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The Bitcoin digital revolution - New way of life!


DECEMBER 29, 2017

By CA Harini Sridharan & Srikanth Krishnaswamy

WHAT is Bitcoin and how does it work?

James A. Garfield, 20th President of the United States of America once said "He who controls the money supply of a Nation controls the Nation".

Garfield’s statement has become contentious today after the new-fangled concept called Bitcoin came into effect. Hitherto, all transactions of legal tender involved triad - the giver, the receiver and the guarantor. In India, the Guarantor to all Indian currency notes is the Central Bank, i.e. Reserve Bank of India and the Government of India for one rupee coins.

The Pioneering concept of Bitcoin is an initiative to eliminate the third party i.e. the Guarantor. Bitcoin is the first decentralized digital currency that can be sent by one person to another through Internet. This is an Innovative Internet Protocol created by Pseudonymous Satoshi Nakamoto. Bitcoin by itself does not represent anything in the physical world, they only have value because people are willing to trade real goods and services for a higher number next to their account and believe others will do the same. The numbers only have value because we believe they have value, just like any other fiat currency.

Once Bitcoin wallet is installed on computer / mobile device, first bitcoin address is generated. Just like any Savings Bank account, to spend bitcoins, one should have unspent balance of Bitcoins in their account.

Bitcoin can be bought from currency exchanges across the world and can be bought by exchanging Dollars, Euros, etc… Bitcoin network is secured by individuals called MINERS. The transactions are recorded in a transparent public ledger, called Block chain after being appropriately verified by the Miners.

For A to send money to B, the sender just broadcasts a message to all the nodes with the sender and the receiver’s accounts and the amount to be transferred. Every node that receives the message will update their copy of the ledger and pass along the transaction message. For the nodes to be sure that the request is from the rightful owner, bitcoin rules requires a unique password, which is in the form of a digital signature for each and every transaction to unlock unspent funds. A digital signature works by utilizing two different but connected keys, a private key to create a signature and a public key that others can use to check it. The signature generation algorithm is based on complex mathematical formulae.

Benefits of Bitcoin:

Business today has expanded to leaps and bounds across the world and hence a medium of transfer involving minimum / no intermediaries would be a boon to the businessmen. Customary wire transfers and foreign purchases encompasses in itself huge fees and exchange costs. Elimination of intermediary institutions or government involvement keeps the transaction cost very low.

Additionally waiting time involved in a transfer is also kept to the minimum due to the elimination of typical authorization requirements.

Cons of Bitcoin: Treating the virtual currencies as goods or services and applying "Goods and Services Tax, 2017" would be a step backward.

Reserve Bank of India, the Central Bank has issued three press releases cautioning the risks of virtual currencies via 2013-2014/1261 dated 24th December 2013; 2016-17/2054 dated 1st February 2017; and 2017-2018/1530 dated 5th December 2017 on the following grounds:

i. There is no underlying or asset backing for virtual currencies, the value of bitcoins hugely depends on the value created by its demand. Hence volatility remains a huge challenge due to its unregulated nature of operation.

ii. Chargebacks / refunds are not in the visibility for bitcoins. The Block-chain technology only ensures that the authenticity of the request for transfer from the owner. The authenticity of the transaction by itself is not guaranteed anywhere.

iii. Virtual currencies being stored in a digital media are exposed to risks like hacking, malware attack, access credentials being compromised, loss of e-wallets, etc. There is no central agency to depend on, once lost would mean lost forever.

iv. Creation of bitcoin addresses doesn’t necessitate any proof/declaration of source / usage of funds for legal purposes. Hence if the transaction though performed with a good intent based on trust by one party, may be used for illegal activities by the other party thus leading to breach of Anti-money laundering / Combating the Financing of Terrorism Laws

v. Bitcoin / any other virtual currency has not been assigned any legal status in India till date.

Tax policies on Bitcoin across the world:

In the recent days, Bitcoin has stretched its quills from merely being used as payment method to being used as a speculative investment instrument. As we have always "Trained our mind to see good in every situation" so as the Taxmen. Let’s understand how the tax policies are framed with reference to bitcoins in various countries. Bitcoins / other virtual currencies are legal recognized in some countries and are either treated as a legal tender or an asset, While it is utterly outlawed in some countries like Bangladesh, Ecuador, Thailand, etc. owing to the disadvantages it brings with itself.

1. Japan, European Union:

Bitcoin has been officially recognized as a Payment method and a distinctive status as an "Asset like value" has been assigned to virtual currencies in these countries. Hence the liability to offer the profits gained from its sale / purchase as Business Income if the income arises out of trading activities, And as Capital Gains Tax if the income arises out of Investment activities arises.

Japan originally subjected the virtual currencies to consumption tax i.e. Goods and Services Tax but subsequently withdrew it by treating the Virtual currency as an "Asset like value" effective 1st July 2017.

2. United States, Australia:

In countries like United States & Australia, Bitcoin is treated as a property rather than as a currency for federal tax purposes. If there is some purchase of goods/ services in exchange of bitcoin, the fair market value of bitcoin as on date of receipt of bitcoin in USD /AUD as the case may be, by the tax payer shall be declared in the tax return.

3. Russia, India:

As on date no legal status has been given for virtual currencies by countries like Russia and India. While Russia is already presenting the draft regulations to the Russian State Duma, and suitable steps are taken to obtain a legal recognition to virtual currency at-least by 2018, India’s Central Bank is still in its nascent stage trying to comprehend what the digital world has got to offer.

Recommendation - India Taxation policy:

Digital India being the slogan preached by the Indian Prime Minister, virtual currencies certainly needs a legal recognition. Adopting the Lessons learnt from Japan’s Things Gone wrong is the need of the hour. Hence treating the virtual currencies as goods or services would be a step backward. Best practices should be followed by treating the Virtual currency as "Asset like value" and thereby recognised as a legal tender by the Reserve Bank of India.

The next matter up for debate would be whether Virtual currencies would be under the purview of Goods and Services Tax or Income Tax. The following definitions should be examined before concluding on whether Virtual currencies would be the subject matter of GST in India.

i. Sec 2(55) of the Central Goods and Services Tax (CGST), 2017 defines "Goods" as every kind of moveable property other than money and Securities.

ii. Sec 2(102) of the CGST, 2017 defines "Services" as anything other than goods, money and Securities.

iii. Sec 2(75) of the CGST Act, 2017 defines "money" as the Indian legal tender or any foreign currency, cheque, promissory note, bill of exchange, letter of credit, draft, pay order, traveller cheque, money order, postal or electronic remittance or any other instrument recognised by the Reserve Bank of India when used as a consideration to settle an obligation or exchange with Indian legal tender of another denomination but shall not include any currency that is held for its numismatic value.

On a conjoint reading of all the above definitions, if Virtual currencies is being recognized as a legal tender and is treated as an "Asset like value" by the Reserve Bank of India, taxing it under the GST net would be out of question.

Hence Virtual currencies would be covered under the scope of Income tax and profits earned out of bitcoin from trading activities should be treated as Business Income and profits earned out of bitcoin from Investment activities should be treated as Income from Capital gains.

As Albert Einstein quoted "Ultimate automation will make our modern industry as primitive and outdated as the Stone Age man looks to us today" - going digital is no longer an option, it is the default. To achieve the vision of being a developed Nation, India needs to keep pace with other developed countries in understanding the nature of virtual currencies and outlining legal framework accordingly.

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