[Editorial] Taxing Cryptocurrency Transactions

What is the current state of cryptocurrency?

  • Though the RBI has been favouring a complete ban on cryptocurrency, they continue to proliferate.
  • This is notwithstanding the eventual introduction, in the Parliament, of the Cryptocurrency and Regulation of Official Digital Currency Bill.
  • Estimates suggest that some 10 crore Indians have already invested in cryptocurrencies with investments exceeding $10 million in total.

What are the implications from tax perspective?

  • This trend of investment means that there is a potential avenue for generating tax revenue. However, the tax authorities face a Herculean task in tracking and taxing transactions involving cryptocurrencies.
  • The 1961 IT Act (Income Tax Act) doesn’t specifically mention cryptocurrency, but it casts a wide net to bring crypto transactions under its purview.
  • Cryptocurrency trading may be considered as transfer of a ‘capital asset’, which is taxable under the head of ‘capital gains’.
  • If the cryptocurrencies are held as stock-in trade by the people and they are traded frequently, they will attract taxation under the head of ‘business income’.
  • If one were to argue that cryptocurrency transaction doesn’t fall under either of these categories, Section 56 of IT Act would come into play i.e. such transactions would be taxable under the head of ‘other sources of income’.
  • However, this isn’t sufficient to enable taxation of cryptocurrency transactions. A simple but effective tax regime is needed for cryptocurrencies as they are unlike other asset classes given how they are stored and traded virtually. The various challenges associated with the crypto must be addressed to streamline the process.

What are the challenges?

  • Absence of explicit tax provision:
    • This has resulted in uncertainty and the adoption of various interpretations with regards to the computation mode, determination of applicable tax rates and tax heads, loss and carry forward, etc.
    • Eg: lack of clarity about the income head under which trading of self-generated cryptocurrency (through mining, air drop, etc.) is to be taxed. If taxed under capital gains, there are questions about what the acquisition cost is (for computation purpose). While this acquisition cost could be taken as the fair market value of that particular cryptocurrency (on date of generation), there are again questions on how such a value can be arrived at. The crypto-exchanges don’t provide the consistent rates and hence determining the fair market value would be difficult.
    • There are also divergent views on whether such incomes should be considered as ‘business income’ or ‘other sources of income’– which are taxed at individual tax rate slabs.
    • There is a lack of clarity on how the value of cryptocurrency received as payment for goods and services should be determined.
  • Identification of tax jurisdiction:
    • People could engage in multiple cryptocurrency transactions, spanning several countries, and could store cryptocurrencies in online wallets on foreign servers. In this light, it is difficult to determine the correct tax jurisdiction for such transactions.
    • Consequently, it becomes difficult to determine which jurisdiction’s tax laws apply and what type of tax treatment should be effected on the transactions. This is especially so because of the differing tax treatment of crypto assets in various countries- including a general ban in some countries.
  • Anonymity:
    • In cryptocurrency transactions, the identity of the transacting party tends to remain anonymous as crypto-addresses have a string of alphanumerical characters (not the party’s identity).
    • This is exploited by tax evaders to park black money abroad and fund terrorism and other criminal activities.
  • Lack of third party information:
    • This makes it difficult to scrutinize and identify cases of tax evasion.
    • CASS or Computer Aided Scrutiny Selection of assessments an efficient enforcement tool used by the IT department in which taxpayers’ returns are selected inter alia based on information from 3rd party intermediaries like banks.
    • In case of cryptocurrency transactions, intermediaries like wallet providers, network operators, exchanges and miners are unregulated. In this case, gathering such information is difficult.
    • This information vacuum mean that authorities don’t have much options for verifying crypto transactions that do get reported. They are forced to depend entirely on the information provided by the taxpayer.
  • Lack of traceability:
    • Even if intermediaries are regulated and KYC norms are followed in the cryptocurrency ecosystem, there is a possibility that physical currency or goods/ services could be exchanged for cryptocurrencies.
    • Such transactions are difficult to trace and enable tax evasions.

What is the way ahead?

  • Need to put in place clear income tax laws pertaining to cryptocurrency transactions. These should incorporate detailed statutory provisions including definitions of crypto assets (for taxation purpose) and guidelines to address major taxable events and income forms associated with cryptocurrencies.
  • Need to undertake extensive awareness creation campaigns about these laws among the taxpayers.
  • To prevent cryptocurrency transactions going unreported, the practice of separate mandatory disclosure requirements in tax returns (like in the USA) should be adopted for the taxpayers and the intermediaries.
  • The existing international legal framework for information exchange should be strengthened to enable smooth collection and sharing of information on cryptocurrency transactions. This will help with linking digital profiles of cryptocurrency holders with real identities.
  • Need to impart training on blockchain technology to tax authorities. The UNODC CMLS (UN Office on Drugs and Crime’s ‘Cybercrime and Anti-Money Laundering’ Section) has developed a unique training module to help equip tax officers with necessary understanding on the underlying tech.
  • Tax authorities must be equipped with the latest forensic software such as Elliptic Forensics Software (used by the US Internal Revenue Service) and the GraphSense (used in the EU). These softwares can analyse large volumes of transactions to identify suspicious cases.

Conclusion:

Cryptocurrencies are here to stay and are set to cause a disruption in the taxation sphere. To create a clear, adaptive and constructive regulatory environment for the cryptos, the tax regime must be streamlined.

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