Cryptocurrency Regulation in India: Tax System and Legal Framework

Introduction

The landscape of Cryptocurrency Regulation in India has evolved significantly from complete regulatory uncertainty to a structured tax framework coupled with stringent anti-money laundering measures. The journey from the Reserve Bank of India’s attempted banking ban to the present-day comprehensive taxation regime represents a fundamental shift in how digital assets are treated within the country’s financial ecosystem. While cryptocurrency remains unrecognized as legal tender, the government has established a distinct regulatory pathway that acknowledges the economic reality of virtual digital assets while maintaining strict oversight through taxation and compliance requirements.

The Indian cryptocurrency landscape operates within a dual framework where trading and holding digital assets is permissible under specific conditions, yet these assets cannot serve as payment instruments for goods and services. This nuanced position reflects the government’s attempt to balance technological innovation with financial stability concerns, creating a unique regulatory environment that differs substantially from both permissive jurisdictions and those imposing complete prohibitions.

Historical Evolution and Judicial Intervention in Cryptocurrency Regulation in India

The Supreme Court Landmark Judgment

The regulatory trajectory of cryptocurrency in India witnessed a watershed moment through the Supreme Court’s decision in Internet and Mobile Association of India v Reserve Bank of India [1]. On March 4, 2020, a three-judge bench comprising Justice Rohinton Fali Nariman, Justice S. Ravindra Bhat, and Justice V. Ramasubramanian struck down the Reserve Bank of India’s circular dated April 6, 2018. This circular had effectively prohibited banks and financial institutions regulated by the RBI from providing services to entities dealing in virtual currencies, thereby crippling the cryptocurrency ecosystem in India. This landmark judgment not only restored banking access to cryptocurrency exchanges but also set the stage for the development of India’s framework for cryptocurrency regulation, including taxation and compliance requirements for virtual digital assets..

The Court’s 180-page judgment established several critical legal principles. The Supreme Court recognized that while virtual currencies possessed characteristics of money and could perform functions similar to real currencies, they existed within a distinct category. The Court acknowledged that virtual currencies “belong to different categories ranging from property to commodity to non-traditional currency to payment instrument to money to fund” while simultaneously recognizing the RBI’s regulatory authority over these instruments given their potential impact on the country’s financial system.

However, the pivotal aspect of the judgment centered on the principle of proportionality. The Court held that the RBI failed to demonstrate that less intrusive regulatory measures were considered before imposing a blanket banking ban. The judgment emphasized that no RBI-regulated entity had suffered any direct or indirect loss due to their interface with virtual currency exchanges. This absence of demonstrable harm made the prohibition disproportionate to the purported risks. The Court stated that when the RBI itself maintained it had not banned virtual currencies, and when the Government of India remained unable to formulate definitive policy despite multiple committee recommendations, the blanket restriction could not satisfy the test of proportionality required under Article 19(1)(g) of the Constitution of India, which guarantees the fundamental right to practice any profession or carry on any occupation, trade, or business.

This judicial intervention proved transformative for cryptocurrency regulation in India, allowing exchanges to resume operations with banking access. Nevertheless, the Court explicitly refrained from declaring the legal status of cryptocurrencies, leaving that determination to legislative action. The judgment merely removed a disproportionate regulatory barrier while preserving the government’s authority to regulate virtual currencies through appropriate legislation.

Taxation Framework for Virtual Digital Assets

Income Tax Act Provisions

The Union Budget of 2022 introduced a comprehensive taxation regime for virtual digital assets through amendments to the Income Tax Act, 1961. Section 115BBH, which became effective from April 1, 2022, established the fundamental tax structure for income arising from the transfer of virtual digital assets. The provision defines virtual digital assets broadly to encompass any information, code, number, or token generated through cryptographic means, specifically excluding Indian currency and foreign currency [2].

The taxation mechanism under Section 115BBH imposes a flat rate of thirty percent on income arising from the transfer of virtual digital assets. This rate applies uniformly regardless of whether the income is characterized as capital gains from investment activities or business income from trading operations. The distinction between short-term and long-term capital gains, which typically influences tax rates for other asset classes, becomes irrelevant for virtual digital assets. Furthermore, the provision mandates that in addition to the thirty percent base rate, applicable surcharge and four percent health and education cess must be calculated, potentially elevating the effective tax rate substantially for high-income individuals.

The restrictive nature of Section 115BBH manifests through its explicit prohibition on deductions. While computing taxable income from virtual digital assets, no deduction is permissible except for the cost of acquisition of the transferred asset. This means transaction fees charged by exchanges, blockchain network fees, custodial charges, advisory expenses, or any other costs associated with holding or transferring virtual digital assets cannot be claimed as deductions. The practical effect is that only the difference between the sale consideration and the original purchase price constitutes the deductible amount.

Additionally, Section 115BBH contains stringent provisions regarding losses. Any loss incurred from the transfer of one virtual digital asset cannot be set off against gains from another virtual digital asset or against income under any other head of the Income Tax Act. Furthermore, such losses cannot be carried forward to subsequent assessment years. Each financial year’s cryptocurrency trading activity stands isolated for tax computation purposes, with losses effectively lapsing at the year-end while gains remain fully taxable.

Tax Deducted at Source Requirements

Complementing the direct taxation under Section 115BBH, the government introduced Section 194S to ensure transaction visibility and tax collection at source. This provision, effective from July 1, 2022, mandates that any person responsible for paying consideration to a resident for the transfer of virtual digital assets must deduct tax at source at the rate of one percent [3].

The threshold for triggering tax deduction at source varies based on the taxpayer’s category. For specified persons, defined as individuals or Hindu Undivided Families whose business turnover does not exceed one crore rupees or professional receipts do not exceed fifty lakh rupees, and who have no income from business or profession, the threshold stands at fifty thousand rupees per financial year. For all other taxpayers, including companies, firms, and limited liability partnerships, the threshold reduces to ten thousand rupees per financial year.

The operational mechanism of Section 194S places the deduction responsibility on the payer of the consideration. In transactions occurring through cryptocurrency exchanges, the exchange platform typically assumes this responsibility, automatically deducting one percent from the sale proceeds before crediting the amount to the seller’s account. However, in peer-to-peer transactions conducted outside exchange platforms, the buyer bears the obligation to deduct the tax and deposit it with the government within prescribed timelines, failing which penalties and interest charges apply.

An important aspect of Section 194S involves transactions where virtual digital assets are exchanged for other virtual digital assets rather than fiat currency. In such scenarios, the buyer must still deduct tax deducted at source in cash at one percent of the transaction value, requiring the buyer to arrange cash payment of the tax even when the transaction itself involves no cash component. This creates practical compliance challenges for pure cryptocurrency-to-cryptocurrency exchanges.

The tax deducted at source under Section 194S can be claimed as credit against final tax liability when filing income tax returns. However, the one percent deduction at the transaction level, combined with the thirty percent tax on net gains, creates significant liquidity constraints for active traders who must ensure sufficient funds remain available to discharge both obligations.

Anti-Money Laundering Framework

Prevention of Money Laundering Act Application

The landscape of Cryptocurrency Regulation in India underwent another fundamental transformation on March 7, 2023, when the Ministry of Finance issued a notification bringing virtual digital asset service providers within the ambit of the Prevention of Money Laundering Act, 2002 [4]. This notification classified entities providing specified services related to virtual digital assets as reporting entities under the anti-money laundering legislation, subjecting them to the same compliance obligations as banks and other traditional financial institutions.

The notification defined reportable activities as those carried out for or on behalf of another person in the course of business, encompassing exchange between virtual digital assets and fiat currencies, exchange between different forms of virtual digital assets, safekeeping or administration of virtual digital assets or instruments enabling control over such assets, and participation in and provision of financial services related to an issuer’s offer and sale of virtual digital assets. This activity-based approach ensures that the obligation applies regardless of whether the entity operates from within India or offshore, provided services are offered to Indian users.

The designation as reporting entities under the Prevention of Money Laundering Act triggered comprehensive compliance obligations. Virtual asset service providers must now register with the Financial Intelligence Unit-India as a prerequisite for legal operation. This registration requirement applies equally to domestic cryptocurrency exchanges and foreign platforms serving Indian customers. Failure to register exposes platforms to enforcement actions including financial penalties, criminal prosecution, and website blocking measures.

Know Your Customer and Due Diligence Requirements

Following their classification as reporting entities, virtual asset service providers must implement rigorous customer due diligence procedures aligned with Prevention of Money Laundering Act standards [5]. These requirements mandate comprehensive identity verification processes during customer onboarding, extending beyond basic documentation to include advanced authentication measures such as selfie-based verification, geolocation capture, bank account verification through penny-drop transactions, and collection of multiple identification documents.

The customer due diligence obligations continue beyond initial onboarding. Virtual asset service providers must conduct ongoing due diligence by monitoring transaction patterns to ensure consistency with the customer’s known business activities, risk profile, and declared source of funds. When transactions appear inconsistent with the customer’s profile or when material changes occur in the customer’s circumstances, the provider must undertake enhanced due diligence including reverification of identity and source of wealth documentation.

The regulatory framework imposes specific requirements for high-risk customers, particularly politically exposed persons. When onboarding or continuing relationships with politically exposed persons, virtual asset service providers must obtain senior management approval, establish the source of wealth and source of funds, and conduct enhanced ongoing monitoring of the business relationship. These heightened measures reflect international best practices recommended by the Financial Action Task Force.

Record retention constitutes another critical compliance obligation. Virtual asset service providers must maintain all customer identification records, transaction records, and supporting documentation for a minimum period of five years following termination of the business relationship or closure of accounts. These records must be maintained in formats that permit their production to competent authorities within reasonable timeframes upon request.

Suspicious Transaction Reporting

Virtual asset service providers bear the responsibility of monitoring transactions for suspicious activity that may indicate money laundering or terrorist financing. Upon identifying suspicious transactions, providers must file Suspicious Transaction Reports with the Financial Intelligence Unit-India within prescribed timelines [6]. The determination of suspicion involves professional judgment based on various red flag indicators including transaction patterns inconsistent with customer profiles, use of privacy-enhancing technologies like mixers or tumblers, transactions involving jurisdictions identified as high-risk by international bodies, rapid movement of funds across multiple accounts, and transactions lacking apparent economic rationale.

The regulatory framework prohibits the use of certain privacy-enhancing technologies and services. Virtual asset service providers cannot facilitate transactions involving cryptocurrency mixers, tumblers, or privacy-focused tokens that obscure transaction trails. This prohibition reflects the regulatory emphasis on transaction transparency and traceability as fundamental pillars of the anti-money laundering framework.

The Financial Intelligence Unit-India has demonstrated vigorous enforcement of these obligations. In December 2023, show-cause notices were issued to multiple major cryptocurrency exchanges including Binance, KuCoin, Huobi, Kraken, Gate.io, Bittrex, Bitstamp, MEXC Global, and Bitfinex for non-compliance with Prevention of Money Laundering Act provisions [7]. These actions resulted in platform blocking, financial penalties, and in some cases, freezing of bank accounts. Subsequently, platforms that achieved compliance through proper registration and implementation of required controls received authorization to resume operations.

Regulatory Bodies and Their Roles

The cryptocurrency regulatory architecture in India involves multiple governmental bodies, each exercising distinct oversight functions. The Reserve Bank of India maintains its role as the primary monetary authority, expressing consistent caution regarding cryptocurrency risks to macroeconomic stability and the integrity of the Indian rupee. Despite the Supreme Court’s striking down of its banking ban, the Reserve Bank of India continues advocating for stringent regulation and has embarked on developing the Digital Rupee, its central bank digital currency initiative.

The Ministry of Finance formulates overall policy direction for virtual digital assets and oversees implementation of the taxation regime. The Central Board of Direct Taxes, functioning under the Ministry of Finance, administers and enforces the taxation provisions contained in Sections 115BBH and 194S, issuing clarifications and conducting assessments to ensure compliance.

The Financial Intelligence Unit-India, operating under the Ministry of Finance, has emerged as the de facto regulator for anti-money laundering compliance within the cryptocurrency sector. Through its registration and enforcement powers under the Prevention of Money Laundering Act, the Financial Intelligence Unit-India exercises substantial control over which platforms can legally operate in India and establishes compliance standards that platforms must meet.

The Securities and Exchange Board of India, while not currently exercising direct regulatory authority over cryptocurrencies, has proposed involvement in a multi-regulator framework. The Securities and Exchange Board of India’s position acknowledges that if cryptocurrencies or tokens are structured as securities or investment contracts, they would naturally fall within its regulatory purview. The organization has advocated for coordinated regulatory action involving multiple authorities rather than single-agency oversight.

Current Legal Status and Market Reality

Cryptocurrencies occupy a legally recognized but carefully circumscribed space within Indian law. They are classified as virtual digital assets under the Income Tax Act and subject to taxation, yet they explicitly do not constitute legal tender. The practical implication is that while individuals can legally purchase, hold, and transfer cryptocurrencies through registered exchanges, these assets cannot serve as payment instruments for goods and services in the manner fiat currency functions.

The absence of comprehensive cryptocurrency-specific legislation beyond taxation and anti-money laundering provisions creates certain ambiguities. The proposed Cryptocurrency and Regulation of Official Digital Currency Bill, mentioned in parliamentary bulletins, has not progressed to enactment. This legislative vacuum means that while taxation and anti-money laundering frameworks are well-established, other aspects such as consumer protection mechanisms, dispute resolution procedures, and regulatory standards for cryptocurrency exchanges beyond anti-money laundering compliance remain underdeveloped.

Despite regulatory challenges including high taxation rates and compliance costs, India maintains a substantial cryptocurrency user base estimated at over one hundred million users [8]. Trading activity continues through both registered domestic exchanges that comply with Financial Intelligence Unit-India requirements and offshore platforms, though the latter face periodic enforcement actions if operating without proper registration.

Global Standards and International Coordination

India’s cryptocurrency regulation approach aligns with recommendations from international standard-setting bodies, particularly the Financial Action Task Force. The activity-based definition of virtual asset service providers, the mandatory registration and licensing regime, the emphasis on customer due diligence and transaction monitoring, and the requirement for suspicious transaction reporting all reflect Financial Action Task Force guidelines for virtual asset service providers.

The classification of virtual digital asset service providers as reporting entities under the Prevention of Money Laundering Act implements the Financial Action Task Force’s risk-based approach to anti-money laundering and counter-terrorist financing regulation. India’s framework recognizes that virtual assets present money laundering and terrorist financing risks similar to traditional financial instruments, necessitating comparable regulatory oversight.

International cooperation forms an essential component of effective cryptocurrency regulation given the borderless nature of digital assets. India’s participation in G20 discussions regarding cryptocurrency regulation demonstrates recognition that unilateral regulatory actions may prove insufficient. The Organisation for Economic Co-operation and Development’s Crypto-Asset Reporting Framework, which establishes standards for cross-border tax information exchange regarding cryptocurrency transactions, represents another international initiative likely to influence India’s evolving regulatory approach.

Challenges and Compliance Considerations

The stringent taxation regime imposes substantial compliance burdens on cryptocurrency investors and traders. The prohibition on loss set-off means that even investors experiencing net losses across their cryptocurrency portfolio may face tax liability on profitable transactions. The thirty percent flat rate, applied without distinction between long-term and short-term holdings, eliminates tax planning strategies available for other asset classes.

Accurate tax computation requires detailed transaction recordkeeping. Investors must maintain comprehensive logs documenting purchase dates, acquisition costs, sale dates, sale proceeds, and exchange rates for each transaction. The multiplicity of transactions common in active cryptocurrency trading, combined with the variety of transaction types including spot trading, derivatives, staking rewards, airdrops, and peer-to-peer transfers, creates significant recordkeeping complexity.

The Prevention of Money Laundering Act compliance obligations impose operational costs on virtual asset service providers. Implementation of robust customer due diligence systems, transaction monitoring infrastructure, suspicious activity detection algorithms, and regulatory reporting mechanisms requires substantial technological and human resource investment. These costs particularly affect smaller platforms and may create barriers to entry for new market participants.

Enforcement actions against non-compliant platforms demonstrate regulatory seriousness. The Financial Intelligence Unit-India has not hesitated to issue show-cause notices, impose financial penalties, order website blocking, and initiate criminal proceedings against platforms failing to meet registration and compliance requirements [9]. This aggressive enforcement posture incentivizes compliance but also creates uncertainty regarding enforcement standards and criteria.

Conclusion

Cryptocurrency regulation in India represents a pragmatic middle path between outright prohibition and unregulated permissiveness. Through the combination of comprehensive taxation under Sections 115BBH and 194S of the Income Tax Act and stringent anti-money laundering obligations under the Prevention of Money Laundering Act, the government has established a system that acknowledges the economic reality of virtual digital assets while maintaining regulatory control through taxation and transaction monitoring.

The Supreme Court’s landmark judgment in Internet and Mobile Association of India v Reserve Bank of India established the constitutional boundaries within which cryptocurrency regulation must operate, requiring proportionality and demonstrable harm before prohibitive measures can be justified. This judicial foundation, combined with the legislative framework for taxation and anti-money laundering compliance, creates a structured environment for cryptocurrency activity in India.

Looking forward, Cryptocurrency Regulation in India continues to evolve. Potential developments include enactment of comprehensive cryptocurrency legislation, refinement of taxation provisions based on operational experience, enhanced coordination among regulatory bodies through formalized multi-regulator frameworks, and continued alignment with international standards. The government’s development of the Digital Rupee as a central bank digital currency may influence broader cryptocurrency policy as authorities gain operational experience with digital assets.

For market participants, success requires rigorous compliance with both taxation obligations and anti-money laundering requirements. Cryptocurrency investors must maintain detailed transaction records, calculate tax liability accurately, ensure timely payment of taxes including tax deducted at source, and file complete disclosures through Schedule VDA in income tax returns. Virtual asset service providers must prioritize registration with the Financial Intelligence Unit-India, implementation of robust know your customer and customer due diligence systems, continuous transaction monitoring, and prompt suspicious transaction reporting.

The cryptocurrency regulatory framework in India, though stringent, provides legal certainty that permits cryptocurrency activity within defined parameters. This regulatory clarity, even with its compliance burdens, represents progress from the earlier period of complete uncertainty when cryptocurrency’s legal status remained undefined.

References

[1] Supreme Court of India. Internet and Mobile Association of India v. Reserve Bank of India, 2020 SCC OnLine SC 275 (decided March 4, 2020). Available at: https://www.scconline.com/blog/post/2020/03/04/sc-quashes-rbis-ban-on-cryptocurrency-trading/ 

[2] Income Tax Act, 1961, Section 115BBH (introduced through Finance Act, 2022). Analysis available at: https://taxguru.in/income-tax/taxation-cryptocurrency-virtual-digital-assets-india-understanding-sections-115bbh-194s-method-taxation.html 

[3] Income Tax Act, 1961, Section 194S (introduced through Finance Act, 2022). Details at: https://www.cryptact.com/en/blog/vda-income-tax-india-2025-complete-guide-to-crypto-tax-rules-sections-and-filing-process 

[4] Ministry of Finance, Government of India. Notification S.O. 1074(E) dated March 7, 2023.  Available at: https://fiuindia.gov.in/pdfs/AML_legislation/AMLCFTguidelines10032023.pdf 

[5] Financial Intelligence Unit-India. AML & CFT Guidelines For Reporting Entities Providing Services Related to Virtual Digital Assets (March 10, 2023). Available at: https://fiuindia.gov.in/pdfs/AML_legislation/AMLCFTguidelines10032023.pdf 

[6] Prevention of Money Laundering Act, 2002. Legislative framework analyzed at: https://iclg.com/practice-areas/anti-money-laundering-laws-and-regulations/india 

[7] Global Legal Insights. Blockchain & Cryptocurrency Laws and Regulations 2026 – India. Available at: https://www.globallegalinsights.com/practice-areas/blockchain-cryptocurrency-laws-and-regulations/india/ 

[8] CoinDCX. Crypto Legal Status in India 2026: Tax Rules, FIU, RBI & More. Available at: https://coindcx.com/blog/cryptocurrency/crypto-legal-status-in-india/ 

[9] Oxford Law Blogs. Digital Assets & the Indian Anti-Money Laundering Regime (July 25, 2023). Available at: https://blogs.law.ox.ac.uk/oblb/blog-post/2023/07/digital-assets-indian-anti-money-laundering-regime