Income TaxLevy of Income Tax on Virtual Digital Asset Transactions

INTRODUCTION

A Virtual Digital Asset (hereinafter referred to as “VDA”) refers to the digital representation of items that can be exchanged with or without consideration. It is a digital medium of property exchange that has value in certain technology-based environments.

Such assets can be traded and transferred digitally and can also be used for payment or investment purposes. An example of a VDA is ‘Bitcoin’ which is a form of cryptocurrency.

Within the realm of virtual currencies, Non-Fungible Tokens (hereinafter referred to as “NFT”) represent intangible or tangible assets like works of art and real estate. They are unique cryptographic tokens that exist on blockchain technology and cannot be replicated. They can be efficiently used for the virtual trading of real-world assets through blockchain.

This Blog shall discuss the levy of Income Tax on VDA transactions under the Income Tax Act, 1961 and the various Circulars and Notifications issued by the Central Government regarding VDAs, NFTs, crypto tokens and the levy of Income Tax on such assets.

VIRTUAL DIGITAL ASSETS UNDER THE INCOME TAX ACT, 1961

The Finance Act, 2022 which came into force on 25.03.2022, introduced several amendments to the Income Tax Act, 1961 (hereinafter referred to as “the IT Act”) which deal inter alia with VDA and NFT.

 The Finance Act, 2022 inserted Section 2(47A) in the IT Act, which defines VDA as any information or code or number or token, excluding Indian currency and foreign currency, providing a digital representation of value exchanged with or without consideration, generated through cryptographic means or otherwise.

According to Section 2(47A) of the IT Act, the promise or representation must have an inherent value or function as a store of value or a unit of account including use in a financial transaction or investment, not be limited to an investment scheme. Such assets can be transferred, stored or traded electronically.

Section 2(47A) (b) of the IT Act expands the scope of VDAs to include NFTs and any other token of similar nature having any other nomenclature. Other digital assets may also be notified by the Central Government as VDAs under Section 2(47A)(c) of the IT Act. However, the proviso to Section 2(47A) of the IT Act enables the Central Government to notify any digital asset to be excluded from the definition of VDA.

The Finance Act, 2022 further introduced Section 115BBH(1)(a) in the IT Act as the charging provision, which levies an Income Tax at the rate of thirty percent on any income earned by way of transfer of any VDA.

Additionally, Section 194S of the IT Act inserted by the Finance Act, 2022 requires a person who pays to any resident a sum by way of consideration for transfer of VDA, to deduct one percent of such sum as Income Tax.

NOTIFICATIONS AND CIRCULARS OF THE CENTRAL BOARD OF DIRECT TAXES

Liability to Deduct Tax at Source

The Central Board of Direct Taxes (hereinafter referred to as “CBDT”) issued Circular No. 13 of 2022 dated 22.06.2022 and Circular No. 14 of 2022 dated 28.06. 2022 for clarification of ambiguities under Section 194S of the IT Act.

Circular No. 13 of 2022 dated 22.06.2022

The Circular clarifies that the liability to deduct Tax Deducted at Source (hereinafter referred to as “TDS”) shall be on the party, which pays the consideration for transfer of VDA. The TDS is to be deducted at the time of crediting the sum to the account of the resident, or at the time of payment, whichever is earlier.

It clarifies the following exclusions from deduction of TDS in VDA transactions:

1. The aggregate value of consideration payable by a specified person is not more than Rs. 50000 during the financial year; or
2. The aggregate value of consideration payable by any person other than the specified person is not more than Rs. 10000 during the financial year.

Pursuant to the aforesaid exclusions, a specified person is defined in the Circular as:

1. Individual or Hindu Undivided Family (“HUF”) not having any income under the head ‘profit and gains of business or profession’; and
2. Individual or HUF having income under the head ‘profit and gains of business or profession’, with total sales/gross receipts/turnover from business not exceeding Rs. 1 crore or earnings from profession not exceeding Rs. 50 lakhs, in the financial year preceding the financial year of VDA transaction.

The Circular defines an Exchange as any person operating a platform or application for transfer of VDAs, causing the matching and execution of buy and sell trades of VDA on such platform.

Further, the term Broker is defined under the Circular as any person operating an application or platform for transferring of VDAs and holding brokerage account/accounts with an Exchange for execution of such trades.

The Circular prescribes the following guidelines for deducting TDS when VDA is not owned by an Exchange, but is transferred through an Exchange:

1. TDS is to be deducted only by the Exchange, which receives payment from the Buyer and thereafter makes to payment to the Owner of the VDA being transferred.
2. TDS is to be deducted by the Exchange from the amount of consideration to be paid to the owner even when the broker is the owner of VDA, as the broker is the seller.
3. In case where the broker is not the seller, TDS shall be deducted by both the Exchange and the broker. However, if a written agreement exists between the broker and the Exchange that the broker shall be deducting TDS on such payment, then the broker alone may deduct TDS.
4. The Exchange is required to furnish a quarterly statement for all such transactions of the quarter as per the due date prescribed by the Income Tax Rules, 1962.

The Circular further prescribes the following guidelines for deducting TDS when VDA is owned by an Exchange and is transferred through that Exchange:

1. The buyer of VDA, or its broker, is required to deduct TDS when multiple players are no involved.
2. However, to avoid the difficulty of the buyer or its broker not knowing if the VDA is owned by the Exchange or not and resultantly, if the TDS is to be deducted or not, the Exchange may enter into written agreement with the buyer or its broker that the Exchange would be paying the tax on or before the due date for that quarter, for such transactions.
3. In such a case, the Exchange will be required to furnish a quarterly statement and its Income Tax return must include such VDA transactions. Upon fulfilment of such conditions, the buyer or its broker would not be held as assessee in default.

The following guidelines are laid down by the Circular when the consideration for transfer of VDA is in kind, or in exchange of another VDA:

1. When consideration to be paid is in kind or in exchange of another VDA, the person paying the consideration shall ensure that the tax required to be deducted has been paid by the seller prior to releasing the consideration.
2. The buyer shall release the consideration in kind after the seller provides the proof of payment of such tax.
3. When the transfer is through an Exchange, the TDS may be deducted by the Exchange, subject to written contractual agreement with the buyers/sellers.

The Circular further prescribes the following general guidelines for the transfer of VDA taking place on or through an Exchange:

1. TDS is to be deducted on the net consideration after excluding Goods and Services Tax (“GST”) and other charges levied for rendering service.
2. A payment gateway is not required to deduct TDS from such consideration when the buyer, the broker, or the Exchange (as applicable) has deducted the TDS under Section 194S of the IT Act.
3. The calculation of consideration for transfer of VDA triggering deduction under section 194S of the Act (being more than Rs. 50000 or Rs. 10000 as applicable) shall be counted from 1.04.2022.
4. The liability to deduct TDS shall only apply on those sums representing consideration for transfer of VDA, credited or paid on or after 01.07.2022. No TDS is to be deducted from the consideration credited or paid before 01.07.2022.

Circular No. 14 of 2022 dated 28.06.2022

The Circular has laid down the following guidelines for the VDA transactions which are not specifically covered by Circular No. 13 of 2022, i.e., not taken place on or through an Exchange:

1. When the VDA is sold without going through an Exchange, the buyer is required to deduct TDS and deposit the same with the Government in accordance with the Income Tax Rules, 1962.
2. The deducter must furnish a quarterly statement for all such transactions of the quarter on or before the due date under the Income Tax Rules, 1962.
3. TDS is to be deducted on the net consideration, excluding GST.
4. When consideration to be paid is in kind or in exchange of another VDA, the person paying the consideration shall ensure that the tax required to be deducted has been paid by the seller prior to releasing the consideration. The buyer shall release the consideration only after the seller provides proof of payment of tax.

Levy of Income Tax on NFTs and other Tokens

The CBDT issued Notification No. 75/2022 dated 30.06.2022 and Notification No. 74/2022 dated 30.06.2022 to notify crypto tokens as falling within the purview of NFT under the IT Act, and to exclude certain tokens from the purview of NFT and VDA.

Notification No. 75/2022 dated 30.06.2022

The CBDT vide Notification No. 75/2022 dated 30.06.2022 notified that any token, which qualifies as a VDA under Section 2(47A) of the IT Act, shall be a NFT under Section 2(47A)(2) of the IT Act.

However, the CBDT has excluded those NFTs from the purview of Section 2(47A) of the IT Act whose transfer results in transfer of ownership of underlying tangible asset and the transfer of ownership of such underlying tangible asset is legally enforceable.

Notification No. 74/2022 dated 30.06.2022

Through Notification No. 74/2022 dated 30.06.2022, the CBDT notified that the following tokens are excluded from the definition of VDA under the IT Act:

1. Gift cards or vouchers, containing a record that may be used to obtain goods or services or discount on goods or services;
2. Mileage points, reward points or loyalty cards, containing a record given without any direct monetary compensation under award, reward, benefit, loyalty, incentive, rebate or promotional program that may be used or redeemed only to obtain goods or services or a discount on goods or services; and
3. Subscription to websites, platforms or applications.

AMLEGALS REMARKS

The recent Notifications and Circulars issued by the CBDT attempt to resolve the ambiguity regarding the levy of Income Tax on VDA transactions and the exclusions therein, if any.

The Circulars regarding liability of TDS deduction have clarified the different taxable persons who are liable to deduct TDS from VDA considerations depending upon the nature of transaction, and the entities involved, i.e., the Exchange and Brokers, who may come into play in such transactions.

Further, the Notifications have widened the ambit of NFTs under Section 2(47A)(b) of the IT Act to include any token which satisfies the requirements of a VDA under Section 2 (47A) of the IT Act.

However, the Notifications have also excluded certain tokens, which involve the transfer of some underlying asset/value and are legally enforceable, from the ambit of NFT and subsequently VDA under the IT Act.

Thus, the Circulars and Notifications have brought forth much needed clarity regarding the exclusions from VDA, as in the absence of such clarifications, multiple tokens which did not essentially categorize as a VDA in the market, would be unfairly subjected to the levy of Income Tax pursuant to Section 2(47A)(b) of the IT Act.

For any queries or feedback, please feel free to get in touch with rohit.lalwani@amlegals.com or riddhi.dutta@amlegals.com.