Prior to introduction of finance bill 2022 there was no clarity in tax regulations for tax treatment for virtual digital assets popularly knows as Crypto assets. There was no clear definition and understanding for recognition of various available and new age tech virtual assets.

In absence of clear tax treatment guidance under tax laws different tax treatments were taken by investor/ trader and tax consultants ranging from taxing gain as capital gain, business incomes or incomes from other sources.

Proposed Tax Regime for Digital Assets

Finance Bill 2022 propose altogether new tax regime for Virtual assets right from defining, taxability, set off and carry forward of losses, gift or without consideration transaction in virtual assets and withholding tax requirements. Same time lots of open question and doubts have been raised post budget proposals with respect to taxability of virtual assets.

Going by broad budget proposal with respect to Virtual digital assets, the proposed regime seems to be designed with a view to deter investors and therefore one can draw parallels between taxation of speculative income such as income from gambling.

Since it is very first time that tax authorities have come out with taxation and other compliances in respect of these emerging and new age technologies. These proposed amendments should be considered as start of work in progress. It is expected that some amendments in new proposed regime may be offered before passing of finance bill. Also, lots of clarities are expected through Rules or circulars post enactment of finance bill.

Virtual Digital Asset – Defined

The definition of the virtual digital assets is wide enough to cover all types of crypto-currency, NFT either generated through cryptographic means or otherwise other than Indian or foreign currency.

A possible interpretation of proposed definition of “virtual digital asset” may potentially cover in its ambit assets other than crypto- currency and NFT such as digital vouchers, cards, token, code, or number that represents value. It would be useful to clarify that virtual digital asset is only limited to crypto currency.

Further, one of the industry expectations was that NFT shall not be classified along with crypto currency but to be treated on par with “capital asset”. This is based on the justification that NFT derives its value from the underlying asset which it represents.

Taxation on Virtual Digital Asset Transfer

With effect from 01st April 2022, transfer of any virtual digital asset shall attract income tax at the rate of 30%. This is a flat rate and the benefit of slab rates in case of individual is not available. Further, no deduction in respect of any expenditure or allowance or set off any loss shall be allowed while computing this income other than cost of acquisition of such virtual digital assets. Similarly, no set-off of loss arising from transfer of any virtual digital asset shall be allowed against any other income. Only a limited set off losses from virtual digital asset is permitted against gain from another virtual digital asset in the same year. No carry forward of any losses from transfer of virtual digital asset is permitted.

Gifting of virtual digital asset is chargeable as income in the hands of the recipient under the head Income from other sources. Gifting of virtual digital asset may also result in taxation in the hands of transferor at the rate of 30% in the absence of any exemption.

It will be critical to watch out for valuation rules for such virtual digital asset to determine deemed transaction value.

Withholding tax on Virtual Digital Assets

The government proposes that with effect from 01 July 2022, tax is to be deducted on payment for transfer of virtual digital asset to a resident at the rate of one per cent of consideration. The withholding tax provisions are applicable even if the consideration is partly or fully paid in kind. There is limited exemption provided for different classes of payers with low threshold of INR 10,000 and INR 50,000 per financial year.

Given the wide coverage of the obligator (individuals, non-resident, or any other person), compliance of TDS provisions may not be practically enforceable especially for retail and small investors. Even for larger players, identifying the party on the other side can be challenging given that these virtual digital assets are mostly purchased and sold over third-party digital platforms. The government may need to consider shifting the responsibility of withholding to the platform on which such transaction takes place.

Open Issues for Clarity In Digital Asset Taxation Scheme

There are some open issues where more clarity or guidance’s required from the Government:

• Definition of Virtual Digital Assets is very wide and also cover NFTs. There are several differentiating factors between NFTs and crypto assets which call for a diverse tax treatment of the assets. Emerging use of NFTs also cover real value from underlying assets such as potential use in Metaverse and edutainment NFT frameworks have the potential to bring large revenue in the long run, and therefore the government must consider offering allowances and tax rebates in order to support the industry.
• Since the digital tax scheme is prospective law and would be effective only from 01 April 2022 (i.e, Assessment Year 2023-24), there is no law governing the taxation of income arising from transfer of digital asset for the previous assessment years. This would leave open several interpretations leading to loopholes.
• Clarification by the government is required on which head the investor would be required to report income arising from the transfer of a digital asset. It is unclear whether such income would fall under the head ‘income from other sources’ or the head ‘capital gains’. Although proposed scheme suggest that this income may be chargeable under Income from other sources but still in absence of specific charging section and unclarity on taxable head, may create unwarranted litigations and confusions.
• The Bill does not define the critical terms like ‘cost of acquisition’ and ‘sales consideration’. This could potentially create confusion and litigation over the method of calculation of gain on disposal of such assets between the investor assessee and the income tax authorities. Apart from cost of acquisition definition, calculation of cost based on acquisition of such assets also need clarification. In case of large volume trade, investor have different choices to calculate cost of acquisition of their holding as per FIFO, LIFO or average costs basis. In absence of specific guidelines this may be points of future litigations.
• The provisions proposed with respect to withholding taxes would cause several unintended yet far-reaching complications. Practically how these transactions happen in digital space, it is difficult to buyer to identify the seller for tax deduction. Again, for Non-resident purchaser there will be additional tax compliances in India even for small transactions. Practically how tax authorities will enforce these TDS provisions need to be seen. A better option would have been implementing these tax collection and reporting provision through digital assets trade platform where these transactions are facilitated. This option additionally helps in strong KYC and reporting compliances on part of such trade platforms.
• One of major aspect of Crypto assets – assets or Crypto mining, has not been clarified in proposed regime.
• While digital assets have been categorized as assets by the Bill, no clarity has been provided on whether goods and services tax (“GST”) would be applicable to them. Also there is no clarities on applicability of Equalisation levy in case NRI selling these assets to Indian Residents.