An impractical impost

The Indian economy has remained resilient and relatively insulated from global financial turmoil, supported in part by the wealth and livelihoods created by Indian industry as well as start-ups across sectors. Technical innovations have allowed the creation of new and fundamentally powerful financial platforms, and India is well poised to be a leader in this burgeoning new fintech industry. Amongst recent technical innovations particularly relevant to financial technology, blockchain & distributed ledger technology (DLT) stand out and continue to emerge as revolutionary, trustworthy instruments that allow discrete, transparent, and secure execution of financial and other transactions.

India’s high tax imposition on cryptocurrency transactions, however, looks to become a boon for overseas exchanges, as Indian users seem to prefer transacting on these exchanges to avoid paying the 1% tax deduction at source (TDS) levied on such transactions, rendering the impost infructuous in a sense. This runs the risk of deterioration in visibility of transactions for the entire market, apart from the potential flight of capital to overseas exchanges.

According to industry estimates, there has been an ~85% reduction in monthly volume on Indian exchanges since February 2022 whereas international trading volumes have maintained a fairly stable growth for the same period. Overseas exchanges have seen high trading volumes, and a 77% increase for their most liquid trading pair between June and July, whereas it is estimated that there has been a ~90% decrease in volume for rupee pairs on Indian exchanges. This, in turn, has created an opportunity for arbitrage where market participants may seek to trade in virtual digital assets (VDAs) abroad, through P2P, or other surrogate means.

India was consistently in the top five countries for overall crypto adoption, as per data analysed directly from various VDA chains. This also means India already had a sizable online P2P market. Estimates on the number of individuals using VDAs in India point to a very significant number of Indian individuals already invested or using VDAs. Unless both users and funds are incentivised to be routed through visible, compliant exchanges, an information deficit on the number and activity of local users will always exist. The 1% TDS further exacerbates this problem.

The estimated opportunity cost for both Indian exchanges and the Indian economy is estimated to be over Rs 3 trillion in annualised volume shifting to overseas exchanges that otherwise would have been conducted in India. It is estimated this shift represents a potential ~Rs 500 crore gross loss in terms of commissions and GST collections that would otherwise have remained in the Indian economy. Several prominent Web3 Indian start-ups seem to exploring the process of moving their offices outside India.

Indian users’ migration to overseas exchanges defeats the basic purpose of the TDS mandate as their transactions do not get tracked and there is a huge probability that these users may not pay any tax at the end of the year. All of this may potentially defeat the primary objective of the provision to maintain traceable records for all VDA transactions by Indian residents, which was intended to address government concerns on FEMA and Anti Money Laundering (AML) law violations. Trading on overseas exchanges sans any tax seems to incentivise Indian users to shift wealth to overseas exchanges and undertake P2P transactions. The provision is in a way discouraging trading in VDAs, and becoming a ground for movement of money that may be difficult to trace. Further, Indian exchanges that are contributing towards nation-building in several ways, including taxation, employment, wealth creation, and nurturing the Web3 ecosystem are the sole bearers of the brunt of the onerous tax mandate.

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It would have been ideal if the applicability rate of TDS for purposes of traceability was 0.01% instead of the 1% as it would have ensured that transactions remained within India. Non-applicability of TDS on overseas exchanges and P2P deals has further made it lucrative for people to look outside. Indiatech.org had earlier recommended that of a 0.01% TDS or a Securities Transaction Tax (STT) like provision as in equities trading and even a threshold-based taxation model on income for those investing in crypto. It is also necessary to enable ease-of-doing-business for young crypto-businesses and encourage start-ups in the sector.

Since a vast number have now shifted to overseas exchanges, and for purposes of having a level playing field, there is now no choice but to recommend establishment of Permanent Establishments (PE) for overseas exchanges that deal with customers domiciled in India.

Imposition of high direct taxes and heavy compliances through GST prepare a fertile ground for online businesses across sectors to be based overseas and still sell to the same customers in India, as we have witnessed in the past across different business segments in the online space. A similar approach for sectors like VDAs will encourage overseas businesses and promote money laundering transactions besides hurting domestic India domiciled start-ups in this space besides stifling local innovation to happen in India.

With countries coming up with their own frameworks besides collaborating with the likes of FATF, the OECD, too, is working on giving a final framework to the cross-border reporting framework for crypto assets. The OECD-recommended Crypto-Asset Reporting Framework (CARF) that covers exchanges, ATM operators, brokers and envisages collection and automatic exchange of information on transactions for relevant crypto-assets can address concerns to a great extent.

India is rightly placed today in a connected world to take a leap in the blockchain and crypto space, and foster the next global giant from her shores. A level playing field has always been a cause of concern for Indian start-ups across sectors, and it is essential to address these issues at the earliest. It is critical that India does not push this business below the radar through heavy taxes and compliances.

The authors are Respectively, CEO, and senior manager (public policy), Indiatech.org