[By Prakhar Khandelwal and Rachita Shah]
The authors are third year students of National Law Institute University, Bhopal
Introduction
Almost twenty-five years ago, the world was introduced to the internet, which poised us towards a new era of technological excellency. Today, with cryptocurrencies and its related technology at rise, we are at the starting point of yet another such revolution. The cryptocurrency industry is still in its premature stage, with skewed knowledge available regarding its working which complicates its classification and therefore its categorization under India’s taxation system. Now, while there is no legal definition for “cryptocurrency”, it can be described as:
“a digital representation of value that (i) is intended to constitute a peer-to-peer (“P2P”) alternative to government-issued legal tender, (ii) is used as a general-purpose medium of exchange (independent of any central bank), (iii) is secured by a mechanism known as cryptography and (iv) can be converted into legal tender and vice versa”[i]
In the recent years, cryptocurrencies are gradually becoming an acceptable digital currency around the world and countries like Russia and Japan are working towards its regulation. As a result, it becomes pertinent to acknowledge the requirement to define the legality and taxability of cryptocurrency in India. The authors shall attempt to lay out the Indian Government’s present position on cryptocurrency as well as provide a brief overview of its treatment under the current taxation regime.
The Government of India’s position
The Reserve Bank of India, (hereinafter “RBI”) on December 24, 2013[ii], February 1, 2017[iii] and December 05, 2017[iv] had cautioned persons dealing in virtual currency about the potential risks that they are exposing themselves to as well as clarified its non-authorization to any entity dealing with such transactions. These notifications gave rise to a petition filed on October 31, 2017 which demands emergent steps for restraining the sale and purchase of cryptocurrency in India.[v] The case is tentatively listed to be heard on July 23, 2019.
On April 6, 2018, entities regulated by the RBI were prohibited from dealing with cryptocurrencies and those which already provided such services were compelled to exit the relationship within three months.[vi] It was against this notification that the Internet And Mobile Association of India (hereinafter “IAMAI”) filed a writ petition on May 15, 2018 in the Supreme Court of India under Article 32 of the Constitution of India.[vii] However, a stay order was not approved for the above notification. Therefore, the April 6, 2018 position subsists today. The case is likely to be listed on July 23, 2019. In November 2017, a panel headed by Economic Affairs Secretary, Subhash Garg had been constituted to oversee India’s policy on cryptocurrency. According to a report released on June 07, 2019,[viii] the bill concerning cryptocurrency which is being looked into by the panel contains a provision for punishment of imprisonment up to 10 years to anyone who deals in cryptocurrency. Therefore, the events between 2013 and June, 2019 strengthen the government’s disapproval to regularising the use of cryptocurrency in India.
Treatment under Direct Taxation System:
At the outset, it is important to note that the illegal nature of income does not bar its taxability. Therefore, although the Government has consistently disapproved the use of cryptocurrency, it is crucial to have a regulatory framework for its taxation. The Income Tax Department sent notices to individuals for non-declaration of investments in cryptocurrency in early 2018 and emphasized that such investments shall be taxable.[ix] As per the notices, the Income Tax Department levies tax on cryptocurrency under two heads.[x] Firstly, under the head “profits or gains from business or profession” under Section 28 of the Income Tax Act, 1961 (hereinafter “IT Act”) and secondly, under the head “capital gains” under Section 45 of the IT Act. Therefore, since cryptocurrency is not declared as legal tender and “money” by itself is not taxable under the IT Act, the Income Tax Department treats cryptocurrency as “goods” or “property”.
i. As profits and gains of business or profession under Section 28 of the Income Tax Act, 1961
The IT Act gives an expansive definition for “business” under Section 2(13) of the IT Act, encompassing any concern in the nature of trade, commerce or manufacture. As a result, profits earned by way of trade in cryptocurrencies falls within the ambit of taxable income under Section 28(i) of the IT Act. Cryptocurrency earned by way of consideration for sale of goods and services as well as when they are held as stock-in-trade comes within the ambit of profits and gains from business or trade.
ii. As Capital gains under Section 45 of the Income Tax Act, 1961
One of the modes of acquiring cryptocurrency is through mining. Mining is a method wherein computer algorithms are solved to produce a cryptocurrency. As a result, this cryptocurrency is a self-acquired capital asset[xi] and is taxable under “capital gains” as given under Section 45 of the IT Act. The capital gains tax is either long term or short term, based on the duration for which the cryptocurrency is held.[xii]
While the above methods may prima facie seem to solve the confusion among cryptocurrency dealers, one of the primary problems faced by the Income Tax Department and tax payers is the very valuation of cryptocurrency. Since the transactions of cryptocurrency are peer to peer, there is no regulatory authority to control the volatile prices. Moreover, the market for cryptocurrency, although fast expanding, is small and therefore, results in fluctuations in supply and demand.[xiii] The IT Department has not stepped in to explain the computation of its prices. With countries ascertaining their stance on the use of cryptocurrency, the volatility of cryptocurrency may reduce due to growth in the market.
Treatment Under Indirect Taxation System
Goods and Services Tax, (hereinafter “GST”) which was implemented with effect from July 1, 2017, across India, subsumes most of the indirect taxes, barring few.[xiv] The implications of GST on cryptocurrencies and the Government’s rumoured decision to allow the state to tax it at a maximum rate of 20%[xv] on all transactions raises an interesting discussion due to the technicalities underlying its implication. Under GST, transactions relating to cryptocurrencies will mainly fall under three scenarios:
- Transactions involving exchange of cryptocurrencies,
- Transactions involving exchange of cryptocurrencies for goods and services, and
- Transactions involving exchange of cryptocurrencies for goods and services through intermediary.[xvi]
Interestingly, if cryptocurrencies were to be considered as money, they would be exempted from tax, but if treated as goods or property it would be categorised under “taxable supply” and therefore open to application of GST. Purchase or sale of cryptocurrencies would fall under supply of “goods”, and related facilitating transactions for example, transfer, supply and storage would fall under “services”. Therefore, not only cryptocurrency mining but storage wallets and the commission earned by such exchanges will also be taxed.
Now, such a system of taxation raises two serious problems. Firstly, if cryptocurrencies are classified as goods then, every transaction related to such currencies would be taxable twice – firstly, on supply of such currencies in exchange of money and secondly on their use as consideration in transactions relating to exchange of goods and services, thereby resulting in levying of a higher tax. Therefore, users of cryptocurrency will end up with the problem of double taxation.
Secondly, under GST, transactions with foreign unregistered entities facilitated through taxable cryptocurrency would attract RCM i.e. Reverse Charge Mechanism, under which instead of the service provider, the service recipient would be liable to pay taxes on the supply of goods and services.[xvii] But, cryptocurrency related transactions are masked with high anonymity as in the transactions with the service provider, the only requirement by the recipient is to disclose his bitcoin address. Therefore, determining the place of supply, in such cases is a major area of concern, and thereby, compliance under Reverse Charge Mechanism is highly improbable, unless voluntarily disclosed.
Conclusion
The application of the country’s current tax system on the volatile cryptocurrency industry, could give rise to major issues like its valuation and double taxation. Since there is an absence of a regulatory authority to check cryptocurrency transactions, it is imperative in light of the taxable income that it is expected to generate, that the Government develops a regulatory framework for its taxability to prevent its misuse. The authors therefore propose a strict set of regulations governing cryptocurrency and its’ related transactions while acknowledging the many benefits that it can potentially bring to the economy.
[i] Prof. Dr. Robby Houben, Cryptocurrencies and blockchain: Legal context and implications for financial crime, money laundering and tax evasion, July 2018, http://www.europarl.europa.eu/cmsdata/150761/TAX3%20Study%20on%20cryptocurrencies%20and%20blockchain.pdf
[ii] Reserve Bank of India, Press Releases, RBI cautions users of Cryptocurrencies against Risks, December 24, 2013, https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=30247
[iii] Reserve Bank of India, Press Releases, RBI cautions users of Cryptocurrencies, February 01, 2017, https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=39435
[iv] Reserve Bank of India, Press Releases, Reserve Bank cautions regarding risk of cryptocurrencies including Bitcoins, December 05, 2017, https://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=42462
[v] Naimish Sanghvi, Writ Petition 1071/2017 filed by Siddharth Dalmia for Banning Cryptocurrencies, March 04, 2019, https://coincrunch.in/2019/03/04/writ-petition-1071-2017-filed-by-siddharth-dalmia-for-banning-cryptocurrencies/
[vi] Reserve Bank of India, Press Releases, Prohibition on dealing in Cryptocurrencies, April 06, 2018, https://rbidocs.rbi.org.in/rdocs/Notification/PDFs/NOTI15465B741A10B0E45E896C62A9C83AB938F.PDF
[vii] Writ Petition (Civil) No. 528/2018, https://www.sci.gov.in/supremecourt/2018/19230/19230_2018_Order_03-Jul-2018.pdf
[viii] Nikunj Ohri, Exclusive: India Proposes 10-year jail for cryptocurrency use, may introduce its own digital currency, June 07, 2019, https://www.bloombergquint.com/bq-blue-exclusive/exclusive-india-proposes-10-year-jail-for-cryptocurrency-use-may-introduce-its-own-digital-currency
[ix] Koinex through Medium, Crypto gains and taxes, March 28, 2018, https://medium.com/koinex-crunch/crypto-gains-and-taxes-cef4b04b5953
[x] Koinex through Medium, Crypto gains and taxes, March 28, 2018, https://medium.com/koinex-crunch/crypto-gains-and-taxes-cef4b04b5953
[xi] Nishith Desai Associates, Bitcoins- A Global Perspective, April 2015, http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Bitcoins_A_Global_Perspective.PDF
[xii] Income Tax Act, 1961, Section 2(42B), Section 2(42C), Section 2(29A), Section 2(29B).
[xiii] FXCM, What Causes Volatility in Bitcoin, https://www.fxcm.com/uk/insights/what-causes-volatility-in-bitcoin/
[xiv] Sharad Raghavan, All you need to know about GST, November 29, 2015, http://www.thehindu.com/business/Industry/all-you-need-to-know-about-goods-and-services-tax/article7929788.ece.
[xv] Central Goods and Services Act, 2017, Section 9.
[xvi] Australian Taxation Office, Goods and services tax: the GST Implications of Transactions Involving Bitcoin, August 20, 2014, http://law.ato.gov.au/atolaw/view.htm?locid=%27DGS/GSTR2014D3/NAT/ATO/fp15%27&PiT=99991231235958#fp15
[xvii] Central Goods and Services Act, 2017, Section 2(98).