Author of this article: Adv. Ravish Bhatt
Connect with Mr. Bhatt on Linkedin: Click Here
1. What Is Cryptocurrency?
Investopedia defines Cryptocurrency as: - "A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation."
Cryptocurrencies enable secure online payments without the use of third-party intermediaries.
2. How is Cryptocurrency defined in Income Tax Act, 1961?
Indian Income Tax Act, 1961 does not use the term "Cryptocurrency" either in definition section or in the charging provision i.e., in s.2(47A) or s.115BBH; rather it uses the term "Virtual Digital Asset" for dealing with Cryptocurrency.
Finance bill,2022 introduced s.2(47A) that defines "Virtual Digital Asset"
s.2(47A) reads: "virtual digital asset" means-
(a) any information or code or number or token(not being Indian currency or foreign currency),
generated through cryptographic means or otherwise, by whatever name called,
providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value,
or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme;
and can be transferred, stored or traded electronically;
(b) a non-fungible token or any other token of similar nature, by whatever name called;
(c) any other digital asset, as the Central Government may, by notification in the Official Gazette specify: Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein.
Explanation - - For the purposes of this clause,- - (a) "non-fungible token" means such digital asset as the Central Government may, by notification in the Official Gazette, specify; (b) the expressions "currency", "foreign currency" and "Indian currency" shall have the same meanings as respectively assigned to them in clauses (h), (m) and (q) of section 2 of the Foreign Exchange Management Act, 1999."
Definition of VDA covers current cryptocurrencies and is dynamic enough to cover any new products. It allows the Central government to specify any other digital assets through notification in Official Gazette.
However, definition specifically excludes any Indian Currency or Foreign Currency essentially excluding any Central Bank issued Currency from the purview of definition of VDA and the charging provision s.115BBH of Income Tax Act, 1961, which may otherwise satisfy the definition of VDA.
3. Difference in Taxation of Crypto Currencies in India before and After Budget 2022
There was neither a definition of Virtual Digital Asset or Cryptocurrency nor a specific charging provision to deal with gains arising from transactions in Virtual Digital Assets.
This meant that taxation of gains from transactions in Cryptocurrencies prior to 1st April, 2022 will be dealt with under the provisions of Income Tax Act, 1961 absent s.115BBH.
Taxation would depend on whether the Cryptocurrency was treated by the holder as business asset or a Capital Asset. In case of treatment thereof as business asset, taxpayer will be taxed at applicable slab rate and in case of treatment thereof as Capital asset, for such currency held for more than 36 months tax will apply at the rate of 20% in terms of s.112 of the Income Tax Act, 1961. For a cryptocurrency treated as capital asset and held for less than 36 months, transfer thereof will entail tax at slab rate for asses.
Finance Act, 2022 introduced a new section 115BBH specifically for taxing gains from transactions in Virtual Digital Assets.
115BBH :-" (1) Where the total income of an assessee includes any income from the transfer of any virtual digital asset, notwithstanding anything contained in any other provision of this Act, the income-tax payable shall be the aggregate of—
(a) the amount of income-tax calculated on the income from transfer of such virtual digital asset at the rate of thirty per cent; and
(b) the amount of income-tax with which the assessee would have been chargeable, had the total income of the assessee been reduced by the income referred to in clause (a).
(2) Notwithstanding anything contained in any other provision of this Act,—
(a) no deduction in respect of any expenditure (other than cost of acquisition, if any) or allowance or set off of any loss shall be allowed to the assesseeunder any provision of this Act in computing the income referred to in clause (a) of sub-section (1); and
(b) no set off of loss from transfer of the virtual digital asset computed under clause (a) of sub-section (1) shall be allowed against income computed under any provision of this Act to the assessee and such loss shall not be allowed to be carried forward to succeeding assessment years.
(3) For the purposes of this section, the word "transfer" as defined in clause (47) of section 2, shall apply to any virtual digital asset, whether capital asset or not."
Thus w.e.f advent of s.115BBH,
- Investors will have to pay up 30 per cent tax on the returns they make from trading or investing in cryptocurrencies or other digital assets such as NFTs.
- For taxing gains u/s.115BBH, there must be a transfer of cryptocurrency giving rise to profits and gains.
- While computing gains on VDA transfer, deduction of any expenditure or allowance or set off of any loss is not permitted; set off of loss from transfer of VDA. Only Cost of acquisition is allowed to be deducted.
- Any losses from transfer of virtual digital asset cannot be set off against any other income, according to the announcement.
- 115BBH(2)(b) states no set-off of loss from transfer of virtual digital asset computed under clause (a) of sub section (1) shall be allowed against income computed under any provision of this Act and such loss shall not be allowed to be carried forward to succeeding assessment years. This will therefore include income calculated u/s.115BBH as well meaning that loss from transfer of one Cryptocurrency could not be set off against profit generated from transfer of another cryptocurrency.
4. Carrying forward and set off of losses from Crypto Currency Transaction undertaken before and after 01.04.2022
In light of provisions of s.115BBH set off of losses from transfer of VDA computed under section 115BBH(1)(a) shall be allowed against income computed under any provisions of Indian Income Tax Act, 1961 (including an income u/s.115BBH(1)(a) itself)
This applies with advent of s.115BBH.
Treatment of losses generated before from transfer of Cryptocurrencies before advent of s.115BBH will be governed by provisions of s.70 to s.74 of the Income Tax Act and set off and carrying forward will be normally permissible.
INTRA HEAD ADJUSTMENT
s.70(1) of the Act provides that where the net result for any assessment year in respect of any source falling under any head of income (other than Capital Gains) is a loss, assessee shall be entitled to have such loss set off against his income from any other source under the same head.
This will be subject to following restrictions:-
- Loss from speculative business cannot be set off against any income other than income from speculative business. However, non-speculative business loss can be set off against income from speculative business.
- Long-term capital loss cannot be set off against any income other than income from long-term capital gain. However, short-term capital loss can be set off against long-term or short-term capital gain.
- No loss can be set off against income from winnings from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or nature.
- Loss from the business of owning and maintaining race horses cannot be set off against any income other than income from the business of owning and maintaining race horses.
5) Loss from business specified under section 35AD cannot be set off against any other income except income from specified business (section 35AD is applicable in respect of certain specified businesses like setting up a cold chain facility, setting up and operating warehousing facility for storage of agricultural produce, developing and building a housing projects, etc.).
INTER HEAD ADJUSTMENT
In terms of s.71 of ITA, 1961, broad principles relating to inter head adjustment that may be relevantare:-
1) After making intra-head adjustment (if any) the next step is to make inter-head adjustment. If in any year, the taxpayer has incurred loss under one head of income and is having income under other head of income, then he can adjust the loss from one head against income from other head, e.g. Loss under the head of house property to be adjusted against salary income.
2) Any income from speculative businesses cannot be set off by losses. Income from speculative businesses. Non-speculative business losses can be Set off against income from speculative businesses.
3) Loss under head "Capital gains" cannot be set off against income under other heads of income.
4) Loss from business and profession cannot be set off against income chargeable to tax under the head "Salaries".
5) Loss under the head "house property" shall be allowed to be set-off against any other head of income only to the extent of Rs. 2,00,000 for any assessment year.
The carry forward of losses owing to disposal of a cryptocurrency prior to introduction of s.115BBH of Income Tax Act, 1961 will be governed by provisions of s.72 or s.74 depending on whether it is treated as business loss or capital loss.
5. Meaning of Transfer for the purpose of s.115BBH and Different Transactions Involving Crypto Currency and Tax Implications from the same
Word Transfer is defined in of section 2(47) of the IT Act, 1961 as including-
- The sale, exchange or relinquishment of the asset;
- The extinguishment of any rights therein;
For taxation of u/s.115BBH
- There should be a Transfer of VDA
- Transfer should give rise to Income
Different possible transactions that will involve transfer of Cryptocurrency are explained hereafter.
(a)Transfer of Cryptocurrency for consideration in Fiat Cryptocurrency
This is when you sell your Cryptocurrency for fiat currency i.e. Indian Rupee.
In Terms of s.115BBH the calculation for tax will be simply deducting the Cost of Acquisition from the Consideration received. You do not get any other deductions and even if you have your income only from transfer of Cryptocurrency and your income is less than minimum taxable income, s.115BBH being a non-obstante clause, income tax will be required to be paid at the rate of 30%.
(b) Buying Cryptocurrency / VDA with Cryptocurrency/VDA
To give rise to a taxable event u/s.115BBH, there must be a transfer of a VDA leading to income to the assessee.
If the value of Crypto that was earlier purchased has increased at the time of swapping it for another Crypto, it will fall within ambit of income in form of profits or gains and to calculate the gain from such transfer of VDA, you would consider the cost base of the Crypto you dispose of in fiat currency and subtract it from the fair market value for the same on the day you traded it for another crypto and pay 30% tax on the difference.
This aspect however may be open to debate as except u/s.194S, which deal only with aspect of deduction of tax at source, there is are no specific charging provisions or rules covering the transaction of swapping of cryptocurrency.
(C) Gift of Cryptocurrency
Gift is defined under the Transfer of Property Act, 1882 and is basically transferring something voluntarily and without consideration.
In case of Gift of a Cryptocurrency, conditions u/s.115BBH are not satisfied and therefore it will not be a taxable event either for donor or done u/s.115BBH. There will be no tax implication for donor under any provisions of the Act.
Donee however will be taxed in terms of s.56(2)(x) of the Income Tax Act as income from other sources. S.56(2)(x) provides that in case of
- receipt of any sum of money without consideration exceeding 50000 rupees
- Receipt of immovable property without consideration, the stamp duty value of which exceeds fifty thousand rupees or for a consideration where stamp duty value of such property exceeds such consideration and excess is more than higher of fifty thousand rupees and amount equal to 10 percent of consideration
- Receipt of any other property without consideration aggregate fair market value of which exceeds fifty thousand rupees or for a consideration that is less than the aggregate fair market value of the property by an amount exceeding fair market value;
The whole of aggregate value of the sum, the stamp duty value of such property or the whole of the aggregate fair market value of such property or FMV as exceeding the consideration respectively shall be treated as income from other sources and will be thus taxable.
(d) Purchasing items using Cryptocurrency
As Cryptocurrency is not considered as currency by government and rather as a Virtual Digital Asset, purchasing items using Cryptocurrency will be construed as Barter Transaction.
In the case of barter transactions leading to income, such income can either be capital gains if such a transaction is not in the normal course of business and can be profits and gains from business and profession if the goods exchanged are stock in trade.
Record keeping for such transaction is difficult owing to divisibility of cryptocurrencies up to more than even 6 or 8 decimal places. However, if you buy any item using a fraction of a given cryptocurrency, you owe taxes on the difference between that fraction of a Cryptocurrency at the time it was purchased and the time it was used.
This aspect also may be open to debate as except u/s.194S, which deal only with aspect of deduction of tax at source, there is are no specific charging provisions or rules covering the transaction of purchase of items using cryptocurrency.
6. Permissible deductions from gain under s.115BBH, meaning of Cost of acquisition and what could be covered within the ambit of 'Cost of Acquisition'
It is very clear that While computing gains on VDA transfer, deduction of any expenditure or allowance or set off of any loss is not permitted; set off of loss from transfer of VDA. Only Cost of acquisition is allowed to be deducted.
This means that if one is into the activity (business) of trading in cryptos and has taken loan and incurred capital expenditure for setting up infrastructure and also pays operational expenditure, neither the interest on loan, nor depreciation nor the operational expenditure will be allowed to be deducted which could have been deducted in any other trading activity.
The term "Cost of acquisition" is not defined in section 115BBH. Additionally sub section (3) of said section has a phrase "whether capital asset or not".
You could therefore import the definition from s.55(2) of the Income Tax Act. Without going deeper in said definition, it may be apt to state that "Cost of Acquisition" is the purchase price or in some eventualities, the amount of purchase price for a previous owner.(e.g. gift)
There are no definite rules as regards deduction of Network fee/ Gas fee, Exchange Trading Fee, payment to wallets for transfer etc., but they seem to be inherent to crypto transfer and must be factored into and subtracted while calculating income from transfer of a cryptocurrency.
7. Whether rewards from staking be taxed and what deductions will be allowed from income from rewards from staking?
Some blockchain network work on "Proof of Stake" concept. One must be holding/ staking coins to be randomly chosen as validator of a block and once so chosen, he will get rewards for participating in network activity.
This happens through multiple ways and commonly by creating a pool on a crypto exchange with members of such exchange being allowed to participate to earn declared rewards for a fixed period
This is more akin to you putting your cryptos an FD with the Exchange as against money being put in a bank FD and at the end of fixed duration, you will get paid with the amount of interest/ rewards.
There is no transfer of crypto by owner of the Cryptocurrency involved in activity of staking(rather rewards are transferred to the person who is putting his crypto for staking) and such rewards through staking are not to be taxable u/s.115BBH therefore.
They may rather be taxed as income from other sources u/s.56(2)(x) and in that case deductions u/s.57 and especially u/s.57(iii) will be allowed. 57(iii) provides that any other expenditure (not being in the nature of capital expenditure ) laid out or expended wholly and exclusively for the purpose of making or earning the income will be allowed to be deducted. Therefore Gas fee, crypto exchange fee etc. will be allowed to be deducted. Also while interest on a loan may not be allowed to be deducted from gains from Crypto Trading Activities if such loan is obtained for setting up infrastructure, in case of staking rewards, if one is paying interest on any loan obtained for buying the cryptos that were used for staking, such interest could be deducted and so could any other expenditure that could be proven to have been incurred for earning staking rewards.
8. Tax Implications with respect to a Cryptocurrency acquired through mining
Investopedia explains Bitcoin Mining as:- "Bitcoin mining is the process of creating new bitcoin by solving puzzles. It consists of computing systems equipped with specialized chips competing to solve mathematical puzzles. The first bitcoin miner (as these systems are called) to solve the puzzle is rewarded with bitcoin. The mining process also confirms transactions on the cryptocurrency's network and makes them trustworthy."
For bitcoin mining, one needs to have special hardware equipment, minimum of 1200 watt power supply and electricity.
Hardware equipment costs anywhere between INR 115000 to INR 3,50,000.
As can be seen s.115BBH would not apply to tax mining rewards as in case of mining as well, one receives crypto as rewards and does not transfer crypto to generate income.
Mining rewards will be taxable again in terms of s.56(2)(x) of the Income Tax Act, 1961 and deductions will be available u/s.57(iii) that will allow the miner to deduct
- Cost of Machinery/ hardware
- Electricity Charges
- Any other expenditure including rent, staff or other resources
- If incurred exclusively for mining operation
From
The Market Price of the Crypto rewards
Whether or not actual rewards is earned, the expenditure could be claimed in terms of s.57(iii) of the Income Tax Act, 1961.
Question however is whether the expense for purchase of hardware equipment is a capital expenditure with availability of depreciation benefit or a revenue expenditure. As depreciation is not to be allowed in the case of income from other sources, I am of the view that whole of machinery purchase expenditure could be claimed at one go. However, that may be a point of tussle between a miner and the Income Tax Department.
9. Forks and Airdrops
Soft forks are simply protocol updates and are backwards compatible; they don't give rise to any gains and there is no question of taxability here.
Hard forks are when blockchain diverges resulting in two different blockchains. What here happens is that the owner of a crypto in original blockchain also becomes owner of a new crypto being recorded in a different blockchain e.g. owner of a bitcoin (bitcoin core) will also be an owner of bitcoincash. This is an additional reward/gains for original owner but it does not result from transfer of a cryptocurrency and hence not taxable u/s.115BBH and rather under s.56(2)(x) as income from other sources subject to gains being in excess of INR 50000.
Airdrops are marketing technique where new cryptocurrency is transferred to wallets of users to generate awareness. This again is a gain but not arising from transfer of a cryptocurrency and will not be taxable u/s.115BBH and rather u/s.56(2)(x) subject to gains being in excess of INR 50000. However, such gains from airdrops, being more than INR 50000 is normally not likely.
10. TDS obligations
s.194S of the Income Tax Act, 1961 applicable with effect from 01.07.2022 provides that:-
"194S. (1) Any person responsible for payingto any resident any sum by way of consideration for transfer of a virtual digital asset, shall, at the time of credit of such sum to the account of the resident or at the time of payment of such sum by any mode, whichever is earlier, deduct an amount equal to one per cent of such sum as income-tax thereon:
Provided that in a case where the consideration for transfer of virtual digital asset is—
(a) wholly in kind or in exchange of another virtual digital asset, where there is no part in cash; or
(b) partly in cash and partly in kind but the part in cash is not sufficient to meet the liability of deduction of tax in respect of whole of such transfer,
the person responsible for paying such consideration shall, before releasing the consideration, ensure that tax required to be deducted has been paid in respect of such consideration for the transfer of virtual digital asset.
(2) The provisions of sections 203A and 206AB shall not apply to a specified person.
(3) Notwithstanding anything contained in sub-section (1), no tax shall be deducted in a case, where—
(a) the consideration is payable by a specified person and the value or aggregate value of such consideration does not exceed fifty thousand rupees during the financial year; or
(b) the consideration is payable by any person other than a specified person and the value or aggregate value of such consideration does not exceed ten thousand rupees during the financial year.
(4) Notwithstanding anything contained in section 194-O, in case of a transaction to which the provisions of the said section are also applicable along with the provisions of this section, then, tax shall be deducted under sub-section (1).
…..
…..
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(7)……
Explanation.—For the purposes of this section "specified person" means a person,—
(a) being an individual or a Hindu undivided family, whose total sales, gross receipts or turnover from the business carried on by him or profession exercised by him does not exceed one crore rupees in case of business or fifty lakh rupees in case of profession, during the financial year immediately preceding the financial year in which such virtual digital asset is transferred;
(b) being an individual or a Hindu undivided family, not having any income under the head "Profits and gains of business or profession".]
This section will not cover staking rewards. Rather staking rewards could be possibly covered within meaning of "interest" in terms of s.2(28A) of the Income Tax Act, 1961 and s.194A will apply for TDS obligations in such case.
One might fruitfully refer to CBDT guidelines / FAQs on TDS u/s.194S on transfer of Virtual Digital Asset being Circular No. 13 of 2022 published on 22.06.2022 and Circular No. 14 of 2022 dated 29.06.2022. These circulars cover provide clarifications on obligations of exchange, broker and buyer of a cryptocurrency for deduction of tax at source in different situations e.g. in a peer to peer transaction, in purchase of crypto in exchange of another crypto, in transacting on crypto on an exchange with and without broker etc.
11. Can an Indian Resident optimize tax implications through purchase of Cryptocurrency in an Exchange outside India?
Simple answer is NO.
s.115BBH is plain and simple that where total income of an assessee includes any income from transfer of virtual digital asset, income tax will be payable in terms of that section.
This therefore has nothing to do with the location of crypto exchange.
It is required to be kept in mind that Indian Resident is liable to tax in India on his worldwide income and there is no requirement to determine situs of VDA in case of Indian resident.
Majority of the tax treaties based on OECD Model Convention provide under Article 13 that income from alienation of immovable property, gains from alienation of movable property forming part of business property of a PE will be taxed in other state (state where the property lies); gains from alienation of ships or aircraft or of movable property pertaining to operation of such ships will be taxed in the Contracting state of the enterprise that operates such ships or aircrafts and that Gains from alienation of shares or comparable interests by resident may be taxed in other contracting state if at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50% of their value directly or indirectly from an immovable property situated in that other state.
Article 13(5) of Model convention specifically provides that Gains from Alienation of any property other than the ones referred to above(including a VDA) shall be taxable only in contracting state of which the alienator is resident.
Thus, irrespective of whether a VDA is purchased on an exchange in India or in an overseas jurisdiction, it always will be taxable in India for an Indian Resident.
Not paying taxes u/s.115BBH for a VDA owned by an Indian resident purchased on a foreign exchange may entail interest, penalty and prosecution under the provisions of ITA, 1961.
Author of this article: Adv. Ravish Bhatt
Connect with Mr. Bhatt on Linkedin: Click Here
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