Taxation as a Form of Regulating Cryptocurrencies In India

[Samarth Chaudhari is a final year LL.B. student at Jindal Global Law School, Sonipat]

Cryptocurrencies, derived from the innovation of blockchain technology, can function as a reliable online payment method with several benefits.[1] However, the Reserve Bank of India (RBI) has unambiguously prohibited all financial institutions regulated by it from dealing in cryptocurrencies and its related services.[2]

In this light, it is urged that banning cryptocurrencies outright is shortsighted and there are sufficient benefits to reconsider regulating it in order to mitigate misuse.[3] Moreover, the ban is critiqued for being ineffective and difficult to impose in practice.[4]

This post thus argues that the Government must undertake a proactive role in countering the vices of cryptocurrency. Furthermore, if the object[5] is to dissuade the cryptocurrency market in India, then the Government should employ taxation as a policy instrument to control consumer behavior as opposed to a blanket ban.

It has been suggested that cryptocurrencies hold an important position in financial transactions and would therefore necessitate a separate section under the Income Tax Act, 1961.[6] It is further posited that an overarching legal mechanism is required to regulate the cryptocurrency market – The Crypto-Currency Act. Cryptocurrency could be defined in the Act to mean a virtual commodity,[7] or a moveable property, or any type of digital unit that may be used as a medium of exchange or a digitally stored value. Such a definition would be consistent with the purposes of other legislation[8] as well. Crypto-currencies can be obtained by purchasing from exchanges and by being accepted as mining or payment for goods and services.[9] These can be identified as taxable events.

While computing tax liability for such events, one must analyze the nature and the manner in which the crypto-currency is held by the assessee. If it is held as an investment, then the same may be considered as a capital asset[10] chargeable to capital gains tax[11] when sold. However, if the cryptocurrency is held as stock-in-trade in the regular course of business, then any income will be considered business income chargeable to tax under the head of profits and gains from business or profession.[12] The period of holding for classification as long term or short term capital asset can be 12 months.

Defining crypto-currency as a virtual commodity would bring it under the ambit of the goods and services tax (GST).[13] Allowing the state to tax it at a maximum rate of 20%[14] on all transactions. Furthermore, in an instance where cryptocurrency is traded for another good, it should be considered as a barter on which GST would be applicable twice[15] resulting in a significant GST impact.

In these circumstances, the regulatory and legal mechanisms recommended include:

1. Establishing a central regulatory board (under the Act), a quasi-judicial body dedicated to dealing with issues arising from cryptocurrency transactions. It would have the power to scrutinize all information reported by exchanges including all KYC documents. It may have some trappings of a civil court such as compelling appearance, taking evidence, giving orders, etc. It may be imperative to insert appeal provisions in the Act.[16] The board can also be vested with the power to make rules for all crypto-currency related transactions.

2. Establishing a licensing authority under the Act which prescribes preconditions for exchanges to obtain a trading license. It shall be vested with the power to scrutinize and subsequently accept or reject licence applications. An important requirement before the grant of any licence would entail an obligation to maintain a specified amount as a statutory reserve appearing on the balance sheet, as a security measure for fraud or technological failures. The authority should retain all future auditing rights and have the power to suo-motu terminate an operating licence for failure to meet requirements subsequent to the award of the licence.

3. Setting up a committee dedicated with the task of devising anti-money-laundering strategies with regard to crypto-currencies. Additional aspects would include setting up cyber-crime cells responsible for tracking and investigating illegal activities associated with crypto-currency. Further, the committee should endeavor to create awareness amongst professionals and the general public.  

4. The Act should endeavor to be inclusive of best consumer protection practices for crypto-currency holders and must enumerate rights of parties to a crypto currency transaction. An attempt must be made to set up a voluntary arbitration procedure for speedy settlement of disputes for parties to a crypto-currency transaction that create rights in personam. To inspire such confidence may be best to just keep matters to be adjudicated by the courts or tribunals.

5. Lastly, attempts must be made to earmark a small portion of taxes dedicated to conduct research to usher in innovations[17] of block-chain technology for a Digital India.  

To conclude, it is vehemently argued that employing tax as a policy instrument can help the Government drastically restrict the pool of parties transacting in cryptocurrencies. This would provide an ideal atmosphere to install the abovementioned regulatory mechanism tailor-made to mitigate the risks[18] surrounding cryptocurrencies. It could also help usher in a new age of technology for Digital India.

Samarth Chaudhari

[1] Deidre A. Liedel, ‘The Taxation Of Bitcoin: How IRS View Cryptocurrencies’ (2018) 66 Drake Law Review 107, 112.

[2] ‘Prohibition on dealing with Virtual Currencies’ RBI Notification No: RBI/2017-18/154 (06.04.2017)

[3] Nischal Joshipura & Meyyappan Nagappan, ‘Crypto-currencies – Regulatory and Tax Issues’ (2018) CTCITJ. I 86, 90.

[4] Ibid. The ban is difficult to impose in practice as all stakeholders lose out: Government loses taxes while traders shift base abroad or underground.

[5] As identified in RBI notices prior to the circular, ‘RBI cautions users of Virtual Currencies against Risks’ RBI Press Release : 2013-2014/1261.

[6] Meenu Gupta, ‘Cryptocurrencies in India: Time to Tax High Amount of Gains’ (2017) 88 taxmann.com 301.

[7] Deidre A. Liedel, ‘The Taxation Of Bitcoin: How IRS View Cryptocurrencies’ (2018) 66 Drake Law Review 107, 135.

[8] Income Tax Act, 1961; Information Technology Act, 2000; Prevention of Money Laundering Act, 2002; Central Goods and Services Tax Act, 2017.

[9]Ahmet Yereli, Isil Fluya Orkunoglu Sahin, ‘Cryptocurrencies and Taxation’ (2018) 5th Int’l AMSS.   

[10] Income Tax Act, 1961, section 2(14).

[11] Income Tax Act, 1961, section 45.

[12] Nagappan Meyyappan, ‘Cryptocurrencies: Indian and Global Approaches to Taxation and Regulation’ (2018) ITRAF 1, 8.  

[13] Central Goods and Services Act, 2017, section 7.

[14] Central Goods and Services Act, 2017, section 9.

[15] N. K. Gupta, ‘Exchange of Assets – Taxability and valuations under GST (2018) 92 taxmann.com 199.

[16] To avoid a flood of litigation in the higher courts from orders of the Regulatory Board under articles 32, 136, 226 of the Constitution.

[17] A more simplified use of the block chain technology could be used in public distribution schemes to increase accountability and reduce costs and effort related to the Right to Information Act, 2005. The block chain technology entails that an incorruptible block of information is added to a list of prior transactions on a public ledger. These blocks can only be triggered by an overt act of the parties. Once that happens all information is available in a decentralized manner accessible for all to view and authenticate. The Central Information Commission has, in relation to the Department of Food and Public Distribution received an average of 188.8 applications per year from 2010 to 2015. By adopting a block-chain technology based distribution system the Department could effectively increase accountability and substantially reduce related costs of Central Information Commission.      

[18] Such as Anonymity; Tax Evasion and Money Laundering; See – Adrian Blundell-Wignall. ‘The Bitcoin Question: Currency Versus Trust-Less Transfer Technology’ (2014) OECD Working Paper on Finance, Insurance and Private Pensions, No. 37.

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