TDS under Section 194S | Who is required to deduct TDS for VDAs transferred through an Exchange?

The Finance Act 2022 inserted a new section 194S in the Income-tax Act, 1961 to provide for deduction of tax by any person who is responsible for paying consideration to a resident person in respect of the transfer of virtual digital assets (VDAs).

It is to be noted that the liability to deduct under section 194S is of a person who is responsible for paying the consideration for the transfer of VDA (i.e., the payer) and not of the person who is buying the VDA (i.e., the buyer). Thus, the payer and buyer of VDA may be a different person. This generally happens when the VDAs are transferred through an Exchange or Broker.

Where VDAs are transferred through an Exchange, the buyer would be crediting or making payment to the Exchange (either directly or through a broker). The Exchange then would be required to credit or make payment to the owner of VDA (either directly or through a broker). Since there can be multiple players involved in a transaction taking place through an Exchange, there is a possibility of tax deduction requirement under section 194S at multiple stages, and, accordingly, there would be a compliance burden on multiple parties involved in such transaction.

To remove the difficulties that may arise while deducting tax at source under section 194S, where VDAs are transferred on or through an exchange, the CBDT has issued certain guidelines in the exercise of the power conferred by sub-section (6) of section 194S, which shall be binding on the income-tax authorities as well as the person responsible for paying the consideration for transfer of VDA.

To answer ‘who will be liable to deduct tax under section 194S where VDA is transferred on or through an exchange?’ the CBDT has clarified the same under the following situations:

• • Where VDA is transferred through an exchange without the involvement of a broker
  • Where VDA is transferred through an exchange with the involvement of a broker
  • Where VDA being transferred is owned by the Exchange
  • Where VDA being transferred is owned by the Exchange and same is bought through a broker
  • Where under aforesaid situations, the consideration for transfer of VDA is in kind or in Exchange for another VDA.

The CBDT clarification in this regard is summarised and explained as under:

It is to be noted that when the Exchange opts for deduction of tax under section 194S, where one VDA is exchanged with another VDA, there is a possibility that the tax amount deducted is also in kind and needs to be converted into cash before it can be deposited with the Government. In this regard, the CBDT has required the exchanges to adopt the following mechanism:

• • If the VDAs (towards tax deducted) are not primary, then the Exchange shall immediately execute a market order for converting these non-primary VDAs into primary VDAs.
  • If the VDAs (towards tax deducted) are primary, then the Exchange shall not convert these primary VDAs into INR immediately but will wait for the closure of the day.
  • On the closure of the day at 00:00 hrs, all Primary VDAs, including those converted from non-primary VDAs (towards tax deduction), shall be converted into INR.
  • The Exchange shall execute the order to convert Primary VDA into INR based on the open buy orders in the market.
  • The Exchange liquidating the VDA shall be prohibited from being a buyer for these VDAs.
  • Time stamps of the timing of orders to be maintained for the transactions executed in step 1.
  • Price and quantity data for every matched trade in Step 4 shall be maintained by the Exchange and shall be available for verification.
  • No tax is to be further deducted on converting the tax withheld in kind in the form of VDA into INR or from one VDA to another VDA and then into INR.