The effect of crypto taxation on the investors

India is one of the fastest growing markets for digital assets and was ranked number four in the Crypto Adoption Index for 2022. Given the huge market size and its potential, from an economic, innovation and employment perspective, it was expected that there would be a support for the ecosystem in the form of laws and regulations. However, the real story is different. While the initial resistance shown by the RBI, through a ban on cryptocurrency, was overturned by a Supreme Court judgment in 2020, nothing positive has moved since then.

While a bill to regulate crypto is currently pending in Parliament, the government is channeling its efforts towards the effective implementation of the Central Bank Digital Currency (CBDC) and has recently notified under the PMLA that operators in the VDA sectors will also qualify as “reporting entities”. While each of these steps still does not lend legitimacy to the crypto operations, one can only hope that constructive regulation may be in the pipeline in the long run.

Income Tax Act

The Finance Act, 2022 introduced for the first time the concept of “Virtual Digital Assets” (VDAs) with a very expansive definition, to include crypto and other similar digital assets. According to this, transactions in crypto are taxed at a flat rate of 30%, on each individual transaction. The strength of the provisions can be seen from the fact that the investors in the sector are not allowed to offset losses on a crypto transaction with the profit generated by another crypto transaction. In the same vein, deductions for 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 major impact on the sector but also made compliance a major headache for exchanges. This year it was made even stricter with severe penalties and prison terms for non-compliance, which were proposed.

Tax laws for goods and services

The levy of GST on the crypto transactions continues to remain ambiguous due to the lack of clarity around the classification of crypto assets. Due to the varied applications of crypto, it is quite possible to have opposing views when it comes to crypto classification as delivery of goods or delivery of services. Rather, the government has failed to provide any form of clarification on the subject.

As of date, the service fee charged by the crypto exchanges is subject to GST, at the rate of 18%, by classifying such consideration as “financial services”. The very nature of the underlying crypto transaction and its tax liability remains a point of dispute.

One could argue that crypto-assets are akin to security or constitute trading with searchable claims, both of which are outside the purview of GST. But taking any of the views at the moment is exposed to risk as the same may not find favor with the tax department.

Money Laundering Prevention Act

On 7 March 2023, the Ministry of Finance announced that operators in the VDA sector would be considered ‘Reproting Entities’ (Res), and thus required to undertake the necessary compliance. For the sector, this is definitely a step in the right direction as it means that the government now views VDA service providers on the same level as financial institutions, banking companies and other intermediaries. It may be noted that some of the other notified sectors include casinos, real estate and jewellery.

The applicability of said notice to non-resident operators in the VDA sector may have certain jurisdictional challenges. However, one must not lose sight of the fact that other licensed non-resident financial institutions are subject to similar notices.

Conclusion

For a market with such great potential, an unfavorable tax policy can hinder growth. According to a recent report, there is a steep downward trend in crypto transactions after the implementation of VDA tax in the country. It seems that the current tax regime along with burdensome compliance has made it a disincentive and unprofitable sector for investors and other stakeholders. Furthermore, a lack of constructive regulation hinders the growth of this setor. These factors have forced crypto operators to move 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 at whether they can collectively regulate cryptocurrencies. There seems to be a global consensus to provide an unfirom regulation, given that crypto transactions are generally considered to be borderless. The recent notification under PMLA also indicates the Indian government’s attitude towards VDAs as it will boost confidence among retail investors due to KYC and reporting requirements.

For a sector to thrive, it is important to create certainty through constructive regulation and by introducing a tax regime that is based on neutrality, which means that stakeholders make decisions based on economic profit and not tax reasons.

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