BACKGROUND

In India, virtual currencies were first identified in the regulatory regime on December 24, 2013, when the Reserve Bank of India (“RBI”) cautioned the holders, users and traders of virtual currencies against the potential economic, financial, legal, operational, customer protection and security related risks associated with virtual currencies.[1] In order to safeguard the interests of the holders, users and traders of virtual currencies, the RBI reiterated the various risks associated with virtual currencies on numerous other occasions.[2] Further, the RBI, vide notification dated April 06, 2018[3] (“Notification”) also restricted the entities regulated by it from dealing in virtual currencies or providing services for facilitating any person or entity dealing in virtual currencies. Moreover, it also mandated the regulated entities already offering such services to exit the relationship within 3 (three) months from the date of the Notification.

However, the Notification was challenged before the Supreme Court of India (“SC”) in Internet Mobile Association v. RBI,[4] wherein the SC while noting the preventative actions taken by the RBI, set aside the Notification. Thereafter, the Ministry of Corporate Affairs, Government of India released a notification dated March 24, 2021, wherein it made certain amendments to Schedule III of the Companies Act, 2013 and mandated companies to make disclosures with respect to the virtual currency transactions undertaken by them during a financial year. Vide notification dated May 31, 2021[5], the RBI also directed all banks and regulated entities to continue carrying out customer due diligences of their customers dealing in virtual currencies as per the various applicable laws.

In light of the above, the legal position of virtual currencies appeared to be settling in India. However, the Lok Sabha Bulletin dated November 23, 2021 revealed that the Central Government proposed to introduce the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 in the Parliament of India to create a facilitative framework for creation of the official digital currency to be issued by the RBI and to prohibit all private cryptocurrencies in India, thereby causing disruption in the market and creating confusion with respect to the legality of cryptocurrencies in India.

 THE FINANCE BILL, 2022

 On February 01, 2022, the Central Government presented the Union Budget and introduced the Finance Bill, 2022 (“Finance Bill”) in the Lok Sabha, Parliament of India, to give effect to the financial proposals of the Central Government for the financial year 2022-2023. The Finance Bill has inter-alia introduced a specific tax regime for transactions relating to virtual digital assets.

The term ‘virtual digital assets’ has been defined to mean any information, code, number or token (including a non-fungible token or any other token of similar nature), which is neither an Indian currency nor foreign currency, generated through cryptographic means or otherwise, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having an inherent value, or functioning as a store of value or a unit of account, capable of being transferred, stored or traded electronically. [6] The definition of ‘virtual digital assets’, as provided in the Finance Bill, is inclusive in nature and may include any other digital asset, as the Central Government may, by notification in the Official Gazette specify. The current definition of ‘virtual digital assets’ includes the various virtual currencies being traded across exchanges in India within its ambit. However, it is pertinent to note that the Finance Bill also provides that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of ‘virtual digital asset’ subject to such conditions as may be specified therein.

While it will be imperative to observe if the Central Government will introduce a notification to exclude certain virtual currencies from the definition of ‘virtual digital assets’, the Finance Bill indicates that the Central Government seeks to regulate virtual currency transactions as opposed to ban such transactions in India. However, the extent of such regulation needs to be observed with time, as the Central Government also proposes to introduce its own digital currency in the financial year 2022-2023, which will be based on blockchain and other similar technologies.

TAXATION OF ‘VIRTUAL DIGITAL ASSET’ TRANSACTIONS

With effect from April 01, 2022, the Finance Bill provides that any income from ‘transfer’ of virtual digital assets shall be taxed at 30% (thirty percent).[7] The usage of the word ‘transfer’, instead of ‘sale’ ensures that any virtual digital asset transferred from one person to another person as ‘gift’ is also subject to tax at the rate of 30% (thirty percent). Further, the Finance Bill provides that no deduction in respect of any expenditure (other than cost of acquisition) or allowance or set-off of any loss shall be allowed to an assessee under any provision of the Income Tax Act, 1961 (“IT Act”), while computing the income from virtual digital assets. It also provides that no-set off of loss from transfer of the virtual digital assets shall be allowed against income computed under any other provision of the IT Act to the assessee and such loss shall also not be allowed to be carried forward to the succeeding assessment years. Accordingly, the losses or profits from the sale/ transfer of virtual digital assets cannot be adjusted against any other income or losses in the current financial year nor can such losses be carried forward to the next year. It is in stark contrast to the other provisions of the IT Act, which allow to either set-off the losses or carry forward the losses up to a period 8 (eight) years.

It is pertinent to note that the Finance Bill also provides that any person, who is responsible for paying consideration for transfer of a virtual digital asset, shall deduct an amount equal to 1% (one percent) of the consideration as income-tax thereon, at the time of crediting such consideration to the account or at the time of payment of such consideration through any other mode, whichever is earlier.[8] It will enable the Central Government to keep an account of all the transactions undertaken by a person during an assessment year.

However, the Finance Bill clarifies that no tax shall be deducted if the consideration is payable by a specified person and the aggregate value of such consideration does not exceed INR 50,000/- (Indian Rupees Fifty Thousand Only) during the financial year or if the consideration is payable by any person other than a specified person and the aggregate value of such consideration does not exceed INR 10,000/- (Indian Rupees Ten Thousand Only) during the financial year.

THE LONG ROAD AHEAD

With the paradigm shift from a complete prohibition on transactions relating to virtual currencies to regulating such transactions by introducing a specific tax regime, the Central Government has arguably moved towards safeguarding the interests of the various stakeholders involved in a virtual currency transaction. Despite the high tax provisions prescribed in relation to ‘virtual digital assets’, the Finance Bill brings respite for a foreseeable future as it may be taken as reaffirmation of the intent of the Central Government to regulate virtual currency transactions. However, it is pertinent to note that the fate of virtual currencies is not settled yet and is largely dependent on the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, which once sought to prohibit all private cryptocurrencies in India.

Moreover, a provision in the definition of ‘virtual digital assets’ that empowers the Central Government to exclude any digital asset from the definition of ‘virtual digital assets’, through a notification in the Official Gazette has also resulted in some ambiguity with respect to the scope of the virtual currencies covered within the ambit of the Finance Bill. Further, the Finance Minister’s reply during the Union Budget discussion in the Rajya Sabha on February 11, 2022, wherein it has been clarified that the Central Government, through the Finance Bill, merely seeks to impose tax on the profit emanating from cryptocurrency transactions as a sovereign right and such taxation does not necessarily legalize cryptocurrencies, has created uncertainty with respect to the future of ‘virtual currencies’ in India. Nonetheless, the Finance Bill may be viewed as a positive step towards recognition of the virtual currency transactions in India and promotion of ‘Digital India’. However, it still does not conclusively resolve the confusion with respect to the legal status of cryptocurrencies/ virtual currencies in India.

Footnotes:

[1] RBI cautions users of Virtual Currencies against Risks, Press Release No. 2013-2014/1261, December 24, 2013.

[2] RBI cautions users of Virtual Currencies, Press Release No. 2016-17/2054, February 01, 2017; Reserve Bank cautions regarding risk of Virtual Currencies, including Bitcoins, Press Release No. 2017-2018/1530, December 05, 2017.

[3] Prohibition on dealing in Virtual Currencies, Notification No. RBI/2017-18/154, April 06, 2018.

[4] Internet and Mobile Association of India v. Reserve Bank of India, AIR 2021 SC 2720.

[5] Customer Due Diligence for transactions in Virtual Currencies (VC), Notification No. RBI/2021-22/45, May 31, 2021.

[6] Section 3(b), The Finance Bill, 2022.

[7] Section 28, The Finance Bill, 2022.

[8] Section 59, The Finance Bill, 2022.