Cryptocurrencies: Their Nature and Prospects for Taxation – Part 1

[Anirudh Singh is a 4thyear B.A LL.B (Hons.) student at NALSAR, Hyderabad]

Cryptocurrencies have gained significant prominence in the market since the inception of “Bitcoins”. (In this post, Bitcoins and cryptocurrencies are treated interchangeably for the sake of simplicity).  The popularity of Bitcoins can be estimated from the fact that upon its introduction in 2009 the value of one Bitcoin was equivalent to one dollar and in 2018 its value skyrocketed to 10,500 dollars. Many people consider Bitcoins as an easy money-generating scheme without even understanding the underlying fundamentals associated with it. Along the way, despite a lot of volatility, controversies, speculations, theft and other criminal activities, it has survived and continues to grow. Recent developments in the financial world suggest that investors have been looking at Bitcoins and other cryptocurrencies as an asset class for long-term investment, indicating that they are here to stay.

However, various agencies around the world are at odds in order to characterize Bitcoins. In United States v Murgio, it was held that the word “funds” in the context of law meant pecuniary resources, which are generally accepted as a medium of exchange or as a means of payment. Because Bitcoin does fulfill the said classification, it will constitute as “funds” and anyone engaged in Bitcoin transfer business will be duly prosecuted. Relevance can also be placed to the Notice 2014-21 of IRS wherein virtual currency is considered to be “property”. Gains or losses shall be taxed either by classifying cryptocurrencies as “capital asset” or “stock in trade”, based on the intent of the assessee while carrying out such transactions.

Origin of Bitcoins

Bitcoin is a type of virtual currency which significantly differs from the established form of currency. Such a cryptocurrency is generated through a specific algorithm which is known as “Mining”. In order to understand the creation of Bitcoins, one has to delve into the concept of “Block-Chain”. Block-chain can be considered as an online ledger where one entry is connected to the other entries through a complicated set of algorithms, and any attempt to tamper with the ledger will regard it untrustworthy. This ledger contains all the transactions via Bitcoins, and therefore exists in the computer network of all Bitcoin users. The persons who verify the entries in this ledger are called “Miners”, whose job is to ensure that each entry is derived from the algorithm devised by Satoshi Nakamoto (a pseudonym for the person considered to be the inventor of Bitcoin). For verifying the entries, the miners are rewarded with Bitcoins generated by the same algorithm. This process creates new Bitcoins and the same can be traded in exchange of goods and services in various jurisdictions. Since the process of generation of Bitcoins is fixed, there is an upper cap of the production of Bitcoins and it cannot exceed beyond 21 million.

Before analysing the taxation prospects of cryptocurrencies, it is important to recognise the correct categorization of the same. The categorization of the Bitcoins is crucial as it informs us of the heads of income under which they are going to be taxed.

Section 2(52) of the Central Goods and Services Tax Act, 2017 (the CGST Act) defines “goods” as every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply.

Section 2(102) of the CGST Act defines “services” as anything other than goods, money and securities but includes activities relating to the use of money or its conversion by cash or by any other mode, from one form, currency or denomination, to another form, currency or denomination for which a separate consideration is charged.

Relying on these definitions, one can conclude that “securities” and “money” have been excluded from the ambit of “goods” and “services” as envisaged in the CGST Act, and therefore not regarded as supply of goods or supply of services. Only activities concerning the usage of money or its conversion from one type of currency to the another form has been made taxable. Given this background, I now seek to analyze all possible scenarios.

Are Bitcoins “Securities”?

Securities are defined under section 2(101) of CGST Act as:

As per Section 2(101) of the Central Goods and Services Tax (CGST) Act, 2017, unless the context otherwise requires, the term “securities” shall have the same meaning as assigned to it in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956.

Therefore, it relies on the explanation provided by section 2(h) of the Securities Contracts (Regulation) Act, 1956 (the SCRA), which defines “securities” as:

Securities include-

 (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;

(ia) derivatives;

(ib) units or any other instruments issued by any collective investment scheme to the investors in such schemes;

(ii) government securities;

(iia) such other instruments as may be declared by the Central Government to be securities; and

(iii) rights or interest in securities.”

In Sudhir Shantilal Mehta v. CBI, the Supreme Court held that since the definition of “securities” is an inclusive one, it takes within its scope not only those subjects specified therein but also all those kinds of securities as commonly understood. Therefore, a broad meaning should be given to the said term. It is evident that cryptocurrencies do not fall under the ambit of the definition provided by section 2(h) of the SCRA. Therefore, the question whether cryptocurrencies can be conferred the status of “securities” under the expansive definition arises for consideration.

According to Webster Dictionary, the term “security” denotes “something given, deposited, or pledged to make certain the fulfillment of an obligation”. In the book “Securities Regulation in a Nutshell”, the author David L. Ratner argues that the securities do not possess an intrinsic value in themselves. They obtain their value from the rights they signify over the person who issues such securities. It is a mode through which one makes a payment of a debt or fulfills the performance of a contract. Therefore, it is evident that there will be two parties in these transactions, where one will be the issuer of security and another person will be the subscriber to the same. Bitcoins cannot fall into this category as there is no issuer who contractually undertakes to repay the value represented by Bitcoins or assures specific performance of a contract. Therefore, Bitcoins cannot be said qualify its prerequisites as “securities”.

Are Bitcoins “Actionable Claims”?   

According to section 2(1) of the CGST Act, actionable claims are defined as follows:

Actionable claim shall have the same meaning as assigned to it in section 3 of the Transfer of Property Act, 1882.

Section 3 of the Transfer of Property Act, 1882 defines “actionable claim” as “a claim to any debt, other than a debt secured by mortgage of immoveable property or by hypothecation or pledge of moveable property, or to any beneficial interest in moveable property not in the possession, either actual or constructive, of the claimant, which the Civil Courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent”.

In H. Anraj v State of Tamil Nadu, the Supreme Court observed that ‘actionable claim’ explained in section 3 of Transfer of Property Act envisages two kinds of claims: (a) a claim to unsecured debt, and (b) a claim to a beneficial interest in movable property which is not in possession of the claimant. It must also be a right which is capable for enforcement.

It is evident that Bitcoins are not a claim to unsecured debt because there is no issuer who guarantees repayment of a fixed value assigned to a Bitcoin. This begets the possibility of a situation where such Bitcoins can be classified as a beneficial interest in a movable property not in possession of the claimant. However, such interest will not be enforced by the courts because Bitcoins create no interest in a movable property which is not in possession of a claimant. Bitcoins are credited in the “Bitcoin Wallet” created by the buyer, and thus it does not represent an interest in a movable property currently in possession of someone else. Even if we consider Bitcoins as “movable property”, the owner of the same does not have an interest in the property which is in possession of someone else. In fact, the Bitcoins generated amidst these transactions remain only in the online wallet.

Are Bitcoins “Movable” Properties?

Under section 2(52) of the CGST Act, the term “goods” is defined as follows:

The term “goods” mean every kind of movable property other than money and securities but includes actionable claim, growing crops, grass and things attached to or forming part of the land which are agreed to be severed before supply or under a contract of supply.

In Vikas Sales Corporation v Commercial Taxes, the Supreme Court observed that the expression “movable properties” includes corporeal as well as incorporeal properties. Laying emphasis on “Salmond on Jurisprudence”, the Court further held that debt contracts and other chooses-in-action are considered to be chattels, no less than furniture or stock in trade. Similarly, patents, copyrights and various other rights in rem which are not rights over land are included in the ambit of “movable property”.

Rights, which results into acquisition of property can be classified into two types: rights in rem(right against a thing, e.g., ownership of a tangible property) and rights in personam (rights against a person, e.g., debts recoverable from a debtor). It is evident that Bitcoins are intangible in nature and therefore cannot create rights in rem. As mentioned above, Bitcoins are created by an algorithm and there is no institution or individual that issues Bitcoins. Therefore, it will be difficult to consider that an owner of the Bitcoins has a right against a person to receive the equivalent worth of Bitcoins held by him. This is in contrast to a legal currency which creates a right for an owner to ensure the receipt of equivalent value from the issuer (i.e., the central bank or the government). Due to this right, currencies issued by a central bank or government appear as liabilities in their books and as assets in the books of the individual who holds it. In case of Bitcoins where there is no issuer, no corresponding liability is created. Therefore, it will be problematic to say that the said cryptocurrencies are movable property. Hence, the same cannot be categorized into goods.

In 2017, the Tokyo District Court applied the same reasoning and dismissed the lawsuit initiated by a man who sought repayment for Bitcoins which he kept in an account at the defunct exchange Mt. Gox Co., observing that virtual currency is not subjected to “ownership” claims as the same is not a property and any claim for theft of such currency cannot be entertained by the courts.

In the next part, I consider the applicability of Bitcoins as a legal form of money and analyze the direct taxation prospects of Cryptocurrencies under the Income Tax Act.

Anirudh Singh

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