Taxation of Virtual Digital Assets (‘VDAs’)

• In the Union Budget 2022, various provisions have been introduced in the Income-tax Act, 1961 (‘the Act’) to regulate and bring the investments/trading in cryptocurrencies, NFTs or other virtual digital assets within the purview of Income Tax. These provisions are applicable with effect from the assessment year (AY) 2023-24 i.e. Financial Year (FY) 2022-23. Thus, any transfer of a virtual digital assets on or after 01-04-2022 shall be taxable as per new provisions of the Act.

• The primary reason for insertion of provisions of Income Tax on VDA’s is due to the rapid increase of investments/trade in cryptocurrency (ex: Bitcoin) and NFT’s in India and lack of specific provision under the Act governing the exchange/transfer of crypto’s or NFT. Accordingly, the Central Govt. has inserted specific provisions governing the transfer of cryptocurrency/NFT’s under the Income Tax Act.

• In general parlance, a cryptocurrency is a digital or virtual currency that uses cryptography for security and operates independently of a central bank. Cryptocurrencies are decentralized, meaning they are not controlled by any government or financial institution, and transactions are recorded on a public ledger called a blockchain.

• A non-fungible token or, NFT, is a unique digital asset that is stored on a blockchain. NFTs are often used to represent digital art, music, videos, or other types of media. Unlike cryptocurrencies, NFTs are not used as a form of currency and do not have a fixed value. Instead, they are used to verify ownership and authenticity of digital assets. NFTs are also unique, meaning they cannot be exchanged for another NFT or any other asset on a one-to-one basis. Each NFT is one-of-a-kind, and its value is determined by supply and demand.

• Currently, no legislation or regulations prohibits trading of cryptocurrencies or NFT’s in India. Therefore, it is not illegal to sell, purchase, deal or mine cryptocurrencies or set up any cryptocurrency exchange in India.

• The VDA is defined in section 2(47A) of the Income Tax Act, 1961 as follows:
“Virtual Digital Asset 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) a non-fungible token 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 terms, the virtual digital asset may mean a cryptocurrency, NFT or any another virtual digital asset as notified by the Central Govt.

► Taxability of Virtual Digital Asset under section 115BBH of the Act:

• The provisions for taxability of VDA are laid in section 115BBH of the Act as follows:

“Where the total income of an assessee includes any income from the transfer of any virtual digital asset, notwithstanding anything contained in any other provision of this Act, the income-tax payable shall be the aggregate of—

(a) the amount of income-tax calculated on the income from transfer of such virtual digital asset at the rate of thirty per cent; and

(b) the amount of income-tax with which the assessee would have been chargeable, had the total income of the assessee been reduced by the income referred to in clause (a).

(2) Notwithstanding anything contained in any other provision of this Act,—

(a) no deduction in respect of any expenditure (other than cost of acquisition, if any) 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 clause (a) of sub-section (1); and

(b) no set off of loss from transfer of the virtual digital asset computed under clause (a) of sub-section (1) shall be allowed against income computed under any provision of this Act to the assessee and such loss shall not be allowed to be carried forward to succeeding assessment years.

Given the above, the income derived from transfer of VDA will be taxed at flat rate of 30% without any deductions or allowances. Further, any loss incurred will not be allowed to be set-off against income from VDA.

► Capital Gains: Where VDA is held as Capital Asset

• Gains arising from the transfer of a virtual digital assets will be treated as Capital Gains and are taxed at a flat rate of 30%. 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.

• No deduction will be allowed other than the cost of acquisition of the VDA. Further, the gains arising from transfer of VDA will not be allowed to set off against any loss available under the provisions of the Act. However, benefit of rebate under section 87A of the Act will be allowed (if applicable) while computing the tax liability on transfer of the VDA’s.

• The following items shall be ignored while computing the capital gains from the transfer of virtual digital assets:

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

• Cost of improvement relating to a virtual digital asset;

• Indexation of cost of acquisition of a virtual digital asset;

• Exemption under Section 54F of the Act.

• Deduction under chapter VIA of the Act

► Taxation of VDA as 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

► Tax deduction at source (‘TDS’) under section 194S of the Act:

• As per section 194S of the Act, any person responsible for paying to a resident, any sum of money by way of consideration for transfer of virtual digital asset, shall deduct TDS at the rate of one percent (1%). TDS shall be deducted at the time of credit of such sum to the account of the resident or at the time of payment of such sum by any mode, whichever is earlier.

• In case the consideration for transfer of virtual digital asset is paid in kind or partly in cash or partly in kind, then person responsible to pay the consideration shall ensure before releasing the consideration that tax has been paid in respect of such consideration for transfer of virtual digital asset.

• No tax shall be deducted where the consideration is payable by specified person to a resident and the value or aggregate of such consideration does not exceed fifty thousand rupees during the financial year. In case consideration is payable by a person other than specified person, then no tax shall be deducted where consideration value does not exceed ten thousand rupees during the financial year.

• The term specified person is defined in the explanation to section 194S of the Act as follows:

Explanation.—For the purposes of this section “specified person” means a person,—

(a) being an individual or a Hindu undivided family, whose total sales, gross receipts or turnover from the business carried on by him or profession exercised by him does not exceed one crore rupees in case of business or fifty lakh rupees in case of profession, during the financial year immediately preceding the financial year in which such virtual digital asset is transferred;

(b) being an individual or a Hindu undivided family, not having any income under the head “Profits and gains of business or profession”.]

► Taxability under section 56(2)(X):

• In Finance Act 2022, an explanation has also been inserted in section 56(2)(x) of the Act and this explanation read as:

• “For the purposes of this clause, the expressions “assessable”, “fair market value”, “jewellery”, “relative” and “stamp duty value” shall have the same meaning assigned to them in the explanation to clause (vii); and

• The expression “Property” shall have the same meaning as assigned to it in clause (d) of the explanation to clause (vii) and shall include virtual digital asset. “

• In case virtual digital asset is transferred to a person without any consideration then section 56(2)(x) shall be triggered, and the recipient of such virtual digital asset shall be liable to pay tax on the fair market value in case the fair market value of such asset exceeds fifty thousand rupees.

• In case virtual digital asset is transferred to a person for a consideration and the consideration is less than the fair market value and the difference between consideration and the fair market value is more than fifty thousand rupees then such difference will also be taxable in the hand of recipient of such asset.

• In both the above cases, virtual digital asset will be treated as Gift and will be taxable under the head income from other sources (‘IFOS’) at the applicable slab rates and the same will not be taxed under section 115BBH of the Act.