Virtual Digital Assets & Cryptocurrency – All That We Know, Yet.
Since its inception, cryptocurrencies have been a subject matter of discussion. Right from its early days, when they were touted to be like just another Ponzi scheme, to now, where we see countries accepting it as a legal tender, the journey has been quite adventurous & interesting. The technology behind cryptos is known as ‘blockchain’. It is a decentralised technology that can be used for multiple purposes, such as land records, medical records, banking, insurance etc. Crypto transactions are just one small application of blockchain technology, which is much larger and can be used for multiple other applications.
The matter related to cryptocurrencies in India was first discussed on the floor of the House of Parliament when the then Finance Minister, late Shri Arun Jaitley, famously remarked, “India does not accept cryptocurrencies as a form of legal tender. However, the benefits of blockchain technology shall be used for the development of our country.”. At this stage, whether cryptocurrencies were legal or illegal was not mentioned. Back then, there was no clarification on whether cryptocurrencies should be considered a separate asset class. Moving forward now, the question was asked to the RBI about the legality of cryptocurrencies. However, it only mentioned that it does not consider any cryptocurrency as a legal tender, so it was not under their jurisdiction.
Should You Invest?
Investments in cryptos are not only subject to market risks but also regulatory risks, geopolitical risks & social media risks. It is emphasised here that social media plays a major role in fluctuating & manipulating the price of certain cryptos. In the past, it has been observed that the price of a particular crypto increases if an entrepreneur/billionaire tweets that they will accept crypto for selling their electric vehicles. Similarly, after a couple of weeks, when the same entrepreneur/billionaire tweeted that they would no longer accept cryptos for selling their electric vehicles, the prices of cryptos started crashing. Though market forces determine the prices of cryptos, one cannot overlook that cryptos are inherently extremely volatile.
Multiple factors should be considered and analysed before one plans to invest in cryptos. It is important to understand that as of now, there are more than 9800 cryptos that are recognised; there could be even more cryptos than this figure which is not yet recognised. This number is constantly increasing as you read this article. For all you know, the number could have crossed 10,000 by the time this article was published. Before investing, multiple factors need to be analysed, such as the price, the total circulating supply, the total mined quantity, the total volume of transactions, exchanges on which a particular crypto can be traded, its team, their vision & finally, if is it a business or just a currency. Quite a few cryptos claim that they need to be paid in their crypto to avail of their service. In such cases, these cryptos are not just a currency but also a business. If the number of people wanting to avail their services is large, then in that case, it is observed that the price of that particular crypto may increase over time. Some cryptos claim that a particular process can be simplified or expedited using their blockchain.
To invest in cryptos in India, the easiest way is to open an account with one of these ‘so-called’, self-assumed, self-regulated & self-governed crypto exchanges. One needs to verify their KYC documents and load money through banking channels to start investing in cryptos. Charges and Commissions on some of these exchanges are not transparent, and they can range from anywhere between 0.25% to 7% of the transaction value.
Cryptos have been classified as a separate asset class in India; they are now considered virtual digital assets (VDA). Another evolving area in the crypto world is non-fungible tokens, also referred to as NFTs. NFTs are a form of digital art that can be bought and sold just like a traditional piece of art. The creator of this digital art or NFT can decide its price, rarity and percentage of royalty on every subsequent sale. NFTs establish ownership of the digital art on the blockchain. There are music NFTs, video NFTs & image NFTs as of now. Any person can create their own NFT and sell it on an open platform. Recent trends have shown that celebrities, sportspeople and entrepreneurs have launched their NFT collections on various platforms. Globally, the demand for NFTs is extremely huge, and India shall also witness demand for digital art from good content creators in the future. Some NFTs also come with real-world benefits, such as seeking advice from an entrepreneur, meeting your favourite celebrity for 15 minutes, or having a video call with a sportsperson. Though the art is digital, to create value for a prospective buyer, some real-world benefits can also be added to the NFT.
We are living in interesting and dynamic times, where investment shall not only be limited to cryptos or NFTs. Corporations are selling virtual land as a digital asset in the Metaverse (or a digital universe). Each company, organisation or group of individuals can create their own Metaverse. It is a place where people can interact with each other without necessarily disclosing their real identity. They can also make a virtual avatar of themselves and be a different personality from what they are in real life. Metaverse will introduce a concept of ‘teleporting’ where one doesn’t need to physically be present, but the virtual avatar of the person is present at that place. It could give a whole new dimension to virtual reality. Gaming, virtual meetings, music concerts & building cities will all happen in the virtual universe.
Whether one should invest in cryptos, NFTs, digital land, or any other virtual digital asset (VDA) totally depends on the individual’s risk appetite. Many people follow the policy of investing only in an amount they can afford to lose. Traditionally, fiat currencies have been backed with some asset; in the case of cryptos, there is no asset backing, and hence, there is no intrinsic value that one can derive. However, nothing contained herein shall be construed as financial or investment advice. Everyone must exercise caution before investing in any asset class, including VDAs.
Legal Viewpoint
The law of the land determines whether cryptos are legal or illegal. As of now, in India, no law regulates it or legalises it. At the same time, no law prohibits it either. So, in the absence of any specific law or regulation, a person’s decision lies in the interpretation of the facts and circumstances of the case.
To understand the legal position, one must look at precedents and the global scenario to determine whether holding, trading & mining cryptos would be a legal or illegal activity. Let’s take an example of marijuana – a prohibited substance under the Narcotic Drugs & Psychotropic Substances Act in India. A law declares it illegal to possess, consume or deal with such substances. However, the same substance is legal for consumption in some states in the USA because the law allows people to consume that substance. So, the question of legality can only be answered if a law is present. Realistically, cryptos enable people to move their wealth from one country to another without reporting it to anyone and without restrictions. The icing is that there is complete anonymity, and the beneficial owner cannot be tracked. This has led to a lot of illicit wealth being parked in cryptos. Based on the present law, this would clearly violate the Foreign Exchange Management Act & Prevention of Money Laundering Act in India.
However, globally some countries have recognised cryptos as a separate asset class. In some countries, such as El Salvador, it is a legal tender, which is to say that one can pay taxes to the government in crypto. In economic crises and sanctions, cryptos are gaining more adaptability and popularity. In China, it is illegal to deal with cryptos.
Due to regulatory hurdles and uncertainty in the crypto policy in India, many Web3 companies have shifted to other countries where they can officially create, distribute, deal and trade in cryptos. Some popular crypto-friendly countries are the British Virgin Islands, St. Vincent & the Grenadines, Curacao & Panama. Many have also selected Singapore as their destination primarily because cryptos are regulated, and there is clarity in the legislation which regulates it. Companies prefer floating 2 entities when creating their own crypto – first, a trust or a foundation that holds the cryptos, and the second one is a marketing or distributing arm which conducts all activities and enters into contracts with others. This structure is preferred so that the founders can safeguard the crypto in case of any eventuality or an adverse regulatory condition.
Regarding the legality of cryptos, a major concern that looms is whether issuing any currency is a ‘sovereign right’ or whether any person or corporation can also enjoy this right. Countries have had the right to issue their own currency, regulate and monitor it. Also, currencies are issued by Central Banks and not by the governments in power at the time of their issuance. So essentially, there is a separation of control and power in fiat currencies. This maintains the value of a currency to a large extent. In cryptos, none of this is possible due to the inherent nature of blockchain technology. At the same time, some also argue that cryptos are necessary to break the monopoly of certain governments which keep printing additional currency without any fundamental justification.
Taxation of VDAs
The Finance Budget of India has introduced a tax on income from crypto transactions at a flat rate of 30%, without claiming any deduction or set-off of any losses against any income. In addition to it, there is also 1% TDS on every transaction, which has become applicable. This implies that any cost incurred, such as brokerage, commission & trading costs, cannot be deducted from the gains. In any other business, various deductions such as rent, office expenses, staff salary etc., are allowed as a business deduction; however, in crypto trading, no such deductions shall be allowed.
The Finance Ministry clarified in the Rajya Sabha (the Upper House) that gains from one crypto cannot be offset against losses from another crypto. It seems the government has taken a strict view considering that there have been some instances in the past where manipulation of stock prices could be done in some listed companies to book losses against actual profits, which would reduce the assessee’s overall tax liability. It seems that the government has taken a correct and fair stand on this matter since cryptos are not regulated, and there could be some deliberate attempts by some sections of society to specifically manipulate the price of cryptos to book losses and make adjustments so that there would be no tax liability. It could amount to an evasion of taxes. This is highly possible in cryptos since they are not regulated. At this stage, there is no clarity on the matter of whether profits arising from crypto trade can be set off against losses arising from the same crypto in another trade. In my opinion, the government seems to have taken an approach to “nationalise profits and privatise losses” arising from cryptos.
Some people argue that taxing cryptos makes it a legal activity. It is pertinent to note that the present Hon’ble Finance Minister, Smt. Nirmala Sitharaman has clarified that taxing a transaction is the government’s right. Still, the issue of legality will be decided only after consulting all stakeholders, and the process would take time to reach its finality.
In recent times, the matter of indirect taxes on crypto transactions has also erupted. Transactions which take place on crypto exchanges are subject to GST. Major crypto exchanges have paid tax on the commission or brokerage charged on transactions. However, there is no GST on trading the full value of the cryptos, but only on the brokerage element in the transaction. Soon there could be GST on the entire transaction value of the crypto trade.
GST also applies to selling NFTs by celebrities, sportspersons and artists who transact in India in Indian currency. However, it is observed that many NFT platforms are registered in jurisdictions outside India. In such a case, the NFTs are listed for sale or auction on the platform of the service provider which is situated outside India. The point of sale for such transactions is outside India. The sale consideration is also paid in crypto and not in fiat currency to a wallet outside India. Due to the nature of transactions, many exchanges and/or NFT creators deem this transaction to be an ‘export of services, and hence there is no taxability in India concerning GST. One may argue that the ultimate buyer could be situated in India for such transactions. However, there is no way, as of now, to identify the location of the buyer from their wallet address.
Source of this information:- https://wirc-icai.org/wirc-reference-manual/part7/Taxation-Virtual-Digital-Assets.html
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