A digital currency or a virtual currency can be defined as a virtual asset that is managed, stored, and exchanged on the internet. Unlike the tangible currency notes and coins, a digital currency is intangible in nature and such currency may or may not be regulated by the government of a country. Cryptocurrencies and Nonfungible tokens are digital currencies which are based on the new blockchain technology and have gained extreme popularity on the internet. It is predicted that with the expansive growth in this sector, the cryptocurrency market is likely to grow exponentially and expected to reach USD 2.3 billion by 2026, up from an estimated size of USD 1.6 billion in 2021.
A brief history of the regulation of digital currency would indicate a strong apprehension of the government and Reserve Bank of India (“RBI”) in the use and trade of such virtual currencies. One of the first few press releases issued by RBI in 2013 was to caution the users, holders, and traders of virtual currencies, including bitcoins about the potential financial, operational, legal, customer protection and security related risks.2 With the increase in the use of virtual currencies, in 2017 the finance ministry clarified that virtual currencies were not legal tender. In 2018, the RBI proactively issued circular restraining all entities regulated by the RBI from dealing with and rendering any kind of services in relation to virtual currencies.3 The circular was however set aside later by the Supreme Court in Internet and Mobile Associations vs Reserve Bank of India WP No.528 of 2018.
Subsequently, a draft bill on “Banning of Cryptocurrency & Regulation of Official Digital Currency Bill 2019” was proposed by a government set-up inter-ministerial committee. The draft bill sought to put a blanket ban on cryptocurrency in India. However, in November 2021 a Standing Committee on finance met with representatives of Blockchain and Crypto Assets Council (BACC) and concluded that there should not be a blanket ban on virtual currencies. As a consequence, a redrafted “Cryptocurrency and Regulation of Official Digital Currency Bill, 2021” was proposed which is yet to be table in the Parliament.
The Union Budget of 2022 has proposed major changes in the area of digital currency. The 2022 budget is indicative of the government’s shifting stance of banning the digital currency to a more facilitative yet regulated environment that caters to all stakeholders in this ever-expanding world of cryptos.
The 2022 Budget has now proposed definition of virtual digital assets which shall be effective from 01 April 2022. The government has also proposed the release of RBI’s digital rupee termed as “Central Bank Digital Currency” (“CBDC”).
The government has proposed to amend Section 2 of the Income Tax Act, 1961 (“Income Tax Act”) by inserting clause (47A) which proposes to define virtual digital as: The government has proposed to amend Section 2 of the Income Tax Act, 1961 (“Income Tax Act”) by inserting clause (47A) which proposes to define virtual digital as:
The proposed definition aims to include all forms of digital asset present in the virtual domain. The specific inclusion of non-fungible tokens (“NFT”) is in recognition of their large scale popularity among artists and content creators. While both cryptocurrency and NFT are based on blockchain technology, unlike a cryptocurrency, each NFT is unique from the other. This is in contrast to cryptocurrencies which are identical to each other, thereby fungible in nature which makes it capable of being used for commercial transactions.
The proviso to the proposed definition also provides power to the Central Government to exclude any form of digital asset from the definition of virtual digital asset by way of a notification in the Official Gazette. It is imperative to understand that while the government has defined a “virtual digital asset”, such intangible assets do not automatically constitute a digital currency. A currency is a form of an asset which is a legal tender and used for discharge of any debt or obligation. The coins issued by the Government of India under Section 6 of The Coinage Act, 2011 as well as the bank notes issued by the RBI are legally tenderable currency.
Therefore, while the government has provided a definition of a virtual digital asset, it does not make such an asset a legal tender. The proposed definition is indeed a positive step especially after the previous RBI circulars and government announcements of a possibility of ban of such currencies. However, the proposed definition and amendments should not be interpreted to conclude that such virtual digital assets would be regarded as legal tender in India.
On the other side, the government has also announced release of the Reserve Bank of India’s (“RBI”) digital rupee termed as the Central Bank Digital Currency (“CBDC”) to be introduced from the next financial year. The Bill proposes the introduction of CBDC using blockchain and other technologies, to be issued by the RBI starting 2022-23. The budget states that introduction of the CBDC will give boost to digital economy and will also lead to a more efficient and cheaper currency management system.4 Further, the finance bill 2022 has proposed to also amend Section 2 of the Reserve Bank of India Act, 1934 to provide clarity that the CBDC should be regarded as bank notes. The CBDC, unlike the other virtual digital assets would therefore be recognized as a legal tender for financial transactions by the government.
The amendments to the Income Tax Act, 1961 with respect to virtual digital assets can be classified into (a) Income tax on virtual digital assets (b) Payment for transfer of virtual digital asset (c) Taxability of virtual digital assets as a gift. The proposed amendments to the Income Tax Act, 1961 to incorporate a new taxation regime for virtual digital assets seems identical to the existing taxation regime in relation to speculation income. Therefore, while the government did not categorically legalise the popular use of various forms of cryptocurrency, the proposed amendments would allow regulating such transactions over the internet. A detailed study of the proposed amendments is as follows:
The finance bill 2022 has proposed Section 115BBH in the Income Tax Act with effect from 01 April 2023. The proposed section seeks to impose a tax of thirty per cent on income from the transfer of any virtual digital asset. Further, as per the proposed section, no deduction or allowance or set off of any loss shall be allowed, except the deduction of cost of acquisition, in computing the tax under Section 115BBH. The proposed new section also prohibits carrying forward the loss from the transfer of virtual digital asset to succeeding assessment years.
The finance bill has proposed the levying of tax on any payment made by way of consideration for transfer of virtual digital asset as per Section 194S of the bill. Any such monetary consideration shall be taxed at one per cent at the time of credit of such sum to the account of the resident or at the time of payment of such sum by any mode, whichever is earlier. The new section shall be applicable from 01 July 2022.
Additionally, if the consideration for transfer of virtual digital asset is (i) wholly in kind or in exchange of another virtual digital asset or (ii) partly in cash and partly in kind, however the part in cash is insufficient to meet the tax deduction liability in respect of whole of such transfer then the proposed section states that the person paying such consideration shall be liable to ensure that tax has been paid prior to the release of consideration for the transfer of virtual digital asset.
Section 194S sub-section (3) provides the exception when tax shall not be deducted on such considerations for transfer of virtual digital asset:
Further, the proposed section provides an Explanation which defines a “specified person” as –
Section 56(2)(x) has an explanation stating that for the purpose of the clause, the definition of inter alia “property” shall have a meaning as per explanation (vii) of the clause. Since the existing definition did not account for virtual digital assets, the finance bill has proposed an amendment to the existing explanation to provide that “property” shall also include virtual digital assets. The amendment will take effect from 01 April 2023.
A combined reading of the Section 56(2)(x) with the amendment to the explanation would provide that in cases where a virtual digital asset is transferred by a person without any consideration (i.e. in the nature of a gift), in such a scenario, the recipient of the virtual digital asset shall be liable to pay tax on the fair market value of the virtual digital asset provided the fair market value of the virtual digital asset exceeds fifty thousand rupees.
Further, in a scenario where the consideration for transfer of the virtual digital asset is less than fair market value then the difference between the consideration and fair market value will be taxable from the recipient of the virtual digital asset. Therefore, both such cases the virtual digital asset will be taxable under the income from other sources head and Section 115BBH shall not be applicable. Additionally, the taxable amount shall be as per the rate of tax applicable to such person.
The Union Budget 2022 is thus a game-changer for the world of digital currencies and is reflective of the changing intent of the government. Technology is disruptive and it is essential for all forms of institutions to provide frameworks that allow it to thrive in unchartered areas of development. Any new technological development is bound to have the potential of being misused and staunch disapprovers of digital currency continue to demand a ban on all forms of cryptocurrencies. However, such a ban would lead to an unregulated illegal market in the virtual world.
The government is now expected to table the new 2021 Cryptocurrency Bill which seeks “to create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India. The Bill also seeks to prohibit all private cryptocurrencies in India; however, it allows for certain exceptions to promote the underlying technology of cryptocurrency and its uses”.
The banning of any form of private cryptocurrencies would lead to a monopoly of the central bank’s CBDC which would mean a step-back for the digital currencies. However, with the constant changes in this dynamic and unexplored area, it is hoped that India may soon take a complete pro-crypto stance which is less ambiguous and more aligned to the growing acceptance of virtual digital currencies worldwide.
Tags: S. Jalan & Co.
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