GUIDE ON CRYPTOCURRENCY AND TAXATION IN INDIA

Table of Contents

1. What is Cryptocurrency?
2. Definition of Virtual Digital Asset under the Income Tax Act, 1961
3. Difference in Taxation of Cryptocurrencies in India: Pre and Post-Budget 2022
4. Meaning of Transfer of Cryptocurrency for the Purpose of Section 115BBH of the Income Tax Act, 1961
5. Carrying Forward and Set-Off of Losses from Cryptocurrency Transactions Before and After April 01, 2022
6. Different Transactions Involving Cryptocurrency and Their Tax Implications

1. What is Cryptocurrency?

Cryptocurrency refers to a digital or virtual form of currency that is secured through cryptography, making it nearly impossible to counterfeit or double-spend. Cryptography entails the application of secure communication techniques, allowing only the sender and the intended recipient to access the message content. The term originates from the Greek word “kryptos”, meaning hidden.

The term “crypto” signifies the various encryption algorithms and cryptographic techniques employed to safeguard these digital entries, including elliptical curve encryption, public-private key pairs, and hashing functions.

In simplified terms, cryptocurrencies are digital or virtual currencies supported by cryptographic systems. They facilitate secure online payments without the involvement of third-party intermediaries.

2. Definition of Virtual Digital Asset under the Income Tax Act, 1961

As per the Finance Bill, 2022, the following clause was introduced in the Income Tax Act, 1961:

Section 2(47A) defines “virtual digital asset” as:

(a) Any information, code, number, or token (excluding Indian currency or foreign currency) generated through cryptographic means or otherwise, by any name, providing a digital representation of value exchanged with or without consideration. This includes assets with a promise or representation of inherent value or functioning as a store of value or unit of account, including its use in financial transactions or investments (not limited to investment schemes), and which can be transferred, stored, or traded electronically.

(b) A non-fungible token (NFT) or any other token of a similar nature, by any name.

(c) Any other digital asset as specified by the Central Government through notification in the Official Gazette.

Proviso: The Central Government, through notification in the Official Gazette, retains the authority to exclude any digital asset from the definition of a virtual digital asset, subject to conditions specified therein.

Explanation: For the purpose of this clause:

(a) A “non-fungible token” refers to a digital asset specified by the Central Government through notification in the Official Gazette.

(b) The terms “currency”, “foreign currency”, and “Indian currency” shall carry the same meanings as defined under clauses (h), (m), and (q) of Section 2 of the Foreign Exchange Management Act, 1999.

3. Difference in Taxation of Cryptocurrencies in India: Pre and Post-Budget 2022

Prior to the introduction of the Finance Bill, 2022, standard income tax regulations applied to cryptocurrency transactions. Gains from crypto dealings were categorized either as business income or capital gains, depending on the nature and duration of the transactions.

However, effective from April 1, 2022, India began taxing income from cryptocurrency transactions akin to lottery winnings, with a tax rate of 31.2%. Investors are now liable to pay 30% tax on returns derived from trading or investing in cryptocurrencies or other digital assets, such as NFTs. Additionally, losses arising from the transfer of virtual digital assets cannot be offset against any other income.

The government further introduced Tax Deducted at Source (TDS) on payments made for the transfer of virtual digital assets at 1% of the consideration amount, applicable above a specified monetary threshold. Moreover, gifts of virtual digital assets are proposed to be taxed in the hands of the recipient.

For income computation purposes, only the cost of acquisition is permitted as a deduction. For crypto traders, every single transaction involving cryptocurrency is subject to 1% TDS, which will be deducted at the time of payment.

In accordance with the Finance Bill, 2022, Section 194S was introduced, effective from July 1, 2022, mandating a 1% TDS deduction on the payment of purchase consideration for the transfer of virtual digital assets to a resident person. This provision aligns with the existing Section 194IA, which requires TDS at 1% on the purchase of immovable property exceeding INR 50 lakh in a financial year.

Under Section 194S, two threshold limits have been prescribed for TDS applicability:

• • For a “specified person” (an individual or HUF) whose total sales or gross receipts in the preceding financial year do not exceed:
    • INR 1 crore  for business or
    • INR 50 lakh for profession,

      TDS under Section 194S is deductible only if the purchase consideration for virtual digital assets exceeds INR 50,000 during the financial year.
  • For persons other than specified individuals (including firms, LLPs, and companies), TDS is deductible if the purchase consideration for virtual digital assets exceeds INR 10,000 during the financial year.

4. Meaning of Transfer of Cryptocurrency for the Purpose of Section 115BBH of the Income Tax Act, 1961

Section 115BBH of the Income Tax Act, 1961, provides that when the total income of an assessee includes any income arising from the transfer of a virtual digital asset, the income tax payable shall comprise the following:

(a) The income tax computed on the income generated from the transfer of such virtual digital asset at the flat rate of thirty percent; and
(b) The income tax with which the assessee would have otherwise been chargeable had the total income been reduced by the income referred to in clause (a)

Pursuant to sub-section (2) of Section 115BBH, it is explicitly provided that:
(a) No deduction in respect of any expenditure (other than the cost of acquisition) or allowance, nor any set-off of losses, shall be permitted while computing the income referred to in clause (a) of sub-section (1); and
(b) Losses arising from the transfer of virtual digital assets, as computed under clause (a) of sub-section (1), cannot be set off against income computed under any other provision of the Act. Furthermore, such losses shall not be eligible for carry forward to subsequent assessment years.

The term “transfer” in the context of virtual digital assets encompasses the following types of transactions:

• • The sale of cryptocurrency.
  • The exchange of one cryptocurrency for another.
  • The relinquishment of rights associated with cryptocurrency.
  • The extinguishment of any rights in cryptocurrency.
  • The compulsory acquisition of cryptocurrency under any statutory authority or legal mandate.

It is pertinent to note that, as per Section 2(47) of the Income Tax Act, “transfer” concerning a capital asset includes:

 (i) Sale, exchange, or relinquishment of the asset;
(ii) Extinguishment of any rights concerning a capital asset;
(iii) Compulsory acquisition of an asset under any law;
(iv) Conversion of a capital asset into stock-in-trade;
(v) Maturity or redemption of a zero-coupon bond;
(vi) Transfer of possession of immovable property to the buyer in part performance of a contract;
(vii) Any transaction enabling the transfer or enjoyment of immovable property; or
(viii) Disposition, parting with, or creation of any interest in an asset in any manner.

5. Carrying Forward and Set-Off of Losses from Cryptocurrency Transactions Before and After April 01, 2022

Effective from April 01, 2022, losses incurred from cryptocurrency transactions cannot be carried forward or set off against any income. Consequently, if investors booked their profits or losses on cryptocurrency holdings before March 31, 2022, they were subject to taxation at the marginal rate applicable to their income bracket.

However, from April 01, 2022, investors are prohibited from offsetting losses arising from one cryptocurrency against income generated from another. Prior to this date, such adjustments were permissible, allowing investors to set off losses from cryptocurrency transactions against other capital gains.

The taxation regime prior to April 01, 2022, was contingent on the tax treatment adopted by the taxpayer. If income from the transfer of cryptocurrency was categorized as business income, the tax rate would have been aligned with the standard business tax rates, permitting the deduction of expenses or charges incurred. Conversely, if the income was classified as capital gains, the tax treatment varied based on the holding period. For long-term capital gains (where the holding period exceeded 36 months), taxation was imposed as per the applicable income tax slab rates for individuals.

6. Different Transactions Involving Cryptocurrency and Their Tax Implications

6.1. Transfer for Consideration in Fiat Currency

It is important to note that cashing out cryptocurrency assets triggers tax obligations on the profits earned. Although cryptocurrency continues to operate in a legal grey area in India, its taxation remains within the purview of existing tax laws. For the period prior to 1 April 2022, any income derived from transactions involving cryptocurrency, where the individual engages in crypto trading as a business and holds the assets as stock-in-trade, is taxable as business income. This applies when the crypto assets are subsequently transferred, exchanged for fiat currency, or traded for other cryptocurrency units.

In cases where cryptocurrency held as stock-in-trade is bartered for goods or services, the income arising from such transactions is also subject to taxation under the head ‘business income’. Furthermore, gifting of cryptocurrencies may attract tax implications, depending on their marketability and underlying value.

For transactions from 1 April 2022 onwards, any transfer of Virtual Digital Assets (VDAs), whether in exchange for fiat currency, other VDA units, or goods and services, is taxable under Section 115BBH of the Income Tax Act, 1961, at a flat rate of 30% plus applicable cess and surcharge. Notably, the tax is levied on the gains from the transaction rather than the entire sale consideration. The taxable gain is calculated as the difference between the value of the fiat currency, VDA units acquired, or goods/services received, and the cost of acquisition of the disposed units.

6.2. SWAP of Different Cryptocurrencies

Swapping one cryptocurrency for another results in taxable gains under Section 115BBH. This applies when a particular cryptocurrency is exchanged as consideration for acquiring another cryptocurrency, often due to limited trading pairs with fiat currency or other strategic reasons.

For instance, if you initially purchase Solana (SOL) and later wish to acquire Binance Coin (BNB), but are unable or unwilling to exchange it directly against INR, you may first swap SOL for Tether (USDT) and subsequently exchange USDT for BNB. The gains arising from each leg of the swap are taxable. The computation of taxable gains is as follows:

SOL (Solana) transferred for USDT:

• • Consideration for transferring Solana = Price of USDT × Number of USDT at the time of swapping
  • Less: Cost of acquisition of Solana
  • (The aggregate gains/losses from this swap are taxable under Section 115BBH of the IT Act, 1961.)

USDT transferred for BNB:

• • Consideration for transferring USDT = Price of BNB × Number of BNB at the time of swapping
  • Less: Cost of acquisition of USDT
  • (The aggregate gains/losses from this swap are taxable under Section 115BBH of the IT Act, 1961.)

6.3. Gift of Cryptocurrency

The taxation of gifting virtual digital assets (VDAs) came into effect from 1 April 2023 and is applicable from Assessment Year (AY) 2023-24 (Financial Year 2022-23) onwards. The Finance Act, 2022 introduced an amendment specifying that the term “property” includes VDAs. Consequently, any cryptocurrency received as a gift is taxable in the hands of the recipient.

As per Section 56 of the Income Tax Act, the fair market value (FMV) of the gifted VDA on the date of transfer is considered as income in the hands of the recipient. This income is chargeable to tax under the head “Income from Other Sources” and is included in the recipient’s taxable income slab. The benefit of the basic exemption limit is available to the recipient if their total income, including the value of the gifted VDA, does not exceed the exemption threshold.

6.4. Buying Items Using Cryptocurrency

Whenever cryptocurrency is used to purchase goods or services, it constitutes a ‘transfer’ of the VDA, making it a taxable event under Section 115BBH of the Income Tax Act, 1961. This applies to both domestic and cross-border transactions.

In cases where Indian residents use cryptocurrency to pay for services rendered or goods sold by non-residents, such transactions may be categorized as exports under the Foreign Exchange Management (Export of Goods and Services) Regulations, 2015, and the Master Directions on Export of Goods and Services. These regulations mandate that the full value of any exports must be received through authorized banking channels. Additionally, any set-off against import payments must also be routed through banking channels.

Therefore, cross-border barter transactions involving cryptocurrency without the involvement of fiat currency and authorized banking channels are likely to violate Export Regulations. Consequently, purchasing items—whether domestically or internationally—using cryptocurrency constitutes a taxable event under Section 115BBH of the Income Tax Act, 1961.

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Author: Ravish Bhatt, Managing Partner, R&D Law Chambers LLP.

Email : ravish@rdlawchambers.com