Crypto is a rare gem in the Indian tech landscape. Rarely has India been able to develop and scale up homegrown startups and cutting-edge tech solutions in lockstep with Western counterparts. India has had great success in the last two decades in establishing a strong IT industry and, later, an internet services industry. Yet, we have lagged behind in adopting and shaping breakthrough technologies—be it semiconductors or smartphones.
On crypto, however, our startups have taken the unchartered route: To build products and services that rival global peers. Even in these early days of crypto, Indian platforms have been able to scale up and cater to the needs of millions of users. India has built unicorns in the crypto investment space as well as in the crypto infrastructure sector. This has taken shape hand-in-hand with the digital transformation of India. The result: India was ranked fourth in the world in crypto adoption on purchasing power parity terms by an international analytical firm, accounting for $172 billion in crypto transactions between July 2021 through June 2022.
Last year’s Union Budget acknowledged this growing adoption by defining, for the first time, what constitutes a Virtual Digital Asset, or VDA. The Finance Act 2022 also established a tax structure for VDAs. Clarity on taxes on crypto was much needed, and the budget offered that. But beyond this relief, the crypto investors were burdened with a tax structure not comparable with other asset classes.
The flat 30% tax on profits came with no basic exemption or categorization into long-term and short-term capital gains based on the period of holding, nor did it allow investors to carry forward or offset losses. More significantly, the TDS of 1% at every sell transaction had a compounding effect on high-frequency traders—the source of liquidity in the market—with capital getting locked up at every trade.
Time to course correct
Nearly a year on, it has become clear that these prohibitive measures have had a counterintuitive impact: Instead of bringing about more transparency and compliance in crypto transactions in India, they have unwittingly incentivized users to move to offshore exchanges and grey markets. A recent study by the Esya Centre and Taxsutra found a shift of cumulative trade volume of around ₹32,000 crores from domestic crypto startups to foreign exchanges between February and October 2022.
This has serious implications: Loss of revenue to the government, loss of oversight of crypto transactions, and significantly exposing users to offshore risks. Our hope is that the government would course correct and introduce taxes that incentivize users to stay compliant and within our jurisdiction.
Better taxes lead to better compliance.
There is room for refinement in other provisions of the tax as well, such as the lack of basic exemption, lack of offset or carry forward, and threshold for TDS. I have explained this in detail below:
- Basic exemption: At present, there is no basic exemption for crypto tax. This might be too difficult for someone whose total income is less than the basic exemption limit set by the finance act of the year.
- Deduction: Currently, section 197 of the Act does not permit the Assessing Officer to issue NIL deduction certificates for withholding under section 194S of the Act. This pushes high-frequency traders and market makers outside the country because they operate at razor-thin margins.
- TDS: The 1% TDS is also a challenge. The high impact of 1% tax deducted at source (TDS) is causing a flight of capital and users to platforms in foreign jurisdictions and the grey market. If the purpose of the TDS is to establish a trail of crypto transactions, it can be achieved by a lower TDS rate of 0.1%. India’s experience with the Securities Transaction Tax (STT) has shown that lower rates are beneficial, with STT generating about ₹22,000 crore in tax revenues every year.
- Threshold for TDS: The threshold of ₹10,000 / ₹50,000 can also be revisited. Most of the crypto sellers (mainly individuals) are in the low-income bracket. Increasing the threshold will reduce the administrative burden on the tax department in processing refunds.
- Set-off and Carry Forward of Loss: Authorities should also allow carrying forward and setting off losses incurred from the sale of VDAs like how it is done for capital gains.
- Parity with Listed Securities: Similar to listed securities, existing provisions pertaining to capital assets should be made applicable for VDAs. This will result in an increase in customer adoption of VDAs as an investment option and in turn result in the source of tax collection to the Government. This would mean categorizing assets as short-term/long-term capital assets based on the period of holding of assets and taxing them differently.
A version of this article was first published on the Financial Express.
