By Gauri Datta
The advent of Web3 and block chain technology as a solution provider finds applications across many sectors worldwide – be it financial transactions, education, or even healthcare. World-over, we are seeing start-ups mushrooming in large numbers that are focused on developing products and services on Web3 that could provide lasting solutions to real-world problems. Take online gaming, for instance – a nascent sector in India to which the Government has been paying attention because of its immense growth potential. Several Web3 companies like Lysto and Loco, which have been founded in Bengaluru, are providing innovative solutions to improve the experience of users playing Web3 games. Lysto offers a ‘Passport’, combined with a ‘Proof of Play Protocol’ to provide gamers with on-chain credentials, which could further be used as proof of participation in games or tournaments. Loco, on the other hand, offers a live streaming platform for online players and audiences, and also hosts eSports tournaments. Both of these Web3 services also offer non-fungible tokens (NFTs), which are digital collectibles or memorabilia.
The proliferation of Web3 services could potentially usher in a new era of a transparent, decentralised, and trustless ecosystem. Web3 businesses are built on blockchain technology and use crypto currencies as a means for financing the upkeep and development of their network. Web3 investments into India from 2020 amount to over US$1.3 billion, according to data from NASSCOM. With the number of active internet subscribers in India being upwards of 750 million and a burgeoning talent in Web3, India is poised to harness the crypto space to catapult its economy into the stratosphere. The economic growth of Web3 businesses is projected to add US$1.1 trillion to India’s GDP by 2032.
Taxation of VDAs in India – effective deterrent or overkill?
Crypto currencies or virtual digital assets (VDAs) are an innovative class of investments that function as a means for financing products and services developed on blockchain. VDAs embody a fair number of positive qualities that deserve to be highlighted – such as decentralisation (thereby reducing the scope for ‘gaming’), transparency (with every transaction visible on the blockchain regardless of size), and limitless potential for upscaling (due to global accessibility), to name a few. Even so, VDAs are a largely unregulated asset class at present, and policy makers are still endeavouring to understand their use cases and the potential for sustainable growth in the sector. India’s comprehensive tax regime for VDAs, which was introduced in the Budget Session of 2022, clearly indicates its intention to slow down investing and monitor transactions. The taxation structure comprises a three-pronged approach: (a) a 30 percent flat tax on all capital gains from sale of VDAs, effective from 1 April 2022; (b) no set-off of losses from VDAs; and (c) a 1 percent TDS charge on all transactions above Rs. 10,000, effective from 1 July 2022.
While the Government’s intentions are no doubt laudable, its method of curbing investment into cryptos through this onerous taxation structure does not seem to have the desired effect. A report published by the Esya Centre (a Delhi-based think tank) in December 2022 titled ‘Virtual Digital Asset Tax Architecture in India: a Critical Examination’ examines the impact of the Government’s VDA tax regime overhaul on the industry. According to the Esya Report, India’s taxation regime – particularly the 1% TDS component – drove down trading volumes on India-based VDA exchanges by about 81 percent in July-October 2022 alone. This led to several Indian investors moving from Indian exchanges to foreign ones, thereby effectively undermining the effect of the taxation structure while simultaneously leaving Indian investors exposed to risks like the FTX collapse.
While the taxation regime is on the whole onerous, the 1% TDS component appears to have had the most debilitating impact on VDA trading and investments in India. Esya’s data makes this clear – while the 30% capital gains tax drove down trading volumes by 14% in April-June 2022, the real blow came from the TDS component.
Big picture – the future of Web3 businesses in India
Aside from the tax structure effectively pulling the plug on VDA investing, another (more serious) side effect is the disincentive to Web3 business development in India. Web3 innovators from India are now choosing to found start-ups in more favourable investment destinations like Dubai and draw in investments by listing their tokens on foreign VDA exchanges. NASSCOM’s report on the Web3 start-up ecosystem in India states that about 60% of Web3 start-ups, which were founded by Indians, are registered outside India. The net result would be that Indian talent and potential for wealth creation will be diverted away from Indian shores. This could prove to be potentially disastrous in the long run, particularly when India is focused on investment inflows, job creation and upskilling its citizens to take on the digital age.
The Government has shown incredible foresight in the case of promoting online gaming with the objective of creating opportunities for their growth and expansion. The regulations for online gaming, which were recently notified, will no doubt effectuate the Government’s intentions to create a fertile landscape for online gaming and fantasy sports, while simultaneously ensuring that there are adequate safeguards for the protection of users. There is no reason why the same attitude cannot be extended towards Web3. The upcoming Budget 2023 Session gives the Government a good opportunity to roll back the 1% TDS on VDA transactions above Rs. 10,000, which is a highly regressive measure, and to bring Web3 businesses back to India by creating favourable conditions for investment.
Author is the Senior Director at Aakhya India.
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