If we had the chance of naming a “financial year”, then FY18 would have been christened as the year of cryptocurrencies. In past few months, these virtual currencies had risen from its status of charcoal to diamonds and now are back to dust. The gains earned by the investors from cryptocurrencies in the second and third quarters of FY18 have got completely eroded in the fourth quarter. In the recent time, Bitcoin became one of the most popular cryptocurrencies, witnessing a growth of over 1,000 times in 2017 itself. Unfortunately its prices crashed in 2018. As of now it is trading at below $8,000 per bitcoin from its highs of $19,783.
Even after authorities like Government, central bank and financial institutions issued several admonishments, bitcoins have remained as one of the most popular speculative investments in India. With the singular hope of another bounce back in the price of bitcoins, many investors are still holding on to them, while others have already booked losses.
Short-term capital gain on equity can be used to set off the losses incurred from the sale of cryptocurencies, before March 31, 2018 (if deemed as short-term capital assets). This would help them lower their tax incidence on short-term capital gains on listed equity.
Let us learn how to classify a cryptocurrency in terms of income tax laws. And the treatment of the losses incurred on their sale.
Cryptocurrency: Capital asset or business asset?
Currently, there are no specific provisions in the Income-tax Act, 1961 about the taxability of cryptocurrencies in India. However, in the view of the general provisions of the Income-tax Act, cryptocurrencies like Bitcoin could be deemed as capital assets, provided they are held as an investment. Thus, any gain arising from the sale of such cryptocurrencies should be taxable as capital gains.
If the Bitcoins are held for a period greater than 36 months from the date of purchase, it will be considered as a long-term capital asset. If held for a period lesser than 36 months then it would be termed as a short-term capital asset.
It is important to note, if the transactions in bitcoins are substantial and frequent, then it could be considered that the taxpayer is trading in cryptocurrencies and the resultant profit has to be considered as business income. Hence, it should be taxable accordingly.
In the same way, losses arising from the transfer of cryptocurrencies shall be deemed as capital or business losses. The IT Act allows for adjustment of losses incurred by a taxpayer against other taxable incomes, however subject to some restrictions.
Trading in Bitcoins: Speculative or non-speculative business?
The IT Act primarily categorizes a business into either ‘speculative’ or ‘non-speculative’. Also, while business losses can be set-off against any other income of the taxpayer, speculative business loss can only be set-off against income from other speculative business income. In a nutshell, if trading in cryptocurrencies is treated as a speculative transaction, then losses in sale of one cryptocurrency, say Bitcoin, can be set off against income or gains from sale of other cryptocurrencies like ripple or ethereum.
Section 43(5) of IT Act states that, a transaction shall be deemed as ‘speculative’ if it isn’t followed by an actual delivery. In Bitcoin trading, the buyers get the delivery of underlying cryptocurrency into their digital wallets. To conclude, these transactions should not be termed as ‘speculative’.
Set-off and carry forward?
The IT Act allows ‘set-off’ of losses against profits. First, the losses are set-off against the income under the same head, i.e. intra-head adjustment. Then any remainder loss after such set off is set against income from another head, i.e. inter-head adjustment. That is to say, before making the inter-head adjustment, one has to first make an intra-head adjustment first.
In case, the taxpayer is unable to set off his losses in the current financial year due to inadequate profits, he is allowed to carry forward such losses to the subsequent year to set it off against any possible future income. All such losses are allowed to be carried forward for eight subsequent years from the year in which such losses were incurred. However, any loss incurred from a speculative business can be carried forward only for a limited period of four years. Additionally, in order to avail the benefits of carry-forward of losses to subsequent years, it is mandatory to file return of income within the due date.
There are some exceptions to the rule of adjustment of losses against profit, in respect of capital gains and business profits:
A. Long-term capital losses can only be adjusted against long-term capital gains. Whereas, short-term capital losses can be adjusted against both short-term, as well as, long-term capital gains.
B. Loss incurred from speculative business can be set-off against speculative income only.
C. Business loss can be adjusted against any other head of income, except salary income.
D. Capital loss can be adjusted against capital gains. However, any loss incurred under any other head can be set-off against capital gains.
When cryptocurrencies are treated as a business asset, any loss incurred with respect to it can be adjusted against any other income, including capital gains, both short-term and long-term, barring the salary head. However, when they are treated as capital assets, any resulting long-term capital loss has to be adjusted against other long-term capital gains only. In case of short term capital loss, as it would be in most of the cases, it can be adjusted against both long-term as well as short-term capital gains. As a matter of fact, short-term capital loss arising from sale of cryptocurrencies is allowed to be adjusted against short-term capital gains arising from trading in listed securities.
Illustration:
Mr. A purchased one bitcoin in Rs 8,00,000 in August 2017 and sold the same in February 2018 for Rs 4,50,000. How this loss shall be treated in the Income-tax Act is illustrated below in four difference scenarios:
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Particulars
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Scenario 1
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Scenario 2
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Scenario 3
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Scenario 4
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Loss incurred (A)
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(3,50,000)
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(3,50,000)
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(3,50,000)
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(3,50,000)
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Nature of loss
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Short-term capital loss
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Long-term capital loss
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Business loss
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Speculative loss
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Other Income:
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Long-term capital gains (B)
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50,000
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50,000
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50,000
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50,000
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Short-term capital gains (C)
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1,25,000
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1,25,000
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1,25,000
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1,25,000
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Salary income (D)
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4,50,000
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4,50,000
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4,50,000
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4,50,000
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Income from house property (E)
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75,000
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75,000
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75,000
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75,000
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Business income (F)
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2,50,000
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2,50,000
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2,50,000
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2,50,000
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Speculative income (G)
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1,30,000
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1,30,000
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1,30,000
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1,30,000
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Set-off allowed (H)
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(1,75,000)
(Against B & C)
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(50,000)
(Against B)
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(3,50,000)
(Against B, C, E, F & G)
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(1,30,000)
(Against G)
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Loss to be carried forward (A-H)
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(1,75,000)
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(3,00,000)
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–
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(2,20,000)
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Taxable income of current year
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9,05,000
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10,30,000
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7,30,000
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9,50,000
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