There are news reports of the Central Economic Intelligence Bureau (CEIB), proposing GST of 18% on bitcoin transactions. The news reports indicate that a suggestion has been made to tax bitcoin under ‘intangible assets’ and impose GST on all transactions.
Virtual Currencies and Cryptocurrencies
A virtual currency is a digital representation of value that can be digitally traded and functions as (1) a medium of exchange, and/ or (2) a unit of account and/or (3) a store of value, but does not have a legal tender status. It is not issued nor guaranteed by any jurisdiction and fulfils the above functions only by agreement within the community of users of the virtual currency.
Another vital definition given legal sanction in Indian laws by virtue of this judgment is that of Cryptocurrencies as defined by the FATF. Cryptocurrency, according to FATF, is a math-based, decentralized convertible virtual currency protected by cryptography by relying on public and private keys to transfer value from one person to another and signed cryptographically each time it is transferred.
Reserve Bank of India, Government of India & Bitcoins
Originally, RBI had issued a Press Release dated 29.12.2017 cautioning the users, holders of Virtual Currencies that they are not recognised as legal tender. The Press Release also stated that the investors should avoid participating in them. The Finance Minister in his budget speech on 01.02.2018 had also stated that the Government did not consider crypto-currencies as legal tender or coin and all measures to eliminate the use of these currencies in financing illegitimate activities or as a part of payment system will be taken by the Government.
RBI Circular prohibited entities regulated by RBI from dealing in Virtual Currencies (VCs) or provide services for facilitating any person or entity in dealing with dealing with or settling VCs. The Circular also instructed the entities which already provide such services to exit the relationship within three months from the date of the Circular. After a series of Writ Petitions being filed in various High Courts and the Petition finally reaching the Supreme Court through transfer petitions, the matter was kept in abeyance as an Inter-Ministerial Committee was constituted and was deliberating on the issue.
The Inter-Ministerial Committee, on 28.02.2019 submitted a report along with a draft bill, namely, ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’.
Supreme Court decision
The Supreme Court in the case of Internet and Mobile Association of India Vs. RBI (2020) 10 SCC 274 struck down the Circular issued by RBI dated 06.04.2018. The sub-headings used in the judgment has a story line, the setting, a flashback, background score, script, unfolding of the plot, a climax, making it as interesting as the subject discussed in the judgment itself.
The Supreme Court applied test of proportionality as laid down in Modern Dental College and Research Centre (2016) 7 SCC 533 and held that the Circular does not meet the tests laid down given the fact that virtual currencies are themselves not banned even though the issue of Circular is within the powers of RBI. The Court observed that
(i) If the Bill ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Act, 2019’ had come through, there would have been an official digital currency, for the creation and circulation of which, RBI/ central government would have had a monopoly. However, that situation did not arise.
(ii) The VCs as on date are not banned but the trading has been subdued completely owing to the Circular disconnecting their interface with the banking sector. This has been done despite RBI not finding anything wrong about the way in which these exchanges function and despite the fact that VCs are not banned.
While the Court dwelled extensively into the scope of virtual currencies in the world and the various regulations and restrictions placed, it is rather intriguing to note that the Court refused to conclude on whether the ban is ideal for our country or not. The Court left it to the experts, after making a remark elsewhere in the judgment about the fact that the Inter-ministerial Committee themselves have not taken a consistent stance.
The judgment is elaborate, comprehensive and has a wonderful flow in relation to the thought process of the Court in arriving at the said conclusion. However, what one must understand from the judgment is that the very nature of the decision is temporary. The action of RBI merely fails due to the fact that the action taken by them is not proportionate to the harm faced by them.
The Court concluded by stating that RBI did not produce any semblance of damage. China banned cryptocurrency after encountering illicit trafficking of weapons and drugs. The judgments cited by the Supreme Court in the judgment takes into account the trading of weapons through virtual currencies.
While it is true that there cannot be a remedy without any damage, pre-emptive action is also a wise route to adopt. Banning is definitely not a solution but the RBI should take some steps to regulate virtual currencies until a proper legislation is in place.
When the regulation of virtual currencies is still a matter of debate and the status of virtual currencies as to whether it is legal tender or commodity or property or capital asset is yet to be determined, it is quite baffling to see a Press Report which indicates a possible GST on virtual currencies in the future.
European Court of Justice
On the question as to whether transactions to exchange a traditional currency for the ‘Bitcoin’ virtual currency or vice versa, which were subject to value added tax (‘VAT’), the European Court of Justice in the case of Skatteverket Vs. David Hedqvist held that in terms of Article 135 (1)(e) of Directive 2006/112, supply of services, which consist of the exchange of traditional currencies for units of the ‘bitcoin’ virtual currency and vice versa, performed in return for payment of a sum equal to the difference between, on the one hand, the price paid by the operator to purchase the currency and, on the other hand, the price at which he sells that currency to his clients, are transactions exempt from VAT, within the meaning of that provision.
US Supreme Court
Justice Breyer, in his dissenting opinion in the judgment of the US Supreme Court in the case of Wisconsin Central Ltd. Et. Al. Vs. United States opines as follows; ‘Moreover, what we view was money has changed over time. Cowrie shells once were a medium but no longer are; our currency originally included gold coins and bullion, but, after 1934, gold could not be used as a medium of exchange; perhaps one day employees will be paid in Bitcoin or some other type of cryptocurrency. Nothing in the statute suggests the meaning of this provision should be trapped in a monetary time warp, forever limited to those forms of money commonly used in the 1930s.’
The United States District Court, E.D. Texas, Sherman Division in the case of SEC Vs. Trendon T. Shavers and Bitcoin Savings and Trust has held that it is clear that Bitcoin can be used as money. It can be used to purchase goods or services, and as Shavers states, used to pay for individual living expenses. The only limitation of Bitcoin is that it is limited to those places that accept it as currency. However, it can also be exchanged for conventional currencies, such as the US dollar, Euro, Yen and Yuan. Therefore, Bitcoin is a currency or a form of money and investors wishing to invest in BTCST provided an investment of money.
The United States District Court, S. D., New York in the case of United States of America Vs. Robert M. Faiella a.k.a. BTCKing and Charlie Shrem has held that Bitcoin clearly qualifies as “money” or “funds”…… Bitcoin can be easily purchased in exchange for ordinary currency, acts as a denominator of value, and is used to conduct financial transactions.
Digital Economy and Cryptocurrency
India is very familiar with the story of ‘Three Blind Men’ describing an elephant based on their perception which in turn was based on which part of the body of the elephant they had touched. In the case of digital economy, the story rings true since every stakeholder has his own perception of how to tax this new animal. Cryptocurrency is an added twist to the tale akin to the elephant having a wry sense of humour and changing its position as and when one of the men approached it. Cryptocurrency is currently predominantly at play in the dark web. If cash transactions which are not accounted are the bane of governments in the physical world, cryptocurrency is its equivalent in the digital world.
Taxing Virtual Currencies
Where virtual currencies are not considered to be legal tender, then what would be their categorization from an accounting and taxation perspective? Should they be considered as capital assets or should there be a separate charge for taxing fluctuations in virtual currency?
If Virtual Currency is not legal tender, then its identification is important from a tax perspective. Should they be considered as capital assets or property? Should there be a separate head of income for taxation of virtual currencies given their fluctuations in value? The value of cryptocurrency is very unstable. On some occasions the value of the Bitcoin has swung 25% in a single day.
United Kingdom Policy Papers
The UK Government had issued policy papers on the taxation of Cryptoassets with regard to individuals and in relation to businesses. Cryptoassets have been defined to mean cryptographically secured digital representations of value or contractual rights that can be transferred; stored; traded electronically.
In terms of the policy, in the context of cryptoassets for individuals, disposal of cryptoassets would result in capital gain thus conferring the status of capital assets. Further, buying and selling of cryptocurrency is not to be considered as gambling. HMRC does not consider Cryptoassets to be currency or money so they cannot be used to make a tax relievable contribution to a registered pension scheme. Cryptoassets will be property for the purposes of Inheritance Tax.
In terms of the policy in the context of cryptoassets for businesses, if a company or business is carrying out activities which involves exchange tokens, they are liable to pay tax on buying and selling of exchange tokens; exchanging tokens for other assets (including other types of Cryptoassets); mining; providing goods or services in return for exchange tokens. The amount of tax a business must pay will depend on its income, expenditure profits and gains. All exchange tokens are digital and therefore intangible. However, they count as a chargeable asset for Capital Gains Tax and Corporation tax if they are both capable of being owned and have a value that can be realised.
For VAT purposes, Bitcoin and similar Cryptoassets are to be treated as follows:
(a) Exchange tokens received by miners for their exchange token mining activities will generally be outside the scope of VAT on the basis that:
- the activity does not constitute an economic activity for VAT purposes because there is an insufficient link between any services provided and any consideration;
- and there is no customer for the mining service
(b) when exchange tokens are exchanged for goods and services, no VAT will be due on the supply of the token itself. charges (in whatever form) made over and above the value of the exchange tokens for arranging any transactions in exchange tokens that meet the conditions outlined in VAT Finance manual (VATFIN7200), will be exempt from VAT under Item 5, Schedule 9, Group 5 of the Value Added Tax Act 1994. The VAT treatment is provisional pending further developments; in particular, in respect of the regulatory and EU VAT positions.
What should India do?
The common thread in the new fabric of virtual currency is that it is not treated as money but the potential for appreciation and the ability to be used to consummate transactions is recognised. Once this is recognised, the basic direct and indirect principles governing assets/ inventory/ personal asset are applied and the tax treatment is structured accordingly.
Insofar as India is concerned, the recommendations of the Inter- Ministerial Committee to enact a law banning Virtual Currencies do not resonate with India’s plans to be a leader in the digital economy and IT space.
Indian income tax law is not alien to expanding the scope of capital assets or property for the purpose of capital gains. Section 55 of the Income Tax Act, 1961 which deals with cost of acquisition for the purpose of computation specifically covers items such as tenancy rights, stage carriage permits, loom hours, etc. Profit on sale of export licenses, duty entitlement is recognised as business income.
In the context of indirect taxes, electricity, trademarks, advance authorisation, duty entitlement passbook, replenishment licenses, technical drawings, etc. have all been considered as goods.
Justice Aftab Alam in the context of taxability of replenishment licenses in the case of Yasha Overseas Vs. Commissioner of Sales Tax and Ors. observed that a meal ticket, a petrol coupon or flying miles credit has its own intrinsic value. If permitted, free transferability those would soon become market commodities and would be sold and bought for their value as goods. This observation rings true in the context of virtual currency.
India should regulate virtual currency instead of banning or prohibiting virtual currency. Strict controls can be part of regulations to ensure that the currency is not used to further illegal objectives. In a country which is plagued by tax evasion and when every effort is being taken to discourage cash transactions and promote digital transactions, leaving virtual currency out of the ambit of regulation can have a serious impact. Banning is not the solution since breaches would occur and would remain undetected. The correct approach should be to regulate virtual currency, treat it as a commodity and provide for a firm tax policy on transactions involving virtual currency. The technical challenges in the context of virtual currency or bitcoins including the massive power consumption that is said to be required, could drive a country like India to consider banning virtual currency. However, technological solutions would find its way and in the long run keeping watch on this space through regulations rather than an outright ban could be a better solution.
In future, it may so happen that even virtual currencies could attain the status of legal tender due to rapid increase in digital transactions. Given the fact that the regulation in respect of virtual currency is yet to take shape and the status of virtual currency is yet to be determined, any attempt to impose GST at this point of time would be ill advised and would only be a misadventure that would complicate matters.
K. VAITHEESWARAN is an Advocate practising in Chennai, Tamil Nadu.