Tax Compliance on Crypto & Blockchains
Written by Sufal Bardwaj & Utkarsh Anand Dt. May 18th, 2022
What are cryptocurrencies?
In layman language, cryptocurrencies are digital currencies designed to buy goods and services, similar to our other used currencies. However, since the beginning, it has largely been controversial due to its decentralised nature, meaning its operation without any intermediary like banks, financial institutions, or central authorities.
Today, more than 1,500 virtual currencies, such as Bitcoin, Ethereum, Litecoin, Dogecoin, Ripple, Matic, etc., are traded in the digital currency world. The investment and trading volume of cryptocurrencies has increased multifold since the nationwide lockdown. The crypto investments have grown despite any precise regulation from the Indian Government or Reserve Bank of India.
Legality of Cryptocurrency
So far, the Indian government has not yet granted any status of legal tender to cryptocurrencies.
In 2018, RBI tried to impose a ban by restricting banking facilities to the crypto exchanges. However, the ban was ruled out by the Supreme Court on constitutional grounds and virtual exchanges fundamental rights.
The income tax department has not yet offered any clarification regarding the tax implications on the gains earned from the crypto transactions.
Is crypto a ‘currency’ or an ‘asset’?
Tax experts have been contemplating the classification of the cryptocurrency between ‘currency’ or an ‘asset’. Cryptocurrency and crypto-assets are the names largely used interchangeably.
However, classifying it as a ‘currency’ needs some legal backing from the government, in the absence of which it is safe to classify it as an ‘asset/property’.
Since the tax implication would arise irrespective of the legality status, classifying them as ‘assets’ would be a better approach than any government clarification.
Further, the U.S government had also issued a notification classifying it as a ‘property’ and thereby levying capital gain taxes on the gain on sale of the cryptocurrencies.
How does cryptocurrency work?
Cryptocurrencies run on a distributed public ledger called blockchain, a record of all transactions updated and held by currency holders. Units of cryptocurrency are created through a process called mining, which involves using computer power to solve complicated mathematical problems that generate coins. Users can also buy the currencies from brokers, then store and spend them using cryptographic wallets.
If you own cryptocurrency, you don’t own anything tangible. What you own is a key that allows you to move a record or a unit of measure from one person to another without a trusted third party.
Although Bitcoin has been around since 2009, cryptocurrencies and applications of blockchain technology are still emerging in financial terms, and more uses are expected in the future. Transactions including bonds, stocks, and other financial assets could eventually be traded using the technology.
There are thousands of cryptocurrencies. Some of the best known include:
- Bitcoin: Founded in 2009, Bitcoin was the first cryptocurrency and is still the most commonly traded. The currency was developed by Satoshi Nakamoto – widely believed to be a pseudonym for an individual or group of people whose precise identity remains unknown.
- Ethereum: Developed in 2015, Ethereum is a blockchain platform with its own cryptocurrency, called Ether (ETH) or Ethereum. It is the most popular cryptocurrency after Bitcoin.
- Litecoin: This currency is most similar to bitcoin but has moved more quickly to develop new innovations, including faster payments and processes to allow more transactions.
- Ripple: Ripple is a distributed ledger system that was founded in 2012. Ripple can be used to track different kinds of transactions, not just cryptocurrency. The company behind it has worked with various banks and financial institutions.
Non-Bitcoin cryptocurrencies are collectively known as “altcoins” to distinguish them from the original.
Taxation on the gain from the sale of crypto
Since the cryptocurrency is not yet legalised by the Reserve Bank of India (RBI), it cannot escape from taxability. An investor earning profits from the sale of cryptocurrency must pay income tax.
All incomes, except exempted explicitly by the Income Tax Act, are subject to tax. Till we receive any clarification from the income tax department, investors must pay income tax on the crypto-transactions based on the nature of the transactions.
As per the standard income tax rules, the gains on the crypto-transactions would become taxable as (i) Business income or (ii) Capital gains. This classification will depend on the investors’ intention and nature of these transactions.
If there are frequent trades and high volumes, gains from the cryptocurrency transactions will be taxed as ‘business income’.
However, they will be taxed as ‘capital gains’ if the purpose of owning them is primarily to benefit from longer-term appreciation in value with fewer trades.
The nature of classification has to be reviewed for every taxpayer, and taxpayers must take the help of an expert for accurate reporting.
If classified under capital gains :
If the crypto-transactions are classified as ‘investments’, they will be considered capital gains or losses under the head ‘capital gain’.
If the sale value of the transaction is more than the cost, it will be regarded as ‘capital gain’, and if the price is higher than the sale value, it will be considered ‘capital losses’.
As per the applicable income tax slabs, short-term capital gains tax will be leviable if crypto assets are held for less than three years (<=36 months). If the crypto-assets are sold after holding the investment for three years (> 36 months), they will be treated as long-term investments and taxed at 20% with indexation benefit.
In case of capital losses :
There is no directive from the income tax authorities regarding the treatment of capital losses. However, if your sale transaction has resulted in a loss, we suggest you consult an expert.
If classified as business income :
If crypto transactions are reported as business income, the implication of Goods and Services Tax (GST law) also needs to be examined. All the direct and indirect expenses will be allowed as deductions from the profits on the sale of the crypto assets. The profits will be added to the other income and taxed as per the income tax slab rates.
- Income from transfer of virtual digital assets such as crypto, NFTs will be taxed at 30%.
- No deduction, except the cost of acquisition, will be allowed while reporting income from transfer of digital assets.
- Loss from digital assets cannot be set-off against any other income.
- Gifting of digital assets will attract tax in the hands of receiver.Losses incurred from one virtual digital currency cannot be set-off against income from another digital currency.
Is cryptocurrency safe ?
Cryptocurrencies are usually built using blockchain technology. Blockchain describes the way transactions are recorded into “blocks” and time stamped. It’s a fairly complex, technical process, but the result is a digital ledger of cryptocurrency transactions that’s hard for hackers to tamper with.
In addition, transactions require a two-factor authentication process. For instance, you might be asked to enter a username and password to start a transaction. Then, you might have to enter an authentication code sent via text to your personal cell phone.
While securities are in place, that does not mean cryptocurrencies are un-hackable. Several high-dollar hacks have cost cryptocurrency start-ups heavily. Hackers hit Coincheck to the tune of $534 million and BitGrail for $195 million, making them two of the biggest cryptocurrency hacks of 2018.
Unlike government-backed money, the value of virtual currencies is driven entirely by supply and demand. This can create wild swings that produce significant gains for investors or big losses. And cryptocurrency investments are subject to far less regulatory protection than traditional financial products like stocks, bonds, and mutual funds.
Sufal Bardwaj & Utkarsh Anand