Understanding the taxability of income from Cryptocurrency
AUGUST 13, 2021
By Ravi Raghavan, Advocate and Senior Partner, Parvathy R. Kartha, Senior Associate & Laksh Manocha, Advocate and Associate, at Lakshmikumaran & Sridharan, Bangalore
THERE has been a lot of buzz around investing in cryptocurrencies since the last year in the Indian Market and everyone is intrigued by what the digital currency holds for them. With the very volatile nature of the currency, people have been investing for both short term and long term gains. But what exactly is cryptocurrency?
As the name suggests cryptocurrency is digital currency which is considered safer than real money as it uses the technology of cryptography. In simple words, the code that is written in comprehensive words is converted into complicated codes that are difficult to "crack" or decrypt, hence ensuring highest level of security when it comes to safeguarding the money invested. Over the recent years, various economies have started recognizing cryptocurrencies and have given them legal status, which has over the time directed more investments in cryptocurrencies. Bitcoin was the first ever cryptocurrency to be introduced in 2009 and currently is synonymous to the word cryptocurrency.
However, with the growth of investments and lack of regulatory framework in India, investors are still unaware of how income generated from trading in cryptocurrency will be treated. Changes by way of amendments to the law have not yet been made as there is still ambiguity regarding the legal status of cryptocurrency. The RBI Circular in 2018 1 had banned trading and possession of cryptocurrency. However, the said Circular was set aside by the Supreme Court in March, 2020 2 . Subsequently, there has been no clarification as such on regulatory aspect of cryptocurrency. One of the major concerns of the investors has been the taxability of income earned by transacting in cryptocurrency. To understand the issue better and to analyze how such transactions will be taxed, it becomes pertinent to understand the methods of acquiring cryptocurrencies.
Methods of acquiring Cryptocurrency
Cryptocurrency can be acquired by either of the two ways: Mining or Trading. Cryptocurrency mining is the name given to the process that involves solving a bunch of extremely complex mathematical problems/puzzles and as reward of which a token is given which is nothing but the cryptocurrency token itself. Mining is a process that is not just done to bring in new crypto tokens into circulation but also to keep a check on the blockchain ledger.
To understand what mining is like let us take this example. Suppose a person A has two 20$ bills, one fake and one real, he is able to spend both of them, now your job is to verify that the same 20$ bill has not been spent twice and you will have to do that by verifying the serial number etc. Akin to this, a bitcoin miner has to verify and make sure that the same bitcoin is not used twice. Once the miner verifies 1 MB worth of bitcoin transactions he/she is rewarded with a bitcoin. 3 But such reward is sporadic and not everyone who verifies the data will be rewarded. Mining is a long process that involves use of highly sophisticated computers and it is painstaking, costly and only sporadically rewarding.
The other way of procuring them is via the exchanges. India at the moment has CoinDCX, WazirX among other exchanges, where cryptocurrencies can be bought and sold. These exchanges let you procure these cryptocoins in exchange of real money. This is the most common way of procuring bitcoins currently.
With the looming ambiguity over the regulations and directives from the government, this article attempts to analyse how income from cryptocurrency may be taxed.
Taxation under Income Tax Act, 1961
Income chargeable to Income Tax is classified into the following 5 heads of income for the purpose of computation viz.:
- Salaries;
- Income from house property;
- Profits and Gains of Business or Profession (' PGBP ');
- Capital Gains- any profits or gains arising from transfer of a capital asset is taxable under the head Capital Gains; and
- Income From Other Sources (' IFOS ')- Income chargeable to tax but which is not classifiable under any of the aforesaid heads of income, is taxed under the head IFOS.
Each head of income dictates separate computation mechanism and rates of tax. Therefore, it is vital or essential to characterise the income under either of the 5 heads of income for understanding its taxation under Income Tax.
Scenario 1- Purchase of bitcoins
In case of purchase of bitcoins, the probable heads of income that are to be analysed are Capital Gains and IFOS. Only taxable income which is not chargeable under any other head of income is chargeable under the head IFOS. Therefore, analysis of taxation of income earned from sale of purchased bitcoins involves testing whether:
- Such income would fall under the head Capital Gains?
- If the answer to the same is in the negative, then test whether the same falls under the head IFOS.
As mentioned above, profits or gains arising from transfer of a capital asset is taxable under the head Capital Gains. The terms capital asset has been defined under the IT Act 4 to mean property of any kind held by an assessee, whether or not connected with his business or profession. The term 'property of any kind' has not been defined under the IT Act. Therefore, applying the principle of Noscitur a Sociis which means that when there is ambiguity, the word should be read in the context it has been presented in , the expression can be said to be having the widest amplitude 5, thereby including within its ambit possession of any kind i.e. tangible and/or intangible. Accordingly, it may be said that cryptocurrency/bitcoins would qualify to be capital asset.
Thus, income earned from sale of bitcoins purchased would be assessed to Income Tax under the head Capital Gains.
Scenario 2- Mining of bitcoins
In case of cryptocurrencies earned by way of mining, the probable heads of income that are to be analysed are PGBP, Capital Gains and IFOS. As discussed supra , the income earned from sale of bitcoins earned by way of mining is to be tested under the head PGBP & Capital Gains to begin with and then IFOS, if required.
As discussed above, bitcoins qualify to be capital asset. Therefore, the income earned from sale of bitcoins earned by way of mining can be assessed under the head Capital Gains.
Section 48 of the IT Act provides for the computation mechanism for income chargeable under the head Capital Gains i.e.:
Full value of consideration received towards transfer of capital asset
Less: expenditure incurred wholly and exclusively in connection with such transfer
Less: cost of acquisition of the asset and cost of improvement thereto
In the case of bitcoins earned by way of mining, there is no cost incurred towards acquisition of such bitcoins. Accordingly, a doubt arises whether the income earned on sale of bitcoins earned by mining can be taxed as Capital Gains when the computation mechanism cannot be fulfilled.
The mode of computation and deductions provide the principal basis for quantifying the income chargeable under the head Capital Gains. What is contemplated under Section 48 of the IT Act is an asset, in the acquisition of which it is possible to envisage a cost 6. I n case of a self-generated intangible asset, the cost of acquisition of such an asset is incapable of determination. Therefore, where the cost of capital asset cannot be determined, the same cannot be taxed under the head Capital Gains. Accordingly, income earned on sale of bitcoins earned by mining cannot be taxed under the head Capital Gains.
Given the same, the next head of income to be tested is PGBP. The question that needs to be analysed in the present case is, whether the activity of mining qualifies to be business under the IT Act. Any profits or gain of business or profession carried on by the assessee is taxable under the head PGBP. The term 'business' has been defined 7 to include any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. It may be noted that the definition is inclusive and, therefore, is not exhaustive.
Basis the various judicial precedents 8, the activity of mining bitcoins may qualify to be business on the following grounds:
- the activity of mining involves consistent and systematic efforts over a period of time;
- the bitcoins are mined with an intent to re-sell the same in future and earn profit;
- the fact that the mining activity is unconnected to the business/profession otherwise undertaken by the miner does not preclude mining activity to be in the nature of business
Thus, income earned by a miner upon sale of bitcoin earned by way of mining may attract taxation under the head PGBP.
In the present parliamentary session, the Lok Sabha bulletin had proposed to introduce the 'Cryptocurrency and Regulation of Official Digital Currency Bill, 2021' to be tabled before the lower house. With the lack of official directives issued regarding taxation of cryptocurrencies/bitcoins by the tax authorities yet, taxation of cryptocurrencies/ bitcoins remains an open debate with no clarity, specifically in case where the investor is a non-resident or the situs is outside India.
[The views expressed are strictly personal.]
1 Circular no. RBI/2017-18/154 dated April 6, 2018
2Internet and Mobile Association of India v. Reserve Bank of India (2020 SCC Online SC 275)
3How Does Bitcoin Mining Work?, https://www.investopedia.com/tech/how-does-bitcoin-mining-work/
4Section 2(14) of the Income Tax Act, 1961
5Haji Abdul Kader Sahib v. CIT [1961] 42 ITR 296 (Kerala HC)
6CIT v. B.C. Srinivasa Setty [1981] 5 Taxman 1 (SC) = 2002-TIOL-587-SC-IT-LB
7 Section 2(13) of the Income Tax Act, 1961
8 Narain Swadeshi Weaving Mills v. Commissioner of Excess Profits Tax [1954] 26 ITR 765 (SC) = 2002-TIOL-1328-SC-IT-CB; Lakshminarayan Ram Gopal and Sons v. Government of Hyderabad [1954] AIR 364 (SC); CIT v. Sutlej Cotton Mills Supply Agency Ltd. [1975] 100 ITR 706 (SC) = 2002-TIOL-1025-SC-IT-LB; G. Venkataswami Naidu & Co. v. CIT [1959] 35 ITR 594, 610, 622 (SC) = 2002-TIOL-179-SC-IT-LB
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