A cryptocurrency is a decentralized digital asset and medium of exchange. Bitcoin was the world’s first cryptocurrency to hit the market in 2009. It was created by a software developer under the pseudonym Satoshi Nakamoto. Based on blockchain technology, over 1,500 virtual currencies such as Litecoin, Ripple, Ethereum and Dogecoin are actively used and traded today.
The cryptocurrency space in India has faced significant regulatory challenges. It started with a circular from the Reserve Bank of India dated April 6, 2018 restricting the offering of banking facilities to participants involved in cryptocurrency transactions. In March 2020, the Supreme Court overturned the RBI circular for constitutional reasons and confirmed the fundamental right of virtual currency exchanges to trade. It is estimated that around 5 million traders in India have traded on 24 exchanges, with trading volumes in the range of 1,500 bitcoins per day, which equates to a volume of 1 billion rupees. According to moneycontrol.com, the volume of cryptocurrency trading in India rose 400 percent during the nationwide lockdown.
On March 24, 2021, as possibly the government’s first move to regulate cryptocurrencies and related transactions in India, the Ministry of Corporate Affairs required companies that trade virtual currencies to disclose profits or losses from crypto transactions and how much cryptocurrency they use keep in their balance sheets as of the balance sheet date. These changes were made in Annex III of the German Stock Corporation Act with effect from April 1, 2021.
Indian income tax law is still unclear about the tax implications for profits made with cryptocurrencies. It’s worth noting that India’s tax authorities have not yet categorized returns from cryptocurrencies and there has been no judicial precedent in this regard.
To understand the taxation of cryptocurrencies, one should study the classification of the cryptocurrency, i.e. is it currency or goods / property?
How are cryptocurrency transactions taxed in other countries?
UNITED STATES: The Internal Revenue Service ruled in 2014 that cryptocurrencies should be treated as “property,” meaning they should be taxed as capital assets, except in situations where crypto is earned from mining activities.
Singapore: Companies that trade virtual currencies as part of their business are taxed on their profits as business income. Companies that hold cryptocurrencies for long-term investment purposes will not be taxed as there is no capital gains tax in Singapore.
United Kingdom: If a person buys and sells crypto assets with such frequency, organization and complexity that the activity amounts to financial trading, then they will be taxed as trading profit / loss, otherwise they will be subject to capital gains tax.
Taxation of cryptocurrency transactions in India
If cryptocurrency is to be classified as a currency, that transaction is not taxable under the Income Tax Act 1961 (“ITA”). Cryptocurrencies are not recognized as currency by the RBI and the word “income” as used in Section 2 (24) of the ITA provides a comprehensive list that does not include “money” or “currency”. On the other hand, if cryptocurrency is considered a property / commodity, it would either fall under the heading of “Capital Gains” or “Profits and Profits from Business or Profession”.
The fact that profits from cryptocurrencies are taxed is now established as the Minister of State for Finance, Mr. Anurag Singh Thakur, clarified on March 28, 2021 that “the profits from the transfer of cryptocurrencies / assets are subject to taxation under an income, depending on the nature of the possession of the same ”.
It is therefore clear that cryptocurrencies are not treated as currency by India and are taxable. The key question is whether virtual currency income is treated as capital gains or as business income. If the seller is a trader, the income is taxable as business income. If it is not business income, this income is taxed in the form of capital gains.
Taxation under “Capital Gains”
Cryptocurrency can be considered an investment when it is bought by a taxpayer for investment purposes. Pursuant to Section 2 (14) of the ITA, an asset is any kind of property held by any person, whether or not related to their business or occupation. While the term “property” has no legal meaning, it is used to describe all kinds of interests that a person can acquire, hold or enjoy. Therefore, any profit from the transfer of cryptocurrency can be considered a capital gain when held for investment.
Rare crypto transactions can be treated as long or short term capital gain depending on the holding period. If investors held cryptocurrencies for 36 months or more, the profits would be taxable as long-term capital gains, and if less than 36 months, they would be short-term capital gains. Short-term capital gains are taxable according to the flat rates applicable to a taxpayer. And long-term capital gains are taxed at a flat rate of 20% and benefit from indexation.
Tax liability under ‘Profit and profit from company or profession’:
However, if the transactions are significant and frequent, it could be assumed that the taxpayer is trading in cryptocurrencies and any profits from them would be taxable as business income. If cryptocurrencies are held as a “trading asset”, the resulting income will also be taxed as corporate income. Therefore, the continuous activity of trading in cryptocurrencies and the profits made become taxable as business income. It is true that the tax authorities can take the position that such a trade is treated as speculative income that would adversely affect the taxpayer.
In summary, virtual currencies can strengthen India’s digital infrastructure and reduce bank infrastructure costs due to cross-border payments, securities trading and regulatory compliance. We still need clarity from the government on the taxation of cryptocurrencies, in particular on issues such as the treatment of capital gains or corporate income, the classification as speculative income, the permissibility of offsetting and loss carryforwards and the applicability of provisions on gift tax.
(The author, Harsh Bhuta, is a partner at Bhuta Shah and Co LLP. The views are his own)