CRYPTO currency, bitcoin was invented in 2009. One Satoshi Nakamoto is credited with its invention. It is probably a pseudonym and no one knows who he actually is. Not that it really matters. The idea developed by the geeks for their peers is now a phenomenon and the products called in popular parlance as crypto currencies are now ubiquitous and regulators and courts are scratching their heads over what to do with the same. In India, a three-judge bench of the Supreme Court had to resort to the Vedic principle of getting to the meaning - Neti, Neti (Not this, not this ) to concur with the dilemma summarized by George Friedman as follows: "Bitcoin is neither fish nor fowl… But both pricing it as a commodity when no commodity exists and trying to make it behave as a currency, seem problematic. The problem is not that it is not issued by the Government nor that it is unregulated. The problem is that it is hard to see what it is." (In Internet and Mobile Association of India v Reserve Bank of India )

For me, what matters is that in any case, this is a product of geeks involving some massive computing and consumes enormous energy. I will not even pretend that I understand its working but the received wisdom is that it works on something called 'the blockchain' technology that as I vaguely understand works on the concept of a distributive ledger that can be seen by all and has to be validated by all before a transaction can take place. The effort was to break out of the control of the central banks in the matter of the administration of fiat currencies and replace the same that is beyond their control and the process is transparent. This involved the use of cryptography and ironically then, in the process of increasing transparency, the process itself is susceptible to misuse and there are many instances where bitcoins were demanded as ransom and perhaps in some cases in acts of terrorism and money laundering. Besides, as a recent Washington Post article points out Crypto is a solution in search of a problem (Adam Lashinsky, May 20,2022); no one uses them to pay for anything with the exception of pornography and criminal activity; neither are these securities, nor are these commodities. "They go up when people pay more for them and down when people pay less. But they have no value unto themselves."

Central bankers generally are averse to legalising its use. The RBI governor has stated that cryptos are not backed by even a tulip and the crypto mania gripping the common investors of making a quick buck may result in adverse consequences. The current IMF chief has stated that merely because the word coin is there in a bitcoin, that does not make it a currency.

Crypto enthusiasts however assert that we are currently in web 2.0 characterised by smart phones, mobile internet access, social networks etc., and the defining features of web 3.0 will be decentralization, permissionlessness, trustlessness, use of artificial intelligence and connectivity. And Cryptos will be part of web 3.0

Whatever may be the justification, because of the peculiar properties of bitcoins and such other coins that have already proliferated in the market worldwide, regulatory authorities are still struggling to determine as to what to do with these. Some countries such as China, Bangladesh, Nepal have banned such bitcoins and anti- money laundering organisations such as FATF have expressed concerns about their misuse. The Reserve bank of India, through a circular issued in 2018, banned the use of such coins. In the meantime, such cryptoshaving already taken root in India, many exchanges now exist that provide an opportunity for investors and traders to participate. The Internet association and these exchanges filed a writ before the Supreme Court arguing that their right to freedom of doing business as guaranteed by the Constitution was violated by the circular. In the end, the Supreme Court, while observing that there were indeed some areas of concern from regulatory standpoint, invoked the principle of proportionality and struck down the circular of the RBI. Various committees appointed by the government are looking into it and although a Bill was drafted in 2018 named the control of bitcoin administration, rules, 2018, it is yet to be passed into law.

As stated earlier crypto mania was gripping India and a number of exchanges were offering their services with an advertisement blitz to aggressively promote its use with stories of making quick money in short time often with endorsement from celebrities. Exploitation of the greed factor,was/ is in full play.

Here comes the interest of the taxman who, ever in search of a source of income to be taxed has been on the watch for some time and it was time to examine whether there is any income involved arising out of all the rigmarole and if so, whether it is possible to tax the same. It is in this context that the government of India, in the budget 2022 introduced some new provisions to tax any income from the transfer of what is now known as virtual digital assets.

While introducing the Finance Bill, the Finance Minister stated that there has been a phenomenal increase in transactions in virtual digital assets and that the magnitude and frequency of these transactions have made it imperative to provide for a specific regime. Therefore, she proposed that any income from transfer of virtual digital assets shall be taxable @30% and that no deduction in respect of any expenditure or allowance shall be allowed except for the cost of acquisition. Further, in order to capture the transactions, she proposed a TDS @ 1% of the consideration above a threshold adding that gift of virtual digital assets will also be subject to taxation in the hands of the recipient.

In the memorandum, the provision is discussed under the broad head- Resource mobilization . In other words, the government expects a sizeable revenue to be garnered from this source.

To fructify the intention, a new section 115 BBH was introduced in the Finance Bill as follows:

115BBH . (1) Where the total income of an assessee includes any income from the transfer of any virtual digital asset, the income-tax payable shall be the aggregate of– –

(a) the amount of income-tax calculated on the income from transfer of such virtual digital asset at the rate of thirty per cent .; and

(b) the amount of income-tax with which the assessee would have been chargeable, had the total income of the assessee been reduced by the income referred to in clause (a).

(2) Notwithstanding anything contained in any other provision of this Act, ––

(a) no deduction in respect of any expenditure (other than cost of acquisition) or allowance or set off of any loss shall be allowed to the assessee under any provision of this Act in computing the income referred to in clause (a) of sub-section (1); and

(b) no set off of loss from transfer of the virtual digital asset computed under clause (a) of sub-section (1) shall be allowed against income computed under any other provision of this Act to the assessee and such loss shall not be allowed to be carried forward to succeeding assessment years.

So, in terms of the provision, the income of the taxpayer has to include income from transfer of a virtual digital asset and under the scheme as formulated, assuming that the total income of an individual taxpayer is only from transfer of the VDA, then whether such income exceeds the basic exemption limit of INR 250000 or not, tax will be charged @ 30%. If there is only loss, the same shall be ignored. If there is loss from one transaction in VDA and gain from another transaction in VDA, the loss-making transaction will be ignored. In calculating the income from such VDA, only the cost of acquisition of the VDA will be considered. In other words, the income from the VDA is the difference between the consideration in respect of transfer and the cost of acquisition of the same.

The term 'transfer' was not originally defined separately in the proposed section. The general definition of transfer as given in section 2(47) is in relation to capital assets which would imply that the income from the transfer of the VDAs could be considered as capital gains and then the rules for computation of capital gains would apply. Apparently, the government did not want to enter into the debate relating to the nature of the income. Therefore, in the Finance Act as finally enacted, two major changes have been made as compared to the draft provisions in the Bill.

First, section 115BBH in the opening line 'notwithstanding anything contained in any other provisions of the Act' has now been added meaning thereby that the provisions of 115BBH now overrides all other provisions of the Act. So, the section now reads-

(1) Where the total income of an assessee includes any income from the transfer of any virtual digital asset, notwithstanding anything contained in any other provision of the Act, the income-tax payable shall be the aggregate of– (…)

Secondly, a sub-section (3) is added as follows

(3) For the purposes of this section, the word 'transfer' as defined in clause (47) of section 2, shall apply to any virtual digital asset, whether capital asset or not .

OK, then income from transfer of VDA is taxable @30%. But what are these VDAs? The term is defined in clause 47A of section 2 as follows:

'(47A) "virtual digital asset" means ––

(a) any information or code or number or token ( not being Indian currency or foreign currency ), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration , with the promise or representation of having inherent value , or function s as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically ;

(b) a non-fungible token or any other token of similar nature, by whatever name called;

(c) any other digital asset , as the Central Government may, by notification in the Official Gazette specify:

Provided that the Central Government may, by notification in the Official Gazette , exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein.

Explanation. ––For the purposes of this clause, ––

(a) "non-fungible token" means such digital asset as the Central Government may, by notification in the Official Gazette, specify ;

(b) the expressions "currency", "foreign currency" and "Indian currency" shall have the same meanings as respectively assigned to them in clauses (h), (m) and (q) of section 2 of the Foreign Exchange Management Act, 1999.'

The definition uses the word 'means' which implies that the meaning is exhaustive and not inclusive. However, sub-clause (c) gives the power to the government to specify by notification any other digital asset as virtual digital asset. The Proviso gives the government the power to also exclude any digital asset from the ambit of the definition of the VDA.

As noted earlier, the RBI had in 2018, issued a circular banning the use of Crypto currencies in India. The Supreme Court subsequently struck it down on grounds of proportionality. The government had also introduced a Bill titled Banning of Cryptocurrency & Regulation of Official Digital Currency Act, 2019 . In the said draft bill, there is a definition of Cryptocurrency as follows:

2(1)(a)

"Cryptocurrency", by whatever name called , means any information or code or number or token (not being part of any Official Digital Currency), generated through cryptographic means or otherwise, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value in any business activity which may involve risk of loss or an expectation of profits or income, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to, investment schemes;"

It can be seen that the definition of the virtual digital asset as adopted in the IT Act is almost identical with the aforesaid definition in the draft Bill, implying that the VDAs of the ITA are the same as what is generally known as crypto currencies. However, the Bill has not become an Act as yet and it seems that the government is in two minds about the outright ban of cryptos as has been done and China and some other countries. In fact, the Bill was not introduced in the budget session as it is reported that the government wants more consultation and for reaction of the RBI that is planning to run its pilot for the official digital currency.

But considering that the government was in fact, talking of banning cryptos while the same was proliferating in India, the provision in the Finance Bill taxing income from Cryptos was seen by some as legalising the use of cryptos in India. Government representatives were however, quick to point out that levying of income has nothing to do with the legality or otherwise of any transaction. Long back, in the case of CIT v S.C. Kothari, the Supreme Court has pointed out that even when a trade is illegal, any profits from such trade would be taxable under the Act as doing otherwise would put a premium on dishonesty. However, the SC in these cases had allowed losses from illegal business to be adjusted against illegal profits. Subsequent to the insertion of an Explanation in section 37 to the effect that any expenditure for a purpose that is an offence prohibited by law, no deduction is to be allowed. The SC in the subsequent case of CIT v Dr T. A. Qureshi upheld this view. Of course, transactions in cryptos are not banned under any law so far. So, a view could be taken that the loss from one crypto transaction could perhaps be adjusted against the gain from another. However, the newly inserted provisions of the Income Tax Act specifically disallow such loss from transfer of ADS.

The FM in her speech had also mentioned that gift of VDAs will also be taxable in the hands of the donee. This has been done by expanding the definition of 'property' in the Explanation, which now states that the expression property as referred to section 56(2)(x)(c) shall include virtual digital assets . However, the issue of valuation that may arise has not been specifically dealt with.

Having a substantial provision of taxation from transfer of ADS would not ensure compliance with the law, particularly in an environment where information may be protected by cryptographic means. Therefore, a new TDS provision has been introduced in section 194-S, which will come into effect from July, 2022 and which imposes a liability to deduct tax at source @1% of the payment on the transfer of VDAs to a resident of India. The relevant provision is as follows:

'194S. (1) Any person responsible for paying to a resident any sum by way of consideration for transfer of a virtual digital asset, shall, at the time of credit of such sum to the account of the resident or at the time of payment of such sum by any mode, whichever is earlier, deduct an amount equal to one per cent. of such sum as income-tax thereon:

Provided that (….) [ Not discussed here]

No TDS is required if the payment is made by anyone up to INR 10,000 in the aggregate in the financial year. Else, TDS is required to be made in all cases except in case the payment is made by an individual or an HUF who either does not have any income from business or profession or is not required to maintain audited accounts and the amount paid does not exceed INR 50,000. In simple terms, the limit for TDS in case the payment is made by individuals/HUF( not subject to audit) is INR 50,000 in a financial year and in all other cases, it is INR 10,000. [ 194S (3) read with the Explanation]

We may recall that the Finance Act 2020 has already introduced a TDS provision in section 194-O whereunder an e-commerce operator is to deduct tax at source @ 1% from the payment made to an e-commerce participant subject to some monetary limits. It may so happen that the transaction relating to the transfer of VDA also comes under the ambit of section 194-O. In such case of an overlap, it is provided that the provisions of section 194S will apply. [194S (4)]

The scheme of the taxation of virtual digital assets and the TDS from the income therefrom being a completely new provision, the Board has been empowered to issue guidelines to remove any difficulty arising in giving effect to the provisions and such guidelines shall be binding.

It is obvious that the crypto regulations are not complete as yet and even though there is a definition of VDA, the definition also includes other items as the central government may by notification specify. The definition of non-fungible tokens is also incomplete and the central government has taken powers to issue guidelines. It is mentioned that the non-fungible tokens (NFT) will be such VDAs as may be notified by the government. The government has also the powers to exclude any item from the ambit of the VDAs. In such a scheme of things, the notifications/ guidelines to be issued will assume importance.

According to the then Chairman CBDT, there were about 40 crypto exchanges in India out of which 10 had significant turnover at around INR 1 trillion and TDS even at just 1% should yield substantial revenue. According to him, four models have been observed- first, there are those that trade in cryptos but are not filing returns. Then there are those that filed their returns but did not include the crypto gains. Then there are those who did not correctly declare their transactions. Finally, there are those that do show incomes from crypto transactions but sometimes as income from other sources, sometimes as business, and sometimes as capital gains.

Crypto currency is supposed to be the next frontier of the internet and a part of web 3.0. Indeed, there are a number of fancy terms like staking, lending, hard fork, air drops; terms that are frequently used in connection with crypto currencies. But that does not mean that the governments are not worried about the wild west style of functioning of the crypto world. In Australia, the ATO has estimated that there are over 6000000 taxpayers that have invested in crypto assets and intends to prompt them into compliance by writing letters. Even In the law-abiding Nordic country, Norway, around 70,000 taxpayers have reported owning cryptos while the real number is estimated to be around 300000.

There are other areas where cryptos may change the rules. As we know, one of the achievements of the OECD has been the strengthening the mechanism of the exchange of information between countries in the world. The Common Reporting Standard (CRS) developed in this regard provides for collection of information from the financial institutions of their respective countries and exchange the same with other countries on an automatic basis. Necessary enabling legislations have been put in place by the countries concerned including India. Now, a system like the crypto currency developed specifically to bypass the control of the financial system would jeopardise the efforts and the results achieved after many years of effort. It is in this context that the OECD has also released a public consultation document on crypto assets and the effort is on to bring within the ambit of the CRS the transactions relating to cryptos also.

To sum up, cryptos is an evolving area and is going to affect us whether we like it or not. Only definitive thing that we can say is that there will be changes. From a purely taxation policy perspective, it will also be helpful if the government releases data about the additional revenue mobilised from the newly introduced measures relating to the digital asset transfer.