Taxability of Cryptocurrency under Income Tax

Taxability of Cryptocurrency under Income Tax

Cryptocurrencies are a kind of virtual currencies that have now become a popular medium of exchange. Some of the main features that characterise cryptocurrencies are decentralisation, anonymity, and security. One of the first forms of cryptocurrencies is 'Bitcoin', which is easily accessible with most of the exchanges and merchants.

Mechanism of Cryptocurrency

Cryptocurrencies use blockchain technology, a decentralized technology spread across many computers that record and manage transactions. It is an open, distributed ledger in which transactions are recorded in code. In practice, it is like a chequebook distributed worldwide across countless computers where transactions are recorded in "blocks". These blocks are then linked together on a "chain" of previous cryptocurrency transactions. The software logs each new transaction as it happens, and every copy of the blockchain is updated simultaneously with the latest information, keeping all records identical and accurate.

Generation of Cryptocurrency

Following are the ways by which cryptocurrency can be generated:
 

• Mining: "Mining" crypto is when an individual uses high-powered computing technology that solves complicated algorithms/codes/equations that cannot be solved by hand. All the data is recorded on the blockchain. In exchange, the miners may receive consideration in new crypto tokens.

 

• Buying: It is the simplest way of acquiring cryptocurrencies. One may buy it from currency exchanges using real currency and store it in an online currency wallet in digital form.

 
Many crypto exchange platforms have made it very easy to buy and sell cryptocurrencies. Unlike stock markets, these platforms work 24x7 which means one can invest and withdraw money on any day at any time of the day.
 
The buying and selling of cryptocurrencies have also become more accessible. A person must sign up on the platforms, complete his KYC process, transfer money to the wallet and make the purchase. The investors are also provided with the option to set a pre-decided limit for selling and buying cryptocurrencies.

Advantages of cryptocurrencies

Decentralisation

The blockchain technology of cryptocurrencies makes them free from any domination and enables it so that no one can direct the rules for cryptocurrency developers and buyers

Fast and unlimited transactions

With cryptocurrency, an unlimited number of transactions can be created and sent almost instantly to anyone with a cryptocurrency wallet, anywhere in the world.

Transparency and anonymity

Due to the distributed nature of blockchains, every transaction is registered, and the records are protected from alterations. Also, if a crypto address is not openly verified, no one will know who made a transaction and who got the cryptocurrency.

Disadvantages of cryptocurrencies

Limited acceptance

Cryptocurrencies have yet not been given the status of a medium of exchange or a legal tender worldwide. There is still no proper mechanism through which cryptocurrencies can be accepted to sell anything of value.

High volatility

The cryptocurrencies market is quite unpredictable. Due to the high volatility of cryptocurrencies, there is always an uncertainty regarding the profitability of such investments.

Transactions are non-reversible

Transacting in cryptocurrencies is very risky because of the non-reversible nature of such transactions. Once you have mistakenly entered into a crypto transaction, you can send a refund request, but if it is declined, you'll lose the money invested.

Cryptocurrency as a currency or an asset?

One of the major confusions about cryptocurrencies is whether they should be considered a currency or an intangible asset. Since cryptocurrencies are not yet commonly accepted as the other currencies, they are now regarded as digital assets in some countries.

Legality and Tax implications of cryptocurrencies in India

There exists a lot of uncertainty about the legal status of cryptocurrencies in India. The government and banks are not backing up support to many such currencies circulating in a substantial volume in the market nowadays. The industry of cryptocurrency is very young, especially in India. The exchange platforms keep facing issues like the inability to execute orders, server crashing and more. So, these are some critical issues that investors need to keep in mind before investing.
 
The vital thing to note for investors is that the lack of a regulatory framework to govern the transactions involving cryptocurrencies leaves a lot of scope for frauds and scams. Anyone out there can start an exchange platform or invent a cryptocurrency which increases the risk for investors. The Reserve Bank of India has neither declared cryptocurrencies as illegal nor provided them with legal tender status. This means that a person can buy and sell cryptocurrency and even hold it as an investment, but there is no regulatory body to look after or protect it. Even the SEBI has not categorized it under the category of 'instrument'. However, in March 2020, the Supreme Court of India permitted the banks to handle transactions related to cryptocurrencies from traders and exchanges.
 
In March 2021, the Ministry of Corporate Affairs made it mandatory for companies dealing in digital currencies to reveal profit or loss incurred on cryptocurrencies' transactions. Hence, the profits from trading in cryptocurrencies are liable to taxation also.

Issues related to taxability of Cryptocurrencies in India

As the tax filing season for Assessment Year 2021-22 begins, many crypto investors may be concerned about the tax implications of their earnings from cryptocurrency trading and investments in the previous financial year. Although income tax department has not yet clarified the tax implications on the gains earned from the crypto transactions, it is not advisable to avoid paying income tax on such gains.
 
In the absence of any clarification regarding the taxability of gains arising from transactions in cryptocurrencies, the taxability of such transactions would have to be determined based on the interpretation of the Income Tax law. Taxability of any income, inter alia, depends upon the following two factors:
 

• Scope of income earned from cryptocurrency, depending upon the residential status of the assessee,
• Taxability of such income as business income or capital gain under Income Tax

 
Since cryptocurrencies are not treated as a currency or a legal tender in India, therefore it will be classified as an asset. However, the major issue will arise whether it will be treated as a business asset or capital asset.  
 
If a seller is a trader of cryptocurrency by occupation or he trades in cryptocurrency frequently in high volumes, then these would be considered as business assets and the income should be taxed as business income.
 
However, if the transactions in cryptocurrencies are made solely for investment purposes, then it will be considered as capital asset, accordingly any gains arising from such transactions should be taxable as capital gains.

Taxability under 'Capital Gains'

As per Section 2(14) of the Income Tax Act, 1961, a capital asset means property of any kind held by a person, whether or not connected with his business or profession. Though it has no statutory meaning, the term' property' signifies every possible interest that a person can acquire, hold, or enjoy. Therefore, if the cryptocurrency is purchased for investment by the taxpayer, it can be deemed a capital asset. Any gain arising out of cryptocurrency transfer may be considered capital gain if it is held for investment.
 

• Depending upon the holding period, gain from cryptocurrency transactions could be treated as long or short-term capital gains.
• If the investors' period of holding of cryptocurrencies is for 36 months or more, the profits arising from their transactions would be taxable as long-term capital gains.
• If the holding period is less than 36 months, it would be short-term capital gains.
• It must be noted that short-term capital gains are taxable under Income Tax Act as per the slab rates applicable to a taxpayer.
• At the same time, long-term capital gains are taxed at the flat rate of 20% with indexation benefit under the Income Tax Act.

Taxability under Profit and Gains from Business or Profession

When an individual frequently and substantially deals in transactions involving cryptocurrency, it could be held that the taxpayer is trading in cryptocurrencies. Therefore, the profits realized from continuous activity of trading in cryptocurrencies will be taxable as business income. However, the revenue authorities can take a position that such trading is treated as speculation income which would adversely impact taxpayers.

Scope of income earned from cryptocurrency, depending upon the residential status of the assessee

As per section 5 of Income Tax Act, 1961, if a person is a resident in India, his total income will include all such income which:
 

• is received or is deemed to be received in India, or
• accrues or arises or is deemed to accrue or arise to him in India; or
• accrues or arises to him outside India. 

 
Therefore, if the assessee is a resident individual who deals in cross-border transactions that involve cryptocurrency, in that case, the income earned from such dealings is taxable in India.
 
Whereas, when the transaction occurs between non-residents, income arising from dealing in cryptocurrency is not taxable in India unless such income is an Indian income or deemed to be an Indian income. 
 
It should be noted that when a transaction involving cryptocurrency takes place between the non-resident individual and a resident individual in India, such transactions are liable to be taxed in India. In such a case, the Indian counterpart would have to comply with the "Deduction of tax at source" requirements under section 195 of the Act.
 
 
Authored by CA Manish Gupta & assisted by Kriti and Akansha
For any queries or suggestions, reach at info@manishanilgupta.com