5 things to know before investing in cryptocurrency

Though the Cryptocurrency Bill was not listed in the budget session, Union Budget 2022 was significant for Indian cryptocurrency investors. Finance Minister Nirmala Sitharaman announced a 30 percent tax on income generated from the transfer of virtual digital assets. 

Let's look at the five things to know about cryptocurrency investing:

1. Cryptocurrencies are taxed at a very high rate

Investors will have to pay a 30 percent tax on income generated from the transfer of cryptocurrencies. It is a higher income tax rate than gains from equity mutual funds and stocks that are taxed at 10-15 percent, depending on the time period for which the investments were held.

The 30 percent tax rate may not impact crypto traders and investors in the highest income tax bracket. However, investors who fall in the lower income tax brackets will feel the impact of a higher tax rate. 

No deduction shall be allowed towards expenses incurred to earn such income. Only the cost of acquisition can be reduced from crypto income. For instance, any crypto exchange fees or interest expenses incurred while earning crypto income cannot be claimed as a tax deduction. 

Suppose you have purchased Bitcoin units worth Rs 1 lakh and sold them for Rs 2 lakh. You will have to pay a 30 percent tax on the sale value less the cost of acquisition (Rs 2 lakh-Rs 1 lakh). You will have to pay a tax of Rs 30,000 (30 percent of Rs 1 lakh) and you won’t get any deduction for expenditure incurred to earn this crypto income. 

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2. Cryptocurrency investments do not qualify for basic income tax exemption.

Income from cryptocurrency does not qualify for income tax deductions and exemptions. You pay tax on every rupee you earn from cryptocurrencies. For example, taxpayers below 60 years of age qualify for a basic tax exemption of Rs 2.5 lakh per year. 

Even if your income is between Rs 2.5 lakh to Rs 5 lakh per year, you don't incur income tax liability because of the tax rebate under Section 87A. However, even small investors who otherwise escape the tax net will incur tax on their cryptocurrency income.

Let’s understand this with an example. Suppose your salary income is Rs 2 lakh per annum whereas crypto income is Rs 10,000. According to the Income Tax Act, your tax liability for the year will be nil as your income is below the basic exemption limit. However, you still have to pay tax on the crypto gains at 30 percent of Rs.10,000 which is Rs 3,000. You won't get the benefit of the basic tax exemption limit, which is Rs.2.5 lakh for individuals below 60 years. 

3. Cryptocurrency losses cannot be set off against other income.

There can be instances when a crypto trader transacts in multiple cryptocurrencies. Then the question might arise: Can losses from one crypto be set off against gains from another crypto? 

As of now the way the law is worded, loss from one crypto transaction is not allowed to be set off from another crypto transaction. We believe the government must allow the loss from one virtual digital asset to be set off against the profit from another virtual digital asset. However, more clarity is required in this matter. 

The losses you incur in cryptocurrency transactions cannot be set off against gains from other assets. For instance, the losses you incur in equity, debt, gold, and property transactions can be set off or adjusted against profits from other virtual digital assets. 

Also, the law clearly states that one cannot carry forward losses from virtual digital assets. It means if you incur a loss from cryptocurrencies in one financial year, you cannot carry forward such a loss to the next financial year. 

4. TDS has to be deducted from payment made to seller

According to the provisions of the Finance Bill 2022, the transferee/buyer of VDAs must deduct 1 percent of the sale consideration as TDS, if it exceeds the specified monetary threshold. The amount must be deposited with the government as per the law. 

The TDS is adjusted against the crypto traders’ annual tax liability and can be claimed as a tax refund. However, it does lock up the trader's liquidity for some time as the refund of excess tax paid can be claimed only after filing IT returns.  

The Union Budget places the responsibility of collecting the TDS on the person who transfers the consideration to the seller. Whether exchanges have any role in this remains to be seen. Also, collecting and depositing TDS requires persons to do detailed compliance.

A TDS return is usually required to be filed. A crypto buyer may have hundreds or thousands of weekly transactions and may not have the resources to do full-scale TDS compliance. We are hopeful that in due course the manner of compliance and on whom the onus of compliance is shall be laid out. 

5. Tax rules around gifting of cryptocurrency 

According to the IT Act, 1961, gifts are defined as assets received without consideration or for inadequate consideration. Gifts received from specified relatives are tax-free. For example, gifts such as property, gold, stocks, mutual funds etc., from parents to children are tax-free. 

Finance Bill 2022 has clarified that any ‘virtual digital assets’ such as cryptocurrencies received as gifts, will also attract similar tax implications.  

The Union Budget 2022 has introduced tax on cryptocurrencies. However, there are still a lot of grey areas around its taxation that need clarity from the government.