Virtual digital asset: How Union Budget 2022 brings cryptocurrency within tax net

The Union Budget 2022 announced on Tuesday by Finance Minister Nirmala Sitharaman has finally brought in a lot of clarity on how cryptocurre...

The Union Budget 2022 announced on Tuesday by Finance Minister Nirmala Sitharaman has finally brought in a lot of clarity on how cryptocurrency will be taxed from Financial Year 2022-23, which is the Assessment Year 2023-24. Along with bringing clarity on taxation, the Finance Minister has also clarified that the Government of India doesn’t consider cryptocurrency as a currency, but shall treat it as a virtual digital asset. This removes all doubts on whether cryptocurrencies would become a legal tender or a medium of exchange in the future or not. In other words, the Government of India would treat cryptocurrency as an investment.

Another important fact that comes out from the text of the proposed provision in Section 115BBH of the Income Tax Act, 1961, is that the Government and Revenue Department doesn’t consider virtual digital assets aka cryptocurrencies as an investment or capital asset. Hence, it is taxing cryptocurrencies at the highest marginal rate of 30 percent, instead of offering any benefits allowed to capital assets like real estate or financial securities that are taxed at a lower rate and allowed benefits of indexation.

Indian Union Budget 2022: Finance Minister Nirmala Sitharaman. PTI

Questions that prevailed on the issue of taxation of cryptocurrencies were:

1.     Whether profits and gains on investing in cryptocurrencies would be treated as business profits or capital gains?

2.     How would the cost of mining cryptocurrencies be ascertained and whether it would be treated as a cost of acquisition, and hence eligible for deduction from sales proceeds arising on sale of cryptocurrencies?

3.     How would receipt of airdrops be treated?

4.     What is the point of taxation in case of mining or receipt of airdrops?

5.     Whether losses arising from trading or investments in cryptocurrencies will be allowed to be set off against income from all other sources?

The Union Budget 2022 has not just addressed all these queries and but has also gone a step ahead in bringing all transactions of cryptocurrencies aka virtual digital assets within the tax net by providing for deduction of tax at source at the time of transfer of cryptocurrency for a consideration in cash. This article shall discuss provisions in the Finance Bill, 2022 that address the concerns raised in the aforementioned questions.

By including taxation of cryptocurrencies in Chapter XII of the Income Tax Act, 1961, instead of Chapter IV, the government has given clear indications that it doesn’t consider trading and investment in cryptocurrencies as a normal business activity.

Instead, the government considers transactions in cryptocurrencies as a “Special Case” and hence is being taxed differently. Income or profit arising from the transfer or sale of cryptocurrencies shall be proposed to be taxed at a rate of 30 percent instead of being taxed at normal slabs or as capital gains. Here again, the government has allowed the cost of acquisition of cryptocurrencies as a deduction for the calculation of profits and gains arising from the sale of cryptocurrencies.

The Finance Bill expressly mentions that no deduction in respect of any expenditure, other than the cost of acquisition, shall be allowed as a deduction. Hence it can be safely assumed that the Government does not consider the cost of mining the cryptocurrency. This would be a cause of concern for miners who invest heavily in hardware and electricity to solve complex algorithms to mine cryptocurrencies, and would not get a deduction on account of these expenditures incurred to earn those cryptocurrencies.

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Airdrops are cryptocurrencies received by traders from issuers of cryptocurrencies to create liquidity in the said cryptocurrencies. This is done to generate investor and trader interest in the said cryptocurrencies on the back of higher volumes.

The government has not expressly mentioned Airdrops but has only mentioned gifts, which could mean that Airdrops would be deemed to be treated as gifts.

In case of receipt of cryptocurrencies as gifts from friends and/or relatives or from issuers of cryptocurrencies in from of Airdrops, the Government has clearly indicated the legislative intent that the said income in form of cryptocurrency received as gift or Airdrop will be taxed at the time of receipt. This is done by amending Explanation to clause (x) of sub-section (2) of section 56 of the Income Tax Act, 1961 to inter-alia, provide that for the purpose of the said clause, the expression “property” shall have the meaning assigned to it in Explanation to clause (vii) and shall include virtual digital asset, that is cryptocurrency.

Hence, the recipient of cryptocurrency will have to pay a tax of 30 percent on the fair or market value of the cryptocurrency at the time of receipt. If this explanation is taken as a base for understanding how cryptocurrencies mined would be taxed, then it can be safely assumed that cryptocurrencies mined would also attract tax in the assessment year in which it is mined.

The Finance Bill is also categorically clear on the issue of set-off of losses arising from cryptocurrency transactions. It states that no allowance or set-off of any loss shall be allowed to the taxpayer under any provision of the Income Tax Act, 1961 while computing income from the sale of cryptocurrencies. This is one more piece of evidence that the government and revenue department consider income arising from trading or mining or investment in cryptocurrencies as a “Special Case” and not as a part of the normal income earned either as a business activity or as an investment.

These clarifications about taxation of cryptocurrencies aka virtual digital assets, as the government wants it to be addressed, come at the right time. It especially becomes extremely important because around 10 crore individual investors have invested around Rs 6 lakh crore in various cryptocurrencies, as per the advertisement issued by The Blockchain and Crypto Assets Council which is a part of the Internet and Mobile Association of India. It is also worth noting that Non-Fungible Tokens (NFT) is also considered as a virtual digital asset and will be taxed exactly the way cryptocurrency is proposed to be taxed.

The author is a Chartered Accountant by qualification and a Corporate Finance Professional. He is the author of ‘Diagnosing GST for Doctors’ published by CNBC Books18. Views expressed are personal.

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