Budget 2022 may provide some clarity on the taxation of cryptocurrencies, such as applicable tax rates, rate of tax deducted at source, and the applicability of goods and services tax (GST) on the sale and purchase of cryptocurrencies.
By Rahul Chadha
Cryptocurrencies have gained mainstream appeal globally as well as in India as an asset class for investors and a mode of payment. However, high volatility, the anonymity of transactions, regulatory vacuum, and the value of cryptocurrencies not being tied to any reference asset unlike fiat currencies issued by governments, have given rise to a number of issues that are being debated in government, financial, technical, academic and commercial circles.
The State of Play
Since Indian lawmakers are still in the process of formulating regulations on cryptocurrencies, an air of uncertainty engulfs the cryptocurrencies market. In April 2018, the Reserve Bank of India (RBI) prohibited banks from facilitating or participating in cryptocurrency transactions. However, this blanket ban was overturned by the Supreme Court in 2020. Last year, a bill titled “The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021” was proposed to be tabled in the Lok Sabha during the winter session of Parliament, but eventually was not introduced since the government desired to hold further consultations with stakeholders.
Going forward, it is possible that the government may ban all private cryptocurrencies and launch a central bank digital currency (CBDC) or non-interest bearing coins that are pegged to a reference currency (stablecoins) which could potentially play an important role in financial markets. At present, however, cryptocurrencies continue to be neither regulated nor outlawed, and a bespoke regulatory framework is awaited.
Security, taxation, and advertisements are some of the concerns related to cryptocurrencies. The security concerns relating to cryptocurrencies have been flagged by various agencies as cryptocurrencies are a common mode of payment on the darknet. Since transactions on the darknet are anonymous, malicious actors can operate right under the noses of security agencies without being detected. Although there is very limited data relating to payments in cryptocurrencies for illegal activities, it is believed that cryptocurrencies are used for activities such as money laundering, terror-funding, drugs and human trafficking, etc.
In the upcoming budget, to address the said security-related concerns, the government may consider requiring screening of users coupled with due diligence by cryptocurrency exchanges. These processes could include conducting know-your-customer checks, monitoring transactional activity within the blockchain, etc., violations of which could result in civil and/or criminal actions. Anti-money laundering and counter-financing of terrorism laws may have to be strengthened.
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The taxability of cryptocurrencies is an area of concern as no distinct head is provided for its taxation under the present tax regime. The present laws are interpreted in a manner that treats cryptocurrencies as an asset, thereby subjecting them to capital gains tax. However, depending on the volume of transactions, income from cryptocurrency trading may also be treated as business income.
Budget 2022 may provide some clarity on the taxation of cryptocurrencies, such as applicable tax rates, rate of tax deducted at source, and the applicability of goods and services tax (GST) on the sale and purchase of cryptocurrencies. It is expected that taxability may form part of the proposed bill on cryptocurrencies, but the government may also consider amending the Income Tax Act, 1961 to incorporate the taxability of cryptocurrencies. Further, the government may consider issuing guidelines relating to GST on trading and brokerage activities related to cryptocurrencies, as in the past year, we saw the enforcement directorate issuing notices to cryptocurrency exchanges due to alleged breaches of the tax laws.
Given the speculative nature of cryptocurrencies and the risks attached to trading in them, advertisements by cryptocurrencies exchanges that could attract individuals into trading in cryptocurrencies without fully understanding the risks should be regulated. The government in the budget may consider regulating advertisements and banning misleading advertisements. A self-regulatory mechanism could be established by the government to monitor and regulate advertisements relating to cryptocurrencies.
The Road Ahead
The increasing attractiveness of cryptocurrencies as an asset class and the resulting growth in the cryptocurrency market merits a comprehensive regulation to protect stakeholders. It is unlikely that the government will recognise private cryptocurrencies as legal tender. However, a blanket ban on cryptocurrencies may prove perverse. Although the government has not elucidated what the proposed regulation would entail, it appears that it would be different from the previous iteration in which cryptocurrencies were banned. Further, it is possible that RBI will launch its own CBDC or stablecoin in the future.
The government should adopt an approach of regulating rather than banning cryptocurrencies and establish an institutional framework for implementing those regulations. If the government proposes a blanket ban, the same should have a sunset provision allowing users of cryptocurrencies and exchanges to deal with the blanket ban. Prior to introducing any regulation, the option of a ‘regulatory sandbox’ for cryptocurrencies should be explored, so that issues related to cryptocurrencies can be evaluated in a closed environment sans regulation, and the resulting findings can be used to guide the proposed regulation. Till then, in the absence of a regulatory framework, the future of cryptocurrencies in India hangs in the balance.
Rahul Chadha is the Managing Partner at Chadha & Co. Views expressed are the author’s own.
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