Context

Notwithstanding the eventual introduction of the Cryptocurrency and Regulation of Official Digital Currency Bill in Parliament, cryptocurrencies continue to proliferate.

Provisions in Income Tax Act 1961 to tax cryptocurrencies

• Cryptocurrencies not mentioned in Income Tax Act, 1961: Although the Income Tax Act, 1961 (“IT Act”) does not specifically mention cryptocurrencies, it does cast a wide enough net to bring crypto transactions under its ambit.
• Capital asset: Trading in cryptocurrency may be classified as transfer of a ‘capital asset’, taxable under the head ‘capital gains.
• Business income: If such cryptocurrencies are held as stock-in trade and the taxpayer is trading in them frequently, the same will attract tax under the head ‘business income’.
• Even if one argues that crypto transactions do not fall under the above heads, Section 56 of the IT Act shall come into play, making them taxable under the head ‘Other sources of income’.

Challenges in taxing cryptocurrencies

• The above provisions in themselves are not sufficient in order to put in place a simple yet effective taxation regime for cryptocurrencies.

[1] Varied interpretations:

• First, the absence of explicit tax provisions has led to uncertainty and varied interpretations being adopted in relation to mode of computation, applicable tax head and tax rates, loss and carry forward, etc.
• For instance, the head of income under which trading of self generated cryptocurrency (currencies which are created by mining, acquired by air drop, etc.) is to be taxed is unclear.
• Since there is no consistency in the rates provided by the crypto-exchanges, it is difficult to arrive at a fair market value.
• Similarly, when a person receives cryptocurrency as payment for rendering goods or services, how should one arrive at the value of the said currency and how should such a transaction be taxed?

[2] Identifying tax jurisdiction

• It is often tricky to identify the tax jurisdiction for crypto transactions as taxpayers may have engaged in multiple transfers across various countries and the cryptocurrencies may have been stored in online wallets, on servers outside India.

[3] The anonymity of taxpayer

• The identities of taxpayers who transact with cryptocurrencies remain anonymous.
• Exploiting this, tax evaders have been using crypto transactions to park their black money abroad and fund criminal activities, terrorism, etc.

[4] Lack of third party information on crypto transaction

• The lack of third party information on crypto transactions makes it difficult to scrutinise and identify instances of tax evasion.
• One of the most efficient enforcement tools in the hands of Income Tax Department is CASS or ‘computer aided scrutiny selection’ of assessments, where returns of taxpayers are selected inter alia based on information gathered from third party intermediaries such as banks.
• However, crypto-market intermediaries like the exchanges, wallet providers, network operators, miners, administrators are unregulated and collecting information from them is very difficult.

[5]  Physical goods/services may change hand in return for cryptocurrencies

• Even if the crypto-market intermediaries are regulated and follow Know Your Customer (KYC) norms, there remains a scenario, where physical cash or other goods/services may change hands in return for cryptocurrencies.
• Such transactions are hard to trace and only voluntary disclosures from the parties involved or a search/survey operation may reveal the tax evaders.

Steps need to be taken

• Statutory provision: The income-tax laws pertaining to the crypto transactions need to be made clear by incorporating detailed statutory provisions.
• Awareness generation: This should be followed by extensive awareness generation among the taxpayers regarding the same.
• Separate mandatory disclosure: The practice of having separate mandatory disclosure requirements in tax returns (as is the case in the United States) should be placed on the taxpayers as well as all the intermediaries involved, so that crypto transactions do not go unreported.
• Strengthen international legal framework: Additionally, the existing international legal framework for exchange of information should be strengthened to enable collecting and sharing of information on crypto-transactions.
• This will go a long way in linking the digital profiles of cryptocurrency holders with their real identities.
• Training tax officers: the Government must impart training to its officers in blockchain technology.
• The United Nations Office on Drugs and Crime’s ‘Cybercrime and Anti-Money Laundering’ Section (UNODC CMLS) has developed a unique cryptocurrency training module, which can aid in equipping tax officers with requisite understanding of the underlying technologies.

Consider the question “What are the provision in Income Tax Act 1961 to tax the cryptocurrencies? What are the challenges in taxing cryptocurrencies? “

Conclusion

It is certain that cryptocurrencies are here to stay. A streamlined tax regime will be essential in the formulation of a clear, constructive and adaptive regulatory environment for cryptocurrencies.

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