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Clarify GST laws for VDAs

Tax treatment of virtual digital assets can be different from other financial instruments

As these digital assets’ use-cases grow in number and transaction volumes leapfrog, the guidance on their tax treatment is yet to cover the ground.
As these digital assets’ use-cases grow in number and transaction volumes leapfrog, the guidance on their tax treatment is yet to cover the ground.

By Mahesh Jaising

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Business and investor communities around the world are buzzing with all sorts of crypto-discussions triggered by developments in blockchain technology. In a very short period of time, the virtual digital assets (VDAs) space has evolved from just cryptocurrencies to tokens, stablecoins, non-fungible tokens (NFT), and a digital representation of everything along with derivatives of each. Each day, blockchain technology witnesses more business models coming up around it and more use-cases, inspiring innovative forms of fund-raising and investment classification, facilitating new payment methods, verifying digital identities, and enabling new types of commerce. As these digital assets’ use-cases grow in number and transaction volumes leapfrog, the guidance on their tax treatment is yet to cover the ground.

The legal framework on VDAs is still in a formative stage. One of the key challenges for the administration is that VDAs bypass the existing, long-established financial system of intermediaries and carry challenges in terms of traceability due to their decentralised nature. The anonymous nature of the assets and related transactions is creating a blind spot for the tax authorities. The Indian government took the first step towards bringing in clarity on taxation of VDAs such as cryptocurrencies and NFTs from a direct tax perspective by recognising them as a new asset class and including them in the tax framework.

Experts have raised concerns on the mechanism to implement the legislation as they believe that one can surpass the levy on crypto-income by trading in decentralised exchanges. In simple terms, decentralised exchanges are a protocol by which VDA-holders can anonymously trade VDA directly with the users instead of using a centralised financial intermediary. Tax authorities are struggling to come to grips with this dynamic nature of VDAs. This makes it difficult for the authorities to understand as to how VDAs could be included in the traditional definitions and concepts of taxes, particularly for the application of the Goods and Services Tax (GST).

One of the key aspects to be identified from a GST perspective is the classification of VDAs into goods or services. As far as cryptocurrencies are concerned, the Indian GST law does not recognise them to be either money or securities. There is also a school of thought that such assets are nothing but actionable claims as they inherit underlying rights and properties and, therefore, are outside the ambit of GST. If one looks at prevalent international practices, some jurisdictions have started to recognise cryptocurrency as equivalent to fiat currency or have exempted transactions in cryptocurrency for the purposes of VAT/GST. At present, GST is applicable on the service provided by crypto-exchanges, but the taxation of transactions in cryptocurrencies remains elusive. The tax authorities have also acknowledged that there is more than one aspect of cryptocurrency that requires detailed examination from a GST perspective. It is understood that the Central Board of Indirect Taxes and Customs is in the process of examining these aspects and there will be some finality in due course.

NFTs are tokens that are used to represent ownership of unique items. NFTs are mostly rare collectibles, or interesting art, music, video and in-game products or similar digital content that can be bought and sold on the NFT marketplace, and the original creator of an NFT sometimes may earn royalty for each resale. The categorisation for NFTs and whether NFT transactions ought to be classified as a supply of goods or services given their intangible nature and character, is still up in the air. NFT marketplaces are also uninformed of the GST implications on NFT transactions and are left in the crosshairs of tax jurisdictions and divergent interpretations.

Each kind of token has its own nuances. While security tokens give ownership rights, voting rights and similar rights in the business to the holders of such tokens, utility tokens represent right to receive future goods/services from business. In order for such tokens to be regarded as security under the Indian GST regime, the same has to be covered under the Securities Control (Regulation) Act, 1956.

Another critical challenge is that in a typical VDA transaction, the parties may be identified based on a digital wallet rather than a physical address. Given the anonymity of the buyer, seller and the underlying assets, it becomes equally challenging to determine if the VDA transaction would qualify as a domestic (inter-/intra-state) or a cross-border transaction (export/import). Another area of consideration for GST treatment and valuation of supplies are the swap transactions, that is, barter where one VDA is swapped for another VDA. For instance, NFTs are generally transacted (i.e., bought and sold) against cryptocurrency.

Blockchain-based and other innovative technologies are converging and playing a big part in a new world known as the Metaverse, which gives rise to new tax challenges on the jurisdiction entitled to tax the commercial transactions in the virtual world.

The details surrounding each digital asset greatly impacts what that asset represents under various regulatory frameworks, especially tax. While the terminology in this space is increasingly misused and overgeneralised, it is important to think uniquely and evaluate about each asset type and its relevant tax treatment. It would be worth it to take a pause and acknowledge that the tax treatment of these new-age digital assets may not be the same as that of traditional financial instruments. It is also important to remember that all digital assets are not created equal, and specifics can have a significant impact on its tax treatment. Policy makers need to be cognisant of the fact that the tax treatment should be coherent with the industry needs and broader regulatory framework.

The author is Partner, Deloitte India

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