JULY 27, 2021

By Rishab J & Sriharsha Palanki*

INTRODUCTION

THE tech-savvy population of the world is fascinated with Virtual Currencies ('VC') due to the staggering valuations and significant gains. As the saying goes, every gain has a corresponding cost, the income from VCs, similar to any other physical asset, are subjected to levy of income tax which is imposed by the Government. However, the implication varies for 'mining' and 'trading' activities respectively, as these are activities of distinct nature. After analyzing the legality of transactions in VCs in Part-I of the Article, we shall now proceed to understand the possible implications of Income Tax Act, 1961 on such transactions.

1.1. CONSTITUTIONAL PROVISIONS

Article 265 of the Constitution of India ('Constitution') lays down the principle that taxes shall be levied or collected only by an authority of law and levy of tax is a power granted to the Central Government by the Constitution. Further, Article 246 of the Constitution grants power to the Parliament as well as the State legislature through Schedule VII of the Constitution that provides the list of subject matters for which State legislatures and Parliament can exercise the power to levy taxes on the same.

Entry 82 of List I of the Constitution covers "Tax on income other than agricultural income". Further, Entry 86 covers "taxes on the capital value of the assets, exclusive of agricultural land, of individuals and companies". The Centre, hence can levy tax on the value of any capital asset akin to tax on gains from property, shares, etc.in the present day. The levy of tax on income from VCs is also determined based on the scope of such income under the Income Tax Act, 1961 ('ITA').

1. LEVY UNDER INCOME TAX ACT, 1961

The scope of income under Section 5 of the ITA states that the total income of an Indian Resident is liable to tax. To understand how income from VCs are taxable, the first factor for consideration is the source of the said income. VCs are commonly acquired through 'trading' or via a process called 'mining', either of which makes the income taxable under the appropriate heads of income under ITA as per the effected classification of VCs. The levy of income tax on transactions relating to VCs can be broadly analyzed under the following heads:

1. Capital Gains

2. Profits or Gains from Business or Profession

3. Income from Other sources

2.1 GAIN ARISING FROM SALE OF CAPITAL ASSET

In India, at present VC is neither recognized nor classified as any asset class. Hence, the Government may be mulling over the possibilities either for recognition or for an appropriate classification to create a unique class of asset owing to the nature of its intangible and novel existence.

To recognize the income from VCs as a gain arising from sale of capital asset, VC must be recognized and included in the definition of a "capital asset" under Section 2(17) of ITA, which defines a capital asset as "a property of any kind irrespective of whether it is connected to the business or profession of the assessee". The scope of the definition is wide and inclusive due to the phrase ' property of any kind' and hence there is high probability that cryptocurrency may be classified as a capital asset. Subject to the period for which the asset would be held, the assessee would be liable to pay tax on transfer of capital asset for consideration. The computation of such gain is likely to be based on the traditional approach, i.e. by reducing the cost of acquisition from such sale value and the resultant gain would be made chargeable to tax based on the computation under Section 48 of ITA. The nature and form of income may not be disputed so long as it could be classifiable under a recognizable head and tax is levied on the same. In the present regime, the tax on gains arising out of sale of stock held for long term (3 years being the benchmark based on transaction in shares) is 10% where the benefit of indexation is not available.

Cryptocurrencies are commonly acquired through a process called 'mining' and in the ordinary course, capital gains would arise on trading of the same in the market. However, a larger bench of the Hon'ble Supreme Court has ruled that the need for ascertainment of capital gain does not arise where cost of acquisition is inconceivable ¹, as the levy per se fails. In this regard, where cryptocurrency has been 'mined' into existence, the cost of acquisition cannot be allowed as a deductible expenditure until the necessary mechanism is enforced. As a consequence, the determination of capital gain is rendered moot in the present scenario in respect of mining until such a time the classification is undertaken. On the other hand, trading of VCs clearly has an ascertained cost of acquisition linked to the transaction; the government may recognize as a distinct class and tax under this head.

2.2 PROFITS OR GAINS FROM BUSINESS OR PROFESSION

Speculative business

Owing to the characteristic nature of VCs, it is clear that various factors including high volatility renders the activity to be highly speculative. Upon closer examination, the revenue officials could adopt a view to classify the trading activity under the definition of "speculative business" according to Section 43(5) of ITA. However, the eventuality of such speculative business may or may not yield any income and, hence, in case of a loss, the same is available for set-off against any other income from speculative business as per the provisions of Section 73 of ITA. For a transaction to be taxed under this head, it must be undertaken as a 'business', which is defined under Section 2 (13) of ITA, to include any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce, or manufacture.

There are two situations under which income from VCs could be classified under the aforementioned head, which are as follows:

1. When the activity in VCs is consistent over a period of time where the assessee is wholly engaged in the said activity.

2. In case VCs are held by the assessee as 'stock-in-trade'.

Though certain assesses may record VCs in line with the aforesaid scenarios, there is a high possibility that this head may not be appropriate as the government may not want to recognize activities in VCs at par with the other activities undertaken under this head. This is, however, subject to the condition that the upcoming Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 ('VC bill') does not recognize VCs as a valid legal tender.

2.3. INCOME FROM OTHER SOURCES

In case, the income earned by an assessee is not qualified to be classified under any particular head of ITA, then a residuary head is provided under which income is considered for the purpose of subjecting the activity to tax. According to Section 56 (1), any kind of income which must be included in total income under ITA is taxable under this head, in case it is not taxable under any other head of ITA. The effect would be that income from VCs could be chargeable to a rate of tax at 30% as per Section 115BB which includes income from gambling, betting and so on.

CONCLUSION

Observing the pattern of the regulatory measures by the Government, it is being speculated that RBI is intent on imposing a ban on privately owned VCs. At this juncture, the definition of "private cryptocurrencies" is speculative until the VC bill receives the assent from the Hon'ble President of India. Notwithstanding these factors, any income derived by or in connection to the VC would be taxable in the hands of the assessee based on the nature of activity i.e., mining or trading. The only aspect for consideration is whether the VC bill of RBI classifies VCs as a separate class of asset, which should also be recognized by the tax authorities. Till then, the income accruing or arising for the relevant previous year can be subjected to tax under any of the aforementioned heads based on the best judgment of the assesses at applicable rates (subject to the necessary deductions and/or exemptions as availed at the time of declaring such income).

…to be continued

See Part -I

(*The authors are Senior Associate and Associate at Shivadass & Shivadass (Law Chambers) The Authors would like to acknowledge the contributions of Ms. Mahek Agarwal, a 3 rd year law student from Symbiosis Law School, Hyderabad. The views expressed are strictly personal. )

¹Commissioner of Income Tax, Bangalore vs BC Srinivasa Shetty, 2002-TIOL-587-SC-IT-LB