Over the last two months, this Feature has examined the legal background surrounding cryptocurrencies and FEMA provisions in relation to Virtual Currencies (VCs). In this, the concluding part, we take up the tax issues pertaining to this exciting new asset class
LEGALITY STILL IN DOUBT
The legality of VCs in India continues to be a question mark. As recently as on 10th August, 2021, the Minister of State for Finance gave a written reply in the Rajya Sabha stating that the Government does not consider cryptocurrencies legal tender or coin and will take all measures to eliminate use of these crypto-assets in financing illegitimate activities or as part of the payment system. The Government will also explore the use of blockchain technology proactively for ushering in a digital economy. He added that a high-level Inter-Ministerial Committee (IMC) constituted under the Chairmanship of the Secretary (Economic Affairs) to study the issues related to VCs and propose specific actions to be taken, had recommended in its report that all private cryptocurrencies, except any cryptocurrency issued by the State, be prohibited in India. The Government would take a decision on the recommendations of the IMC and the legislative proposal, if any, would be introduced in the Parliament.
Coupled with this is the action taken by the Enforcement Directorate against a crypto exchange in India on the grounds of money-laundering. The accusation was that the exchange was facilitating some Chinese betting apps which converted their Indian earnings into VCs and then transferred the same to digital wallets based in the Cayman Islands.
In spite of the above regulatory heat, the popularity of VCs and crypto exchanges is growing by the day and a crypto exchange has now even entered the Unicorn club!
However, in the midst of the regulatory hullabaloo and the hype over VCs, one must not lose sight of the fact that at the end of the day tax must be paid on all earnings from VCs. The Income-tax Act is not concerned with the legality of a trade. In CIT vs. S.C. Kothari [1972] 4 SCC 402 it was observed that: ‘…If the business is illegal, neither the profits earned nor the losses incurred would be enforceable in law. But that does not take the profits out of the taxing statute.’
Again, in CIT vs. K. Thangamani [2009] 309 ITR 15 (Mad), the Madras High Court held that the income-tax authorities are not concerned about the manner or means of acquiring income. The income might have been earned illegally or by resorting to unlawful means. But any illegality associated with the earning has no bearing on its taxability. The assessee, having acquired income by unethical means or by resorting to acts forbidden by law, cannot be heard to say that the State cannot be a party to such sharing of ill-gotten wealth. Allowing such income to escape the tax net would be nothing but a premium or reward to a person for doing an illegal trade. In the event of taxing the income of only those who had acquired the same in a legal manner, the tendency of those who acquire income by illegal means would increase. It is not possible for the Income-tax authorities to act like the police to prevent the commission of unlawful acts, but it is possible for the tax machinery to tax such income.
The Finance Ministry in reply to a question raised in the Rajya Sabha has stated that irrespective of the nature of business, the extant statutory provisions on the scope of total income for taxation as per section 5 of the Income-tax Act, 1961 envisage that total income shall include all income from whatever source derived, the legality of income thus being of no consequence. The gains arising from the transfer of cryptocurrencies / assets is liable to tax under a head of income, depending upon the nature of holding of the same. It further stated that no data is maintained on cryptocurrency earnings of Indians as there is no provision in the Income-tax return to capture data on earnings arising from cryptocurrencies / assets.
Accordingly, irrespective of whether a crypto trade is legal or illegal, we need to examine its taxability. Let us briefly analyse the same. At the outset, it may be noted that since this is an evolving subject, there is no settled view and hence an attempt has been made to present all the possible views.
TAXABILITY OF TRADERS IN VCs
Whether a particular asset is a capital asset or a stock-in-trade has been one of the burning issues under the Income-tax Act. Section 2(14) defines the term ‘capital asset’ to mean property of any kind held by an assessee, whether or not connected with his business or profession, but it does not include any stock-in-trade. Hence, a stock-in-trade of any nature, whether securities, land or VCs, would be outside the purview of a capital asset.
People who trade in VCs, i.e., frequently buy and sell cryptos, are as much traders in VCs as a person dealing in shares and securities. The usual tests laid down to distinguish a trader from an investor would apply even in the case of VCs. Hence, tests such as intention at the time of purchase, frequency of trades, quantum, regularity, accounting treatment, amount of stock held on hand, whether purchase and sale take place in quick succession, whether borrowed funds have been used for the purchase, etc., are all relevant tests to help determine whether a person is a dealer / trader in VCs or an investor. The ratio laid down by the Supreme Court in CIT vs. Associated Industrial Development Company (P) Ltd. 82 ITR 586 (SC) in the context of securities would be equally relevant even in the case of VCs. The Court held that whether a particular holding is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the asset and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment.
The CBDT Circular No. 4/2007, dated 15th June, 2007 and Circular No. 6/2016 dated 29th February, 2016, issued in the context of taxability of gains on sale of securities would assist in determining the issue even for VCs.
If a person is a trader in VCs, then any gain made by him would be taxable as business income. The purchase price of the VCs would be allowed as a deduction even if the Government / RBI takes a stand that trading in VCs is illegal.
One school of thought also suggests that since there is no actual delivery involved in the case of VCs, transactions in VCs should be treated as a speculative transaction u/s 43(5). But it would be incorrect to say that delivery is not given in case of VCs because they are credited to a digital wallet. Delivery need not always be physical and could even be constructive or symbolic and should be seen in the context of the goods in question. However, this could become a litigious issue. For example, shares in dematerialised format are credited to a demat account and not physically delivered. Similarly, mutual fund units only appear in a statement.
Section 43(5) states that any commodity in which a contract for the purchase / sale is settled otherwise than by an actual delivery or transfer of the commodity, would be treated as a speculative transaction. The decision of the Supreme Court in the case of Internet and Mobile Association of India vs. Reserve Bank of India, WP(C) No. 528/2018, order dated 4th March, 2020 (SC) has held that it was not possible to accept the contention that VCs were just goods / commodities and could never be regarded as real money! Thus, while the Court has not come to a definite conclusion, the fact that VCs are commodities has been upheld by the Apex Court. In such a scenario, could the trading in VCs be treated as a speculative business? If so, then the losses from this business can only be set off against speculative gains u/s 73 of the Act, and the losses to the extent not set off can be carried forward only for four assessment years. Yet another school of thought suggests that the profits from trading in VCs should be taxed as Income from Other Sources.
TAXABILITY OF INVESTORS IN VCs
For investors in VCs, the gains would be taxable as capital gains. Depending upon whether the VC in question has been held for a period of more than or less than three years, the VCs would be treated as long-term capital assets or short-term capital assets. Long-term capital gains would be eligible for indexation and would be taxed @ 20% + surcharge + cess. Short-term capital gains, on the other hand, would be taxed as per the regular slab rate applicable to the investor. It must be pointed out that the special concessional tax rates of 10% with grandfathering of the cost for long-term gains in case of listed shares and 15% in the case of short-term gains on listed shares, do not apply to gains on VCs. Any long-term capital gain made on the sale of VCs can be saved by an Individual / HUF by reinvesting the net sale consideration in the purchase / construction of a new house property u/s 54F.
Receiving VCs as payment for goods / services
If a business receives payment for the goods / services sold by it in the form of VCs, then it would be treated as a barter exchange and the fair market value of the VCs received would be treated as the consideration received for the sale / supply. The cost of goods sold / services rendered would be deducted from this consideration and the gains would be taxable as business income.
Payment for mining
One buzzword associated with VCs is ‘mining’. A ‘VC miner’ is like the miner in the coal / gold / ore mine who, through his arduous labour, comes up with a prized catch. A Bitcoin miner is one who solves complex, cryptic math puzzles on the Bitcoin network and makes the network secure by validating the transactions which take place on it. While it is difficult to explain this concept, suffice it to say that miners help in improving the transaction network of VCs. And a miner receives payment in the form of VCs! Now how would this transaction be taxed is the question.
A good way to look at this would be that the miner is actually providing a service by carrying out the mining. Hence, the income from the same should be taxed as his business income. The cost of power, depreciation on IT equipment, maintenance, etc., would all be deductible expenses incurred to earn this income. The fair market value of the VCs received by the miner would be treated as the consideration for the service and the difference would be taxed as his business income. The Central Board of Indirect Taxes and Customs is also considering levying GST on mining activities on the ground that these constitute a service. Alternatively, if it is not a business income, it may be taxed as Income from Other Sources.
A more aggressive view is that income from mining consists of capital gains arising from a self-generated asset. This could be used for amateurs who are into VC mining as opposed to miners who carry on the activity as an occupation. Here, applying the principle laid down by the Supreme Court in CIT vs. B.C. Srinivasa Shetty [1981] 128 ITR 294 (SC), a view is taken that since the cost of acquisition of such a self-generated capital asset cannot be determined and that since section 55(2) has not prescribed the cost of acquisition / improvement of the same to be Nil, the income cannot be taxed. It is likely that the Tax Department would contest this view.
Gift of VCs
What would be the tax treatment if a person gifts VCs to another person? A gift of specified property is taxable u/s 56(2)(x) in the hands of the recipient except in the exempt cases. However, the gift must be of property as defined in the Explanation to section 56(2)(x). Property is defined to mean any sum of money, immovable property, shares and securities, jewellery / bullion, art / sculptures and archaeological collections. The Government of India has constantly taken a stand (as explained above) that VCs are not money / legal currency in India. And that VCs are not shares and securities. Thus, VCs are not property as understood u/s 56(2)(x). Accordingly, it stands to reason that the provisions of section 56(2)(x) cannot apply in the hands of a donee who gets a gift of VCs.
Disclosure in Income-tax returns
Any individual / HUF who has annual total income exceeding Rs. 50 lakhs needs to file Schedule AL on Assets and Liabilities in his Income-tax return.
The assets required to be reported in this Schedule include immovable assets (land and building), financial assets, viz., bank deposits, shares and securities, insurance policies, loans and advances given, cash in hand, movable assets, viz., jewellery, bullion, vehicles, yachts, boats, aircraft, etc. Hence, it is an inclusive definition of the term assets. If a person owns VCs, it stands to reason that the same should also be included in the asset disclosures under Schedule AL. The cost price of the VC needs to be disclosed under this Schedule. For a resident who holds VCs credited to an overseas digital wallet / held with a foreign crypto exchange during the previous year, even if he has duly reported them in Schedule FA (foreign assets), he is required to report such foreign assets again in Schedule AL, if applicable.
However, for a non-resident or ‘resident but not ordinarily resident’, only the details of VCs located in India are to be mentioned. It would be interesting to note in the case of VCs how the situs of the asset would be determined.
Another Schedule to be considered is Schedule FA on foreign assets. A resident in India is required to furnish details of any foreign asset held by him in Schedule FA. This Schedule need not be filled up by a ‘not ordinarily resident’ or a ‘non-resident’. The details of all foreign assets or accounts in respect of which a resident is a beneficial owner, a beneficiary or the legal owner, is required to be mandatorily disclosed in the Schedule FA. Tables A1 to G of Schedule FA deal with the disclosures of various foreign assets and comprise of foreign depository accounts – foreign custodian accounts, foreign equity and debt interest, foreign cash value insurance contract or annuity contract, financial interest in any entity outside India, any immovable property outside India, any other capital assets outside India, any other account located outside India in which the resident is a signing authority, etc. The CBDT has not offered any guidance on how foreign VCs should be disclosed. However, in the absence of any clarity the same may be disclosed under either of the following two Tables of Schedule FA:
• Table D – Any other capital assets outside India
• Table E – Any other account located outside India in which the resident assessee is a signing authority (which is not reported in Tables A1 to D).
In Table D, the value of total investment at cost of any other capital asset held at any time during the accounting period and the nature and amount of income derived from the capital asset during the accounting period is required to be disclosed after converting the same into Indian currency. Further, the amount of income which is chargeable to tax in India, out of the foreign source income, should also be specified at column (9). The relevant Schedule of the ITR where income has been offered to tax should be mentioned at columns (10) and (11). The instructions state that for the purposes of disclosure in Table D, capital assets include any other financial asset which is not reported in Table B, but shall not include stock-in-trade and business assets which are included in the balance sheet. Hence, VCs held as stock-in-trade by traders would not be included in this Table.
In Table E, the value of peak balance or total investment at cost, in respect of the accounts in which the assessee has a signing authority, during the accounting period is required to be disclosed after converting the same into Indian currency. Only those foreign accounts which have not been reported in Table A1 to Table D of the Schedule should be reported in Table E.
One school of thought tends to suggest that in the absence of any specific guidance on disclosure under Schedule FA, VCs need not be disclosed. This would be playing with fire. The Black Money (Undisclosed Foreign Income and Assets) Act, 2015 levies a penalty of Rs. 10 lakhs for non- / improper disclosures in Schedule FA. Hence, it would be better to err on the safe side and disclose the foreign VCs held.
It should be remembered that even though there is a question mark under FEMA over whether the Liberalised Remittance Scheme can be used for buying foreign VCs, disclosures under Schedule FA should nevertheless be made. Income-tax disclosures and taxation are not dependent upon the permissibility or otherwise of a transaction!
CONCLUSION
The world of cryptocurrencies is of high reward but carries high regulatory risk. This is due to the fact that there are a lot of uncertainties and unknown factors coupled with the apparently hostile attitude of the RBI and the Government towards VCs. People transacting in them should do so with full knowledge of the underlying issues that could arise. The famous Latin maxim ‘Caveat Emptor’ or ‘Buyer Beware’ squarely applies to all transactions involving virtual currencies!
(Concluded)
