Cryptocurrency in India: One Step
Forward, Two Steps Back
INTRODUCTION
Any recognized currency used around the world is defined
as a "fiat currency" since such currencies are backed by a fixed
commodity and are issued by the government. However, changing this is
cryptocurrency. Cryptocurrency is not backed against a commodity or issued by
the government and does not exist physically.
Cryptocurrency is a collection of binary data, stored on
secured transaction records and distributed over a vast network of technological
infrastructure and protocols called a distributed ledger technology (“DLT”).
The DLT allows a user to simultaneously
access, validate, and update records in an unchangeable manner across a network
that's spread across multiple entities or locations. There are two principal
ways in which cryptocurrencies are deployed, i.e., as a legal tender through
payment systems such as cryptocurrency trading platforms or cryptocurrency
wallets or as a form of an asset issued through an initial coin offering where
it is issued in exchange for an existing fiat currency.
NEED FOR REGULATION
As cryptocurrencies are hosted on DLTs and are linked to
a private key phrase rather than an individual person, it is private and highly
secure. Therefore, it could be challenging to trace the origin of a
transaction.
The Reserve Bank of India (“RBI”) has repeatedly
warned that cryptocurrency could pose "serious concerns on macroeconomic
and financial stability," and that unregulated crypto markets could become
avenues for money laundering, fraud and terror financing.
Currently, at least eight cases of cryptocurrency-related
fraud are under investigation by the Directorate of Enforcement. As cryptocurrency
is not backed by a government or considered a fixed commodity, it can lose its
value if the promoter of the cryptocurrency stops trading activity as evidenced
in the Squid Game Crypto Scam which began as a pay-to-play token on October 20,
2021, and the holders of the ‘squid game coin’ were promised that they can
participate in an online game inspired by the popular Netflix show, ‘Squid
Game’. Despite the fact that there was no option for the buyers of the coin to
sell the coin on the platform and the presence of various other red flags, due to
the increased popularity and demand for the coin around the world, the value of
the, saw an appreciation of 3,10,000%, from its initial listing at USD 0.01 per
coin and reached a peak value of USD 2,861 per coin. Overnight the creators of
the coin sold their entire holdings while the value was at the peak and brought
the value of the coin down to USD 0 causing a loss to every holder of the coin.
INTERMINISTERIAL
COMMITTEE REPORT, 2017
Various startups and domestic companies launched
their own cryptocurrency wallets which gained significant success in the Indian
market, resulted in the rapid rise in cryptocurrency holders of Indian origin
in the year 2017. As a result of the increasing
number of Indian cryptocurrency holders and the RBI’s concerns regarding the
flow of money in cryptocurrency, a high-level Inter-ministerial committee was
constituted on November 2, 2017,
with the task of putting together key issues pertaining to Cryptocurrencies,
comparing global experiences and identifying challenges faced by the industry
and proposing policy options and
specific actions to be taken in this matter. While the committee acknowledged
the potential application of the DLT in the areas of trade finance, mortgage
loan applications, digital identity management or KYC requirements,
cross-border fund transfers and clearing and settlement systems, it also
acknowledged that there are several risks and regulatory challenges. It recognized
that the technological scalability and integration into existing financial
systems will also pose a challenge. The committee recommended that each government
regulator needs to explore an appropriate regulatory framework for the development
of DLTs and cryptocurrencies in their respective areas. The committee‘s review
and recommendations were proposed in the form of a draft bill.
RBI
CIRCULAR AND SUPREME COURT OF INDIA’S VERDICT
After years of voicing concerns regarding cryptocurrencies and the lack of safeguards the RBI via circular dated April 6, 2018, prohibited all entities regulated by the RBI from rendering services in connection with cryptocurrencies including maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them and transfer/receipt of money in accounts relating to purchase/sale of Cryptocurrencies.
However, the validity of the circular was
contested in the Supreme Court in March 4, 2020 in the case of Internet
and Mobile Association of India V. Reserve Bank of India. While setting
aside the circular it was held by the Supreme Court that cryptocurrencies
were not directly banned by the circular, but the trading in virtual currencies
and the functioning of cryptocurrencies were sent to a comatose stage as the
circular prohibited the banking sector from interfacing with the trading of
virtual currencies. The Supreme Court held that the role of the RBI in the
present case should not be to ban or prohibit the trading of cryptocurrencies
but to pass regulations to regulate the same in India.
BANNING OF CRYPTOCURRENCY AND REGULATION OF OFFICIAL DIGITAL CURRENCY BILL, 2019 (“2019 BILL”)
Pursuant to the ban on the trading of cryptocurrencies
by the RBI in 2018 and pursuant to the report of the Inter-Ministerial
Committee which proposed the need for a draft bill to ban cryptocurrencies in
the country and provide for an official digital currency, the 2019 Bill was
formulated and tabled for discussion in the Lok Sabha in 2019.
Key highlights and issues of the 2019 Bill
The 2019 Bill prohibited any mining, holding,
selling, trading, issuance, disposal or use of cryptocurrency in India and also
purported to make such acts punishable with a fine or imprisonment of up to 10
years, or both. Further, the 2019 Bill required a person
to declare and dispose of any cryptocurrency in his possession, within 90 days
from the enactment of the 2019 Bill.
Interestingly, the 2019 Bill provided that the
central government, in consultation with the RBI, may issue a digital rupee as
legal tender in both Indian and foreign jurisdictions. Despite the
proposed ban, the 2019 Bill permitted the use of processes or technology
underlying any cryptocurrency for the purpose of experimenting, researching, or
teaching the underlying technology.
Issues and concerns
While the 2019 Bill banned all cryptocurrencies
based on the risks associated with them, it neglected the potential benefits
such as better record-keeping, faster transactions, secure storage of data and
more efficient cross-border payments. Additionally, the penalties
prescribed for certain offences under the 2019 Bill were disproportionately
higher compared to other similar economic offences in the country.
The definition of cryptocurrency under the
2019 Bill was too broad and non-exhaustive as it defined cryptocurrency to mean
any information, code, number or token, generated through cryptographic
means or ‘otherwise’, which has a digital representation of value
and has utility in business activities, or acts as a store of value, or a unit
of account. Given the wide ambit of the definition, potentially certain tokens
which are not generated through cryptographic means such as discount coupons,
gift cards, and loyalty reward points, could be included within its ambit, and could
require e-commerce or other entities providing or generating such tokens to
comply with the 2019 Bill by banning such tokens.
SC GARG COMMITTEE, 2019
Due to the ever-increasing
investments made by Indian residents in cryptocurrencies, the stakeholders of
the cryptocurrency industry raised concerns regarding the 2019 Bill and sought
to clarify the intent of the Indian government regarding the trading of
cryptocurrencies in India. However, the Steering Committee of 2019, which
was constituted to make fintech-related regulations more
flexible and enhance entrepreneurship, examined such concerns of the
stakeholders and put forth its findings stating
that nearly all cryptocurrencies are issued abroad with huge numbers of people
in India investing in them and that there exist multiple security and regulatory
concerns regarding cryptocurrencies which pose a hurdle to its legalization as
currency in India. Further, the committee's report held that cryptocurrency
will not be able to act as a currency since cryptocurrencies are not consistent
with the essential features of a currency and held the view that cryptocurrencies
stand the risk of being misused for the purposes of money laundering and are to
be regarded as volatile and unsafe investments.
THE CRYPTOCURRENCY AND REGULATION OF OFFICIAL DIGITAL CURRENCY BILL, 2021 (“2021 Bill”)
Due to the issues raised by the relevant
stakeholders in India with the 2019 Bill and in pursuance of the SC Garg
Committee report, the Lok Sabha bulletin dated January 29, 2021, listed the
2021 Bill for deliberations. While the 2021 Bill is not available in the public
domain, as per the bulletin, the purpose of the 2021 Bill is to create an
enabling framework for the official digital currency to be issued by the RBI,
and to prohibit all private cryptocurrencies available in India. The 2021 Bill
was listed after a week of the first-ever Parliamentary panel discussion
on crypto finance. During the panel discussion, a consensus was
reached that cryptocurrency needs to be regulated, instead of its complete
ban, thereby resulting in the removal of the word “Banning” from the title of
the 2021 Bill. The 2021 Bill has been prepared after several meetings with
stakeholders and discussions on regulating digital currencies. While the 2021
Bill was tabled for the winter session of the Parliament, it did not come up
during the session and the discussions have been postponed.
MCA
NOTIFICATION
While the 2021
Bill was listed in the Lok Sabha, on March 24, 2021, the Ministry of Corporate
Affairs released a notification mandating companies to make disclosures with
respect to the virtual currency/cryptocurrency transactions undertaken by them
during a financial year. The purpose of the disclosure has not been clarified, so
it could potentially be construed as a means for the government to get an
update on the current status of cryptocurrency transactions in India including
details such as the amount of transactions, the number of cryptocurrencies held
by investors in India and the flow of money from individuals to the
cryptocurrency-based startups in India.
FINANCIAL BUDGET, 2022
In countries like the
United States of America or the United Kingdom, cryptocurrency transactions are
taxed as capital gains, whereas in countries like Germany cryptocurrency
transactions are considered as private money and are therefore exempt from certain
tax payments. Contrary to the global trend, India has, proposed to become one
of the few countries to tax digital assets (which is proposed to include
cryptocurrencies and non-fungible tokens) at a rate of 30% on the transfer of
such assets as proposed under the Financial Budget 2022. The Financial Budget
2022 also proposes a 1% tax deduction at source on payments made related to
purchasing of virtual assets and no deduction in respect of any expenditure or
allowance is allowed while computing such income except the cost of
acquisition. With the release of the Financial Budget, 2022, the Finance
Minister also informed that gift of a virtual digital asset is also proposed to
be taxed at the hand of the recipient and any loss from the transfer of the digital
asset cannot be set off against any other income. While the proposed tax amendments
do not bring legitimacy to cryptocurrency, it is likely to be the foundational
steps toward the strict regulation of cryptocurrency in India.
REVISED TAXATION
While the RBI has,
through its annual report, maintained its stance that cryptocurrencies are a
‘clear danger’ and that such currencies derive value based on make-believe, on
June 22, 2022, it passed a circular bearing no. F. No. 370142/29/2022-TPL, which
inserted Section 194S in the Income Tax Act, 1961 (as per the Finance Act,
2022), to be effective from July 1, 2022. The amendment mandates that a person
who is responsible for paying any resident consideration for the transfer of
virtual digital assets (which includes cryptocurrencies) shall, at the time of
credit of such consideration to the account of the resident or at the time of
payment\, deduct an amount equal to 1% of such consideration as income tax. However,
the tax is not deductible in the following cases: (i) if the consideration is
payable by a specified person[1]
and the value or aggregate value of such consideration does not exceed INR
50,000 during the financial year; or (ii) if the consideration is payable by
any person other than a specified person and the value or aggregate value of
such consideration does not exceed INR 10,000/- during the financial year.
CLARIFICATION FROM
THE FINANCE MINISTER
On July 18, 2022,
contradictory to the expectation of stakeholders after the release of the Financial
Budget 2022 and the subsequent amendments to the taxation of virtual digital
assets, the finance minister clarified the government’s position on
cryptocurrencies. In response to a written reply to a question from a Lok Sabha
MP seeking information on the government’s plans to legislate restrictions on
cryptocurrencies, the Finance Minister clarified that cryptocurrencies are by
definition borderless and any move towards banning or regulation shall require
international collaboration to prevent regulatory arbitrage. The Finance
Minister further clarified that any legislation for the regulation of
cryptocurrencies shall require the evaluation of the risks and benefits and
evolution of common taxonomy and standards by all international stakeholders and
the proposed 2021 Bill is off the table till a global compact of some form can
be firmed up on the regulation of cryptocurrencies.
CONCLUSION
While the 2022 financial budget
and subsequent amendments promised a future toward the legalization and regulation
of cryptocurrencies in India without a blanket ban on any activity related to cryptocurrencies,
whether direct or indirect, the intent of the Ministry of Finance and the RBI
seems to be uncertain given that no explicit steps have been taken towards this
end in India. Additionally, from the clarifications issued by the Finance
Minister, it seems that the stakeholders of cryptocurrency will have to wait
for international collaboration, an international move or a global review of
the regulation of cryptocurrencies and hope that the international stance leans
towards regulation and restriction of certain activities related to
cryptocurrencies, instead of an outright ban.
Authors: Nivedita Nivargi, Partner, Kevin Varghese Robin,
Sr. Associate, Samanth Dushyanth, Associate
[1]
A specified person shall
mean an individual or Hindu undivided family (HUF) who either does not have any
income under the head “profit and gains of business or profession” or such
income exists but the total sales/gross receipts/turnover from business carried
on by him does not exceed INR 1,00,00,000/- or in case of profession exercised
by him does not exceed INR 50,00,000/-. This threshold is to be seen in the
financial year immediately preceding the financial year in which the virtual
digital asset is transferred.