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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.