1% TDS pushes crypto investors into the gray market: will the 2024 budget reconsider it?

Virtual digital assets (VDA) such as cryptocurrencies, non-fungible tokens (NFT) are digital assets encrypted on the blockchain. Chainalysis’s “Global Cryptocurrency Adoption Index” (2023) also suggests that India is currently leading the game of “popular adoption” in VDAs. India also has the second largest VDA global market. Amid the conundrum of effective regulation of VDAs, the Union government Budget In 2022, a 1% TDS (tax deducted at source) was imposed on the purchase and sale of VDA under Section 194S of the Income Tax Act, 1961. It involved closely monitoring VDA-centric transactions and investments as well as introducing a systematic tax regime. It was further aimed at controlling VDA-centric speculations and putting in place adequate safeguards around the same. In the meantime, all purchases, sales and transactions in VDAs are subject to a 30% tax capital gains tax on profits, without any provision for reduced rates or deductions under section 115BBH. This is independent of the individual’s income tax rate.

In March 2023, the Ministry of Finance brought all VDA-related financial services under the scope of the Money Laundering Prevention Act (PMLA), 2002. Currently, 28 VDA service providers are registered with the Financial Intelligence Unit (FIU) under these regulations, indicating compliance in the sector. On the other hand, the imposition of 1% TDS has a negative impact on VDA investors who are turning to the grey market, an uncharted and difficult to trace labyrinth, especially in the absence of reliable statistics. The tax regime has also paved the way for regulatory arbitrage and led investors to turn to non-compliant international exchanges to evade taxes. This overshadows the government’s intention to put in place a legal tax regime and make it easier to do business.

The impact of 1% TDS is also borne by the exchequer due to non-compliance of stock exchange norms and closure of businesses. In addition, investors are at serious risk of losing their money due to the vulnerability of grey market platforms due to scams and frauds.

Domestic trades are clear about when TDS will be deducted and deposited. However, there is no clarity on the applicability of 1% TDS to international trades. It is important to note that 1% TDS was introduced when the market was unorganized and relatively new, but with time, the VDA market has evolved and it is now more monitored by the government through PMLA. Hence, reducing TDS is the right approach now as it will put India on a par with other countries.

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India’s first G20 Presidency has raised hopes and aspirations for businesses and the general public. India seized the opportunity to shape and lead the global VDA agenda, with the G20 New Delhi Leaders’ Declaration, and pushed for a globally coordinated approach to VDA regulation at the earliest possible to avoid incidents of regulatory arbitrage. G20 leaders also unanimously agreed to provide better information to tax authorities, with respect to VDA transactions.

It is important to note that most developed and developing countries where VDA transactions are prevalent, including the US, UK, Canada, South Africa, and Singapore, among others, have a progressive tax structure. This is because these countries do not impose TDS on VDA transactions and also have a provision to offset losses. At the same time, several countries have put in place internal mechanisms to track VDA transactions to ensure tax compliance. The case of the Canada Revenue Agency (CRA), the US, and the UK, which obtain investor information from centralized VDA exchanges, helps them track VDA investments without affecting market liquidity.

In this context, it is timely for India to re-evaluate the existing TDS norms and align them with global standards such as the Crypto-Asset Reporting Framework (CARF) developed by the Organisation for Economic Co-operation and Development (OECD). This framework enables countries to transparently exchange tax information and transactions in VDAs in a standardised manner. The tax regime of VDA-friendly countries such as Singapore, Germany, Switzerland and Canada should also be studied to assess the impact of the removal of the tax on economic prospects and consumer protection.

With regard to VDAs, it is essential that Budget 2024 amends the existing tax structure, which would be in line with India’s commitment to formulate comprehensive regulations for VDAs for G20 countries. To enable a progressive tax regime, it is strongly recommended that India consider a nominal TDS rate between 0.01 and 0.05 per cent to support transaction tracking. This would also facilitate tax collection if Indian investors continue to trade from KYC-enabled Indian platforms. Further, there should be a provision to set off or defer any losses arising on transfer of VDAs. Absence of this provision would create a barrier to capital inflows and international investments. In a nutshell, India should adopt a progressive tax regime for VDAs as this would demonstrate the nation’s interest in global coordination and economic growth.

(The article was written by Shashi Mathews, Partner at INDUSLAW and Gaurav Chaudhary, Account Director at Chase India, a research and policy consultancy. The views expressed are personal.)

(Disclaimer: The opinions expressed in this column are those of the author. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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