Decrypting the tax on cryptocurrencies

Decentralised cryptocurrency, blockchain, proof of work, decentralised apps, currency wallets, mining, and proof of stake. These words may sound all too familiar for some of us, thanks to the unprecedented juggernaut of digital currencies in the past few months. However, despite this sense of familiarity, understanding the world of cryptocurrencies and how they work is no child’s play.

For the unversed, cryptocurrencies are new-age digital assets/ currencies, carrying an underlying value and tradable in exchange for goods or services online.

In a world that thrives on the internet and technology, the concept of a digital currency was nothing drastically new, but what caught the world’s attention and imagination was the concept of decentralising them.

Since its debut in 2009, crypto’s have seen a massive uptick, especially in the past few months. Today, there are over 10k+ cryptocurrencies in the world, the most popular ones being Etherium, Bitcoin, and Tether.

As per data published on CoinMarketCap, cryptocurrencies today enjoy a market cap of over $1.3 trillion, touching all-time highs of $2.3 trillion in May this year.

It comes as no surprise that India is not far behind in this global phenomenon. Recent reports suggest over 1.5 crore Indians have invested over Rs 15,000 crore in cryptocurrencies and it is only expected to grow.

India currently does not have a regulatory framework to govern crypto transactions. In a recent media interaction on the government’s stance on cryptocurrency, Finance Minister Nirmala Seetharaman said: “A Cabinet note is being prepared. It's almost nearing completion and then it will be taken to the Cabinet... we will allow a certain amount of window for people to experiment on blockchain and bitcoin. However, the what formulation of cryptocurrency will be part of the Cabinet note which will get ready soon.”

As we wait for more clarity on this from the government, as things stand today, there is a lot of grey area on the regulatory and legal implications of transacting in crypto in India.

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Having said this, in this article, we have moved a step ahead to discuss what happens when you transact in crypto – especially from an Indian tax perspective. Before we jump into the technicalities of it, let us break it down to the most common types of transactions associated with crypto:

1. Trading: Buying and selling crypto’s on designated exchanges (crypto exchanges) – similar to trading in stocks or securities on a stock exchange.

2. Purchase of goods or services: Many businesses recognise crypto as an accepted form of payment for goods or services offered by them. Think of it as similar to paying for groceries using food coupons – however, in coupons the price/ value is constant unlike cryptos.

There is one more concept to understand before we move to taxation – and that is how does one acquire a crypto? The three most common ways are:

1. Purchase using traditional currency (like INR/ USD);

2. Earn by approving crypto transactions on the block-chain (popularly known as “Mining”)

3. Receive cryptos in exchange for goods or services that you offer (other than as Miners).

The current tax laws do not provide for any specific tax treatment of cryptos. As we witness a surge in crypto transactions with each passing day, it is only a matter of time before we see legislative provisions brought in to address it. Until then, let us look at the possible tax trigger under the law as it stands today.

Currently, any form of gain or loss from trading in shares, securities, properties, etc. falls under the tax net and is taxed based on the most appropriate head of income applicable to the facts of each case. In the case of cryptos, the first step is to see whether it can be regarded as an “asset” subject to tax in India. The answer to this leans towards a “yes”. This is because the definition of an asset under the current tax laws is especially wide and covers the property of any kind.

Once it is an “asset” the next step is to further categorise it as a “Business Asset” or “Capital Asset”. Typically, for someone who regularly trades in crypto and builds their business around it, crypto’s are likely to partake the nature of a “Business Asset” (technically known as “Stock-in-trade”) and consequently, any gain or loss from such trading is likely to be classified as “Business Income”.

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In contrast, trading in crypto typically as an investment or wealth management strategy is likely to be taxed as “Capital Gains”, as in such cases the crypto is likely to partake the nature of a “Capital Asset”. Of course, classification as “business” or “capital gains” depends on various factors applicable to each case, such as the intent of holding, period of holding, frequency of trading, time spent on such trading, etc. Once the nature of income is established, the next step is the computation of taxable income.

In the case of a trader who deals in cryptos regularly, it is more likely that the income is generated through the purchase and sale of cryptos is on the designated crypto exchanges. In such a case, the gain or loss made from trading (i.e. difference between sale consideration and cost of acquisition) would likely be taxed as “Business Income” at the applicable rates.

The applicable tax rate depends on the legal form of the business – in case of individuals or partnership firm, slab rates or presumptive tax rates would apply; for companies tax rate could be 22 percent.  

In case the income is regarded as “capital gains”, there could be two alternatives:

1. Purchase and sale of the crypto are routed via a crypto exchange: In this case, both the sale consideration and the acquisition cost are clearly identifiable. Where the crypto is held for more than 36 months prior to transfer, gain/ loss would be classified as “long-term” in nature and taxable at the rate of 20 percent.

In case of long-term gains, the actual cost of acquisition is adjusted to the notified inflation rate and such inflation-indexed cost would be considered for computing the taxable gain/ loss. Alternatively, if held for less than 36 months prior to the date of transfer, the gain/ loss would be classified as “short-term” and taxed at 30 percent.

2. Alternatively, one leg of the transaction could be executed on a crypto exchange while the other could be in return for services/ goods sold. Let’s look at the tax nuances of these through examples:    

a. A miner has earned cryptos as a transaction fee from mining and these are later sold on a crypto exchange for a value. In this case, the sale consideration derived through the crypto exchange is easily identifiable. But what about the cost? One could argue that this is a “self-generated” asset and no cost attributable to it – which would lead to a break-down of the capital gain computation mechanism and accordingly fall outside the tax net. Another view could be to consider the cost associated with mining (such as electricity costs, IT infrastructure cost, etc.) or the value of the coin as on the date it was earned, as the cost of acquisition while computing the taxable capital gain income.  

b. Crypto is acquired as a payment for goods or services offered and is subsequently sold on a crypto exchange. In this case, the cost of acquisition is likely to be the value of goods or services offered in exchange of the crypto. The sale consideration would be the price at which the crypto is sold on the exchange.

c. Crypto is acquired via a crypto exchange but subsequently used/ traded in exchange of goods or services. In this case, the cost of acquisition is clearly identifiable – being price paid on the exchange for acquiring the crypto. However, sale consideration is not so straightforward. As per the current laws, where the sale consideration is indeterminate, the fair value of the asset transferred is deemed to be the consideration. With crypto prices being so dynamic, determining the ideal “fair value” of crypto for tax purposes is a vexed issue and requires careful evaluation.

It is important to note that there is a certain element of ambiguity on how these transactions will be taxed and more importantly the legality of accepting cryptos in exchange of the goods or services (including mining), in India.

Understanding the enigma of crypto is not easy. The same goes with its taxation. For those who seek a foot in this game, it is only wise to tread this path carefully, considering the lack of legal and tax clarity surrounding them in India.