Last year, the Union government amended the Income Tax Act to impose a 30 percent tax on the transfer of virtual digital assets (VDAs), with a 1 percent TDS requirement. This was hailed as a major step towards legitimising digital assets in India. On March 7, 2023, the Department of Revenue in the Ministry of Finance issued a landmark notification under the Prevention of Money Laundering Act, 2002 (PMLA) bringing VDAs within the purview of the Act. The PMLA gives the government the authority to notify/identify categories of individuals engaged in a ‘designated business or profession’, who would qualify as a ‘reporting entity’ (RE). This notification is significant since being a RE - which includes banks, financial institutions, intermediaries or a ‘person carrying on a designated business or profession’ - is the trigger for consequences and compliances under the Act. So far, beyond the financial services licensed players, the PMLA umbrella was extended to only casinos, the real estate sector, jewellers, and now the VDA players.
A RE has extensive obligations under the PMLA and rules, including client verification, i.e., know your customer (KYC) and beneficial owners, record-keeping and reporting, including to the Financial Intelligence Unit-India (FIU-IND), transaction due diligence that also covers the source of funds verification, suspicious transaction reporting (STR), and appointment of Designated Director & Principal Officer, with exposure for non-compliance through prescribed financial penalties, audit, enhanced reporting and specific instructions.
The language in the notification is, albeit, wide and covers various VDA activities, including exchange between VDA and fiat currencies (i.e., real money), exchange between one or more forms of VDAs, transfer of VDA, safekeeping or administration of VDA or instruments enabling control over VDA, and participation in and provision of financial services related to an issuer’s offer and sale of a VDA. The definition of VDA would be as under tax laws, which itself has been a subject matter of interpretation.
The extent and scope of the above is raising the following key questions:
Sunrise date and fine print
PMLA reporting is robust, with several prescribed formats, including under PMLA rules. If the notification is enforced immediately, the Indian and global VDA players/exchanges may not be fully prepared to attest compliance from day zero. Since no compliance period is indicated, a suitable ‘sunrise’ period may be considered, after which the notification would come into effect. Also, clarity on whether fine print, i.e., additional rules and formats, would be prescribed for VDA players to comply with PMLA’s far-reaching obligations would be helpful.
Scope of transfer of VDAs
The PMLA was drafted in 2002 with a view to get a better handle on proceeds of crime, cash and suspicious transactions. Additional businesses notified so far as PMLA ‘Regulated Entities’ cover casinos, real estate and the gems and jewellery sector. As the notification also covers ‘exchange between different forms of VDAs’ and ‘transfer of VDAs’, which may be similar to a ‘barter’ without cash (fiat) involvement, PMLA compliance may get tricky. The scope of expected monitoring and reporting would also be useful. Existing reporting formats prescribed under the PMLA for banks, financial institutions, other intermediaries, and additional notified categories may not be pari passu applicable to VDAs, given sector nuances. Clarity on reporting formats would be useful.
Impact on offshore exchanges
The notification not only covers VDA players domiciled in India but is also widely worded to cover ‘activities when carried out for or on behalf of another natural or legal person’, which could potentially cover overseas exchanges and counterparties. While REs can include certain categories of global players with RBI or SEBI licence such as card networks, inward money remittance players, investment advisors, research analysts, etc., i.e., technically PMLA has extra-territorial jurisdiction, this is untested qua foreign VDA and cryptocurrency exchanges. As the nature of VDAs and the emerging Web3 ecosystem is inherently cross-border, both with the location of exchanges, and trading counterparties involved, enforcement under the PMLA could raise jurisdictional issues, as is also being debated in the PayPal/FIU Delhi High Court proceedings.
While the Cryptocurrencies Bill is still pending, presumably on account of our recent Central Bank Digital Currency (CBDC) related developments and ongoing G20 discussion on uniform digital assets framework, the notification is a positive step and was much awaited by the Indian Web3/ VDA players. It lends an increasingly sovereign recognition to the emerging Indian digital assets ecosystem. The impact of the PMLA umbrella is extensive, especially as the industry, in India and even globally, is coming to terms with enhanced bank and securities exchange-like compliance obligations. Establishing open communication channels with PMLA regulators would eliminate the teething troubles that VDA players may face with understanding PMLA scope and compliance. Given the severe consequences of default, such channels of communication will go a long way in giving the ‘soft landing’ and the necessary support to the industry.