The Curious case of taxing Virtual Digital Assets (Cryptocurrencies) in India

Once upon a time, the great Akbar asked one of his intelligent ministers, Birbal, to resolve a case where the issue was a valuation of food aroma stolen by a person from a sweet shop. Birbal was in doubt as to how something could be valued or charged which does not exist.

The fragrance, in this case, could be relatable to the Cryptocurrencies and Non Fungible Tokens (NFTs) [both referred to together as Virtual Digital Assets (VDA)], the valuation of which in itself is an exercise for taxation reasons in India. VDA in India are currently unregulated, and the Indian Central Government attempted to ban the use of VDA, which the Supreme Court then quashed. As a result, there is now a tax of 30% plus a surcharge and cess on the transfer of any VDA (the e-Rupee currently would be outside the tax net).

The tax issue around VDA

Where a person receives a VDA without consideration or at a lower consideration than the Fair Market Value (FMV) of the VDA, the FMV or the sale consideration minus the cost of acquisition is treated as gain being subject to tax at 30%++.[1]

In such a case, there is an inherent difficulty in determining the FMV of the VDA. The VDA under consideration is volatile, with valuations fluctuating on a regular basis. Therefore, it may be difficult to pinpoint the asset’s fair market value.

Where a VDA is purchased on the exchange, the price of the transaction could be considered an FMV. However, the Income-tax regulations of India provide valuation methods that are different from the exchange price as FMV. In such a case, there is no clarity on how the VDA should be valued for tax purposes.

Further, the only deduction allowed against the sale price or FMV is the purchase price. The problem arises in determining such purchase price when such VDAs are exchanged for other VDAs (sort of barter). In addition, any expenditure incurred for mining VDA is treated as a capital expenditure, not a revenue expenditure, making it not deductible against the sale proceeds.  

Another tax issue around VDAs is the prohibition of set-off of losses against any other or VDA income. This acts as a deterrent in a market where the probability of making a loss is significantly higher.

What are practices followed in other countries?

• In the USA, the VDA is treated as property and taxes the gains derived from the transfer of such property. The FMV, in that case, is the rate at which VDA was trading on the exchange
• In Canada ad UK, the VDA is treated as a commodity or property based on the motive of the holder and accordingly taxed as corporation tax or capital gains.

Taking a cue from other countries, India must provide a Characterisation to a VDA rather than ad-hoc taxation on the transaction. A characterisation would provide an identity to the underlying substance/ asset; accordingly, taxation could be ensured. Otherwise, it would be coloured as taxing the fragrance in the story of Akbar and Birbal.

What are the key takeaways for you?

• The investors should analyse and understand the tax regulations around the VDA and familiarise themselves towards the new tax regime.
• To the extent possible, transactions should be ensured on exchanges with appropriate documentation to prove the transaction.
• Taxpayers should also keep in mind that any losses would not be allowed for set-off
• Consult a tax advisor or a transfer pricing firm to understand the tax impact on the VDA transactions

For more information on Virtual Digital Assets, you can reach out to us at info@transprice.in.

[1] A tolerance of INR 50,000 between the FMV and the Sale Consideration is considered acceptable