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Crypto Losses Under Section 115BBH: Why the No-Set-Off Rule Creates an Unconstitutional Tax on Notional Gains
Introduction
When the Finance Act, 2022 introduced Section 115BBH into the Income Tax Act, 1961, it created one of the most structurally aggressive tax provisions that India’s crypto ecosystem had ever seen. The provision imposes a flat 30% tax on any income arising from the transfer of Virtual Digital Assets (VDAs), including cryptocurrencies and non-fungible tokens, regardless of the investor’s income slab, holding period, or the broader financial position of the taxpayer in that year. While the government justified this framework as a mechanism to bring transparency and uniformity to an otherwise opaque sector, the provision carries a deeply problematic feature — it completely prohibits the set-off of losses from one VDA against gains from another, and bars the carry-forward of those losses to subsequent years.[1]
This article examines the legal architecture of Section 115BBH, places it in the context of the existing framework under Sections 70 and 71 of the Income Tax Act for set-off of losses, and argues that the no-set-off rule, as applied to a volatile asset class like cryptocurrency, effectively creates a tax on notional gains — gains that may not reflect the taxpayer’s actual economic position. The constitutional dimensions of this provision, particularly its tension with Article 14 of the Constitution of India, are brought into focus by tracing judicial precedents on the right to equality and the limits of legislative classification in tax law. The article also situates the provision within the broader trajectory of India’s regulatory approach to cryptocurrencies, anchored by the Supreme Court’s landmark ruling in Internet and Mobile Association of India v. Reserve Bank of India, Writ Petition (Civil) No. 528 of 2018, decided on March 4, 2020.[2]
The Legal Framework: Section 115BBH of the Income Tax Act, 1961
What Section 115BBH Says
Section 115BBH was inserted into the Income Tax Act, 1961 by the Finance Act, 2022, with effect from April 1, 2022. It provides that where the total income of an assessee includes any income from the transfer of any virtual digital asset, income tax shall be charged on such income at the rate of thirty percent. The provision explicitly states that no deduction in respect of any expenditure (other than the cost of acquisition) or allowance or set-off of any loss shall be allowed. Furthermore, it mandates that any loss arising from the transfer of a VDA shall not be set off against income computed under any other provision of the Act, and shall not be carried forward to subsequent assessment years.[1]
The definition of VDA is drawn from Section 2(47A) of the Income Tax Act, 1961, which reads: ‘virtual digital asset’ means any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme, and which can be transferred, stored or traded electronically.[3]
Complementing Section 115BBH is Section 194S of the Income Tax Act, inserted simultaneously by the Finance Act, 2022, which requires the deduction of Tax Deducted at Source (TDS) at the rate of 1% on the payment of any sum to any resident person on the transfer of a VDA, where such consideration exceeds Rs. 50,000 in a financial year (or Rs. 10,000 in specified cases). This TDS provision came into effect on July 1, 2022, and operates as a compliance and tracking mechanism layered on top of the primary tax charge under Section 115BBH.[3]
How the No-Set-Off Rule Works in Practice
To understand why the no-set-off rule is problematic, a practical illustration is necessary. Suppose a taxpayer purchases Bitcoin worth Rs. 1,00,000 and sells it during the same assessment year for Rs. 1,50,000, generating a gain of Rs. 50,000. In the same year, the same taxpayer purchases Ethereum worth Rs. 80,000 and sells it for Rs. 50,000, incurring a loss of Rs. 30,000. Under the normal tax framework governing capital assets — namely Sections 70 and 71 of the Income Tax Act — the taxpayer would be entitled to set off the Rs. 30,000 loss against the Rs. 50,000 gain, resulting in a net taxable income of Rs. 20,000. Section 115BBH strips away this possibility entirely. The taxpayer is liable to pay 30% tax on Rs. 50,000, amounting to Rs. 15,000 (plus 4% cess), while the Rs. 30,000 loss evaporates without any tax benefit, and cannot be carried forward either.[1]
This outcome is not confined to intra-VDA set-offs. Losses from VDA transactions also cannot be set off against income from salary, business, house property, or capital gains from other asset classes. This is in direct contrast to the treatment of most other income-generating assets. A person holding equity shares, for instance, can set off a short-term capital loss from one share against a short-term or long-term capital gain from another, and can carry forward unabsorbed capital losses for up to eight assessment years under Section 74 of the Income Tax Act.[4]
The Existing Framework for Set-Off of Losses
Sections 70 and 71: The General Scheme
The Income Tax Act, 1961 recognizes a well-established principle that income tax should be levied on net income rather than gross receipts. This principle is operationalized through the provisions on set-off and carry-forward of losses contained in Sections 70 to 80 of the Act. Section 70 governs intra-head or inter-source adjustments. It provides that where the net result for any assessment year in respect of any source falling under any head of income, other than ‘Capital Gains’, is a loss, the assessee shall be entitled to have the amount of such loss set off against income from any other source under the same head of income.[4]
Section 70(2) specifically addresses capital gains. It provides that where the result of computation in respect of any short-term capital asset is a loss, the assessee shall be entitled to set off such loss against income from any other capital asset, whether long-term or short-term. Section 70(3) limits the set-off of long-term capital losses to long-term capital gains only. Section 71, on the other hand, governs inter-head set-offs. It permits losses under any head of income (other than capital gains) to be adjusted against income from any other head of income in the same assessment year. Section 74 governs the carry-forward of unabsorbed capital losses for up to eight assessment years.[4]
The philosophical underpinning of this framework is the recognition that economic losses are real. Taxing gross gains without accounting for losses in the same economic activity results in a distorted picture of the taxpayer’s actual income. This principle has been judicially affirmed. In CIT v. Harprasad & Co. Pvt. Ltd., (1975) 99 ITR 118 (SC), the Supreme Court of India held that losses under exempted heads cannot be set off against taxable heads, drawing a principled distinction between categories of income — but within each category, the net income approach remained the default.[5]
The Carve-Out for Speculative Income
The Income Tax Act does create specific restrictions on set-off for certain categories. Under Section 73, losses from speculative business — defined as a business that consists of the purchase and sale of commodities, including stocks and shares, where delivery is not actually taken or given — can only be set off against income from another speculative business, and can be carried forward only for four years. The government’s implicit logic in designing Section 115BBH may have been to treat crypto similarly to speculative income.
However, VDA transactions under Section 115BBH are not classified as speculative business income. The provision does not refer to Section 73 or borrow its framework. VDA income is taxed at 30% regardless of whether the underlying transaction involves actual delivery, exchange for goods or services, gifting, or any other form of transfer. The comparison to speculative income is, therefore, analytically flawed, and the complete bar on set-off — which is even stricter than the speculative income regime — cannot be defended by analogy.
Constitutional Analysis: Does Section 115BBH Violate Article 14?
The Article 14 Framework
Article 14 of the Constitution of India reads: ‘The State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India.’ The Supreme Court, in a line of cases beginning with E.P. Royappa v. State of Tamil Nadu, (1974) 4 SCC 3, held that equality is antithetic to arbitrariness, and that where an act is arbitrary, it is implicit that it is unequal both according to political logic and constitutional law. The Court further held in Maneka Gandhi v. Union of India, (1978) 1 SCC 248 that the fundamental rights under Chapter III of the Constitution are not to be read in isolation but as part of an integrated scheme, and that any State action must be just, fair, and reasonable.[6]
The doctrine of reasonable classification permits the legislature to classify persons, objects, or transactions for the purpose of achieving specific ends, provided two conditions are satisfied: first, that the classification is based on intelligible differentia — a real and substantial distinction that separates the class from those excluded from it; and second, that the differentia has a rational nexus with the object of the legislation. This two-pronged test was laid down authoritatively by the Supreme Court in Ram Krishna Dalmia v. Justice S.R. Tendolkar, AIR 1958 SC 538, and has remained the foundational standard for testing legislative classifications under Article 14.[7]
The Classification Problem in Section 115BBH
Section 115BBH creates a distinct class of taxpayers — those deriving income from VDA transfers — and subjects them to a tax regime that is materially inferior to that applicable to persons deriving income from other capital assets. The inferiority is not limited to the rate of tax (30% versus 15% or 20% for other capital assets). It extends to the denial of loss set-offs, the prohibition on carry-forward, and the exclusion of all deductions except the cost of acquisition. No other category of capital asset income suffers this combined deprivation.[3]
The question is whether this differentiation passes the two-pronged test under Article 14. The government’s rationale for the no-set-off rule appears to be twofold: first, to deter speculative trading in crypto markets, and second, to prevent tax avoidance through strategic loss booking in unregulated markets. These are legitimate policy objectives. The issue, however, is whether the complete bar on set-off — even within the same asset class, even for genuine economic losses — has a rational nexus with these objectives.
A prohibition on set-off of crypto losses against salary or business income might be defensible. But a prohibition on setting off a Bitcoin loss against an Ethereum gain, where both transactions occur in the same year, in the same economic context, within the same regulatory category, does not easily satisfy the nexus requirement. The taxpayer who loses Rs. 40,000 on Ethereum and gains Rs. 50,000 on Bitcoin has a real economic gain of Rs. 10,000. Taxing Rs. 50,000 at 30% — a tax of Rs. 15,000 on a real gain of Rs. 10,000 — is not merely aggressive; it is economically fictitious. It taxes notional gain, not actual enrichment.
The Proportionality Dimension
India’s constitutional jurisprudence has increasingly adopted the doctrine of proportionality as part of the Article 14 inquiry. The Supreme Court articulated this in Modern Dental College and Research Centre v. State of Madhya Pradesh, (2016) 7 SCC 353, holding that State action must be proportionate to the objective sought to be achieved. In the context of tax legislation, the Court has generally accorded a wider margin of discretion to Parliament, recognizing the complexity of fiscal policy. However, this deference is not unconditional. In R.K. Garg v. Union of India, AIR 1981 SC 2138, the Court held that reasonable classification must not be arbitrary, artificial or evasive, but must be based on some real and substantial distinction bearing a just and reasonable relation to the object sought to be achieved.[7]
A complete prohibition on loss set-off, which results in taxing a taxpayer on Rs. 50,000 when she has genuinely earned only Rs. 10,000 in net economic terms, appears disproportionate even against the government’s anti-speculation objective. Less restrictive alternatives exist — such as ring-fencing VDA losses to be set off only against VDA gains (as is done with capital losses generally), or allowing intra-VDA set-off while barring cross-class set-off — which would serve the same regulatory purpose without creating the distortionary outcome of taxing losses.
Regulatory Context: India’s Cryptocurrency Framework
The Supreme Court’s 2020 Ruling and Its Implications
The constitutional backdrop to Section 115BBH cannot be understood without reference to the Supreme Court’s ruling in Internet and Mobile Association of India v. Reserve Bank of India, Writ Petition (Civil) No. 528 of 2018, decided on March 4, 2020 by a bench comprising Justices Rohinton Fali Nariman, Aniruddha Bose, and V. Ramasubramanian. In this case, the Court set aside the Reserve Bank of India’s circular dated April 6, 2018, which had prohibited banks and other RBI-regulated entities from facilitating any transactions involving virtual currencies. The Court found that the RBI circular was a disproportionate restriction on the fundamental right to carry on any trade or profession under Article 19(1)(g) of the Constitution, since the RBI had not demonstrated actual harm to regulated entities from cryptocurrency activities.[2]
Justice V. Ramasubramanian, authoring the judgment, held: ‘When the consistent stand of RBI is that they have not banned Virtual currencies (VCs) and when the Government of India is unable to take a call despite several committees coming up with several proposals including two draft bills, both of which advocated exactly opposite positions, it is not possible for us to hold that the impugned measure is proportionate.’ This ruling had profound significance: it affirmed that cryptocurrency trading is a legitimate economic activity protected under the Constitution, and that regulatory responses must be calibrated and proportionate, not blunt prohibitions.[8]
The doctrinal importance of this ruling for Section 115BBH is significant. If an outright prohibition on crypto trading is unconstitutional on proportionality grounds, then a tax regime that effectively penalizes crypto traders by denying them the economic reality of net income computation — a right universally available to traders in every other asset class — raises parallel proportionality concerns. Taxation, like prohibition, can be an instrument of de facto regulation; and its proportionality must accordingly be scrutinized.
The Paradox of Taxing the Unregulated
One of the most striking features of India’s current approach is that the state taxes VDAs comprehensively under Section 115BBH while simultaneously refusing to accord them clear regulatory recognition. As of 2025, there is no dedicated cryptocurrency legislation in India. The Reserve Bank of India does not recognize cryptocurrency as legal tender. The Supreme Court itself, in a 2025 proceeding, declined to direct the government to formulate regulations for digital assets, holding that this fell within the domain of legislative and executive discretion.[9]
This creates a fiscal paradox that has been noted by commentators: the State extracts tax from an activity it does not officially sanction. VDA holders are obligated to comply with an extensive reporting regime under Schedule VDA in the Income Tax Return, face TDS deductions under Section 194S, and bear the 30% flat tax — yet they receive none of the regulatory protections that accompany the taxation of conventional financial instruments. This asymmetry further reinforces the constitutional critique of Section 115BBH: it imposes obligations without corresponding rights, and treats a heterogeneous and volatile asset class with greater punitiveness than any other recognized category of taxable income.
The Notional Gains Problem: Taxing What Does Not Exist
The phrase ‘notional gains’ in the context of Section 115BBH refers to the situation where the tax base created by the provision does not correspond to the taxpayer’s actual economic enrichment in the assessment year. This occurs when a taxpayer has both gains and losses from VDA transactions in the same year, and the denial of inter-VDA set-off results in a tax calculated on the gross gain rather than the net economic outcome.
Indian income tax law has traditionally resisted the taxation of notional income. The Supreme Court, in CIT v. B.C. Srinivasa Setty, (1981) 128 ITR 294 (SC), observed that the charging provisions of the Act must be read in a manner that imposes tax on real income. The Court held that where the charging provision and the computation provision cannot work harmoniously in relation to a particular transaction, the charging provision fails. The principle of taxing actual income over notional or fictitious income has been a consistent thread in Indian tax jurisprudence.[5]
Section 115BBH explicitly departs from this principle. By prohibiting loss set-off even within the VDA category, it creates a tax base that exceeds the taxpayer’s actual net income from VDA activity. A taxpayer who engages in 50 VDA transactions in a year, profiting on 25 and losing on 25, is taxed as if only the 25 profitable transactions occurred. The 25 loss-making transactions generate no tax benefit but represent real economic loss. The result is that the effective rate of taxation on actual net VDA income can far exceed 30% — and in years where losses exceed gains, a taxpayer may owe substantial tax despite being economically worse off at year-end.[1]
This is not a hypothetical concern. Cryptocurrency markets are characterized by extreme volatility. Price swings of 20–50% within a single trading day are not uncommon. An investor actively managing a portfolio of five to ten cryptocurrencies in a bear market may book gains on one coin coincidentally while sustaining deep losses on others. Under Section 115BBH, she pays 30% on each profitable transaction, receives no relief for any losing transaction, and carries no losses forward. The tax she pays may exceed the cash she has actually earned. This is not tax on income; it is tax on gross transaction receipts, partially offset only by cost of acquisition.
Conclusion
Section 115BBH of the Income Tax Act, 1961 represents Parliament’s attempt to bring the rapidly growing cryptocurrency sector into the formal tax net. As a revenue-raising measure, it is effective. As a policy instrument, it is deeply problematic. The absolute prohibition on loss set-off — even within the same asset category — produces tax liabilities that bear no rational relationship to the taxpayer’s actual economic gain. It taxes notional wealth rather than real enrichment, departs from the net-income principles that govern every other asset class in India, and imposes burdens on a class of taxpayers that are not merely disproportionate but arguably unconstitutional under Article 14.
The Supreme Court’s 2020 ruling in IAMAI v. RBI established that cryptocurrency trading is a constitutionally protected economic activity, and that regulatory responses targeting it must satisfy proportionality. The no-set-off rule under Section 115BBH does not satisfy this test. A reform that permits at least intra-VDA set-off — following the model of capital gains under Sections 70 and 74 — would address the constitutional concern without abandoning the revenue objective. Until such reform is undertaken, Section 115BBH remains a legal anomaly: a provision that taxes the phantom of profit while ignoring the reality of loss.
References
[1] Section 115BBH, Income Tax Act, 1961 (as inserted by Finance Act, 2022) — ClearTax Guide
[3] Section 2(47A), Income Tax Act, 1961 — VDA Definition and Tax Treatment, Majmudar & Partners
[4] Sections 70, 71 and 74, Income Tax Act, 1961 — Set-off and Carry Forward of Losses, The Legal Lock
[6] Maneka Gandhi v. Union of India, (1978) 1 SCC 248 — Indian Kanoon
[8] SCC Times — SC Quashes RBI’s Ban on Cryptocurrency Trading (March 4, 2020)
[9] Supreme Court of India Declines Appeal on Crypto Regulation (2025) — CoinGeek
