INTRODUCTION
Non-fungible Tokens (‘NFTs’) are known as unique tokens that provide ownership over digital assets such as an image, audio, video, or document that represents some real-life projects or digital works on the internet and are capable of being recorded, stored, and transacted on blockchain technology.
The NFTs and Cryptocurrencies are similar as they both are traded and programmed in the same way. and therefore the sudden demand in trading of cryptocurrencies has led to further demand in investment in other digital assets primarily the Non-Fungible Tokens (NFTs).
However, the similarities end there since cryptocurrencies is a “Fungible Token” as it is interchangeable and can be exchanged for another cryptocurrency, as they both have the exact same value, whereas, in the case of NFTs they are “Non-Fungible Tokens” as each NFT is unique since it contains a digital signature that prevents it from being exchanged for or compared to one another.
The rapid surge in demand for NFTs has sparked a debate regarding their legality and efficacy. In India, currently, there is no official law that forbids or restricts an Indian resident from trading NFTs as of now. However, there is still ambiguity surrounding the legality of NFTs in India.
In this article, we attempt to clear such ambiguity to the best of our efforts by discussing the concept of NFTs, the legal issues pertaining to it, and the road ahead.
THE LEGALITIES
That even though there is a lack of regulations to govern NFTs, the regulatory authorities and making the best efforts to catch up. Most countries do not have a statute in place that deals with the dynamism of NFTs, and the legal uncertainty surrounding cryptocurrencies is adding to the skepticism with regards to NFTs as well. The key legal issues associated with NFTs in India are summarised below.
1. Intellectual Property Rights
That as discussed earlier NFTs is a token that represents ownership in a piece of digital assets such as image, audio, video, or a document that can be represented digitally. Therefore, as evident NFTs are minted on an underlying piece of art, the owner of the NFTs does not hold any intellectual property right in such NFTs, as in accordance of Section 57 of the Copyright Act, 1957, the creator/artist of the NFTs reserves the right to claim authorship and has right to restrain or claim damages in respect of any distortion, mutilation or modification of the said work.
Further, Section 14 of the Copyright Act, 1957 provides a right to the creator/artist of the NFTs to reproduce or distribute copies of her work. Therefore, each time someone wants to display an artwork categorized as NFT, the permission and authorization of the original creator/artist of such artwork is required. In doing so, the original creator/artist might impose conditions as to how the NFTs so developed should be used, apart from charging a licensing or royalty fee.
Therefore, if the smart contract transferring the NFTs does not stipulate transfer of the right of resale of reproduction of the digital asset, its use is likely to attract infringement provisions under the Copyright Act.
2. Smart Contracts
Smart contracts are digital contracts wherein the contractual terms are written in code and embedded within the purchase tokens, accessible with relevant triggers.
NFTs are usually purchased through a specific platform, which acts as a facilitator for the trading of NFTs. Now, prior to any successful purchase transaction or auction, takes place, the terms and conditions of such transaction are shared with the buyer through a smart contract, which establishes all the terms and conditions regarding the use of these NFTs by the buyer, such as whether the owner of the NFTs has transferred the right of resale of reproduction of the digital asset to the buyer or the buyer shall be entitled to use the same for personal non-commercial purposes only.
Once the buyer makes the payment of the consideration, the contract comes into effect and both parties shall be bound by the laws of the Indian Contract Act, 1872. However, the legal validity and binding nature of such contracts are ambiguous in the absence of an explicit statute or provision.
NFTs transactions usually involve transfer through smart contracts. Hence, the legality of smart contracts adds another layer of complexity to the status of NFTs trading.
3. FEMA Laws
If NFTs are classified as “intangible assets” in India, the provisions of the Foreign Exchange Management Act will come into the picture. This is likely to raise issues because if classified as “intangible assets”, it will become imperative to trace the location of the NFT, which is difficult because they are built on blockchain and mostly backed by cryptocurrencies. Their data is recorded, shared, and synchronized over multiple data stores, and distributed through a network of participants all over the globe, thereby making it nearly impossible to ascertain a single location.
But, the more pressing question is related to the implicit ban on crypto-trading in India. There is no statutory ban on the trading of NFTs, but the current legal scenario does not see cryptocurrencies as a standard means of exchange in India. Given that cryptocurrencies and NFTs are essentially built on the same technology, the legal status of cryptocurrencies is likely to percolate to that of NFTs as well.
4. Income Tax
That, in the Finance Bill, 2022, the Central Government declared that earnings from all virtual digital assets would be subject to income tax under the Income Tax Act, 1961.
That, Section 3(b) of the Finance Bill, 2022 amends Section 2 of the Income Tax Act, 1961 to insert clause (47A) which defines a virtual digital asset as:
“(47A) “virtual digital asset” means –
(a) any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;
(b) a non-fungible token or any other token of similar nature, by whatever name called;
(c) any other digital asset, as the Central Government may, by notification in the Official Gazette specify:
Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of the virtual digital asset subject to such conditions as may be specified therein.”
That, Section 2(47A)(a) of the Income Tax Act, 1961 includes within the purview of “virtual digital assets” any Non-Fungible Token (NFTs) generated through cryptographic means which provides a digital representation of the value exchanged with consideration and functions as a store of value, therefore NFTs fall within the classification of “virtual digital assets” under the Income Tax Act, 1961.
That, Section 28 of the Finance Bill, 2022 inserts the provision for tax on income from virtual digital assets under Section 115BBH in the Income Tax Act, 1961.
The relevant provision is reproduced hereunder for ease of reference:
“115BBH. Tax on income from virtual digital assets.
(1) Where the total income of an assessee includes any income from the transfer of any virtual digital asset, the income- tax payable shall be the aggregate of––
(a) the amount of income-tax calculated on the income from transfer of such virtual digital asset at the rate of thirty per cent.; and
(b) the amount of income-tax with which the assessee would have been chargeable, had the total income of the assessee been reduced by the income referred to in clause (a).”
Therefore, in accordance with Section 115BBH of the Income Tax Act, 1961, any income from the transfer of any virtual digital asset shall be subject to income tax at the rate of 30%.
STATUTORY AND JUDICIAL RESPONSE TO CRYPTOCURRENCY AND NFTS
Since NFTs can be traded through cryptocurrencies, the legality of the cryptocurrency act as the biggest hurdle in trading NFTs. Since Reserve Bank of India vide circular bearing no. RBI/2017-18/154 dated 06.04.2018 had banned all the regulated entities from dealing in cryptocurrencies.
However, a ray of hope has aroused since the Supreme Court of India in the case of Internet and Mobile Association of India v. Reserve Bank of India (Writ Petition (Civil) No.528 & 373 of 2018), has struck down the RBI’s circular banning regulated entities from dealing in cryptocurrencies, stating that the impugned circular was unreasonable and hence violative of Article 19(1)(g) of the Constitution of India.
Further, in the past few years, India has witnessed a drastic change in the approach of the Government towards cryptocurrencies since the Government has introduced the long-awaited Cryptocurrency Bill, which might change the regulatory status of NFTs in India. Since NFTs and cryptocurrencies are based on the same technology, that is blockchain, the statutory and judicial response to one is likely to determine the legality and status of the other.
The Central Government in its Financial Bill 2021, has stated that it will also be introducing a “Digital Rupee”, which is likely to revolutionize the digital economy of India in the upcoming years.
THE ROAD AHEAD
In the absence of a certain statutory categorization of NFTs, a section of academicians and scholars are of the belief that NFTs are ‘derivatives’. If the same turns out to be the case, the provisions of the Securities Contract (Regulation) Act, 1956, (“SCRA”) would be attracted, effectively placing a ban on NFT trading in the country.
As per Section 2(ac) of SCRA the definition of ‘derivative’ also includes contracts, which derives their value from prices or index prices of underlying securities.
Therefore, if NFTs will be categorized as NFTs, then in accordance with Section 18A of SCRA the contracts in derivate can be legally traded on recognized stock exchange only.
This would mean that trading of NFTs on virtual platforms will be hit by this Section unless such virtual platforms are given the status of a stock exchange. However, given the non-fungibility of NFTs, it is not like other ‘securities’ traded in stock exchanges, because it essentially only acts as an assurance of authenticity and ownership.
That being said, the sky-high prices of NFTs have resulted in the trading of ‘fractional NFTs’, proving only partial ownership over the main NFT. While categorizing the former as security may be improper, the latter can be put into that categorization. This further complicates the legal and regulatory aspects of classifying NFTs as security.
AMLEGALS REMARKS
As discussed above, there is no specific regulation that governs cryptocurrencies and NFTs in India, Therefore, in light of the legal ambiguity, the future of NFTs in India is ambiguous as well. However, the fate of NFTs does not necessarily have to be the same for long.
Unlike cryptocurrencies, NFTs are backed by physical assets. While dealing in cryptocurrencies is entirely speculative, the level of speculation involved in NFT trading is arguably lesser.
NFTs are the newest class of digital assets and there is a lack of a regulatory framework to regulate NFTs. Therefore, it is need of the hour to get influence from countries like Singapore, Canada, Japan, and Switzerland which offers a balanced legal and regulatory environment and develop a similar regulatory framework in India.
– Team AMLEGALS assisted by Ms. Gazal Sancheti
For any query or feedback, please feel free to get in touch with arushi.vyas@amlegals.com or tanmay.banthia@amlegals.com.
Leave a Reply