Virtual digital assets and the complex world of tax compliance

The Finance Act 2022 instituted section 115BBH and it is applicable from AY 2023-24. The section provides that income from the transfer of Virtual Digital Assets (VDA) will be taxable at the rate of 30 percent. The taxpayer cannot claim a deduction for expenses other than acquisition costs. In this article, we will deal with the taxation on Virtual Digital Assets.

Meaning of VDA

The proposed definition of “virtual digital assets” [section 2(47A)] appears to be very broad. VDA is proposed to mean:

• Any information or code or number or token (not Indian currency or any foreign currency),
• generated by cryptographic means or otherwise,
• Providing a digital representation of value that is exchanged with or without payment,
• With the promise or representation that it has intrinsic value or functions as a store of value or unit of account and involves its use in any financial transaction or investment,
• But not only that, investment schemes can be transferred, stored, or traded electronically.
• The definition also includes non-fungible tokens and any other tokens of a similar nature.

What would be included within this definition will have to be seen in due course. For example – could credit card points, which are numbers and represent value, fall under the definition of “VDA” and therefore if any redemption (as the transfer covers the redemption) would fall under the mischief of this section.

While the authorities intend to tax the gains arising from the transfer of VDA, the broad definition of VDA can cause significant problems in implementing the provisions.

Tax on VDA as a gift

The proposed amendment (according to which VDA will be included in the definition of “assets” for Section 56(2) (x) of the Act) will take effect on 1 April 2022. Accordingly, gratuitous takeovers of VDA or disproportionate consideration before 1 April 2022 may not be taxable at all.

Further, in the absence of a corresponding section similar to section 50C or 50CA of the Act (which deals with fair market valuation (FMV) in the transfer of immovable property and unlisted shares), questions may arise regarding the valuation of VDA for computing taxable income.

In the absence of a corresponding section similar to section 50C or 50CA of the Act (which deal with fair market valuation (FMV) on transfers of immovable property and unlisted shares), questions may arise regarding the valuation of VDA for computing taxable income.

This problem is further exacerbated because the trading price of VDA on different exchanges can be different and in some cases, even one-day fluctuations in the price can be very significant.

VDA Transfer Tax

The Bill seeks to tax income arising from the transfer of virtual digital assets at a rate of 30% (without any deduction in respect of any expenditure (other than the cost of acquisition)).

As of today, taxes of 30% are also levied on income from sources such as winnings from lotteries, bets, horse races, etc. Somewhere, this indicates that the ministry views income from cryptocurrencies in the same way as other income (which is mainly from betting contracts). Since individuals with income above INR 1 million are already taxed at 30% today, the proposed 30% tax rate may not be viewed negatively by the industry.

However, the ministry also proposed to ban/ignore any losses suffered by cryptocurrency investors. Although there was some ambiguity as to whether losses incurred in the same year on one VDA can be set off against another VDA, it has been clarified that losses arising from one type of VDA cannot be set off against profits from any transaction involving another VDA when calculating tax. So if a taxpayer makes a profit of say INR 100 on Bitcoin and incurs a loss of INR 10 on Ethereum during the same year, the loss of Rs. 10 will be ignored and the taxpayer will pay tax of INR 100.

Further, income from a transfer of VDA will be taxed under this section, regardless of whether it is held as capital property or stock on an exchange.

Withholding of consideration payment

The bill provides for a withholding tax of 1 percent of the VDA transfer payment. It seems that in the case of a VDA transfer to a crypto exchange, the responsibility for withholding may fall on the crypto exchange since the buyer practically does not need to know who the seller is.

Initial Coin Offering

Initial coin offerings are the most fascinating concept in the cryptocurrency world and the most misunderstood concept by newcomer. An initial coin offering is just a fancy name for a “token sale” or “token offering”. In an initial coin offering, a person has to pay the token purchase price that was originally generated by the project proponent.

The initial coin offering is available to the general public against a dropout where only a small group of people enjoy the privilege. It is not like an initial public offering in the case of a company’s primary stock market, where the coins are sold as shares of the company. Token sales are mostly done by promoters who are developing new projects or platforms, as most of the activities (buying and selling) on ​​the platform will be done using the tokens issued by the promoters. It’s like going to a food stand where the shop owner will exchange your fiat currency for a food token and you can then exchange the food token for your favorite food.

Let’s take a real-world example- the bold browser. The browser provides BAT (Basic Attention Token) to users when they open ads in a bold browser. BAT can be used to purchase advertising space on websites. BAT is like a unit of currency to do any transaction in a bold browser. If you don’t need BAT, you can also convert them to Ethereum later. The token sale helps promoters establish their underlying market (creating supply and demand), thus indirectly funding their working capital needs. Currently, tokens are generated on the Ethereum blockchain according to the ERC-20 standard.

Final words

Taxation of cryptocurrencies and other related financial instruments is a huge challenge for the government. As this technology is very dynamic, it facilitates the creation of more sophisticated financial instruments and real-world solutions would be more challenging. The government has to choose a middle path because it also knows that blockchain is the technology of tomorrow and if it prevents it, it can hinder the technological growth of the country. The government must and will have to issue clarifications and notifications, otherwise, it would lead to confusion and suffering for taxpayers.