PMLA cover a boon for crypto

This will provide much-needed legitimacy to Indian and global crypto players by weeding out bad actors.

Going by sources, CerTik is a smart-contract auditor
Going by sources, CerTik is a smart-contract auditor

By Anu Tiwari and Utkarsh Bhatnagar

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Over the last few years, digital assets and cryptocurrencies have become mainstream, with trading volumes increasing, new players and exchanges entering the global and Indian markets, increasing scrutiny from law enforcement, emerging global dialogue on preferred means for recognising and regulating digital assets, Central Bank Digital Currency (CBDC)-related discourse, and of course, the recent developments around certain exchanges and widely-traded digital currencies. India is supposedly among the world’s top three digital assets markets.

The concern governments and regulators have globally expressed their concerns about digital and crypto-assets revolving around anonymity as well as these assets bypassing age-established financial transactions monitoring frameworks such as anti-money laundering (AML), controlling financial terrorism (CFT), tax evasion, exchange control rules, client identification (KYC), suspicious transaction monitoring, record-keeping, and reporting. The Financial Action Task Force (FATF), Bank for International Settlements (BIS), the Organisation for Economic Co-operation and Development (OECD), and global regulators, such as those in the US and UK, as well as the March 9 2022 Biden Order have contributed towards initiating a global and national consensus around balancing the benefits of emerging cryptography technology with the risks to financial order arising from the ‘bad actor’ worries, given the use and trading of virtual digital assets (VDA), as they are now popularly known.

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In India, we had a string of warnings issued by Reserve Bank of India (RBI) in 2013 and 2017, followed by RBI’s April 6, 2018 cryptocurrencies ban circular which was challenged and overturned by the Supreme Court in March 2020. This was the catalyst for the hockey-stick growth of the Indian digital and crypto-assets sector from 2020 till date.

Issues or risks surrounding mis-selling, misleading advertisements promising assured returns, speculative losses, data incidents, offshoring proceeds of crime, and unlawful elements using crypto-assets also increased. As a countermeasure, India has been working on a Cryptocurrencies Bill. Multiple drafts of the same, albeit pending global consensus implementation, have been, rightly so, deferred. All of this led to the Indian government bringing VDAs within the fold of the Income Tax Act last year by levying a 30% tax on gains made through trades in VDAs and a 1% tax deducted at source (TDS) requirement, which led to a drop in trading volumes, as was expected. The new definition of the VDA ensured sovereign transaction monitoring, identification of players involved, better understanding of the benefits and risks involved with digital assets, and was hailed as a positive step.

However, the chief worry the industry still faced was law enforcement scrutiny, including through information requests under the Criminal Procedure Code, Prevention of Money Laundering Act, 2002 (PMLA) and rules, and Foreign Exchange Management Act (FEMA), given the absence of a statutorily reporting framework in India for the crypto-assets sector, as only ‘reporting entities’, such as banks, financial institutions, licensed intermediaries and certain notified activities like casinos, real estate and gems/jewellery sector were required, and eligible, to legally follow client identification/ KYC, transaction monitoring, record keeping and reporting requirements under the PMLA.

In a landmark move, on March 7, 2023, the department of revenue, ministry of finance, issued a notification under PMLA, notifying certain types of VDA activities as ‘persons carrying on designated business or profession’, qualifying the sector as a ‘reporting entity’ (RE). This will provide much-needed legitimacy to the Indian, and even global, crypto players, as well as to crypto-assets and digital ecosystem by providing greater transparency and state monitoring of the sector from a AML/ CFT and tax management standpoint and weed out non-serious and bad actors.

The Financial Intelligence Unit-India (FIU-IND), in late 2022, revised its reporting user manual and introduced FinGate 2.0 to include data reporting format for younger business models such as payment aggregators (now licensed by RBI). However, this and other existing reporting formats under PMLA do not provide a reporting mechanism for VDA players. Clarity on this would be useful. Impact on offshore crypto and digital assets exchanges is also not clear, given the jurisdictional challenges, albeit overseas entities licenced by RBI/ Sebi are covered as ‘reporting entities’ under PMLA, and it may be difficult to make territoriality-related arguments to avoid reporting by global exchanges targeting Indian users. The nature of VDAs and the emerging Web3 ecosystem is inherently cross-border, both in terms of exchange domicile and trading counterparties. The outcome of the ongoing PayPal/ FIU Delhi High Court proceedings would be interesting to see. Clarity on how the crypto exchanges are expected to report VDA transfers covered in the Notification, which do not involve actual fiat/ cash payouts, would also be useful.

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While this development in no way implies sovereign recognition for the sector, the air will only clear once the proposed Cryptocurrencies Bill moves ahead. The Notification is a positive step, and was much awaited by the Indian Web3/ VDA industry and, going forward, it will open a formal channel between the VDA industry and government/law enforcement agencies, which was hitherto missing. The PMLA umbrella is wide. As the industry, both in India and overseas, adjusts to banks and securities markets-like compliance norms; open communication with authorities would be key to ensuring monitoring and reporting under the PMLA, as VDA players learn the ropes, given the extent and reach of the PMLA.

Writers are respectively respectively, partner, and principal associate, Cyril Amarchand Mangaldas

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First published on: 18-03-2023 at 04:30 IST
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