THE POLICY LAB (TPL) - 59
JANUARY 29, 2025

By J B Mohapatra

A: Neither a principal regulation on virtual digital asset (VDA) has been notified nor any specific principal regulator for VDA designated in India thus far, but there is no denying the fact that many significant statutory sub-systems underpinning the VDA have gradually come into effect.

First, the notification dated 24-3-21 u/s 467 of the Companies Act, 2013 has amended schedule III of the Act which requires disclosure from companies with regard to details of crypto currency or virtual currency in the statement of profit and loss, including

(a) disclosure of profit or loss on transactions involving crypto currency or virtual currency

(b) amount of currency held as at the reporting date,

(c) deposits or advances from any person for the purpose of trading or investing in crypto currency/ virtual currency.

Second, section 115BBH in the Income Tax Act (ITA) has been introduced vide Finance Act 2022 providing for definition of VDA ITA. It includes the manner of determining profits for the purposes of that section, the specific taxation methodology and the rate at which the surplus is to be taxed.

Third, PMLA, 2002, a notification dated 7-3-23 has been issued u/s 2(1)(sa)(vi) (which authorises the government to designate any person carrying on such other activities to ensure his discharge of reporting obligations under the Act) notifying reporting obligations for VDA exchanges which facilitate

(i) exchange between virtual digital assets and fiat currencies

(ii) exchange between one or more forms of virtual digital assets

(iii) transfer of virtual digital assets

(iv) safekeeping or administration of virtual digital assets or instruments enabling control over virtual digital assets and

(v) participation in and provision of financial services related to an issuer's offer and sale of a virtual digital asset,

and thereby casting reporting obligations on that new class of persons.

The legislative development under various laws on VDA through amendments to existing statutes despite lack of any single principal regulation on VDA throws up two interesting questions:

(a) are more and more functional attributes of VDA getting progressively addressed in those amendments ? and

(b) while there is one regulator for taxation under the ITA and two for reporting under PMLA and the Companies Act for VDA respectively, has there been an implicit judicial approval for a fourth one ?

B: First, the question- "are more and more functional attributes of VDA getting progressively addressed in those amendments":

At least there is uniformity in the definition as to what constitutes VDA in ITA and in the Department of Revenue (DOR) notification.

DOR Notification defines VDA in the Explanation below its notification as follows: "For the purposes of this notification "virtual digital asset" shall have the same meaning assigned to it in clause (47A) of section 2 of the Income-tax Act, 1961 (43 of 1961)".

Definition of VDA in section 2(47A) of the ITA is as below:

"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:

Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein.

Explanation.-For the purposes of this clause,-

(a) "non-fungible token" means such digital asset as the Central Government may, by notification in the Official Gazette, specify;

(b) the expressions "currency", "foreign currency" and "Indian currency" shall have the same meanings as respectively assigned to them in clauses (h), (m) and (q) of section 2 of the Foreign Exchange Management Act, 1999 (42 of 1999);]"

C: In essence, ITA has drawn upon FATF's definition of virtual asset quoted below in configuring its own definition of VDA. The definition of VDA as per FATF is:

"Virtual asset" as a digital representation of value that can be digitally traded or transferred and can be used for payment or investment purposes. Virtual assets do not include digital representations of fiat currencies, securities, and other financial assets that are already covered elsewhere in the FATF recommendations"

D: MCA's notification dated 24-3-21 inserting the additional disclosure requirements for VDA did not define VDA one way or the other.

E: While the definition of VDA in ITA follows the FATF's, both saying that (a) VDA is a digital representation of value which can be stored, transferred or traded electronically (b) VDA does not include digital representation of fiat currencies (c) VDA is capable of being used for conducting a financial transaction, and (d) VDA equally can be used for investment purposes, the methodology in ITA for the purpose of taxation explicitly included 3 of the above 4 attributes/ functions, and did not elaborate in any manner the 4th attribute, as italicized above.

Methodology for taxation explicitly stated in ITA are these:

(i) VDA can be purchased and sold, whether for the purposes of trading or for investment, and in both cases, surplus is to be taxed u/s 115BBH in the manner outlined therein;

(ii) in case of transfer of VDA without consideration or for inadequate consideration, VDA is liable to be included within the definition of 'property' and taxed as income from other sources u/s 56(2)(x).

The only area where ITA did not provide for a methodology for taxation or any guidance, vis a vis the inclusive definition of VDA that it had configured at par with FATF's definition is the statutory consequence if VDA were to be employed or found to have been employed for conducting any financial transaction other than for trading or for investment, in short VDA being used as a medium of exchange.

F: MCA's notification though not defining VDA per se while demanding disclosure of profit or loss on transactions involving VDA has specifically brought in disclosure requirements for the purpose of trading or investing in VDA. There is nothing explicit with regard to disclosure of any other matter included in FATF/ITA's definition of VDA or when VDA is used as an instrument for conducting a financial transaction.

G: While the provision with regard to VDA in ITA or the reporting requirements for VDA under the Companies Act, 2013 or under PMLA, 2002 stopped short of elaborating on the functional capability of VDA as a medium of exchange at par with FATF's definition, one amendment to the CGST Act and another to the CGST Rules in 2023 do appear to have moved the needle. First, the amendment to the CGST Act in August, 2023 to insert section 2(117A), which runs as below:

"'virtual digital asset' shall have the same meaning as assigned to it in clause (47A) of section 2 of the Income-tax Act, 1961;"

Two, the amendment to the CGST Rules and insertion of Rule 31B (value of supply in case of online money gaming) dated 29-9-23 vide notification 51/2023 reproduced below:

"Notwithstanding anything contained in this chapter, the value of supply of online gaming, including supply of actionable claims involved in online money gaming, shall be the total amount paid or payable to or deposited with the supplier by way of money or money's worth, including virtual digital assets, by or on behalf of the player:

Provided that any amount returned or refunded by the supplier to the player for any reasons whatsoever, including player not using the amount paid or deposited with the supplier for participating in any event, shall not be deductible from the value of supply of online money gaming."

Thus in the case of online gaming, both - the consideration for the supply and the actionable claim are now statutorily permitted through an additional avenue, that is VDA. Acknowledgement of VDA as a store of value that can be exchanged for a specified actionable claim is clear from the amendments to the CGST Act and the Rules, and CGST in that context should be the first among the fiscal statutes thus far in explicitly recognising VDA as a medium for payment.

Thus answer to the question- "are more and more functional attributes of VDA getting progressively addressed in those amendments"- is yes, and amendment to CGST Act and the Rules testifies to that.

H: To the question- "while there is one regulator for taxation under the ITA and two for reporting under PMLA and the Companies Act for VDA respectively, has there been an implicit judicial approval for a fourth one"-, one needs to refer to SC judgement of 2020 in the case of Internet and Mobile Association of India vs RBI in WP (Civil) No 528 with 378 of 2018 = 2020-TIOLCORP-09-SC-MISC-LB in respect of a petition questioning the legality and constitutionality of RBI circular dated 6-4-18 whereby RBI invoking its powers under various provisions of Banking Regulation Act, 1949, RBI Act, 1934 and under section 10(2) and 18 of the Payments and Settlement Systems Act, 2007 (PSS Act, 2007) directed its regulated entities meaning banks not to deal in virtual currencies and refrain from providing services to any of their constituents in dealing with or settling virtual currencies. While the RBI had claimed in the said proceeding its competence under the law to have issued the circular citing section 10(2) and 18 of the PSS Act, 2007 to its regulated entities, the petitioners disputed that claim. Reasoning in support of RBI's case that it has the jurisdiction and competence under the PSS Act, 2007 to have issued the circular which found favour in SC's aforesaid judgement are:

(a) no matter virtual currency does not satisfy all the characteristics of fiat money, matter of regulation under the PSS Act by RBI can extend to virtual currency as well. Para 6.65 of that judgement reads: "But we do not think that RBI's role and power can come into play only if something has actually acquired the status of a legal tender. We do not also think that for RBI to invoke its power, something should have all the four characteristics or functions of money."

(b) on the basis of what are stated in the statement of objects and reasons of PSS Act, 2007 empowering the RBI to regulate and supervise various payment and settlement systems in India including those operated by non-banks, card companies, other payment system providers and the proposed umbrella organization for retail payments, "the statutory obligation that RBI has, as a central bank, (i) to operate the currency and credit system, (ii) to regulate the financial system and (iii) to ensure the payment system of the country to be on track, would compel them naturally to address all issues that are perceived as potential risks to the monetary, currency, payment, credit and financial systems of the country" (para 6.87), and the power of supervision by the central bank extends to virtual currency as well.

(c) That "the expression "management of the currency" appearing in Section 3(1) need not necessarily be confined to the management of what is recognized in law to be currency but would also include what is capable of faking or playing the role of a currency" (para 6.90)

(d) 4 provisions of the PSS Act, 2007 have been prominently analysed by the SC in course of its judgement.

First, section 18 of the PSS Act, which reads as follows:

"Power of Reserve Bank to give directions generally.-

Without prejudice to the provisions of the foregoing, the Reserve Bank may, if it is satisfied that for the purpose of enabling it to regulate the payment systems or in the interest of management or operation of any of the payment systems or in public interest, it is necessary so to do, lay down policies relating to the regulation of payment systems including electronic, non-electronic, domestic and international payment systems affecting domestic transactions and give such directions in writing as it may consider necessary to system providers or the system participants or any other person either generally or to any such agency and in particular, pertaining to the conduct of business relating to payment systems."

Second, section 2(1)(i) which reads as below:

"payment system" means a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange

Explanation.--For the purposes of this clause, "payment system" includes the systems enabling credit card operations, debit card operations, smart card operations, money transfer operations or similar operations;"

Third, section 2(1)(q) defining a "system provider" to mean "a person who operates an authorised payment system"

Fourth, section 2(1)(p) defining a system participant to mean "a bank or any other person participating in a payment system and includes the system provider"

I: At para 6.109 of the judgement building upon its reading of the provisions in the PSS Act and inter alia holding that RBI has competence under the Act to issue a circular to the banks in the context of virtual currency, SC says the following:

".. the impugned circular is primarily addressed to banks who are "system participants" within the meaning of section 2(1)(p). The banks certainly have a system of payment to be effected between a payer and a beneficiary, falling thereby within the meaning of the expression payment system."

When SC proceeded to hold banks as system participants in the payment system within the meaning of PSS Act, 2007 in context of virtual currency, it never could have intended that banks are the only system participants in the payment system involving virtual currency nor could it have failed to notice the existence of a system provider in the virtual currency payment system under which the system participants operate.

It follows therefore that just as the banks, payment gateways and payment aggregators comprise the system participants in the payment system involving discharge of payment obligations in fiat currency, SC's judgement irresistibly leads to an inference that the provisions of PSS Act, 2007 if it were applicable to the banks would be equally be applicable to the virtual asset service providers who are engaged in settlement and clearing or lending and borrowing or custodial and non-custodial wallet provisioning etc as well. RBI in so far as it successfully defended its position for issuing the circular u/s 18 of the PSS Act before the SC, as per the meaning derived from the SC judgement above, could not be any one other than that designated authority for the regulation and supervision of the VDA payment system under the PSS Act, 2007.

Answer therefore to the question- while there is one regulator for taxation under the ITA and two for reporting under PMLA and the Companies Act for VDA respectively, has there been an implicit judicial approval for a fourth one- is yes.

J: While India prepares its stance qua the fast paced developments world-wide on VDA, we must not lose sight of the legislative history that has been crafted and build forward on those foundations.