The government has clarified that investors won’t be allowed to offset losses in one crypto asset against gains in another, and that crypto mining infrastructure costs will not be included in the cost of acquisition to be claimed as a deduction.

How are crypto investments taxed?

• The Union Budget 2022-23 in February proposed that gains from virtual digital assets or crypto assets would be taxed at 30% irrespective of the individual’s income tax slab.
• In addition, a 1% tax deducted at source or TDS was introduced on the transfer of such assets.
• The government did not say if crypto assets are to be treated as currency, commodity, or security, and a clarification is expected in due course via separate legislation.
• Gifting of crypto assets to non-relatives is also taxed in the hands of the recipient if the value exceeds ₹50,000 in a year.

How does crypto tax differ from others?

• If listed shares are sold within 12 months of purchase, short-term capital gains (STCG) tax is applied on the gains, while beyond one year, long-term capital gains (LTCG) tax is levied.
• STCG is levied at 15.6%, including cess, while LTCG for gains over ₹1 lakh is 10.4%, including cess.
• There is no provision of long-term or short-term crypto assets, while gains are taxed at a flat rate of 30%.
• Investors in equities can offset the loss in one stock against another, while they can carry forward both short-term and long-term loss for eight assessment years.
• This has not been allowed in crypto.

How will crypto tax impact investors?

• In a fiscal year, if an investor had made gains in bitcoin and losses in ether, he or she will have to pay tax at 30% on gains in bitcoin.
• Further, the absence of loss set-off provision would cause a double whammy —paying taxes on gains and no offset of losses.
• Tax experts believe that in certain cases, the effective rate of taxation can even cross 100% on crypto investments.

How will miners be affected?

• The government has clarified that mining infrastructure will also not be eligible to be deducted as the cost of acquisition.
• So far, it was understood by some that crypto generated during the ‘mining’ process is taxable only on the profits, after accounting for mining expenses such as electricity.
• But with the latest explanation, a 30% tax plus cess and surcharges will be levied on such transactions.
• Experts believe that crypto mining operations would become non-profitable under the current announcement.

Will crypto tax trigger an investor exodus?

• The crypto industry has been unequivocal in criticizing the tax proposals.
• Thanks to the tearing rally in crypto assets over the past two years, it is estimated by some that more than 20 million Indian investors have poured more than ₹1 trillion into cryptos.
• However, the industry leaders fear that the lack of provision to offset losses will drive away users from KYC-compliant exchanges and platforms to the underground peer-to-peer grey market, which would defeat the purpose of regulation.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

Context

In the Union Budget speech, Finance Minister Nirmala Sitharaman announced a 30% flat tax rate levied on any gains made from the transfer of virtual assets including cryptocurrencies and Non-Fungible Tokens (NFTs).

What is cryptocurrency?

• Cryptocurrency (crypto) consists of a digital denomination designed to work as a medium of exchange through a distributed computer network (a blockchain) that is not reliant on any central authority such as a government or a bank for its upholding and maintenance.
• Legal status: The announcement of the tax by the Finance Minister now leads to the assumption that crypto is legal in India.
• Foreseeable are changes that would, down the road, legitimize and formally legalize the activities of crypto start-ups and enable them to access the necessary support system which might not have been available previously.

What are the implications of taxing cryptocurrencies in India?

• While critics are right in observing that the 30% flat tax rate is a harsh rate, this is a premium and price well-worth paying in exchange for what is effectively a ruling-out of prospects for a total ban on crypto by the central government.
• Scope for innovation: The high tax rate would inevitably hamper the willingness of investors to convert cryptocurrencies into national fiat, this may, in turn, open up more doors for technologically savvy and innovation-minded investors.
•  The extremely high tax rate and the fact that the losses cannot be offset would invariably propel investors to turn to alternative means of storing and undertaking transactions in cryptocurrencies, without foregoing the significant losses involved as they “switch” back into the rupee.
• An inadvertent upside of this, then, is the prospective conversion and reallocation of crypto-funds from one form to another.
• Such transformations would involve DeFi (Decentralised Finance) activities such as staking, lending, and providing liquidity, among others.

Scope for DeFi in India

• DeFi (or “decentralized finance”) is “an umbrella term for financial services on public blockchains.
• With DeFi, one can do most of the things that banks support — earn interest, borrow, lend, buy insurance, trade derivatives, trade assets, and more — but it is faster and does not require paperwork or a third party. 
• DeFi is global, peer-to-peer (meaning directly between two people, and not routed through a centralised system), pseudonymous, and open to all.
•  The processes highlighted above would drive innovation in the field of Indian DeFi.

Concerns

• Low participation due to high rate: The community of small and medium-sized enterprises (SMEs) and lower-end high net-worth individuals are going to find it most difficult to access the ecosystem given the substantial barriers posed by the tax rates.
• Lack of clarity: Additionally, when it comes to India’s crypto policy at large, there is a fundamental lack of clarity in aspects other than taxation.
• There appears to be a push to treat crypto as purely an asset class than a currency.
• The consolation offered by the Government in the form of the Reserve Bank of India’s CBDC, or Central Bank Digital Currency, will definitely help in pushing for the adoption of digital currencies, but, equally, defeats the fundamental purpose of cryptocurrency, which is decentralization.

Suggestion

• Reduce the tax rate:  There is a need to reduce tax rates in the future, though this must be weighed against considerations concerning government revenue and the need to curb speculative bubbles surfacing in relation to the currency.
• Incorporation of insights: The second reform constitutes the incorporation of insights from seasoned partners from international communities, the key should rest with engaging these individuals for their insights and advice on the best practices associated with cryptocurrency policymaking.

Consider the question “What is DeFi (decentralised finance)? What are the implications levying high tax on the cryptocurrencies?”

Conclusion

Systemic reforms are by no means easy, but they are critical as an amplifier of the successes that India has already accrued in the field and as an accelerator of India’s advancement in the sphere of crypto finance and blockchain social policymaking.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

Law to ban private cryptocurrencies

• The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 aims to prohibit all private cryptocurrencies.
• It lays the regulatory framework for the launch of an “official digital currency” was set to be introduced in Parliament during the Budget session, but was not taken up.
• A high-powered inter-ministerial committee has also previously recommended the banning of all private cryptocurrencies.
• In April 2018, the RBI banned banks and other regulated entities from supporting crypto transactions after digital currencies were used for frauds.
• In March 2020, the Supreme Court struck down the RBI’s ban on crypto, terming its circular unconstitutional.
• One of the SC’s reasons for overturning the ban is that cryptocurrencies are unregulated but not illegal in India.

Central bank-issued digital currency

• The RBI had said central banks are not only exploring DLT (Distributed Ledger Technology) for its application in improving financial market infrastructure but also considering it as a potential technological solution in implementing central bank digital currency (CBDC).
• DLT and blockchain have been explored extensively by the People’s Bank of China as a possible technology for launching CBDC.
• Apart from CBDC, PBoC is supporting research on using blockchain for trade finance, especially after the support from the President of China for the blockchain technology, as an important breakthrough for innovations.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now

Context

There’s an opportunity to stabilize the financial system and prevent a rival power from widening its lead.

The backdrop of YES bank failure time for cryptocurrency

• Perfect time for cryptocurrency: Confidence in the Indian financial system has been breaking down for some time. Instead of trying to restore trust, it may be time to require less of it — with the help of an official rupee cryptocurrency.
• The last straw: The collapse of corporate lender Yes Bank Ltd. was the last straw, which failed in slow motion in full view of authorities.
  • Depositors have been assured that their $20 billion-plus in stuck funds will be released after a rescue by the government-controlled State Bank of India.
  • What could be the impact on the sentiment of the people? While that may help prevent widespread panic, even temporarily stopping people from accessing their funds would mean that from now on, not all savings and current accounts will be treated by individuals and businesses as a perfect substitute for cash.

Why it would be costly and difficult to revive the public faith?

• It will be both difficult and costly to revive the public’s dwindling faith.
• Nationalisation not an option: A nuclear option is to nationalize the banks and non-bank finance firms that provide $1.75 trillion in annual funding. Doing so would be a doomed throwback to the late 1960s when India lurched toward stultifying socialist-style state controls.
• Corruption in banking won’t go away: Similarly, it would be unrealistic to assume that the Yes Bank embarrassment would trigger an improvement in the status quo.
  • Deep crony-capital relationship: The crony-capital relationships between financiers and borrowers in India are steeped in its colonial history.
  • Basel III won’t solve the problem: Putting on the gloss of Basel III capital requirements, which are supposed to make lenders less prone to failure, doesn’t make corruption in banking go away.

Can cryptocurrency be an answer?

• It offers hope: Blockchain technology, which the Indian establishment is trying to snuff out in finance, offers hope. Government should consider official crypto to obviate the need for trusted intermediaries, which are in short supply, anyway.
• China expected to launch digital currency: Before the coronavirus outbreak, China was widely expected to start its own central bank digital currency this year.
  • But India’s need is greater, and its motivation very different from Beijing’s desire to shake the hegemony of the dollar.
• After the Yes Bank debacle and botched rescue, deposits in India will probably gravitate toward four or five large lenders, whose managers may be emboldened to make risky bets with other people’s money. The remaining banks will struggle for liquidity. A perennially unstable credit delivery network will always be one misstep away from the next blowup. While every country has its share of manias, panics and crashes, to be gripped by absolute financial mistrust every few years is not an environment where growth can flourish.
• Opportunity to think afresh: Earlier this month, India’s highest court set aside the Reserve Bank of India’s directive that asked banks to not offer services to cryptocurrency traders and exchanges.
  • A legal defeat has provided the opportunity to think afresh.
  • But in parallel, the government is considering a blanket ban on private virtual tokens. The crypto activity could get slammed again.
• Possibility of misuse: To be sure, one popular use of technology is money laundering.
  • But to kill the industry and send practitioners packing would be to lose out on a valuable innovation at a time when India needs to build on the globally recognized successes of its digital payments industry, which has gained users’ trust just as banks and shadow banks have lost it.

Implications for deposit in the aftermath of Yes bank debacle

• Deposits may gravitate towards big banks: After the Yes Bank debacle and botched rescue, deposits in India will probably gravitate toward four or five large lenders, whose managers may be emboldened to make risky bets with other people’s money.
  • The remaining banks will struggle for liquidity.
• Next blowup: A perennially unstable credit delivery network will always be one misstep away from the next blowup.
• Impact on growth: While every country has its share of manias, panics and crashes, to be gripped by absolute financial mistrust every few years is not an environment where growth can flourish.

Possible pathways for central banks digital currency

• Pathways suggested by BIS: After surveying 17 projects around the world — from Norway and Sweden to China, Cambodia and South Africa — the Bank for International Settlements (BIS) has identified four possible pathways for a central bank digital currency.
• Starting point- Rupee token: Of the pathways suggested by the BIS, a rupee token that doesn’t require the holder to have an account with anyone but has value guaranteed by the Reserve Bank of India could be a starting point.
• Who should enable the fund transfer? Cryptography (“I know a secret, therefore I own the funds”) rather than an account relationship (“I am who I say I am, therefore I own the funds”) would be used to enable transfers.
  • Later, the RBI can open up the validation of transactions to authorized parties on distributed ledgers.
• What is the current system and issues with it? Currently, a deposit holder has to rely on everyone from the bank’s management and board to the auditors, the rating firms and the regulator to do their jobs.
  • When they all fail, as in the case of Yes, the bank’s chequebook, ATM card, and online banking password cease to generate liquidity.
  • Deposits stop being the same as cash, even if the state guarantees their safety.
  • It would be far less painful if deposit owners only had to trust the RBI, not as a banking regulator but as a money-printing authority that could never run out of resources to settle its IOUs.

Conclusion

• China’s ambition challenge dollars position as a reserve currency: China wants the yuan to take over from the dollar as the world’s reserve currency. A tech-enabled global alternative to the greenback — of the kind that Facebook Inc.’s proposed Libra had threatened to be — would have been an obstacle. Hence, Beijing accelerated its tokenized currency initiative.
• India should jump the bandwagon: India needs to jump on the bandwagon for self-preservation. If the RBI doesn’t make easy-to-transact digital rupees available and leaves ordinary folks at the mercy of poorly run and supervised banks like Yes, people would rather store their wealth in Silicon Valley-sponsored tokenized money — or Beijing’s digital yuan — whenever they arrive.

Get an IAS/IPS ranker as your 1: 1 personal mentor for UPSC 2024

Attend Now