Non fungible tokens (NFTs) gained tremendous popularity in India in last 4 or 5 years. Eminent personalities, movie stars and pop artists all over the world showed interest and promoted their own NFTs and NFT marketplaces. . Over the centuries, the currency has undergone several metamorphosis in different ages, starting with stone, to cowri, to metal, to paper to paperless and cashless (net banking) transactions. In the digital age, the cryptocurrency or virtual currency (VC) is the new Avatar of the currency. There was fear that the cryptocurrency will be banned in India and the crypto enthusiasts were living under great fear. While the proposal in Finance Bill 2022 has dispelled this fear of impending ban of cryptocurrency, it has also cleared the decks for the introduction of a centralized digital currency by the RBI.
The cryptocurrency was hitherto seen as ‘a bubble, a ponji scheme and an environmental disaster’. It was further argued that it is susceptible to hacking, as it is in digital media and because of its anonymity, it will also be outside the ambit of the anti-money laundering and anti-terrorism laws. Although cryptocurrency promotes technological innovation and has the potential to improve the efficiency and inclusiveness of the financial system and the economy in the long run, the then Finance Minister Mr Arun Jaitley in his budget speech in 2018 said that the Government did not consider cryptocurrencies as legal tender or coin, but the Government would explore the use of blockchain technology proactively for ushering in digital economy.
The RBI issued Circular in 2018 that the entities regulated by the Reserve Bank shall not deal in VCs or provide services for facilitating any person or entity in dealing with or settling VCs. The Central Board of Direct Taxes also had recommended to the Department of Economic Affairs in 2018 for its ban. The government was apprehensive of its likely misuse in the hands of miscreants for the purpose of illegal activities and as a knee jerk reaction, the Government introduced ‘The Crypto-token Regulation Bill, 2018’ contained a proposal (i) to prohibit persons dealing with activities related to crypto tokens from falsely posing these products as not being securities or investment schemes or offering investment schemes due to gaps in the existing regulatory framework and (ii) to regulate Virtual Currency exchanges and brokers where sale and purchase may be permitted. But within a year, there was a volte-face and the government introduced a bill “Banning of Cryptocurrency and Regulation of Official Digital Currency Act, 2019” with a proposal to ban the mining, generation, holding, selling, dealing in, issuing, transferring, disposing of or using cryptocurrency in the territory of India.
The apex court hearing a writ petition held in the year 2020 that NFT transactions are not illegal, but set aside the circular of RBI. With the Finance Minister in her budget speech, announcing introduction of central bank digital currency by RBI with centralized ledger, it is now clear that the government aims to treat other cryptocurrencies with decentralized ledger as digital assets and at the same time doesn’t want to make it legal tender.
With this hype around NFTs and cryptocurrencies, the Finance Bill 2022 also proposes amendments in Section 2 of the Income Tax Act, 1961 to define ‘virtual digital assets’ to include all NFTs and crypto currencies. A new section 115BBH has been proposed, which requires gain from the sale of virtual digital assets to be taxed at flat rate of 30%, without any allowance of expenses, except the cost of purchase of such asset and without any provision of set off of losses against other income and without any carry forward of losses from such transactions. Thus the taxation of gain from sale of virtual digital asset has been treated differently from the capital gains arising from sale of other capital assets, which provide for lesser rate of taxation of long term capital gains at 20%, with provision for indexation of the cost of asset and allowance of other costs like brokerage etc.
This move gives a clear picture that the Government encourages the centralised digital currency by RBI, since it has removed the ambiguities on legality of cryptocurrency transactions by taxing it. At the same time, it certainly shows intent not to promote other cryptocurrency transactions, by taxing the gain from such transactions at a higher rate.
The move is understandable because although NFTs and crypto currencies use blockchain technology for storage of binary data using cryptography, these virtual assets are decentralized and do not exist in a physical form, thus having no single authority regulating its issuance. The blockchain on which the ownership of these virtual assets gets recorded, is highly secure, which makes it impossible for the Government authorities to track the transactions, identify the investors and regulate the transactions undertaken through such assets. It leaves a large scope for its usage in illegal activities like funding terrorism etc. Though the bill to ban cryptocurrency is still pending, it seems to be a volte face again on the part of the government, by taxing the gains from the crypto currency transactions, which indirectly clears the government intent about its legality.
However, on the other hand the exorbitant rate of tax imposed on digital asset transfer might come as a dampener to the investors dealing in them, especially so, when transfer of digital assets being treated differently to be taxed at a flat rate of 30% without allowance of any expenses etc. Additionally, the Finance Bill provides for 1% tax deduction at source (TDS) to be made, while transferring the digital assets. Going even further, the transfer of digital assets in form of ‘gift’ is also not exempted from taxation.
The proposal demonstrates the Government’s realization of immense potential that the digital asset trading holds for the Indian economy. After the introduction of TDS on crypto currency transactions, such transactions will leave a trail and the fear of anonymity and its usage for terror funding will be over, as this will create instant report to the government, about the transactions by the agencies dealing in transfer of such digital assets.
The Government, through this move has created a sand-box of sorts that shall allow the regulators to observe the system formally and formulate policies in the future that focus on laying equal standards for all capital assets, be it digital or otherwise.
The RBI issued Circular in 2018 that the entities regulated by the Reserve Bank shall not deal in VCs or provide services for facilitating any person or entity in dealing with or settling VCs. The Central Board of Direct Taxes also had recommended to the Department of Economic Affairs in 2018 for its ban.