India is one of the fastest growing markets for digital assets and was ranked fourth in the Crypto Adoption Index for 2022. Given the huge market size and its potential, from an economic, innovation and employment perspective, there was an expectation that there would be a support ecosystem in terms of laws and regulation. However, the real story is different. While the initial resistance shown by RBI, through a ban on cryptocurrency, was overturned by a Supreme Court ruling in 2020, nothing positive has moved since then.
While a bill to regulate crypto is currently pending before the Parliament, the Government is channelizing its efforts towards effective implementation of Central Bank Digital Currency (CBDC) and has recently notified under PMLA that operators in the VDA sectors will also qualify as ‘Reporting Entities’. While each of these steps still fail to provide legitimacy to the crypto operations, one only hopes that a constructive regulation may be in the pipeline in the long-run.
Income Tax Laws
The Finance Act, 2022, for the first time, introduced the concept of ‘Virtual Digital Assets’ (VDAs) with a very expansive definition, so as to include crypto and other similar digital assets. Pursuant to this, transactions in crypto are taxed at a flat rate of 30%, on every individual transaction. The harshness of the provisions can be seen from the fact that the investors of the sector are not permitted to set-off losses on one transaction of crypto from the profits generated in another transaction of crypto. On the same lines, deduction in respect of any expenses or carry forward of losses are also not permitted. Additionally, harsh TDS at the rate of 1% was introduced which not only had a huge impact on the sector but also made compliance a big headache for exchanges. This year, it was made even more stringent with harsh penalties and jail term for non-compliance, being proposed.
Goods and Services Tax Laws
The levy of GST on the crypto transactions continues to remain ambiguous, owing to the lack of clarity around classification of crypto assets. Due to the varied applications of crypto, it is quite possible to take contrary views as regards crypto classifying as supply of goods or supply of services. The Government has also failed to provide any kind of clarification on the subject matter.
As on date, the service fee charged by the crypto exchanges are subject to GST, at the rate of 18%, by classifying such consideration as ‘financial services’. However, the very nature of underlying crypto being transacted and its taxability remains a point of dispute.
One may argue that crypto assets as akin to security or amounts to dealing in actionable claims, both of which are outside the purview of GST. However, taking either of the views at the moment are subject to risk, as the same may not find favour with the tax department.
The Prevention of Money Laundering Act
On March 7, 2023, the Ministry of Finance notified that operators in the VDA sector would be considered as ‘Reproting Entities’ (Res), thereby required to undertake the necessary compliances. For the sector, this is definitely a step in the right direction since it implies that the government now views VDA service providers at par with the financial institutions, banking companies, and other intermediaries. It may be noted that some of the other notified sectors include casinos, real estate and jewellery.
Applicability of the said notification on non-resident operators in the VDA sector may have certain jurisdicitional challenges. However, one must not lose sight of the fact that other licensed non-resident financial institutions are subject to similar notifications.
Conclusion
For a market, with such big potential, an unfavourable tax policy could cause hindrance in its growth. As per a recent report, there is a steep declining trend in crypto transactions post the implementation of VDA tax in the country. It appears that the current taxing regime along with onerous compliances has made it a disincentivizing and unprofitable sector for investors and other stake holders. Further, a lack of constructive regulation is styming the growth of this setor. These factors have forced crypto operators to shift their offices to other jurisdictions, such as Dubai and Singapore.
While there has been some progress in the regulation of VDAs, as the G20 is now looking into whether they can collectively regulate cryptocurrencies. It appears to be a global consensus to provide a unfirom regulation, given that crypto transactions are generally seen to be borderless. The recent notification under the PMLA is also indicating the Indian government’s position on on VDAs, as it will raise the level of trust among retail investors due to KYC and reporting requirements.
For a sector to thrive, it is important to institute certainty through constructive regulation and by introducing a tax regime that is based on neutrality, which makes the stakeholders take decisions on economic merit and not tax reasons.
Disclaimer
Views expressed above are the author’s own.
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