Why VDA taxation needs attention in the Budget 2023

   2023-01-22 17:01

In India, the relationship between regulators and the crypto community has been tumultuous. While the legal status of cryptocurrency in India is still ambiguous, Union budget 2022 had set the stage for taxation of Virtual Digital Assets (VDAs) by introducing a three-pillar tax regime: income arising from transfer of VDA to be taxed at a flat 30% rate, 1% withholding tax, and limitations on offsetting of losses on VDA transactions. There has been a massive exodus of crypto players from India to overseas markets and it shows the negative effects of the VDA tax architecture within a year of its introduction. A recent study reported a shift in India’s cumulative trade volume in VDA to the tune of 32,000 crore from February to October 2022. Numerous recommendations to change VDA taxation, thereby reducing tax burden and eradicating ambiguities, have been made to the government for the upcoming budget.

Clarity for NR players

VDA taxation brings under its ambit both residents and non-residents (NR). In absence of a criteria to determine the trigger of taxation in India for NRs, it becomes crucial to comprehend the status of VDAs, particularly in cases where they are traded through Indian markets or sold to Indian residents. To clear the air and encourage foreign investment, clear norms in this area are needed.

Cataloging VDA

VDA taxation regime, which is silent on assigning income from the transfer of VDA to a particular head of income, has posed challenges not only from a reporting angle but also puts taxpayers in a quandary when they have to claim reduced surcharge rate of 15% (applicable to long-term capital gains for individuals) and disregards the impact of interest on deferment of advance tax on segmenting income under the ‘capital gains’ head. So, clarification is awaited on this stance.

Transition to progressive taxation

With a flat rate of 30%, which is analogous to taxing lottery, betting, and gambling money, the VDA taxation regime appears to be regressive. Allowing inclusion of VDA under the umbrella of shares and securities and application of different tax rate provisions based on holding period (short-term and long-term assets) for investors, could pave the way for progressive taxation and enable stabilization of the waning crypto market in India.

Guidelines for valuing VDA

The lack of a precise definition and prescribed valuation method for arriving at cost of acquisition (CoA) of VDA has left room for uncertainty in the contemporary digital age, especially where VDAs are given as gifts, bartered for goods/services, used as an employee incentive, as rewards in the gaming industry or created by mining or stacking. The challenge of implementing FIFO/ LIFO/ other techniques to determine the CoA is still a concern as VDAs are digital assets. This calls for a comprehensive definition for CoA with appropriate valuation rules structured similar to existing income tax valuation rules for other assets.

Allowable deductions and loss offset

One of the factors making VDA taxation onerous is that only CoA can be claimed as deduction, disregarding other expenses directly related to transfer of VDAs (such as exchange fees, transaction costs, etc), as well as the lack of ability to set off or carry forward losses arising on transfer of VDA even at an inter-source or inter-head level. Appropriate amendments to taxation provisions around these issues would be seen as a positive move.

Tracking mechanism of VDA

TDS mechanism is used to keep track of VDA transactions by levying 1% tax on sale proceeds of VDAs transferred. A higher tax rate is leading to liquidity crunch for traders as it acts as an immediate reduction from revenue generated. If tracking is the sole objective of the TDS mechanism, other measures such as the government collaboration with exchanges for reporting, as seen in countries such as the US and UK, could be implemented to lighten the load on traders. Alternatively, the rate may be equated with the rates of securities transaction tax, ie, 0.01 to 0.05%, which may not only motivate traders but also help in raising tax collections with a wide spectrum of traders engaging in crypto transactions due to decreased taxes.

(With inputs from Amita Jivrajani and Usha Uppala)

Rakesh Nangia is chairman and Sandeep Jhunjhunwala is partner at Nangia Andersen LLP.

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