India has emerged as one of the fastest-growing crypto-economies, with transactions in the virtual digital assets (VDA) space becoming increasingly popular over the past few years. With the scope of exponential gains, Indians have ventured into VDA transactions with open arms, with India becoming home to the highest number of crypto-owners in the world. To earn revenue from such transactions in VDA, the government hurriedly introduced a taxation regime to tax the gains from the sale of VDAs with some peculiar features, via last year’s budget. The regime and its impact on the industry sparked several concerns regarding its efficacy, and one only hopes that these are addressed in the upcoming Budget.
The current taxation regime defines VDAs to include cryptocurrency and non-fungible tokens and provides for a flat rate of taxation at 30 percent on the gains made from their sale. It further requires the buyer to deduct tax at source at one percent, without offset of any losses. The fundamental objective behind introducing the tax regime was threefold: track and trace VDA transactions in the economy, curb the potential misuse of cryptocurrencies, and generate tax revenue in this process.
The high rate of taxation seems to indicate the intention of the government to deter speculative investments. Notably, the tax regime has resulted in disincentivising investors to operate through Indian VDA exchanges. To escape the onerous tax obligations, many investors have switched from domestic VDA exchanges to foreign counterparts. Further, many first-time investors have been discouraged to invest through the domestic VDA exchanges. A recent study has indicated that Indian VDA exchanges have lost over 95 percent of their trading volumes from January 2022 to October 2022. The unintended consequence of the flight of VDA accounts to foreign exchanges has been the reduction in the potential tax base, loss of liquidity in the Indian economy and decrease in the traceability of VDA transactions. The combination of the above has defeated the key objectives behind introducing the tax regime.
Align With Global Practices
In addition, the regressive tax regime - with no regard to the VDAs being held as a capital asset or inventory or the period of holding - has significantly deflated the risk appetite of the investors. Transactions in VDAs are treated akin to taxation on winnings from gambling and betting. Such tax structure has discouraged trading in the VDA space, causing many investors to cash out their investments. In comparison, other countries have adopted a progressive tax structure, taxing crypto gains like any other capital asset based on the settled principles of taxation. To ensure sustainable growth in the industry, the government must revise the current taxation regime to become internationally competitive. It is hoped that the government adopts a structure similar to the taxation of capital gains on the transfer of VDAs.
The TDS obligation on VDA transactions is also largely unique to India. At one percent of the transaction value, the current rate is significantly higher for an industry with high-frequency transactions. The primary objective of a TDS obligation is to keep a track of the transactions and to ensure tax compliance. This can be achieved through a lower rate without impacting the liquidity of the industry. For example, the TDS at 0.1 percent on the sale of goods or the Securities Transaction Tax (STT) which is levied at the rate of 0.01 percent to 0.1 percent has had a positive impact on tracking the transactions, ensuring compliance and generating healthy tax revenue. Hence, it is advisable that the government revisits these steps in the upcoming Budget and introduces a pro-industry policy where the TDS obligation is at par with other securities and a provision to set off losses is provided.
Another aspect that requires clarification is the valuation mechanism for the VDAs. A uniform valuation mechanism is the basis of any effective taxation policy. However, the current taxation regime does not provide any guidelines to ascertain the value of the VDAs. Owing to the dynamic nature of the industry, the value of VDAs varies across exchange platforms and ascertaining the cost of acquisition and the sale consideration remains an arduous task for the taxpayers. Accordingly, the government must come up with valuation rules to clarify the same. Guidance can be taken from other jurisdictions like the US, where the government has provided detailed guidelines to determine the fair market value of VDAs at the time of transaction.
Unclear Legal Status
Recent reports have indicated that the upcoming Budget may also offer clarity on the treatment of VDA transactions under the Goods and Service Tax (GST) regime. Since VDAs do not qualify as legal tender, they are most likely to be classified as goods. Further, if the government continues with its current approach to tax VDAs at a high rate under the income tax regime, VDAs might be accorded a similar treatment under the GST. In such a scenario, transactions in VDAs are most likely to be treated as a supply of goods with the gross value taxed at the highest rate of 28 percent. Such a move could further disincentivise investors to escape the VDA space or cause a further flight of accounts to foreign exchanges.
Interestingly, the legal status of transacting in or settling dues through VDAs remains unclear. A lack of a robust regulatory framework contributes to eroding investor confidence and weakening the efficacy of the taxation regime. As per a recent report, the current taxation regime is expected to cause a loss of approximately $1.2 trillion worth of trade volume to domestic crypto exchanges in the next four years. The need of the hour is to regulate VDAs and tax the transactions with a pro-market approach which may encourage investments, lead to innovation in the VDA industry and ensure digital activity is encouraged in India. This could go in a long way to turn India into a global hub and market for emerging technologies.
Considering this is the last full budget before the country goes to general elections next year, Budget 2023 is expected to be a game changer in all such aspects and accordingly, the crypto industry is also looking for a sympathetic treatment.
With inputs from Reema Arya and Mohak Thukral
SR Patnaik is Partner & Head – Taxation, Reema Arya is Consultant and Mohak Thukral is Associate at Cyril Amarchand Mangaldas. Views are personal and do not represent the stand of this publication.
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