The proposed taxation of virtual digital assets, among other things, creates ambiguity on many aspects of ‘acquisition costs’

By Sunil Badala & Rinkesh Devnani

Budget FY23 proposed to impose a tax on virtual digital asset (VDA) gains at a flat rate of 30%. Given the VDA frenzy and the size and frequency of VDA transactions, the government considered it necessary to provide for a specific tax regime in order to allay any concerns about how income from such transactions will be taxed. The flat rate of 30% corresponds to the rate that applies to winnings from lotteries, games, etc. Due to the applicability of the highest slab rate, many investors may turn away from VDA; perhaps that is the intention of the government, in view of the risks, money laundering problems and the lack of adequate regulations.

The bill defines VDA in a very broad way and includes any virtual currency (other than those recognized under the currency regulations), a non-fungible token, or any other digital asset as may be reported by the government. Given this, the central bank digital currency (CBDC) proposed by the governments should be out of the reach of the VDA.

The bill proposes to calculate profits by only reducing the acquisition costs of VDA. Other costs/losses are not deductible. VDA’s losses may not be offset against other income and may not be carried forward. In addition, any gift from VDA is taxable in the hands of the recipient at fair market value.

The intent behind the specification of the above tax mechanisms seems to be aimed at ensuring symmetry and a common standard for the taxability of profits from VDA, and to some extent discourage speculation in VDA. That said, specified calculation mechanisms can fall short in many situations. Clarity should be provided regarding the following situations to reduce potential lawsuits:

It should be clarified that the loss of one VDA can be offset against the profit of another. There is no definition of the term ‘acquisition costs’. Although this term is defined in the context of capital gains, it is not clear under which title the profits from VDA are taxable. No mechanisms are specified to determine the fair market value in the case of a donation from VDA. Furthermore, there is no clarity as to what the acquisition costs of VDA will be in the hands of the recipient of such a gift when she eventually sells the VDA. Again, in the context of capital gains, it is determined that the fair value on which the recipient has already paid tax at the time of receipt of the gift is considered the acquisition price at the time of disposal of such assets.

As mentioned before, it is not clear under which heading the VDA profits are taxable and this can therefore lead to double taxation.

It should be clarified how the acquisition cost should be determined where the VDAs are acquired through mining. What is the place (the place to which, for purposes of legal jurisdiction or taxation, a property belongs) of a VDA? This is relevant in the case of non-residents acquiring VDA in India. Likewise, clarity of the situation will help determine the tax rights of the offshore jurisdictions (subject to the tax laws of such offshore jurisdictions), as the provisions apply from April 1, 2022, questions are already being raised about how the past earnings may be determined and the rate at which such gains are taxable. The proposed law also provides for a tax deduction by the buyer from payment to the seller. Therefore, in case of exchange of VDAs (for example, when NFTs are obtained using Bitcoin), both parties to the transaction will have to deduct tax. Moreover, most of the VDA transactions in India take place through crypto exchanges where the buyers and sellers do not know each other. In such a situation, it is difficult for the buyers to meet this requirement. This obligation may rest on the exchanges that facilitate trading.

All of this is just an illustrative list of issues that may arise given the proposed provisions for taxing profits from VDA. The position also needs to be clarified from an indirect tax point of view as the GST authorities recently investigated several crypto exchanges for defaults from an indirect tax point of view.

In the interest of all stakeholders, the government should clarify the ambiguous points, both from a direct and indirect tax point of view, in order to avoid potential lawsuits. This will certainly boost the innovative spirit of this nascent industry and the possible beneficial use cases for society as a whole.

Respectively partner and head, financial services, tax, KPMG in India and chartered accountantConsiderations are personal

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