Cryptocurrency and Taxation Challenges

Cryptocurrencies have been in the news recently because tax authorities believe they can be used to launder money and evade taxes. Even the Supreme Court appointed a Special Investigating Team on Black Money recommended that trading in such currency be discouraged. While China was reported to have banned some its largest Bitcoin trading operators, countries such as the USA and Canada have laws in place to restrict stock trade in cryptocurrency.

What is Cryptocurrency?

Cryptocurrency, as the name suggests, uses encrypted codes to effect a transaction. These codes are recognized by other computers in the user community. Instead of using paper money, an online ledger is updated by ordinary bookkeeping entries. The buyer’s account is debited and the seller’s account is credited with such currency.

How are Transactions Made on Cryptocurrency?

When a transaction is initiated by one user, her computer sends out a public cipher or public key that interacts with the private cipher of the person receiving the currency. If the receiver accepts the transaction, the initiating computer attaches a piece of code onto a block of several such encrypted codes that is known to every user in the network. Special users called ‘Miners’ can attach the extra code to the publicly shared block by solving a cryptographic puzzle and earn more cryptocurrency in the process. Once a miner confirms a transaction, the record in the block cannot be changed or deleted.

BitCoin, for example, can be used on mobile devices as well to enact purchases. All you need do is let the receiver scan a QR code from an app on your smartphone or bring them face to face by utilizing Near Field Communication (NFC). Note that this is very similar to ordinary online wallets such as PayTM or MobiQuick.

Die-hard users swear by BitCoin for its decentralized nature, international acceptance, anonymity, permanence of transactions and data security. Unlike paper currency, no Central Bank controls inflationary pressures on cryptocurrency. Transaction ledgers are stored in a Peer-to-Peer network. That means every computer chips in its computing power and copies of databases are stored on every such node in the network. Banks, on the other hand, store transaction data in central repositories which are in the hands of private individuals hired by the firm.

How Can Cryptocurrency be used for Money Laundering?

The very fact that there is no control over cryptocurrency transactions by Central Banks or tax authorities means that transactions cannot always be tagged to a particular individual. This means that we don’t know whether the transactor has obtained the store of value legally or not. The transactee’s store is similarly suspect as nobody can tell what consideration was given for the currency received.

What does Indian Law Say about such Virtual Currencies?

Virtual Currencies or cryptocurrencies are commonly seen as pieces of software and hence classify as a good under the Sale of Goods Act, 1930.

Being a good, indirect taxes on their sale or purchase as well as GST on the services provided by Miners would be applicable to them.

There is still quite a bit of confusion about whether cryptocurrencies are valid as currency in India and the RBI, which has authority over clearing and payment systems and pre-paid negotiable instruments, has certainly not authorized buying and selling via this medium of exchange.

Any cryptocurrencies received by a resident in India would thus be governed by the Foreign Exchange Management Act, 1999 as an import of goods into this country.

India has allowed the trading of BitCoins in Special Exchanges with built-in safeguards for tax evasion or money-laundering activities and enforcement of Know Your Customer norms. These exchanges include Zebpay, Unocoin and Coinsecure.

Those investing in BitCoins, for instance, are liable to be charged on dividends received.

Capital gains received due to sale of securities involving Virtual currencies are also liable to be taxed as income and consequent online filing of IT returns.

Should your investments in this currency be large, you are better off obtaining the assistance of a personalised tax service. Online platforms have eased the process of tax compliance by a long way.