Megha Bhartiya is a second year student at RGNUL, Patiala
Introduction
On February 1, 2022, Union Finance Minister Nirmala Sitharaman delivered the budget speech for 2022-23. For the shortest speech since 2019, it included one of the most interesting updates for the cryptocurrency industry. A ‘crypto tax’ was introduced to tax the profits from continuous trade in cryptocurrencies. Gains generated from such trade would be taxed at a flat rate of 30 % and 1% TDS (Tax Deducted at Source). These currencies were referred to as ‘virtual digital assets’ in the budget speech, distanced from the term ‘cryptocurrencies.’ It is also a broader term covering all cryptocurrencies as well as non-fungible tokens (NFTs). Soon after, articles based on the notion that the tax announcement meant the legitimization of cryptocurrencies flooded the internet. From Economic Times’ “8 Best Cryptocurrency to Invest in for February 2022”, to Fortune reporting how India had taken “a step closer to adopting cryptocurrencies”. The prospect for digital currencies was for the crypto-enthusiasts. The environment for investment was congenial. However, a few months later, Fortune reported a 70% plummet in the crypto market due to several hurdles faced by investors. Recently the Business Standard predicted a harsh winter for crypto enthusiasts and trade volumes plunged over 80%. This begs the question, what went wrong?
In this blog, the author aims to answer this by countering the prevailing notion that the Union Budget announcement about the taxation of cryptocurrency in any way translated to the legalization of cryptocurrency in India. This will be done by deconstructing the underlying assumptions for believing the same. A flood of analysis of the announcement with positive and ill-informed feedback resulted in private investors believing that taxation was beneficial. They were, as we will discuss, celebrated prematurely. Why and how taxation of private cryptocurrency does not entail its legalization can be concluded by analyzing two key issues –why the assumption that taxation is legitimization is wrong and the relationship between Central Bank Digital Currency (CBDC) and private cryptocurrencies like Bitcoin, Litecoin, Ethereum and more.
Critical Appraisal:
Taxation does not entail Legalization
Before February 1, 2022, identifying the status quo of cryptocurrencies in India was relatively difficult. While two Reserve Bank of India statements and notices ordering all entities under it to not deal in digital currencies were struck down by the Supreme Court in 2020 in IMAI v. RBI after declaring them unconstitutional, this did not legitimize cryptocurrencies. This is because uplifting a ban cannot be equated to assigning legal status to the crypto trade. Moreover, the government’s approach towards digital currency remained, and still remains, apprehensive due to its decentralized nature and the anonymity it brings. After the budget speech, the Union Finance Minister chose to dismiss any misconception through a statement to the media where she explained that the legitimacy of such digital assets was not yet broached and consultations were ongoing. Currently, they were only taxing. She also pointed out how she does not see a digital asset developing out of the domain of the Indian sovereign as an Indian currency and thus refrains from calling it so. Thus, legitimization was ruled out by the Finance Minister explicitly. This begs the question, is the trade of cryptocurrencies illegal? Is the status quo the same as it was before the budget announcement? Most importantly, is taxation something crypto investors should celebrate?
Possession and trade of cryptocurrencies sustain in the grey area between legal and illegal and this persists even after taxation. The possible legality of private cryptocurrency is only speculative and nothing concrete can be interpreted without government and tax departments’ clarifications, and, before a statute for the same is passed by the Parliament. The status quo though is not the same, but the change may not necessarily be in a positive sense. This is because the public belief that taxation is in parity with legality is founded on the notion that only legal income can be taxed. This notion is proven false on several accounts; first, the Income Tax Act, 1961 does not differentiate between ‘legal’ and ‘illegal’ income and keeps its ambit wide. This entails that the Act includes all ‘legal’, ‘illegal’, and uncategorized income sources. Secondly, the Supreme Court in Commissioner of Income Tax (CIT) v. Piara Singh and the Madras High Court in CIT v. K. Thangamani have also not differentiated between legal or illegal income sources. Hence, any income source is taxable – including illegal and un-categorized sources. This implies that private cryptocurrencies like Bitcoin, Litecoin, Dogecoin, Ethereum, and more can be taxed now (as they have been) and may also never be legalized. This also opens room for the possibility that they may even be declared illegal in the future.
The Relationship between CBDC and Private Cryptocurrencies
Another highlight of the budget speech was the announcement that RBI will launch a Centrally Backed Digital Currency (CBDC) in FY23. This became another false pillar of hope for digital currency enthusiasts. The government’s intention to bring in a centrally backed up digital currency (likely to be tied to the value of the rupee) is a strong statement as to why it may not legitimize private cryptocurrency at all – for the simple reason that it is private in nature and beyond the control of the Indian sovereign. Moreover, a government-backed digital currency that is tied to the national currency’s value and private cryptocurrencies that have already been classified as ‘assets’ do not share anything in common except for the foundational technology and algorithm behind them. The structure and system of implementation remains different and so do the regulations that follow. Since digital currencies and assets are not ordinary trade commodities, the existence of both private and government-backed digital currencies in a market cannot be analyzed without analyzing who controls them in the economy. This is where it is difficult to regulate and direct the flow of private cryptocurrencies. If they are indeed legalized, it will entail several implications for how the central bank’s monetary transmission mechanism would work and its efficiency. This is essentially the foundation of why the government is skeptical of giving private digital currencies the status of legal tender. The belief that a future CBDC may also mean recognition for cryptocurrencies is thus, for the moment, misconceived. The government’s plans to bring a centrally backed digital currency is in fact, their strongest statement against the acceptance of private digital currencies.
Conclusion:
Curtailing Ill-informed Investments
The announcement hence did not bring any truly desired reform for the crypto investors apart from coming officially under the taxable bracket. The crypto market itself remains as volatile, if not more, as before (with its fair share of ups and downs), and the new influx of investments induced by the ‘taxation = legalization’ misconception must be curtailed. As the crypto trade plummets further, it is imperative that the crypto investors be aware of the legal implications of taxation of cryptocurrency. Additionally, it must be noted that current taxation also does not equate to future legalization. This is grounded in Government’s push towards CBDC by the next financial year. What now remains is to correct the assumptions of investors to ensure informed, strategic, and most importantly, free investment into the market.