Why taxation of virtual digital assets still needs clarity

Amendments proposed by Budget 2022

In her Budget Speech for the year 2022-23, the Finance Minister said, “There has been a phenomenal increase in transactions in virtual digital assets. The magnitude and frequency of these transactions have made it imperative to provide for a specific tax regime.”

In light of this background and in order to provide clarity on taxation of cryptocurrencies, vide the Finance Bill 2022 (Bill), the following amendments have been proposed in the Income-tax Act, 1961 (Act):

1.  Meaning of the term VDA (new section 2(47A) proposed to be inserted)

The proposed definition of the term ‘virtual digital assets’ appears to be very wide. VDA is proposed to mean:

• Any information or code or number or token (not being Indian currency or any foreign currency),
  
• Generated through cryptographic means or otherwise,
• Providing a digital representation of value which is 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 and includes its use in any financial transaction or investment,
• But not limited to, investment schemes and can be transferred, stored, or traded electronically.
• Non fungible tokens^[3] and any other token of similar nature are also included in the definition.

What all would be covered within the ambit of this definition will have to be seen in due course. For example - could credit card points, which are numbers and represents value, be covered under the definition of ‘VDA’, and if any redemption (given that transfer covers redemption) would therefore get covered within the mischief of this section is open for debate.

While the intent of the authorities is to tax gains arising from transfer of VDAs, the wide definition of VDAs may create significant challenges in implementing the provisions.

2.  Tax on gifting of VDAs (VDA to be included in the definition of ‘property’ for the purpose of section 56(2)(x) of the Act)

The proposed amendment (as per which VDA shall be included in the definition of ‘property’ for the purpose of section 56(2)(x) of the Act) shall be effective from 1 April 2022. Accordingly, receipts of VDAs for no consideration or inadequate consideration prior to 1 April 2022 may not be taxable at all.

Further, in absence of a corresponding section similar to section 50C or 50CA of the Act (which deal with fair market valuation (FMV) on transfer of immovable property and unlisted equity shares respectively), questions may arise on the valuation of VDAs for the purpose of computation of the taxable income. In absence of a corresponding section similar to section 50C or 50CA of the Act (which deal with fair market valuation (FMV) on transfer of immovable property and unlisted equity shares respectively), questions may arise on the valuation of VDAs for the purpose of computation of the taxable income. This issue is further amplified since the trading price of VDAs on different exchanges may be different and, in some cases, even a single day fluctuation in price could be very significant.

3.  Tax on transfer of VDAs (new section 115BBH proposed to be inserted)

The Bill seeks to tax income arising on transfer of virtual digital assets at the rate of 30% (without any deduction in respect of any expenditure (other than cost of acquisition)).

As of today, a tax of 30% is also levied on income from sources such as winnings from lotteries, betting, horse races, etc. This somewhere indicates that the Ministry is viewing income from cryptocurrencies with the same lens as other incomes (which are largely in the nature of wagering contracts). Considering that individuals having income exceeding INR 1 million are anyways taxed at 30% today, the proposed tax rate of 30% may not be viewed negatively by the industry.

However, the Ministry has also proposed to disallow/ ignore any losses incurred by crypto investors. While there was some ambiguity on whether losses arising in the same year on one VDAs could be set-off against another VDA, however, it has been clarified that losses incurred from one kind of VDAs cannot be set off against the gains from any transaction involving another VDA while computing tax. Thus, where a taxpayer earns a gain say INR 100 on Bitcoin and incurs a loss of INR 10 on Ethereum during the same year, the loss of INR 10 will be ignored, and the taxpayer will be liable to pay tax on INR 100.

Further, income on transfer of VDA shall be taxed under this section, irrespective of whether the same are held as capital assets or stock-in-trade.

4.  Withholding on payment of consideration (new section 194S proposed to be inserted)

The Bill provides for withholding tax at the rate of 1 percent on payment on transfer of VDAs.  It appears that in case of transfer of VDAs on a crypto-exchange, the responsibility to withhold may fall on the crypto-exchange since practically the buyers may not know who the seller is.

This could create significant challenges in case of swap transactions where one VDA (say a bitcoin) is swapped for another VDA (say Ethereum).

(This article is co-authored by Harsh Kothari, EY India Senior Manager – Tax.)