Is crypto legal now?

Union Budget FY2023 has finally ended the speculation about the impending ban on cryptocurrencies in India by introducing a 30% tax on transfer of virtual digital assets. The Finance Bill’s definition of virtual digital asset is wide enough to cover emerging digital assets, including non-fungible tokens (NFTs), metaverse assets, digital currencies and tokens. The industry has welcomed the move, though some veterans say that the high tax rate and no setoff of losses against other income may discourage people from dealing in cryptocurrencies.

Does recognition of digital assets under income tax laws mean they have got legal status? What are the grey areas?

Most importantly, what do the changes mean for investors?

Crypto is an Asset

“A currency is a currency only when it is issued by the central bank, even if it is a crypto. Anything outside of that, what we refer loosely as cryptocurrencies, are not currencies,” the finance minister said while clearing the air around cryptocurrencies at her post-Budget press conference. “We are not taxing the currency (digital rupee) that is yet to be issued by RBI. Everything that prevails outside of it, in the name of digital, are assets being created by individuals. And if profits are being made by transacting those assets, we will tax them at 30%.” She said government will keep a watch on the crypto world by imposing a 1% tax deducted at source (TDS) on every transaction.

Amitabh Kant, CEO, NITI Aayog, gave more clarity and said government is not banning cryptos. “Once you start taxing, it means you will have a regulatory mechanism, whether some aspect is regulated by RBI or Sebi. The Budget provides absolute clarity. Government has not banned cryptos. It has, in fact, treated crypto as an asset class, defined as a virtual digital asset,” he told Fortune India.

The Tax Implication

The crypto asset market in India is worth $15 billion, says a report by CREBACO, a research, rating and intelligence firm focused on blockchain and cryptocurrencies. The report says the Indian crypto community may have over six million people or 0.5% of the country’s population. Centre calls the numbers highly exaggerated, but acknowledges that transactions have been rising. “There has been a phenomenal increase in transactions in virtual digital assets. The magnitude and frequency of these transactions have made it imperative to provide for a specific tax regime. I propose that any income from transfer of any virtual digital asset shall be taxed at the rate of 30%,” she said in her Budget speech. This will be applicable from April 1, 2023, that is, for income earned from April 1, 2022, to March 31, 2023.

“To some extent, I feel it’s a knee-jerk reaction by government to show that they are doing something in this space,” says Badri Narayanan, executive partner, Lakshmikumaran & Sridharan Attorneys. “I believe some of these things will be clarified or amended. Some tax experts are unhappy with the high tax rate. These are the highest level of taxes possible on cryptocurrencies,” says Narayanan. Others agree. “Taxation of profits at 30% may not receive equal appreciation from all stakeholders,” says Jay Hao, CEO of OKX.com, the world’s second-largest crypto exchange. It may discourage investors, he says.

The Bill further specifies that no deduction shall be allowed for expenditure on virtual digital assets except cost of acquisition. Also, no setoff and carry-forward of losses will be allowed against income from other sources. “The new crypto tax regime seems to be a deterrent to investor interest and is similar to taxation on gambling,” says Badri Narayanan.

The finance minister also proposed a 1% TDS on every transaction involving virtual digital assets. “Any person responsible for paying to a resident any sum by way of consideration for transfer of a virtual digital asset shall …deduct an amount equal to 1% of such sum as income-tax.” This has to be done even when the consideration is wholly in kind or any other virtual digital asset.

The industry is divided on the proposal for TDS. “The 1% TDS seems high because in crypto transactions, especially by day traders, transaction frequency is high but margins are low. Therefore, 1% TDS on each transaction may lower volumes," says Rahul Garg, partner, Price Waterhouse & Co LLP. If they want the business to flourish so that they can collect more taxes, they should get a more practical TDS framework, he adds.

Ravi S. Raghavan, partner, Tax and Private Client Group, Majmudar& Partners, says the seller will have to withhold tax even when there is no cash involved. “As such, compliance obligations are cumbersome and, to avoid the high rate of 30% tax and 1% withholding tax obligations, investors may choose options like listed/unlisted securities, property and gold bonds. Investors will become cautious,” he adds.

Some experts raise the point about NFTs and other entertainment assets being different from crypto tokens. “Crypto is a traceable asset and NFTs or gaming virtual goods are entertainment assets or collectible assets like digital music and digital art,” says Keyur Patel, chairman & co-Founder, GuardianLink, and co-Founder, BeyondLife.club. Patel says NFTs are non-taxable worldwide and it’s imperative to understand that a crypto token is different from a digital NFT token so that industries such as gaming, interactive immersive museums and other edutainment NFT frameworks can succeed.

“There will also be practical issues in complying with tax provisions on transactions where the identity of the buyer is unknown,” says Harry Parikh, associate partner, M&A tax and regulatory services, BDO India.

However, others argue that the TDS will, in fact, help government get more visibility about transactions on exchanges and, in the long term, encourage more investors to join this space. With increasing awareness about how shady elements use crypto assets to launder money, TDS can provide information for monitoring transactions, they say. “I do not think that 1% is a prohibitive amount. It will bring foreign investment to India. In fact, uncertainty and concerns about legal, regulatory, and taxation status cause more concern and volatility. Once these are addressed to a reasonable extent, we will be on our way to normalising and legalising crypto investments,” says Pratik Gauri, CEO & founder, 5ire, a blockchain ecosystem.

Some stakeholders are still hopeful that the final regulations will have amendments to favour investors. “There are more nuances to this, which is, could we look at taxing this on a par with other assets like securities?” says Ashish Singhal, founder and CEO, CoinSwitch. I’m hoping that government will work with the industry on some of these aspects, he says.

Corporate Acceptance

New taxation rules mean a larger number of people, especially corporates, will now be able to participate in the crypto market, says Nischal Shetty, founder, WazirX. No doubt, a short-term market fall can be expected, but then, there is nothing to worry about as from now on, we will witness several seasoned and serious investors stepping in, he says. “Corporations have stayed away primarily due to lack of regulatory clarity. We might see a surge in corporate interest from sectors which will benefit from blockchain technology,” says Amit Nayak, CEO and co-Founder of Sahicoin. We also look forward to many banks and financial partners supporting exchanges, says Shetty of WazirX.

Time has come for sophisticated investors to understand risk and access opportunities, in India and globally, in this emerging asset class, says Arihant Bardia, CIO, Valtrust Capital.

Dhaval Kapadia, director, managed portfolios, Morningstar Investment Advisers India, agrees. “In that sense, the higher taxation is a positive move to curb/control retail participation in the crypto segment,” he says.