Rapid technological advancement has led to the emergence of a new asset class—crypto-assets. Built on blockchain technology, these have caught the attention of tech pioneers, investors, businesses, and consumers, given their potential to be revolutionary and ubiquitous.
In recent years, on the back of crypto exchanges setting up shop in India, there has been an increased momentum in crypto-asset transactions and a significant increase in the number of investors. Taking cognisance of the rise in the crypto-trading volume in India, the government introduced a specific taxation regime for virtual digital assets (VDA) in the Finance Act 2022. The VDA provisions impose 30% tax on their transfer, without any deductions except for the VDA’s cost of acquisition. This also prevents the set-off of losses against gains, which is a bit too harsh. Levying 30% tax and prohibiting set-off of losses is a significant disincentive for investors and has already seen volumes on crypto-exchanges getting affected. It would be pertinent to note that even losses from speculative share trading are allowed to be set off against speculative income; hence, there may be a case for treating VDAs on a similar footing.
The ‘cost of acquisition’, the only deduction allowed from VDA gains, has not been defined, which leaves room for interpretation and consequent litigation. Further, a VDA has been defined to include code—the number or token generated through cryptographic means or otherwise. This open definition has led to apprehension that the 30% tax may also apply to other non-crypto digital assets such as loyalty points, airline miles, discount vouchers, etc. Also, the introduction of 1% Tax Deduction at Source (TDS), to be undertaken by the buyer of VDA, not only creates an onerous obligation on retail investors but also has a stifling impact on liquidity. This is compounded by practical challenges faced by buyers in complying with the TDS provisions due to the anonymity of the seller, volatility, and the instantaneous nature of crypto transactions. The government should consider easing the TDS compliance burden on retail investors by shifting the TDS compliances to crypto exchanges. Under the VDA gift taxation provisions, the gift of crypto-assets may also attract 30% tax in the hands of the recipient. Absent any valuation rules, ambiguity arises on the ‘value’ of the crypto-asset on which taxes are to be paid. The government should prescribe appropriate valuation rules and also allow deduction of such value as the cost of acquisition at the time of subsequent sale.
NFT is a digital token that represents ownership of a unique digital or physical asset, which can be stored and traded on the blockchain. While the definition of VDA for tax purposes seeks to include NFTs, the class of NFTs to be covered within the definition of VDA is yet to be notified. Considering that NFTs are merely a title record of the underlying asset on the blockchain, it may not be justified to equate NFTs with other VDAs from a taxation standpoint. The taxation of NFTs should follow the taxation of the underlying asset. For instance, the sale of a physical painting held as a capital asset by an investor attracts long-term capital gains at 20%. Merely because the investor tokenises the painting and sells it as NFT ought not to change the treatment and attract a 30% penal tax.
Other jurisdictions have adopted a similar approach to NFT taxation. Singapore has come up with detailed guidance on the taxation of digital tokens. It has specifically clarified that taxation of NFTs shall continue to be governed as per prevailing normal taxation rules. Similarly, it is important to note that the United States is seeking to treat ‘virtual currencies’ also as ‘property’ and apply the general tax principles to taxation of property, rather than introducing a specific punitive taxation scheme. A gross 30% tax is a big blow to the nascent NFT industry and a deterrent to innovation and technological development in India. Given the potential opportunities which NFTs present for the economy, including employment, the government should consider excluding NFTs from the ambit of VDA since the prevailing regime already provides an effective taxation mechanism for this asset class.
While the government’s objective with VDA provisions was to bring clarity and streamline the taxation of VDA transactions in India, the provisions have created uncertainty and put the brakes on India’s growing crypto and NFT industry. With countries introducing inclusive policies for this asset class, Indian businesses and entrepreneurs may shift their base to more conducive jurisdictions, accelerating the brain drain of India’s tech talent. Stringent tax measures would also discourage trading on Indian exchanges, potentially shifting trading to non-compliant foreign exchanges or the unorganised market, thereby defeating the very purpose of the tax itself.
This tax policy may also hinder the innovation and development of blockchain technology in India. The Indian government and financial sector have been early adopters and are exploring more use cases for this technology. With the right governance policies, India can attract FDI, generate employment, create wealth and be at the forefront of the global blockchain industry.
The author is EY India tax leader
Views are personal
Co-authored with Anand Jain, tax partner, EY