Cryptocurrency/Virtual Digital Assets Tax in India

Table of Content

1. New Section 115BBH introduced by the Finance Act, 2022
2. Chargeability of Virtual Digital Assets
3. Classification of Virtual Digital Assets
4. Scheme of Taxation of Virtual Digital Assets
5. Transfer of Virtual Digital Assets

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1. New Section 115BBH introduced by the Finance Act, 2022

The Finance Act, 2022 has inserted a new Section 115BBH with effect from 01-04-2022 to tax the income arising from the transfer of virtual digital assets (including cryptocurrencies/NFTs). The Section 115BBH reads as under:

1. 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 this Act, 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).

1. 2. Notwithstanding anything contained in any other provision of this Act,–

(a) no deduction in respect of any expenditure (other than cost of acquisition, if any) 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 provision of this Act to the assessee and such loss shall not be allowed to be carried forward to succeeding assessment years.

1. 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.

Before discussing the computation of income from the transfer of VDA and levy of tax on such income, it is essential to examine the chargeability and classification of income arising from VDA.

2. Chargeability of Virtual Digital Assets

Section 115BBH only provides for the tax rate and the manner in which income from the transfer of VDA shall be computed. It does not provide for the chargeability of such income to tax. The income arising from the transfer of VDA shall be chargeable to tax as per extant provisions of the law, i.e., section 4, section 5, section 9 and section 14 of the Income-tax Act.

Indian taxation is based on the principle of the residence of the person and the source of income. The worldwide income of the Indian residents is taxable in India. Non-residents, however, are subject to source-based taxation. Only amounts received or accrued from a source or so deemed to accrue or arise in India are subject to income tax in India. Section 9 contains provisions as to when certain income shall be deemed to accrue or arise in India. Section 9 enumerates various categories of income under clauses (i) to (viii). Income falling under each of the clauses shall be deemed to accrue or arise in India. However, the ultimate tax liability of a non-resident person shall depend upon the Double Taxation Avoidance Agreement (DTAA) that India has entered into with various countries.

To determine whether the income arising to a non-resident from the transfer of VDA shall be taxable in India, among other factors, one needs to identify the situs of VDA. If the situs of a VDA is situated in India, the income arising to a non-resident on its transfer shall be taxable in India subject to the provisions of Section 9(1)(i) and DTAA. The situs/location of an asset matters only for non-resident assessees and not ordinarily resident assessees. In the cases of these assessees, if an asset located outside India is transferred outside India and sale proceeds are received outside India, no taxability arises in view of section 5 of the Act [except in the case of shares/interest as referred to in Explanation 5 to Section 9(1)(i)]. Such assessees will be liable to be taxed under section 9(1)(i) of the Act in respect of income accruing or arising through the transfer of any property, asset or capital asset situated in India.

Currently, Income-tax Act does not contain any explicit provision to identify the situs of VDAs. VDAs being an intangible property, the judicial pronouncements on the situs of intangible property may be referred to determine the situs of VDA.

In the case of CUB Pty. Ltd. v. Union of India [2016] 71 taxmann.com 315, the Delhi High Court held as under:

(a)  The issue of situs of an intangible asset is indeed a tricky one. Insofar as the tangible assets are concerned, there is absolutely no difficulty. They exist in physical form and their existence is at specific locations. Thus, fixing their situs does not pose any problem.

(b)  An intangible asset, by its very nature, does not have any physical form. Therefore, it does not exist in a physical form at any particular location. The legislature could have, through a deeming fiction, provided for the location of an intangible asset but, it has not done so insofar. With regard to a share or interest in a company registered/incorporated outside India, Explanation 5 has been added to section 9(1)(i) by virtue of the Finance Act, 2012 with retrospective effect from 1-4-1962.

(c)  Thus, the legislature, where it wanted to specifically provide for a particular situation, as in the case of shares, where the share derives, directly or indirectly, its value substantially from assets located in India, it did so. There is no such provision with regard to intangible assets. Therefore, the well-accepted principle of ‘mobilia sequuntur personam’  have to be followed. The situs of the owner of an intangible asset would be the closest approximation of the situs of an intangible asset. This is an internationally accepted rule, unless it is altered by local legislation. There is no such alteration in the Indian context.

Earlier it was held that income arising on transfer, outside India, of an intangible asset such as technology, designs or drawings, would not be taxable in India (Pfizer Corpn., In re [2004] 141 Taxman 642/271 ITR 101 (AAR – New Delhi), CIT v. Davy Ashmore [1991] 190 ITR 626 (Cal.), Union of India v. Azadi Bachao Andolan [2003] 132 Taxman 373/263 ITR 706 (SC) and CIT v. Maggronic Devices [2010] 190 Taxman 382/329 ITR 442 (HP). But a specific amendment by virtue of Explanation 5, enabled the tax authorities to tax income on the transfer of shares/interest if they derived, directly or indirectly, their value substantially from the assets located in India. However, no provision has been inserted in the Act to tax income arising on the transfer of other intangible assets whose owner is a resident of another country.

There are several kinds of intangible properties. The situs of these properties may vary according to their nature and obligations attached to them. The general law is that the situs of an intangible would be according to the law of the State which created the intangible property and interest therein. However, various parameters involved in deciding situs may create conflict and confusion and thereby pose problems in deciding the taxability of income arising therefrom.

If there are several criteria on the basis of which situs of intangible property can be decided, and there is no definite basis that would attribute situs to India, the courts would always lean in favour of the taxpayer. It has already been held in Vodafone International Holdings B.V. v. Union of India [2008] 175 Taxman 399 (Bom.) and Azadi Bachao Andolan’s case (supra) that if the owner of the property is not a resident of India and the property is transferred outside India then income arising on its transfer cannot be taxed in India. Explanation 5 to section (1)(i) alters the situation only to a limited extent in the case of shares and interest in a company, and their locations will be deemed to be in India if substantial assets of the company are in India. In the case of other intangible assets, there are no such provisions in the Income-tax Act. Therefore, even if an intangible asset is developed, used or commercially exploited in India, income arising from their transfer outside India cannot be taxed in India. It would clearly be a case of profit shifting. Therefore, if revenue leakage is sought to be plugged in, the amendment must be brought into the Act.

In the absence of any provision in the Act, the situs of the intangible property can only be decided based on the domicile of the owner of such property, and if the owner of the intangible property is not a resident of India, then income on their transfer outside India cannot be taxed in India. Therefore, if the government intends to prevent the shifting of revenue, an amendment by way of expanding the operation of Explanation 5 to other intangible assets would be necessary.

3. Classification of Virtual Digital Assets

Before discussing the computation of income arising from the transfer of VDA, it is essential to identify the nature of income arising from the transfer of VDAs, particularly cryptocurrencies.

The total income of any assessee is computed under the five heads of income, the provisions of which are contained in Chapter IV computation of total income (section 14). The income so computed is taxed at normal rates specified in Part III of the First Schedule to the Finance Act and special rates specified in Chapter XII (Determination of tax in certain special cases), which includes Section 110 to Section 115BBI¹. Chapter XII shall follow Chapter IV. Unless the nature of an income is classified under the relevant head of income specified in Chapter IV, the special rates specified in Chapter XII cannot be applied.

The income arising from the transfer of VDAs can be classified under any of the following heads of income:

(a)  Profits and gains from business or profession (PGBP);

(b)  Income under the head of capital gains; or

(c)  Income from other sources.

3.1 Taxable under the head of Profits and gains from business or profession

When an entity holds VDAs for sale in the ordinary course of business (i.e., trading asset), the profits arising therefrom should be taxed under the head PGBP. This would apply in particular to traders of cryptocurrencies. Whereas, if the VDAs are held as a capital asset, the income shall be taxed under the head of “capital gains”.

When a person holds virtual assets for sale in the ordinary course of business (i.e., as a trading asset), the profits arising therefrom should be taxed under the head of PGBP. Business income arises when a person carries on business, commerce or adventure in the nature of trade. A person is said to be carrying on a business if he carries on some activities continuously and systematically by the application of his labour and skill to earn an income. If the virtual assets are held for investment purposes, the income shall be taxed under the head of “capital gain”.

3.2 Taxable under the head of Capital Gains

As per Section 2(14), ‘capital asset’ means property of any kind held by an assessee, whether or not connected with his business or profession. The word ‘property’ is of the widest amplitude, including the right and interest of a person in a particular asset. Every possible interest that a person can hold or enjoy in an asset can be termed as ‘property’ within the definition of a capital asset¹. Any right which can be called property will be included in the definition of ‘capital assets’². It would comprise a bundle of rights and interests that a person may conceivably hold and enjoy. It includes such rights that a person may lawfully exercise to the exclusion of others or entitled to use and enjoy as he pleases, provided he does not infringe any law of the State³. It is also defined as an aggregate of rights having monetary value. It includes money and all other property, real or personal, including things in action and other intangible property⁴.

A VDA has all elements a capital asset has. Thus, if the VDAs are not held as stock-in-trade in the books of account or the assessee is not engaged in the business of (or adventure in the nature of trade) dealing in VDAs, the resultant gains should be taxable under the head of the capital gains.

Though the tax rates are the same and notwithstanding the income is taxed under the head of business or profession, capital gains or other sources, this classification is essential for computation of interest under Section 234C. If a shortfall in payment of advance tax happens on account of underestimating or failure to estimate the accrual of capital gains, then such shortfall shall be ignored while computing interest under Section 234C.

3.3 Taxable under the head of other sources

As per Section 56(1), any income shall be chargeable to tax under the head “Income from other sources”, if it is not chargeable under any other heads. Therefore, the classification of such income should be tested first under the head of business income or capital gains. Only on unsuccessful classification it can be taxed under the head of other sources [see Nalinikant A Mody v. S.A.L. Narayan Row, CIT [1966] 61 ITR 428 (SC) & CIT v. Smt. T. P. Sidhwa [1981] 6 Taxman 91/[1982] 133 ITR 840 (Bom.)].

4. Scheme of Taxation of Virtual Digital Assets

The taxation under section 115BBH shall be as under:

(a)  There should be a transfer of any VDA, whether held as a capital asset or not;

(b)  The transfer of VDA should result in income which should be included in the total income;

(c)  The tax on the income from the transfer of such VDA shall be calculated at the rate of 30%;

(d)  No deduction in respect of any expenditure (other than the cost of acquisition, if any) or allowance or set-off of any loss shall be allowed in computing such income;

(e)  No set-off of loss from the transfer of a VDA shall be allowed against income computed under any provision of this Act; and

(f)  Such loss shall not be allowed to be carried forward to succeeding assessment years

5. Transfer of Virtual Digital Assets

The income from VDA shall be taxable under Section 115BBH only if it arises on the transfer of VDA. The word ‘transfer’ is defined under section 2(47) of the Act in relation to capital assets.

As VDA can be held as a trading asset or capital asset (as discussed earlier), it could be argued that section 115BBH would apply only in the case of transfer of VDA held as a capital asset. To avoid any controversy on this aspect, sub-section (3) of section 115BBH provides that the definition of transfer shall apply to any VDA, whether a capital asset or not. Thus, income from VDA shall be computed and taxed as per Section 115BBH irrespective of the fact whether it is covered under the head business or profession, capital gain, or other sources.

The term ‘transfer’ has been defined under Section 2(47) in an inclusive manner. This means that the term shall be deemed to include all transactions prescribed below besides what is otherwise understood as transfer in common parlance:

(a)  Transfer by way of sale;

(b)  Transfer by way of exchange;

(c)  Transfer by way of relinquishment;

(d)  Transfer by way of extinguishment of rights;

(e)  Transfer by way of compulsory acquisition; and

(f)  Transfer by way of conversion into stock-in-trade;

However, the transactions listed below are not regarded as a transfer to compute the capital gains. Therefore, any profit or gain arising from these transactions is not chargeable to tax under Section 115BBH:

(a)  Lending of virtual digital assets;

(b)  Any distribution of assets in kind by a company to its shareholders at the time of liquidation is not treated as a transfer of an asset by the company. However, in this case, the shareholders are liable to pay tax if any capital gain arises therefrom;

(c)  Transfers in a mode listed in Section 47;

(d)  Mining of VDA;

(e)  Transfer of VDA without consideration;

(f)  Transfer by way of donation of VDAs;

(g)  VDAs lost or stolen;

1. Section 115BBH and Section 115BBI have been inserted by the Finance Act, 2022.
2. Nila V. Shah (Mrs.) v. CIT [2012] 21 taxmann.com 324/51 SOT 461 (Mum.)
3. CIT v. Tata Services Ltd. [1980] 122 ITR 594 (Bom.)
4. Indian Aluminium Cables Ltd. v. Dy. CIT [2000] 73 ITD 109 (Delhi – Trib.)
5. Shakti Insulated Wires Ltd. v. Jt. CIT [2003] 132 Taxman 171/87 ITD 56 (Mum. – Trib.)