Mr. Prakash Sinha (Partner, Prakash Sachin & Co. Chartered Accountant) examines the legality of Virtual Digital Assets. He analyses the definition of Virtual Digital Assets under newly inserted section 2(47A) and states that the term has been defined widely, thereby including every form of virtual assets barring Indian or Foreign Currency. He points out that RBI in the past had taken actions to deter the financial institutes and people at large from dealing increasingly popular in Virtual Digital Assets. The author discusses the decisions of the Apex Court and HC, wherein the legality of the virtual digital assets were questioned along with their taxability. He opines that, "the absence of any legislative/regulatory framework or policy confirming the status of crypto currencies till date and the validity of trading in and dealing with them, questioned their future in India which hinged over a murky structure."

Virtual Digital Assets ( VDA ) – Unlawful or Unregulated

With the recent announcement in the Budget proposal, one of the proposal is to levy the tax arising out of transfer of Virtual digital assets . Although the term “Virtual Digital assets” has been defined widely under newly inserted section 2(47A) and therefore it includes every form of virtual assets excluding Indian Currency or Foreign Currency. Further the Central govt has the power to include or exclude something from the scope of the Virtual digital assets. For our discussion, we are not going into the detail of the VDA, but for understanding we have termed this Cryptocurrency Tax.

The moments the budget announced that there will be  new section 115BBH wherein the income arising out of the transfer of the VDA will be taxed at the flat 30% , without any set off of the expenses ( except the cost of acquisition of such VDA ) and there will no carry forward of such losses ( if any ) to the subsequent years , just like the taxation of the speculation business and its taxation. Further it was also proposed to amend the term “Property “ for the purpose of 56(2)(x), and therefore gift of such VDA will also be taxed @ 30% under section 56(2)(x).  There was a sense of joy among all the stake holder under an purported impression that now the transactions has become legal in India or at least the government by way of the taxing the VDA has shown its intent to legalize the transaction in India .

Transaction in Cryptocurrencies are legal or illegal –

Background

In 2017, a high level Inter-ministerial Committee ("IMC") was constituted to study the issues related to virtual currencies ("VC") and make recommendations for the same. The IMC recommended a ban on all private cryptocurrencies in India since they were considered inconsistent with the essential functions of money/currency. The IMC noted that there was no country that had provided the status of legal tender to cryptocurrencies. It was also recommended that an official digital currency be introduced by the RBI to reap the benefits of VCs while avoiding its detriments. To this end, the IMC proposed a draft bill, which was not tabled in the Indian Parliament.

The RBI has issued “Statement on Developmental and Regulatory Policies “ on 5^Th April 2018 and based on this RBI directed the entities regulated by it.

a. not to deal with or provide services to any individual or business entities dealing with or settling virtual currencies and

b. to exit the relationship, if they already have one, with such individuals/ business entities, dealing with or settling virtual currencies (VCs).

Following the said Statement, RBI also issued a circular dated April 6, 2018, on the same subject, in exercise of the powers conferred by Section 35A read with Section 36(1)(a) and Section 56 of the Banking Regulation Act, 1949 and Section 45JA and 45L of the Reserve Bank of India Act, 1934 (hereinafter, “RBI Act, 1934”) and Section 10(2) read with Section 18 of the Payment and Settlement Systems Act, 2007, reiterating the directions laid down by the aforementioned Statement. 

The Supreme court , through  Hon’ble  Justice R F Nariman , Justice Anuradha Bose and Justice V Ramasubramanian,  in the case of Internet and Mobile Association of India Vs RBI as reported in (2020) 10 SCC 274, wherein the constitutional validity of the circular was assailed , observed as under –

6.170. But within a year, there was a volte-face and the final report of the very same Inter-Ministerial Committee, submitted in February 2019 recommended the imposition of a total ban on private crypto currencies through a legislation to be known as “Banning of Cryptocurrency and Regulation of Official Digital Currency Act, 2019”. The draft of the bill contained a proposal to ban the mining, generation, holding, selling, dealing in, issuing, transferring, disposing of or using crypto currency in the territory of India. At the same time, the bill contemplated (i) the creation of a digital rupee as a legal tender, by the central government in consultation with RBI and (ii) the recognition of any official foreign digital currency, as foreign currency in India.

6.171. In case the said enactment (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. But that situation had not arisen. The position as on date is that VCs are not banned, but the trading in VCs and the functioning of VC exchanges are sent to comatose by the impugned Circular by disconnecting their lifeline namely, the interface with the regular banking sector. What is worse is that this has been done (i) despite RBI not finding anything wrong about the way in which these exchanges function and (ii) despite the fact that VCs are not banned.

6.172. As we have pointed out earlier, the concern of RBI is and it ought to be, about the entities regulated by it. Till date, RBI has not come out with a stand that any of the entities regulated by it namely, the nationalized banks/scheduled commercial banks/co- operative banks/NBFCs has suffered any loss or adverse effect directly or indirectly, on account of the interface that the VC exchanges had with any of them. As held by this court in State of Maharashtra v. Indian Hotel and Restaurants Association, there must have been at least some empirical data about the degree of harm suffered by the regulated entities (after establishing that they were harmed). It is not the case of RBI that any of the entities regulated by it has suffered on account of the provision of banking services to the online platforms running VC exchanges.

6.173. It is no doubt true that RBI has very wide powers not only in view of the statutory scheme of the 3 enactments indicated earlier, but also in view of the special place and role that it has in the economy of the country. These powers can be exercised both in the form of preventive as well as curative measures. But the availability of power is different from the manner and extent to which it can be exercised. While we have recognized elsewhere in this order, the power of RBI to take a pre-emptive action, we are testing in this part of the order the proportionality of such measure, for the determination of which RBI needs to show at least some semblance of any damage suffered by its regulated entities. But there is none. When the consistent stand of RBI is that they have not banned VCs and when the Government of India is unable to take a call despite several committees coming up with several proposals including two draft bills, both of which advocated exactly opposite positions, it is not possible for us to hold that the impugned measure is proportionate.

Therefore, the Circular was hold unconstitutional on the ground of Proportionality , however  it was also held that RBI has inherent powers to regulate the dealing and trading of CCs in the interest of the banking system, monetary stability and sound economic growth.  While this development was emblematic of optimism amongst industry players in India, the quashing of Notification had only brought cryptocurrencies  into a grey area and one could not have elided that RBI and legislators will be oblivion to any activity relating to CCs in future.

Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 ("Crypto Bill") – It was in the media that government is proposing to bring the crypto Bill in the last year Parliament session . Although there was no draft of the said bill was available with the author , but it was in the news that the Crypto Bill seeks to ban all private cryptocurrencies and create a legitimate framework for official digital currency in India, backed by government/RBI, while providing certain exceptions to promote the underlying technology driving the digital currency. Therefore  the Crypto Bill  suggests banning of all the private cryptocurrencies. The industry practitioners have hit the panic button due to the speculative foresightedness attached to the Crypto Bill, including more particularly the banning of 'private cryptocurrencies'.

Therefore the  absence of any legislative/regulatory framework or policy confirming the status of crypto currencies  till date and the validity of trading in and dealing with them, questioned their future in India which hinged over a murky structure.

PIL before Bombay High Court – A  PIL petition was filed in November 2021 before the Bombay High Court wherein  seeking directions to the Union of India for formulating a comprehensive mechanism to rectify the risks involved in the largely unregulated cryptocurrency market in India, including appropriate legislation and guidelines. The petitioner has approached the High Court to issue directions to the respondent state for formulating law/ rules governing the use of cryptocurrency within India, preparing a robust mechanism for monitoring international crypto transactions, overseeing the registration of crypto exchange platforms, instituting a proper grievance redressal mechanism against trading platforms, and putting in place a fool proof taxation scheme for such transactions.  In the PIL it was stated that there's no central authority to manage or control the value of cryptocurrency, unlike the normal currencies. The absence of laws/ regulatory bodies in the realm of crypto trade might result in a scam of the magnitude of the 2013 NSEL Case, the petition notes. The petitioner has also annexed an analytical study of cryptocurrency with the petition.

PIL before Madras High Court -  In December 2021 , a PIL was filed before the  Madras High Court seeking  a ban on advertisements about cryptocurrency trading in all media platforms until the Government makes proper rules and regulations for Crypto trading. The Finance Secretary, Cabinet Secretary and the Ministry of Information & Broadcasting have been arraigned as the Respondents to stop advertisements on crypto trade within a fixed time as stipulated by the High Court. The PIL filed states that illegal trading in cryptocurrencies has aggravated money laundering, terrorist financing and extortion activities.

Delhi High Court in the case of Arnav Gulati  Vs SBI & Ors wherein the petitioner has assailed the SBI action prohibiting the action of the UPI platform for dealing and settling the funds in Wazir X crypto Exchange, it was alleged that such action is unconstitutional as it infringes the fundamental right of trading under article 19(1)(g) and right of equality under article 14 of the Constitution. It was alleged in the petition that through its prohibition, the Bank is forcing its customers to use other payment deposit options which takes more time to get completed and extra charges like convenience fees, GST charges or service charges are charged, which makes it difficult for the retail investors and users to get the funds on time.

In view of the above , it is concluded that in the absence of any Crypto law in India , the transaction in the crypto currencies are not legal in India. This view has further been cemented through the post budget press conference Revenue Secretary stated that this proposal to tax the Virtual digital assets has nothing to do with the legality of the transaction in cryptocurrencies in India and by mere taxing the income due to transaction in VDA , does not make the transaction legal .

Illegality of the Business and Taxation

The question arises whether trading in Bitcoins / VDA will be a business income  and if it is business income whether it should be covered under the head “ Income from Business & Profession”.  Since the VDA is not a capital assets , it may not be covered under the head “ Capital gain “ . But being an assets , and trading of such assets should be covered under Income from Business & Profession and if so , there are many judgement suggesting that all the expenses incurred for such earning the income should also be allowed , rather than restricting it to “ cost of acquisition of the VDA “ .

The Supreme Court in the case of CIT Vs Piara Singh , 124 ITR 140] = [TS-6389-ITAT-2012(Delhi)-O] has held that business income arising from unlawful business will also be subject to tax and  allowed the deduction for the expenses from such income .

In CIT v. S. C. Kothari [1971]  82 ITR 794] = [TS-5134-SC-1971-O],  Supreme Court  held that for the purpose of s. 10(1) of the Indian I.T. Act, 1922, a loss incurred in carrying on an illegal business must be deducted before the true figure of profits brought to tax can be computed. Grover J., speaking for the court, observed (p. 802); 

"If the business is illegal, neither the profits earned nor the losses incurred would be enforceable in law. But, that does not take the profits out of the taxing statute. Similarly, the taint of illegality of the business cannot detract from the losses being taken into account for computation of the amount which can be subjected to tax as ' profits ' under section 10(1) of the Act of 1922. The tax collector cannot be heard to say that he will bring the gross receipts to tax. He can only tax profits of a trade or business. That cannot be done without deducting the losses and the legitimate expenses of the business."

The High Court of Calcutta in the case of CIT Vs Lalchatoorah  Tea Co Ltd as reported in 200 ITR 391] = [TS-5527-HC-1989(Calcutta)-O], on the issue of taxability of the income arising from the illegal business has held as under -

It is now well-settled that, even if a business is illegal, it would still be a business within the meaning of the Income-tax Act; if any profits are derived from such business, the same are assessable and there cannot be any distinction between the losses and profits of the illegal business.

The Supreme Court in the case of Barriadas Daga  Vs CIT (1958 ) 34 ITR 10] = [TS-5003-SC-1958-O] has explained that even though the income is from unlawful activities , it was be taxable and the expenses was also allowed .

Therefore following are the moot question –

1. Whether unlawful / unregulated income can be taxed – Yes it can be taxed and there is no bar as such . SC in above mentioned cases , not only affirmed the taxation of such income from unlawful sources , but also allowed deduction for expenses in carrying out such business .

2. Whether VDA income can be hit by section 68 – No , the income from VDA income is coming from the explained sources and is not an unexplained income . It’s a business income , but tax with a flat rate of 30% and with a limited deduction of cost of acquisition only .

3. Whether VDA income can be covered under the Head – “ Income from other sources . – Since the definition of Income under section 2(24) is an inclusive definition and it includes “ Profits and Gains“. Therefore it can also be covered under the Income from other sources  under section 56(1). If it is covered under 56(1), then again 115BBH can be applied for the computation of tax liability .  

4. Whether Cost of acquisition under 115BBH can be hit by section 37 Explanation 3, if the business is prohibited by law. – As per the discussion above , business of bitcoins may be unregulated today but certainly not prohibited by law. Considering, even if , the trading in VDA is prohibited by law , section 115BBH is special section and it allows the expenditure for the acquisition of the VDA and therefore it should not be hit by general section 37.