Taxing Cryptocurrency transactions

News: As many as 10 crore Indians may already have investments exceeding a total of $10 million in Cryptocurrencies.

This not only creates an avenue for generation of tax revenue, but also puts forth a huge challenge for the tax authorities who have to track and tax transactions involving cryptocurrencies.

What is the current legal framework for taxing Crypto transactions?

The Income Tax Act, 1961 does not specifically mention cryptocurrencies. Still, it has the following categories under which Crypto transactions can be taxed:

– Capital asset: Trading in cryptocurrency may be classified as transfer of a ‘capital asset’, taxable under the head ‘capital gains’.

– Business income: However, if such cryptocurrencies are held as stock-in-trade and the taxpayer is trading in them frequently, the same will attract tax under the head ‘business income’.

– Other sources of income: Even if one argues that crypto transactions do not fall under the above heads, Section 56 of the IT Act shall come into play, making them taxable under the head ‘Other sources of income’.

But, this is not sufficient for an effective Cryptocurrency taxation regime. Many challenges need to be overcome.

What are the challenges that need to be tackled with?

1) Absence of explicit tax provisions has led to uncertainty and varied interpretations related to mode of computation, applicable tax head and tax rates, loss and carry forward, etc.

For instance, the head of income under which trading of self generated cryptocurrency (currencies which are created by mining, acquired by air drop, etc.) is to be taxed is unclear.

2) Identifying tax jurisdiction: It is often tricky to identify the tax jurisdiction for crypto transactions, as taxpayers may have engaged in multiple transfers across various countries. Moreover, the cryptocurrencies may have been stored in online wallets, on servers outside India.

In such cases, it becomes difficult to pinpoint which jurisdiction’s tax laws would become applicable, especially when various nations have differing tax structures for crypto assets.

3) Anonymity provided by Cryptocurrency: Each crypto address comprises a string of alphanumeric characters and not the person’s real identity, giving tax evaders a cloak of invisibility. Tax evaders have been using this to park their black money abroad and fund criminal activities, terrorism, etc.

4) The lack of third party information on crypto transactions makes it difficult to scrutinise and identify instances of tax evasion. Crypto-market intermediaries like the exchanges, wallet providers, network operators, miners, administrators are unregulated and collecting information from them is very difficult.

5) Even if the crypto-market intermediaries are regulated and follow KYC norms, there remains a scenario, where physical cash or other goods/services may change hands in return for cryptocurrencies. Such transactions are hard to trace, and only voluntary disclosures from the parties involved or a search/survey operation may reveal the tax evaders.

What is the way forward?

– Clear Income-tax laws pertaining to the crypto transactions with detailed statutory provisions.

– Extensive awareness generation among the taxpayers

– Mandatory disclosure requirements in tax returns for both taxpayers and intermediaries (as is the case in the United States)

– Strengthening the existing international legal framework for exchange of information. This will enable collecting and sharing of information on crypto-transactions. This will go a long way in linking the digital profiles of cryptocurrency holders with their real identities.

– Training officers in blockchain technology. United Nations Office on Drugs and Crime’s ‘Cybercrime and Anti-Money Laundering’ Section (UNODC CMLS) has developed a unique cryptocurrency training module, which can aid in equipping tax officers with requisite understanding of the underlying technologies.

– Authorities should have access to latest forensic software (such as Elliptic Forensics Software is being used by the USA Internal Revenue Service and GraphSense used in the European Union) which can analyse a high volume of crypto transactions at a time and raise red flags in cases of suspicious transactions.

Source: This post is based on the article “Taxing Cryptocurrency transactions” published in The Hindu on 17^th Jan 2022.