Budget 2023: Expect only committed crypto players to stay invested in India

The Indian regulations may have more-than-stringent penalty clauses for defaulting entities or fraudulent activities which could potentially restore investor confidence.

The Finance Act, 2022 introduced an adverse tax regime for the virtual digital asset (VDA), where a high rate of 30 percent tax was imposed on the transfer with no deduction in respect of expenditure other than the cost of acquisition. Moreover, losses from the transfer of VDAs were not allowed to be set off or being allowed to carry forward to subsequent years. Additionally, every transfer of VDA became subject to a tax deducted at source (TDS) of one percent of the transaction value. Lastly, as a gift, VDA was taxed in the hands of the recipient.

The tax regime impacted the sector negatively, but the absence of a clear regulatory regime coupled with warnings against investing in VDAs from the government and the Reserve Bank of India (RBI) started an exodus of VDA-related businesses to more favourable jurisdictions. The implementation of a high rate of tax in India had the most distortionary impact as the country’s VDA exchanges lost up to 81 percent of their trading volumes in a very short span of time following the levy. This tax structure not only negatively impacted the trading volume but also the adoption of VDAs by Indians, as measured by mobile app downloads, which fell by a sizable 16 percent on a month-on-month basis for domestic exchanges.

Crushed Hope

Nevertheless, given the number of industry representations and a promise of self-regulation, the sector was hoping against hope that Budget 2023 would provide a token relief by liberalising at least the TDS applicability from one percent to 0.01 percent, which would still enable tracking VDA transactions. It was expected that Budget 2023 would address the ambiguities such as the place of VDA transactions and carve-out for non-fungible tokens (NFT). Even on the GST front, clarity was awaited on the tax rate.

To encourage foreign investment, certain clarity was expected on the taxability for non-residents as well. Further, the classification of VDA under the appropriate head of income was the need of the hour. The cost of acquisition has an important role in VDA taxation and therefore a comprehensive definition with appropriate valuation rules structured similarly to existing income tax valuation rules for other assets was also anticipated.

However, the finance minister did not mention the VDA sector at all in her speech. So, what exactly does Budget 2023 do for the sector?

To begin with, the Economic Survey 2022-2023 highlighted the recent collapse of FTX and the tumbling prices while pointing out that once touted to be decentralised markets, the VDA sector is relying on centralised entities. Nonetheless, these entities are unregulated and termed this phenomenon as a cause for concern as the minimum global standards are not enough to mitigate the risks and vulnerabilities. Taking into account the cross-sector and cross-border nature of crypto assets, the Survey observed that the regulation cannot be uncoordinated. Yet another important takeaway was the inconsistent terminology adopted for describing VDAs across countries that may have the potential of creating unnecessary confusion. The Survey further listed the salient features of regulations of major jurisdictions while concluding that global standards must be consistent.

The observations of the Survey are encouraging to some extent since it acknowledges that VDAs are here to stay. It may, after all, not be possible to ban VDAs. Considering the ever-increasing acceptability of VDAs in a few jurisdictions, though not always as a medium of exchange but as a trading commodity, coupled with volatility due to the unregulated nature of the market, the Survey does make a compelling case for introducing regulations within the country. The comments related to regulations of different countries also indicate that the Government has closely been monitoring and analysing the regulatory progress of VDAs across the globe.

Ideas For Regulation

Even though such critical observations in the Survey still provide no clarity on where India stands on drafting regulations for the vulnerable sector, there are few indications with respect to the contents of an ideal regulation. For instance, the current market regulators are not equipped enough to control the sector considering the complexity and ever-evolving nature of virtual assets. As such, Indian regulations may create a separate regulator exclusively for the sector with the necessary technical skills of managing the intricate sector. This could be an excellent move considering the unique way in which the VDAs work.

Further, any regulations that are introduced, will have to demonstrate a uniform global collaborative effort to make the management of VDA effective. Laws cannot work in isolation in the crypto world given the decentralised nature of the sector. Moreover, because the current anti-money laundering/combating the financing of terrorism (AML/CFT) norms of the Financial Action Task Force (FATF) are still not uniformly implemented across jurisdictions, the potential Indian regulations are likely to emphasise the standardised application within a stipulated time. Lastly, as the Survey mentions the FTX collapse, the Indian regulations may have more-than-stringent penalty clauses for defaulting entities or fraudulent activities which could potentially restore investor confidence.

As far as the fine print of Budget 2023 goes, barring an introduction of the applicability of TDS on non-monetary payments as well, there is nothing for the sector.

Accordingly, the current tax regime for the VDA sector will continue for the next one year or perhaps till the next general elections. As such, there may not be any immediate reversal of the recent exodus to better jurisdictions. In fact, more players may depart in the next few months. Moreover, on a global level, the crypto winter could possibly continue as the slowdown sets in. In the long run, though, the wait-and-watch attitude of the government may bear fruit as this will clear out the fly-by-the-night operators but companies with a stronger foundation, continuous innovation, and robust know-your-customer/anti-money laundering norms shall prevail. Additionally, India may create matured regulations basis the experience of other countries resulting in a conducive atmosphere for the VDA sector. One could only hope that the government gets the timing right.

Rashmi Deshpande is Partner and Samiksha Agarwal is Associate, Business Law Chamber. Views are personal and do not represent the stand of this publication.