Taxation on Virtual Digital Assets
Prepared by Vasanth Kumar
Introduction:
Simply explained, a virtual digital asset is a digital holding that has been encrypted on the blockchain so that anyone can verify its legitimacy and ascertain who owns it.
Its non-fungibility, or the fact that it cannot be duplicated, reproduced, or hacked, turns it into a special asset that may be bought, sold, or given to a new owner.
Virtual digital assets include things like cryptocurrencies, non-fungible tokens (NFTs), and decentralized finance.
- Digital money known as “cryptocurrencies” uses encryption to safeguard transactions and regulate the generation of new units.
- Non-Fungible Tokens (NFTs): These distinctive digital assets employ blockchain technology to confirm the legitimacy and ownership of digital material, such as music, videos, and artwork.
- Decentralized Finance (DeFi): The term “Decentralized Finance” (or “DeFi”) refers to a group of financial apps based on blockchain technology that are designed to offer decentralized and permissionless access to financial services like borrowing, lending, and trading.
Meaning of Virtual Digital Assets:
Section 2(47A)
- 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 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 scheme; and can be transferred, stored or traded electronically.
- Non-fungible Token (NFT) or any other token of similar nature, by whatever name called.
- Any other digital asset, as the Central Government may, by notification in the Official Gazette specify.
A cryptocurrency, an NFT, or another virtual digital asset as announced by the Central Government shall be considered a virtual digital asset. It won’t cover OTT platform subscriptions, mobile apps, e-commerce platforms, etc.
Subject to any criteria that may be included therein, the Central Government may, by announcement in the Official Gazette, exclude any digital asset from the definition of a virtual digital asset. The Central Government may have been granted such authority to prohibit the Central Bank Digital Currency (CBDC), India’s first digital currency.
Classification of Virtual Digital Asset:
The government left it unclear if the virtual digital assets would function as money, good, or security. The virtual digital asset should be categorised as a capital asset in the absence of any such explanation.
According to Section 2(14) of the Income-tax Act, a person’s possessions of any type, whether they are related to his company or profession, are capital assets. The word “property” has no legal definition, but it refers to any kind of interest that a person would be able to obtain, hold, or enjoy.
Therefore, if purchased as investments by the taxpayers, cryptocurrencies or NFTs should be considered capital assets. Therefore, any profit realized from the sale of such assets will be subject to capital gains tax. However, it should be determined that the taxpayer is trading in such assets if the transactions are significant and regular. Income from the sale of such assets should be taxed as company income in this situation.
Taxation under the head Capital Gains (Section 115BBH)
Nature of Virtual Digital Assets:
If gains from the sale of virtual digital assets are considered capital gains, the length of time that the assets were held before being sold would determine whether the gains were short-term or long-term.
A virtual asset will be regarded as a long-term capital asset if it is retained for more than 36 months after the date of purchase; otherwise, it will be regarded as a short-term capital asset.
No deduction to be allowed for any expenditure or allowance:
Section 115BBH(2)(a) provides that 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 Section 115BBH(1)(a).
In other words, no additional deduction or exemption shall be allowed for calculating short-term or long-term capital gains, other than the cost of acquisition. Therefore, while calculating the capital gains from the transfer of virtual digital assets, the following items shall be disregarded:
- Expenditure incurred in connection with the transfer of a virtual digital asset.
- Cost of improvement relating to a virtual digital asset.
- Indexation of cost of acquisition of a virtual digital asset.
- Exemption under Section 54F
Tax Rates on Capital Gains:
The revenue from the transfer of virtual digital assets is subject to a 30% tax under Section 115BBH (1). As a result, both short-term and long-term capital gains are subject to a flat tax of 30%. Furthermore, such capital gains shall not be subject to a deduction under Chapter VI-A or an exemption under Section 54F. Nevertheless, relief under Section 87A may be requested.
Surcharge Rates
The following rate of surcharge will be applied to both short-term and long-term capital gains resulting from the transfer of virtual digital assets:
- Rate of Surcharge in the case of Individual, HUF, AOP, BOI or AJP
Nature of Income | Range of Income | ||||
Upto Rs. 50 Lakh | More than Rs. 50 lakh but up to Rs. 1 crore | More than Rs. 1 crore but up to Rs. 2 crore | More than Rs. 2 crore but up to Rs. 5 crore | More than Rs. 5 crore | |
Long-term capital gain | Nil | 10% | 15% | 15% | 15% |
Short-term capital gains | Nil | 10% | 15% | 25% | 37% |
Any other income | Nil | 10% | 15% | 25% | 37% |
** From A.Y. 2023-24 onwards, the surcharge rates for AOP with all members as a company, cannot exceed 15%.
- Rate of Surcharge in case of any other assessee.
Taxpayer | Upto Rs.1 Crore | More than Rs.1 Crore to Rs. 10 Crore | Exceeding Rs. 10 Crores |
Firm/Local Authority | – | 12% | 12% |
Domestic Company Opting for Section 115BAA or 115BAB | 10% | 10% | 10% |
Other Domestic Company | – | 7% | 12% |
Foreign Company | – | 2% | 5% |
Co-operative Society opting for section 115BAD | 10% | 10% | 10% |
Other co-operative society | – | 7% | 12% |
*Health and Education Cess at the rate of 4% shall be charged on the aggregate of income-tax and surcharge.
Taxation under the Head Business Income:
If the taxpayer is found to be dealing in virtual digital assets if the transactions are significant and frequent. The proceeds from the sale of these assets in this situation need to be subject to taxation as business income. The gains (without any deductions for expenses or allowances) will be taxed at a flat rate of 30% plus the surcharge (stated above) and cess.
Taxation under the Head of other Sources [Section 56(2)(x)]
- Scope of Section 56(2)(x).
When a person receives a benefit with a value greater than Rs. 50,000, Section 56(2)(x) takes effect. Regardless of the assessee’s residential status or class, this clause is applicable. The donor or donee might be either a resident or non-resident individual, partnership firm, LLP, business, AOP, BOI, cooperative society, or artificial juridical body.
- Benefit arising from movable property.
The following transactions may result in considered income under this provision:
- Where any property is received without consideration and the aggregate fair market value of which exceeds Rs. 50,000, the whole of the aggregate fair market value of such property will be chargeable to tax.
- Where any property is received for a consideration that is less than the aggregate fair market value of the property by an amount exceeding Rs. 50,000, the difference between fair market value and consideration is chargeable to tax.
The Rs. 50,000 limit must be checked for each transaction in all scenarios, not only the total number of transactions.
The Finance Bill, 2022 proposes to include virtual digital assets within the scope of movable assets. Thus, after the amendment, Section 56(2)(x) shall apply to the following properties:
(a) Shares and securities.
(b) Jewellery.
(c) Archaeological collections.
(d) Drawings.
(e) Paintings.
(f) Sculptures.
(g) Any work of art.
(h) Bullion.
(i) Virtual Digital Assets.
A virtual digital asset will be taxable in the recipient’s hands under Section 56(2)(x) as income from other sources if it is received without consideration (a gift) or for insufficient consideration and its worth exceeds Rs. 50,000.
- Determination of fair market value of virtual digital assets
For taxability under Section 56(2)(x), the fair market value of the virtual digital asset must be calculated in line with Rule 11UA.
- If Purchased from a registered dealer:
In case the virtual digital assets are purchased on the valuation date from a registered dealer, the invoice value of such asset shall be its fair market value.
- If received in other mode:
In case the virtual digital assets are received by any other mode (i.e., mining, etc.) the fair market value of such asset shall be estimated to be the price that it would fetch if sold in the open market on the valuation date. If the value of such asset exceeds Rs. 50,000, then the assessee may obtain the report of the registered valuer in respect of the price it would fetch if sold in the open market on the valuation date.
- Tax Rates
The value of the benefit arising under this provision shall be taxed at the rate applicable to the assessee. Such income shall not be taxed at 30% under Section 115BBH because it does not arise due to the transfer of a virtual digital asset. However, when the recipient further transfers such assets, the resultant gains shall be taxable under Section 115BBH.
Treatment of Losses
- General rules of set-off and carry forward.
An assessee is required to pay income tax on their entire income. To calculate total income, income is therefore computed head-wise. The Income Tax Act has provisions that make the concept of aggregation legitimate by allowing some losses to be set off but not others or by allowing some losses to be set off in a specific way. Three phases are used to offset losses from the relevant year: intra-head adjustment, inter-head adjustment, and carry forward of losses.
- No set-off and carry forward allowed to losses from virtual digital assets.
According to Section 115BBH(2)(b), losses incurred from the transfer of virtual digital assets cannot be set off against income calculated for the assessee under any other provision of this Act and cannot be carried over to subsequent assessment years.
It is obvious that the intra-head and inter-head adjustment rules prohibit the use of capital losses from the transfer of virtual digital assets as a counterbalance to any other capital gains. This means that the short-term capital gain from the sale of listed shares cannot be offset by the short-term capital loss from the sale of a cryptocurrency. Like the long-term capital loss from the sale of NFTs, the long-term capital gain from the sale of mutual funds cannot be offset by the long-term capital loss from the sale of mutual funds.
However, it should be possible to offset losses from one virtual digital asset against profits from another virtual digital asset. Losses from virtual digital assets calculated in accordance with Section 115BBH(1)(a) may not be set-off against revenue calculated in accordance with any other provision of this Act, according to Section 115BBH(2)(b). This set-off of a loss from one virtual asset against an income from another virtual asset is permitted because capital gains from the transfer of other assets are calculated and taxed in accordance with other regulations, whereas the income from the sale of all virtual assets is calculated in accordance with Section 115BBH. These set-offs must adhere to the current intra- and inter-head adjustment regulations.
For example, short-term capital loss arising from the transfer of Ethrum (cryptocurrency) can be set-off against short-term capital gains arising from the transfer of bitcoin or an NFT.
Deduction Tax at Source [Section 194S]
A new Section 194S has been proposed to be inserted in Income-tax Act for the deduction of tax from the payment of consideration on the transfer of virtual digital asset. This provision is applicable from 01-07-2022.
- Deductor
Any individual who is accountable for providing any money as payment in exchange for the transfer of a virtual digital asset must withhold tax at the source.
- Deductee
Tax is required to be deducted under this provision if the amount is payable to a resident person.
- Rate of TDS
Tax is required to be deducted at the rate of 1% of the consideration. The rate shall not be further increased by Surcharge and Health & Education Cess.
If the deductee does not furnish his PAN to the deductor, the tax shall be deducted at the rate of 20% as prescribed under Section 206AA.
- Time of Deduction
The tax shall be deducted at the time of payment by any mode or at the time of credit of such sum to the account of the resident, whichever is earlier.
- Amount on which tax is to be deducted.
Tax is required to be deducted from the gross amount of consideration paid to the resident person for the transfer of virtual digital assets.
However, in the following cases, before releasing the consideration, the person responsible shall ensure that tax has been paid in respect of such consideration for the transfer of virtual digital asset:
- Where consideration is wholly in kind.
- Where a transaction is in exchange for another virtual digital asset, and there is no part in cash; or
- Where consideration is partly in cash and partly in kind, but the part in cash is not sufficient to meet the liability of deduction of tax in respect of whole of such transfer.
- Exemption from deduction of tax at source
No tax shall be deducted under this provision in the following circumstances.
Consideration below Rs.10,000
No tax shall be deducted under this provision if the consideration is payable by any person (other than a specified person) and its aggregate value does not exceed Rs. 10,000 during the financial year.
Consideration below Rs. 50,000
No tax shall be deducted under this provision if the consideration is payable by the following specified persons and its aggregate value does not exceed Rs. 50,000 during the financial year:
- An individual or a HUF, whose total sales, gross receipts or turnover does not exceed Rs. 1 crore in case of business or Rs. 50 lakhs in case of a profession, during the financial year immediately preceding the financial year in which such virtual digital asset is transferred.
- An individual or a HUF who does not have any income under the head profits and gains of business or profession.