Understand the Taxation of Virtual Digital Assets

Table of Contents:

1. Introduction
2. Meaning of Virtual Digital Asset
3. Classification of Virtual Digital Asset
4. Taxation under the Head Capital Gains
5. Taxation under the Head Business Income
6. Taxation under the Head of other Sources
7. Treatment of Losses
8. Illustrations
9. Deduction of Tax at Source
10. Comprehensive Example

1. Introduction

Bitcoin was the first cryptocurrency to hit the market in 2009, and it was invented by a person or group using the alias Satoshi Nakamoto. After that, several Cryptocurrencies were launched, and some of the popular currencies are Bitcoin Cash, Ripple (XRP), Litecoin, etc. As per an estimate, more than 8,000 cryptocurrencies exist as of January 2022.
As per the recent study by Nasscom and WazirX, India’s cryptocurrency market has seen exponential growth over the past few years. It is expected that the investment by Indians in Cryptocurrency could touch $ 241 million by 2030. Currently, India has the highest number of crypto owners globally.

Currently, no legislation governs, regulates, or prohibits dealing in cryptocurrencies in India. Therefore, it is not illegal to sell, purchase, deal or mine cryptocurrencies or set up any cryptocurrency exchange in India. Considering the risks associated with investment in cryptocurrencies, there were speculations that a bill could be introduced in the Winter Session of Parliament to ban or regulate Cryptocurrencies. However, the bill was not introduced.

Now in the Union Budget 2022 the Govt. has cleared its stand that it is not going to prohibit Indians from dealing in Cryptocurrencies but to regulate it. Various provisions have been proposed in the Income-tax Act to regulate investments in cryptocurrencies, NFTs or other virtual digital assets. These provisions are applicable from the assessment year 2023-24. Thus, any transfer of a virtual digital assets on or after 01-04-2022 shall be taxable as per new provisions proposed by the Finance Bill, 2022.

2. Meaning of Virtual Digital Asset [Section 2(47A)]

A new clause (47A) has been inserted in Section 2 to provide an exclusive meaning of Virtual Digital Asset.

It means:

(a) 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;

(b) Non-fungible Token (NFT) or any other token of similar nature, by whatever name called;

(c) Any other digital asset, as the Central Government may, by notification in the Official Gazette specify.

In simple words, the virtual digital asset shall mean a cryptocurrency, NFT or another virtual digital asset as notified by the Central Govt. It will not cover subscriptions to any OTT platform, mobile applications, e-commerce platforms, etc.

The Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of a virtual digital asset subject to such conditions as may be specified therein. Such powers might have been given to the Central Govt. to exclude India’s first digital currency or Central Bank Digital Currency (CBDC).

Watch Taxmann's Latest Video to understand the following:

• Meaning of Virtual Digital Asset 

• Taxation on Gift of Virtual Digital Asset 

• Taxation on the transfer of Virtual Digital Asset 

• TDS from payment of consideration on transfer of Virtual Digital Asset 

• Taxation on dividend income received from a specified foreign company 

• Obligation to prove Source of Loan or Borrowing

3. Classification of Virtual Digital Asset

The Govt. did not clarify if the virtual digital assets will be a currency, commodity, or security. In the absence of any such clarification, the virtual digital asset should be classified as a capital asset.

In view of Section 2(14) of the Income-tax Act, a capital asset means property of any kind held by a person, whether or not connected with his business or profession. The term ‘property’ has no statutory meaning, yet it signifies every possible interest that a person can acquire, hold, or enjoy.

Therefore, cryptocurrencies or NFTs should be deemed capital assets, if purchased for investments by the taxpayers. Therefore, any gain arising on the transfer of such assets shall be taxable as capital gains. However, if the transactions in such assets are substantial and frequent, it should be held that the taxpayer is trading in such assets. In this case, income from the sale of such assets should be taxable as business income.

Dive Deeper:
GST on Cryptocurrency – An Overview

4. Taxation under the Head Capital Gains [Section 115BBH]

4.1 Nature of Virtual Digital Assets

If gains arising from the transfer of virtual digital assets are treated as capital gains, their further classification into short-term or long-term gains would depend upon the period of holding of such assets.

If a virtual asset is held for more than 36 months from the date of purchase, it will be considered a long-term capital asset; otherwise a short-term capital asset.

4.2 Computation of capital gains

The capital gains from the sale of virtual digital assets shall be computed in the following manner:

4.2 A: 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, while computing the short-term or long-term capital gains, except the cost of acquisition, no other deduction or exemption shall be allowed. Thus, the following items shall be ignored while computing the capital gains from the transfer of virtual digital assets:

   (a)  Expenditure incurred in connection with the transfer of a virtual digital asset;

   (b)  Cost of improvement relating to a virtual digital asset;

   (c)  Indexation of cost of acquisition of a virtual digital asset;

   (d)  Exemption under Section 54F.

4.2 B: Tax rates on capital gains

As per Section 115BBH(1), the income arising from the transfer of virtual digital assets shall be taxed at the rate of 30%. Thus, short-term and long-term capital gains both shall be taxed at a flat rate of 30%. Further, no deduction under Chapter VI-A or an exemption under Section 54F shall be allowed from such capital gains. However, relief under Section 87A can be claimed.

4.2 C: Surcharge rates

The rate of surcharge applicable on the short-term and long-term capital gains from the transfer of virtual digital assets shall be as follows:

1. Rate of Surcharge in the case of Individual, HUF, AOP,** BOI or AJP

** From A.Y. 2023-24 onwards, the surcharge rates for AOP with all members as a company, cannot exceed 15%.

2. Rate of Surcharge in case of any other assessee

*Health and Education Cess at the rate of 4% shall be charged on the aggregate of income-tax and surcharge.

Dive Deeper:
Cryptocurrency/Virtual Digital Assets Tax in India
New Scheme for Taxation of Virtual Digital Assets or Cryptocurrencies

5. Taxation under the Head Business Income

If the transactions in virtual digital assets are substantial and frequent, it should be held that the taxpayer is trading in such assets. In this case, income from the sale of such assets should be taxable as business income. The gains (without deduction of any expense or allowance) shall be taxable at the flat rate of 30% plus surcharge (as mentioned above) and cess.

6. Taxation under the Head of other Sources [Section 56(2)(x)]

6.1 Scope of Section 56(2)(x)

Section 56(2)(x) applies when any person receives any benefit whose value exceeds Rs. 50,000. This provision is applicable notwithstanding the residential status or class of assessee. The donor or donee can be an individual, partnership firm, LLP, company, AOP, BOI, co-operative society or artificial juridical person, whether resident or non-resident.

The deemed income under this provision arises from the following transactions:

   (a)  Receiving monetary benefits without consideration;

   (b)  Receiving immovable property without consideration or for inadequate consideration; and

   (c)  Receiving specified movable properties without consideration or for inadequate consideration.

6.2 Benefit arising from movable property

The deemed income under this provision can arise from the following transactions:

(a)  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.

(b)  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.

In both the situations, the limit of Rs. 50,000 shall be checked for every transaction and not in aggregate of all transactions.

This provision is applicable to any property in the nature of shares and securities, jewellery, archaeological collections, drawings, paintings, sculptures, any work of art, or bullion. Where the transaction involves any other movable property, excess of consideration over the fair market value shall not be chargeable to tax.

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; and

   (i)   Virtual Digital Assets.

Thus, if a person receives a virtual digital asset without consideration (gift) or for inadequate consideration and the value of such benefit exceeds Rs. 50,000, it shall be taxable in the hands of the recipient under Section 56(2)(x) as income from other sources.

6.3 Determination of fair market value of virtual digital assets

The fair market value of the virtual digital asset for taxability under Section 56(2)(x) shall be determined in accordance with Rule 11UA.

6.3 A: If purchased from 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.

6.3 B: 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.

6.4  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.

7. Treatment of Losses

7.1 General rules of set-off and carry forward

Income-tax is charged on the total income of an assessee. Therefore, income is computed head-wise to determine the total income. Income-tax Act contains certain provisions which do not allow to set-off certain losses but allow some of them in a particular manner and thus make the aggregation a legal concept. Losses incurred in the relevant year are adjusted against another income in three steps – Intra-head Adjustment, Inter-head Adjustment, and Carry forward of losses.

If several sources of income fall under the same head of income, the loss from one source of income may be set-off against the income from another source falling under the same head of income. This is called intra-head adjustment of losses.

If after setting-off the loss from one source against the income of another source falling under the same head, the net result is still a loss, the loss under one head of income may be set-off against the income under another head in the same previous year. This is called as inter-head adjustment of losses.

Where a loss cannot be completely set-off against income under the same head (intra-head adjustment) and against income under another head (inter-head adjustment), then the losses remaining shall be carried forward to next year.

7.2 No set-off and carry forward allowed to losses from virtual digital assets

Section 115BBH(2)(b) provides that no set-off of loss from the transfer of the virtual digital asset computed shall be allowed against income computed under any other provision of this Act to the assessee, and such loss shall not be allowed to be carried forward to succeeding assessment years.

It is clear that the capital losses from the transfer of virtual digital assets cannot be set-off against any other capital gains subject to the rules of intra-head and inter-head adjustment. In other words, the short-term capital loss from the sale of a cryptocurrency cannot be set-off against the short-term capital gains from the sale of listed shares. Similarly, the long-term capital loss from the sale of NFTs cannot be set-off against the long-term capital gains from the sale of mutual funds.

However, the losses from one virtual digital asset should be allowed to be set-off from the gains from another virtual digital asset. Section 115BBH(2)(b) prohibits set-off the losses from virtual digital assets as computed under Section 115BBH(1)(a) against income computed under any other provision of this Act. As capital gains from the transfer of any other assets are computed and taxed under other provisions, while as the income from sale of all virtual assets are computed under Section 115BBH, such set-off of loss from one virtual asset against income from another virtual asset shall be allowed. Such set-off shall be subjected to the existing rules of intra-head and inter-head adjustment.

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.

8. Illustrations

Example 1: Mr. A has purchased 60,000 USDT (cryptocurrency) at Rs. 67 each on 16 July 2018. He transferred 20,000 USDT in the previous year 2021-22, and the remaining 40,000 in 2022-23. The capital gains from the transfer of USDT shall be computed as under:

Example 2: Mr. A has purchased 2,000 NFTs at Rs. 1,000 each on 16 July 2020. He transferred all NFTs in the previous year 2022-23. The capital gains from the transfer of NFTs shall be computed as under:

Example 3: Mr. A has purchased 1,000 NFTs and 1,000 Cryptocurrency at Rs. 1,500 each on 16 July 2020. He transferred all NFTs and Cryptocurrency in the previous year 2022-23. The capital gains from such transfer shall be computed as under:

9. Deduction of 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.

9.1 Deductor

Any person responsible for paying any sum by way of consideration for the transfer of a virtual digital asset is required to deduct tax at source.

9.2 Deductee

Tax is required to be deducted under this provision if the amount is payable to a resident person.

9.3 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.

However, the provisions of Section 206AB shall not apply in the case of a specified person. Thus, even if the deductee has not furnished the return of income for a specified period, the tax shall be deducted at the rate prescribed under this provision and not as specified in Section 206AB, if the payer is a specified person. If the payer is not a specified person as specified in Para 2.9-6b, the tax shall be deducted as per Section 206AB if the payee is a non-filer.

9.4 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.

9.5 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:

(a)  Where consideration is wholly in kind;

(b)  Where a transaction is in exchange for another virtual digital asset, and there is no part in cash; or

(c)  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.

9.6 Exemption from deduction of tax at source

No tax shall be deducted under this provision in the following circumstances.

9.6 A: Consideration is 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.

9.6 B: Consideration is 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:

   (a)  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 lakh in case of a profession, during the financial year immediately preceding the financial year in which such virtual digital asset is transferred;

   (b)  An individual or a HUF who does not have any income under the head profits and gains of business or profession.

9.6 C: Summary

9.7 Overriding effect of provision

Where a transaction is subject to TDS under section 194-O and section 194S, tax shall be deducted under section 194S. Further, a transaction in respect of which tax has been deducted under this provision, no tax shall be deducted or collected under any other provisions.

9.8 TAN is not mandatory

Specified person as defined in para 2.9-6b does not require to apply or obtain a Tax Deduction or Collection Account Number (TAN) for deducting tax under this section. Hence, such a dedu-ctor can use his PAN in place of TAN.

9.9 Others

If any difficulty arises in giving effect to the provisions of this section, the Board may, with the prior approval of the Central Government, issue guidelines to remove the difficulty. Every guideline issued by the Board shall be laid before each House of Parliament and shall be binding on the income-tax authorities and on the person responsible for paying the consideration on the transfer of such virtual digital asset.

9.10 Example

10. Comprehensive Example

Mr. A earns the following income from the virtual digital assets. The tax on his taxable income shall be computed as under: