I. Introduction to Virtual Digital Assets and Cryptocurrencies.

To establish a solid foundation, let’s begin by defining virtual digital assets and cryptocurrencies. Virtual digital assets are digital representations of value that can be digitally traded or transferred, typically using blockchain technology. Cryptocurrencies, on the other hand, are a specific type of virtual digital asset that employs cryptographic techniques for secure transactions and control the creation of additional units. Prominent examples include Bitcoin (BTC), Ethereum (ETH), and Ripple (XRP) Including Non-Fungible tokens or any other digital assets as may be notified by the government.

II. Legal Framework for Taxation of Cryptocurrencies in India.

In recent legislative developments, the Indian government has introduced a significant amendment to the Income Tax Act, of 1961. This amendment takes the form of Clause (47A), which has been inserted into Section 2 of the Act. Clause (47A) has been incorporated to address the taxation of specific transactions related to virtual digital assets or cryptocurrencies.

With the introduction of Clause (47A), the Income Tax Act now encompasses provisions that define the tax treatment of virtual digital assets, bringing them under the purview of the existing tax regime. The inclusion of this clause ensures that income arising from transactions involving cryptocurrencies will be subject to taxation, thereby enabling the government to capture potential tax revenue from this emerging sector.

III. Taxation of Virtual Digital Assets/Cryptocurrencies in India.

1. Classifying Cryptocurrencies as Capital Assets.

Cryptocurrencies, such as Bitcoin or Ethereum, can be considered capital assets if they are acquired for investment purposes. According to section 2(14) of the tax code, a capital asset refers to any property owned by an individual, irrespective of its connection to their business or not. Therefore, if an individual purchases cryptocurrency as an investment, any profit made from their sale would be taxed under the “Capital gains” head.

a. Taxation of Capital Gains on VDA.

When a person sells their cryptocurrencies and realizes a profit, it is important to understand the tax implications. Capital gains tax is applicable on the profit earned from the sale of capital assets. The gain is calculated by deducting the cost of acquisition from the selling price.

2. Treating Cryptocurrencies income as Business Income.

In certain scenarios, cryptocurrency transactions may be deemed substantial, or the assets may be held for trading purposes. In such cases, the income generated from the sale or purchase of virtual digital assets can be classified as business income. It is crucial to note that the intention and frequency of the transactions play a significant role in determining the nature of income.

a. Taxation of Business Income.

If the income from cryptocurrency transactions is considered business income, it is subject to taxation as per the applicable income tax rates. The profits earned are added to the individual’s overall income and taxed accordingly. Additionally, individuals engaged in cryptocurrency trading as a business may also be required to comply with other tax obligations, such as maintaining proper books of accounts and filing regular returns.

Section 115BBH of the Income-tax Act 1961, which deals with the taxation of income from cryptocurrencies or virtual digital assets, does not explicitly state whether it should be treated as business income, capital gains, or income from other sources. This lack of clarity often creates confusion among taxpayers and tax authorities alike.

3. Tax rate. 

Under section 115BBH of the act, income from the transfer of virtual digital assets will be taxable at the rate of 30 percent (+ SC + HEC). The tax rate is the same whether it is business income, short-term or long-term capital gains.

IV. Manner of Computation of Income from Virtual Digital Assets.

When it comes to computing income from the transfer of virtual digital assets, Section 115BBH(2)(a) lays out specific provisions that need to be understood. In this article, we will explore the key rules and deductions about income computation for virtual digital assets, shedding light on the nuances involved.

a. Deduction of Cost of Acquisition.

As per Section 115BBH(2)(a), the cost of acquisition, if any, must be deducted from the full value of the consideration received. However, it’s important to note that if the income falls under the category of “Capital gains,” indexation benefits will not be available. This deduction allows for a more accurate determination of the net income from the transfer of virtual digital assets.

b. No Deduction for the Cost of Improvement and Transfer Expenditure.

It is essential to understand that no deductions will be permitted for the cost of improvement or any expenditure related to the transfer of virtual digital assets. Unlike other forms of income computation, where expenses can be offset against the total income, the provisions under Section 115BBH restrict such allowances. Therefore, any costs incurred in improving or facilitating the transfer of virtual digital assets cannot be claimed as deductions.

c. Application of “Transfer” Definition.

For computing tax under Section 115BBH, the definition of “transfer” as stated in Section 2(47) will be applicable. This definition determines what transactions constitute a transfer, and whether the virtual digital asset is considered a capital asset or not. It is crucial to have a clear understanding of this definition to ensure accurate tax calculation on income derived from the transfer of virtual digital assets.

d. Inability to Adjust Losses.

When it comes to losses arising from the transfer of virtual digital assets, they cannot be adjusted against any other form of income. This provision prevents the offsetting of losses from such transactions against gains in other areas. Losses incurred specifically from the transfer of virtual digital assets must be treated independently and cannot be utilized to offset taxable income from other sources.

e. Inability to Offset Losses from Other Transactions

Additionally, any losses incurred by an assessee from transactions other than the transfer of virtual digital assets cannot be adjusted against income derived from the transfer. This means that losses from other heads of income cannot be used to reduce the tax liability associated explicitly with income from the transfer of virtual digital assets. It is important to consider the individual nature of losses and ensure they are appropriately accounted for in tax calculations.

For Instance

A purchased 60,000 BTC (cryptocurrency) at Rs. 67 each on the 10th of Jan. of 2018. He transferred 20,000 BTC in the previous year 2021-22, and the remaining 40,000 in 2022-23. The capital gains from the transfer of BTC shall be computed as under Brokerage on 01-03-2022 Rs.3,245, 01-04-2022 Rs. 2,660 and on 31-03-2023 Rs. 4,150

Solution: Accounting Net profit of sales of 20,000 BTC took place on 01-03-2022 of Rs. 4,63,245 and taxable profit of Rs. 2,35,064* is taxable at the rate of 20% plus 4% HEC.

*The benefit of indexation shall be allowed because Section 115BBH shall be applicable from the assessment year 2023-24.

Mr. A suffer a loss on sales of 20,000 BTC on 01-04-2022 after the effect of the Brokerage of Rs. 2,660 is 5,42,660 but Taxable losses are only of Rs. 5,40,000.

Mr. A earned a profit on sales of the rest of 20,000 BTC on 31-03-2023 Rs. 16,60,000 without the effect of a brokerage shall be taxable at the rate of 30% plus HEC 4% because the loss on sales of BTC shall not be eligible to set-off and carry forward as per the provision of a section of 115BBH of Income-tax Act 1961.

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