.