In 2021, around 20 million people in India started investing in cryptocurrency, and held crypto assets worth over US$ 5.3 billion. Acknowledging this, the Budget 2022 introduced a tax regime to tax crypto assets, or as the lawmakers calls it ‘Virtual Digital Assets’.
Budget 2022 has proved to be a costly affair for the crypto community since tax at a rate of 30% is sought to be levied on transfer of crypto assets without any deduction of expenditure (besides the cost of acquisition) or set off of losses.
The real pain point for the stakeholders is the introduction of Tax Deduction at Source (TDS) at the rate of 1% on each and every transfer of crypto assets with effect from July 1, 2022. With the introduction of this TDS, the government intends to widen the tax base and track crypto transactions which may be difficult to trace otherwise.
In this article, we have analyzed the TDS provision and highlighted potential disputes that may arise for taxpayers.
Responsibility to deduct tax - Is it on the buyer or the exchange, or both?
As per the new provision, ‘any person responsible for paying’ to a resident any sum by way of consideration for transfer of a virtual digital asset shall withhold tax at the rate of 1% at the time of credit or payment by any mode.
A crypto asset can be transferred in many ways, including through peer to peer (P2P) or through exchanges. In P2P transactions, the buyer and the seller are identifiable and known to each other. In this case, the seller can furnish its Permanent Account Number (PAN) details to the buyer and the buyer can accordingly deduct tax on the consideration paid to the seller.
However, in cases where crypto assets are transferred through exchanges, the consideration for the sale of a crypto asset is routed through crypto exchanges, where the buyer and seller are not identifiable and are unknown to each other. There is no one-to-one contract between the buyer and seller. In such a scenario, it is practically impossible for the buyer to deduct tax while making payments, unless the exchange collects, maps and shares requisite information of the seller with the buyer. Crypto exchanges will be required to set up necessary infrastructure to map such transactions.
A primary question that arises in this scenario is whether crypto exchanges are liable to deduct tax on transfer of crypto assets upon payment of consideration to the seller. The term ‘any person responsible for paying’ may be interpreted widely to include crypto exchanges as well.
Certain recognized exchanges such as stock exchanges and power exchanges were provided relief from withholding tax obligations last year in specified situations. This relief has not been extended to crypto exchanges. To eliminate this dilemma, crypto exchanges can make an appropriate representation before the Central Board of Direct Taxes (CBDT) to obtain relief/clarification citing the onerous nature of this compliance obligation.
Deduction of tax by non-residents
Tax is required to be withheld by ‘any person’ responsible for paying to a resident. The term ‘any person’ indicates that the payer can be a resident or a non-resident. However, based on the ruling by the apex court, it can be argued that the deductor/payer should have a taxable presence in India. Hence, it can be argued that TDS is applicable only in case of a transaction between a resident seller and a resident buyer. This can encourage international transfer of crypto while discouraging domestic trading or it can increase the use of foreign crypto exchanges in India, such as Coinbase and Binance.
Further, the new tax provisions lack clarity on whether the recipient of the payment can be only sellers or can include crypto exchanges as well. It is relevant especially in cases wherein the seller is a non-resident and the exchange is a resident of India.
Barter: Exchange of one crypto asset for another
In barter transactions involving exchange of crypto assets, the obligation is on the transferee to ensure that the taxes applicable are paid by the transferor. In such cases, it can be argued that the transferee has no liability to deduct TDS and is only liable to ensure that the applicable taxes are paid by the transferor before releasing the consideration. Further, in such cases, deduction of tax by the transferee will be a challenge, as the value on which tax needs to be deducted is not clear.
It can be argued that the transferee can meet this obligation by either obtaining a declaration from the transferor or through a certificate issued by a Chartered Accountant.
While exchanging crypto assets, there are two transferors effectively and both the parties are transferring their respective crypto assets. Accordingly, each of the parties (being transferee of their respective assets) will need to ensure that applicable taxes are paid by the other party/transferor.
If the transferor does not furnish PAN, tax needs to be withheld at a higher rate of 20%. Further, in case the transferor does not file an Income Tax Return, tax needs to be withheld at a higher rate of 5%, subject to certain conditions and exceptions.
Industry insiders believe that the application of 1% TDS on transfer of crypto assets is a harsh step especially for small investors and traders who undertake multiple transactions in a day. This will also impact the availability of capital and margins of such traders and acts as a deterrent from trading in crypto assets. Though exemption is provided to small investors, however, the threshold of such exemption is nominal and must be increased. Further, it is evident that clarification is needed to ensure smooth compliance. All stakeholders are advised to take a considered view on the above issues.
Puneet Jain is a Joint Partner and Aanchal Jain is an Associate in the Direct Tax practice of Lakshmikumaran and Sridharan Attorneys, New Delhi.