A Watchdog For ‘Born Free’

Regulation of cryptocurrency in India depends primarily on its classification under a particular asset class. The narrative so far suggests reluctance from central regulatory bodies to recognise it as a legal tender. As on date, it is not recognised as a sovereign-backed currency just as in many jurisdictions across the globe.

There is no ban from buying cryptocurrency through an exchange in India at the moment and private bourses function in an unregulated environment in the country facilitating trades in cryptocurrencies.

These exchanges are expected to comply with the RBI Master Direction on KYC Norms to ensure a level of authenticity. Being a tech-based product, the safety of trades also depends upon the IT infrastructure and security protocols adopted by the exchanges. To ensure trust in the system, the dealers can comply with the existing security measures as mandated for banks or NBFCs like RBI’s master direction on ‘IT Framework for NBFC Sector.’

These exchanges also need to account for relevant FEMA guidelines for transactions in foreign exchanges. WazirX, for instance, was recently  served a show-cause notice by the Enforcement Directorate for alleged violation of KYC norms and FEMA guidelines.

Over the period, cryptocurrency has seemingly taken the form of a digital asset which could be traded through exchanges or mining. For an investor, there is no law that prohibits investment in cryptocurrencies. Its safety still lies in the hands of the exchanges carrying out the primary transactions. An investor can also buy cryptocurrency in a foreign jurisdiction, subject to FEMA guidelines. The transactional treatment as a ‘current account transaction’ or ‘capital account transaction’ will also invite compliance under FEMA.

Being a borderless currency, it is inevitable that exchanges tap into various jurisdictions across the globe to procure and store cryptocurrency in exchange of fiat from investors. This adds to the risk of theft. No insurer in India covers theft of cryptocurrency on account of hacking practices. It is unlikely that Deposit Insurance and Credit Guarantee Corporation (DICGC) will treat this asset class at par with bank deposits.

With a clear framework in place, private companies may cover instances of theft. The speculative and volatile nature of the currency will make the insurers cautious to cover any form of value degradation of the asset. Even if done, the premiums can be high for many to afford such policies.

The Income Tax Act, 1961 has not included cryptocurrency under the definition of capital asset. Hence the same may not be taxed as a capital gain. Gains made from transacting in cryptocurrency may be taxed under the category of ‘income from other sources.’ The modes of acquiring like ‘mining’, ‘buying from exchanges’, ‘purchase and sale as stock-in-trade’ will influence the taxability of this asset. For example, in case of mining, determination of cost of acquisition can be a tricky concept to assess ultimate tax liability.

Cryptocurrency being intangible in nature may take a form of ‘goods’ or ‘commodity’. As a result, transfer of cryptocurrency may be considered as a ‘supply’ or ‘sale of goods’ under the indirect tax framework. The ways in which it can be used also adds to uncertainty. For example, mining is one of the ways to procure Bitcoin. Hence, the question arises if mining can be treated as a ‘service’. Cryptocurrency can also be used as a mode of exchange for goods or services. In such a situation, this barter transaction can also fall under the taxing powers of the GST laws.

The regulatory vacuum around virtual currencies demands a comprehensive legislative framework. The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 is expected to be tabled in the Monsoon Session of the Parliament. It will be intriguing to watch out for the outcome.

The author is Partner, Khaitan & Company