INCOME TAX IN THE CRYPTOCURRENCY ECONOMY
Introduction to taxation aspects pertaining to cryptocurrency in India
A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.
A cryptocurrency is a form of digital asset based on a network that is distributed across a large number of computers. This decentralized structure allows them to exist outside the control of governments and central authorities. The word “cryptocurrency” is derived from the encryption techniques which are used to secure the network. Blockchains, which are organizational methods for ensuring the integrity of transactional data, are an essential component of many cryptocurrencies. Many experts believe that blockchain and related technology will disrupt many industries, including finance and law. Cryptocurrencies face criticism for a number of reasons, including their use for illegal activities, exchange rate volatility, and vulnerabilities of the infrastructure underlying them. However, they also have been praised for their portability, divisibility, inflation resistance, and transparency.
The Constitution of India under Article 246 grants the power to levy taxes to the Parliament as well as the state legislatures to impose taxes. Article 265 provides that no tax can be imposed or collected without the authority of law. With the introduction of the Constitution (One Hundred and First Amendment) Act, 2016, the Parliament made several amendments concerning the imposition of Goods and Services Tax (‘GST’) including Article 246A, wherein exclusive power was given to the Parliament to make laws about interstate trade and commerce. Furthermore, Schedule VII lists the subject matters where Parliament and state legislatures can impose taxes.
Accordingly, any transaction involving cryptocurrency can be analyzed from two viewpoints:
The nature of the transaction and parties to the transaction would decide if it may be taxable under the Income Tax Act, 1961, or Central Goods and Services Tax Act, 2017, and other laws. As it is well established that the regulatory framework regarding cryptocurrencies is uncertain, this article tries to analyze the taxation (or non-taxation) by considering them as both goods and currency, two major approaches currently prevalent across the world.
Ways for generating Cryptocurrency:
Cryptocurrency can be generated in the following ways:
- Mining: “Mining” crypto is when an individual miner uses computing technology to solve complicated algorithms/codes/equations and record data on the blockchain. In exchange for this work, one may receive payment in new crypto tokens.
- Buying: Buying it from currency exchanges using real currency and storing it in an online currency wallet in digital form.
- As legal tender: It can be used as a consideration for sale of goods and services, instead of real currency.
Cryptocurrency in India:
In 2018, the Reserve Bank of India (RBI) banned the use of cryptocurrency as legal tender in India by issuing a circular. However, this decision was overturned by the Indian Supreme Court in March 2020, permitting banks to handle cryptocurrency transactions from traders and exchanges. The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 has been tabled by the government in the parliament and will most probably be taken up for discussion in the upcoming monsoon session
Taxation under direct tax regime:
The treatment of cryptocurrencies under the direct tax regime is mainly governed by the Income Tax Act in India. In the current legal landscape, there is no certainty regarding the taxation of cryptocurrency nor any disclosure requirement about the income earned issued by the Income Tax Department. Moving on, if cryptocurrency is considered as ‘currency’, it would not be susceptible to tax under the IT Act. The first reason being, under the Act, the definition of ‘income’ is an inclusive one, which comprises not only the ‘natural’ meaning but also the items mentioned under Sec 2(24) of the IT Act. But neither the natural meaning nor Sec 2(24) of the IT Act includes ‘money’ or ‘currency’ as income, although it includes ‘monetary payment’. Secondly, being a mode of consideration, the tax incidence would be on the transaction and not on the currency. On the other hand, if cryptocurrency is considered as goods/property, then clearly it would be either covered within the charging provision of ‘Profit and Gains from Business and Profession’ or ‘Income from Capital Gains’, depending upon its use for business/profession or not. It would not be out of place to state that the ambit of the word ‘income’ is not restricted to the words ‘profits’ and ‘gains’ and anything which can appropriately be designated as ‘income’ is liable to be taxed under the IT Act, unless expressly exempted.
Profits and gains from business and profession:
These transactions include receipt of cryptocurrency as consideration for sale of goods or supply of services, and sale and purchase of cryptocurrency as stock in trade. Such transactions are liable for taxation under the Income Tax Act. Under Section 2(13) of the Income Tax Act, the definition of business is inclusive, consisting of “trade, commerce or manufacture or any adventure or concern of such nature.” Any continuous activity like trade in cryptocurrencies is included within this definition, and profits realized are taxable thereunder, chargeable under Section 28 of the Income Tax Act.
Section 2(14) of the Income Tax Act defines a capital asset as ‘property of any kind held by the assessee whether or not connected with his business or profession’. Thus capital assets include all kinds of property except those expressly excluded under the Act. Therefore, any gains arising out of the transfer of cryptocurrency must be considered as capital gains, if they are held for investment. Depending on the duration for which these crypto assets are held for the purpose of investment, they would be subject to taxation under long-term capital gains or short-term capital gains.
Taxation under indirect tax regime:
The treatment of cryptocurrency as goods/property implies that the supply of bitcoins is a ‘taxable supply’ and hence subject to GST. Technically, a supply of cryptocurrency as goods or property in exchange for other virtual/real goods should fall within the ambit of ‘barter transaction’ since bartering is simply an exchange of one good for another. Before GST, under the various state VAT laws, the incidence of tax arose when there was a sale of goods in exchange for cash, deferred payment, or any other valuable consideration. The expression ‘any other valuable consideration’ leaves out a wide scope of ambiguity, since the term should typically derive reference, ejusdem generis, from its preceding terms (i.e., cash and deferred payment), and therefore, must not include an exchange of goods for other goods. This view was reiterated by the Supreme Court in the case of Sales Tax Commissioner v. Ram Kumar Agarwal, where a transaction of gold bullions in exchange for ornaments was excluded from the definition of sale under Sec 2(h) of the Sale of Goods Act, 1930. However, the position is similar to when a transaction is used as a device to conceal monetary consideration, courts may unravel the device to include it within the ambit of sale.
An approach where cryptocurrencies are considered as goods means that some transactions would be taxed twice – at first on supply (otherwise exempted for a transaction in money) and secondly on consideration, unnecessarily leading to higher tax. This higher incidence of taxation puts the businesses operating in cryptocurrencies at a huge disadvantage which also diminishes their purchasing capacity. The issue gets further complicated in cases of international transactions.
The crypto in today’s scenario has the potential to boost the backbone of India’s digital infrastructure and also secure all the transactions made on the digital network. In this situation levying taxes on the transactions involving cryptocurrency should be considered a welcoming move and should not be seen as a restriction. It is a two-way street for the crypto transactions to be traced and used legally as well as generating income for the government to be used efficiently.