Explained | What is the debate around the legality of cryptocurrencies after the announcement of a 30% tax?

The story so far: In her Budget speech, Finance Minister Nirmala Sitharaman introduced a 30% tax on income earned from transfer of virtual digital assets. The Government is yet to recognise cryptocurrencies, including Bitcoin and Ethereum, but this ambiguity has not stopped people from trading in digital assets in large numbers, which apparently forced the Government’s hand in announcing a tax on such transactions. At a press conference after presenting the Budget, Ms. Sitharaman said consultation is underway with stakeholders on digital assets, adding that there is no clarity yet on how the Government of India will regulate cryptocurrencies.

What would be the tax component for income from virtual digital assets?

The Budget has proposed a 30% tax on income from the “transfer of any virtual digital asset.” Secondly, except for the cost of acquisition, no deduction will be allowed. Thirdly, losses from such transfers cannot be set off against any income. Fourthly, tax will be deducted at source at the rate of 1%, so as to capture transaction details, thus initiating a tax deducted at source (TDS) mechanism.

What has been India’s approach to cryptocurrencies?

The Government and the Reserve Bank of India have in the past cautioned people against considering cryptocurrencies as legal tender. The fact that transactions using such currencies can easily bypass the tax net, and therefore be used for illicit transactions, have been bothering governments across the world.

The Reserve Bank of India, in 2018, directed banks not to provide services to the cryptocurrency ecosystem. The Supreme Court set this aside, calling the move disproportionate, given that such currencies were not banned in the country. A law on cryptocurrencies, which was supposed to have been brought in last year, is yet to see the light of day. The broad expectation about the Government’s approach to this was set by a 2019 report by an inter-ministerial committee which recommended a ban on all cryptocurrencies.

Yet, through all this, cryptocurrency trading has grown in India. In fact, Ms. Sitharaman noted in her Budget speech that “there has been a phenomenal increase in transactions in virtual digital assets. The magnitude and frequency of these transactions have made it imperative to provide for a specific tax regime.”

How has the cryptocurrency ecosystem read this move?

All major players have welcomed it. They have understood it as a move that provides clarity and “mainstreams” their industry. Nischal Shetty, the CEO of cryptocurrency exchange WazirX, tweeted that the Government has legitimised the industry. He wrote: “This doubles down on the fact that virtual digital assets are legal in India.”

The industry is now ready to lobby with the Government to bring down the tax on par with other asset classes.

Does this mean that cryptocurrencies are legal?

Statements by ministers and bureaucrats after the Budget seem to suggest that the legality of cryptocurrencies in the country is still a grey area, never mind the tax.

Editorial | A disjointed response: On crypto assets and regulation

In an interview with Bloomberg TV, Finance Secretary T.V. Somanathan said: “They are in a grey area. It’s not illegal to buy and sell crypto.”

He further said, “We have now put in a taxation framework that treats crypto assets the same way we treat winnings from horse races, or from bets and other speculative transactions.”

Union Minister Rajeev Chandrasekhar told NDTV a day after the Budget, “Yesterday’s Budget has given a direct answer —crypto won’t be banned.”

However, Ms. Sitharaman, in an interview with Times Now, seemed to suggest that the question on the ban hasn’t been decided one way or another. She also seemed to divorce the taxability issue from the legitimacy issue.

She said, “There is no way anything can stop a sovereign Government from taxing an activity. Banning or not banning will come subsequently when the consultations give me inputs. But would you say till then I do not even tax the huge profits being transacted? I will. Legitimate or not legitimate is a different question, taxing is completely my prerogative.”

In recent days, experts have pointed out that the legal position is in sync with this thought process.

For instance, the verdict in the Commissioner of Income Tax v. Piara Singh in 1980 quoted from the judgment in the Commissioner of Income Tax, Gujarat v. SC Kothari, in which the court had observed that “if the business is illegal, neither the profits earned nor the losses incurred would be enforceable in law. But, that does not take the profits out of the taxing statute.”