Rethinking Virtual Digital Assets & Taxation

The younger population sees VDAs as a serious investment class, despite last 18 months of global volatility in this space. Industry estimates indicate that in 2022, Delhi led crypto asset investments , measured in terms of value invested, while Bengaluru, Hyderabad and Mumbai follow suit. Jaipur had the highest crypto adoption amongst tier-2 and tier-3 cities, followed by Lucknow and Pune. Hyderabad had the highest share of women investors. Nearly half or Indian crypto investors were in the 18-25 year-old age bracket, with nearly 1/3rd of total investors in the 26–35 years bracket, and nearly 1/8th of total investors in the 36–45 years group, the rest above 45 years of age.

The Union Budget 2022-23 brought to the virtual digital asset (VDA) industry : a levy of a flat 30 percent tax on gains from VDA trade applicable from 1st April 2022; a levy of 1 percent tax deducted at source (TDS) on transactions above INR 10,000 from 1st July 2022; the provision disallowing the offsetting of losses applicable from 1st April 2022. This meant to achieve a threefold objective: tracking VDA transactions by resident Indians and the corresponding sources of income; discouraging speculation and trading on VDAs; and building guard rails for financial stability. 

The impact of India’s tax policy on the  centralised Virtual Digital Asset (VDA) exchanges, that are similar to stock exchanges, is actually profound compared to many other economies. The US taxes short-term and long- term gains from VDA at separate rates. While short-term gains are taxed at a rate between 10-37 percent, long-term gains attract a lower tax rate of 10-20 percent. On the contrary, India’s flat tax approach equates VDAs to gambling and betting. 

None of the countries, except India, impose a TDS on VDA transactions. A TDS of one percent (on transactions above INR 10,000) is quite high for an industry that has high-frequency transactions akin to securities markets. India should pick up cues from existing other markets where they have mechanisms to track VDA transactions, to ensure tax compliance. Regulations should have these VDA exchanges hold a minimum level of capital to ensure that they have sufficient resources to protect against losses.

Web3.0 potential

In the run up to Web3 scaling up, India can lead global policy stewardship on Web3.0. This would need to factor its learnings, bias and prejudices on digital finance, including the ‘can’t name it’ sector of Cryptos. Cryptos alone don’t define Web3.0. 

The  distinctive feature of Web3 is the decentralisation of business models. Web3, potentially changes the power equation with control back to users. Open standards and protocols would emerge to shape Web3. Control would no longer be centralised with large platforms. The Web 3.0 tokens are digital assets that are associated with the idea of building a decentralised Internet. Digital assets are intangible digital items with assigned & clear ownership rights. They offer  verifiable and ownable digital values. Yet the legal sanctity is not clear in many countries. These assets exist on the blockchain across applications and can engage with smart contracts. The market volatility & reduced valuations of major cryptocurrencies,  reduced trading volume of non-fungible tokens (NFTs), and early movers and few large platforms in this space have shut due to misuse of customer funds and poor risk management and governance practices. However this does not mean that the underlying potential of digital assets and their growth in the medium to long term is to be doubted. 

Policy framework

Current policy thinking around VDAs seems to have pushed the domestic VDA transactions and corresponding trading liquidity to foreign exchanges, at greater risk to Indian domestic investors. While much of these policy formation shaped up with idea to keep cryptos at bay, and to discourage Indian investors from investing into VDAs. But the data shows different trend of Indian consumers continuing to invest into VDAs, but simply shifting their investments into VDA exchanges abroad ! There is a notable fall in the volumes of each of the three Indian VDA exchanges at the relevant regulatory inflexion events.. With current issues at global exchanges, there is greater chance of Indian retail investors in those exchanges losing their assets. We can’t outsource domestic consumers’ protection to foreign market regulators. 

Given that the TDS mandate is also meant to enhance transaction tracking, lower its rate, akin to the securities transaction tax (STT). This will help curb the distortionary effect of TDS on the industry; The government should reconcile tax rates vis-a-vis revenue maximisation by ascertaining the optimal taxation point(s). The government should adopt a progressive tax structure with differentiated rates for short term and long-term gains, in line with international best-practice.

India’s tax treatment of VDAs is negative in comparison to other countries with high VDA adoption rates, such as the USA, UK, South Africa, Vietnam, Philippines and Brazil. Regulatory uncertainty in the fledgling VDA industry also has the potential to lead to capital outflow, deter international investors from investing into Indian VDA sector. This reduces the competitiveness of Indian VDA exchanges relative to their international counterparts to attract investments in this space. In a Web 3.0 where India can have a larger pie of the global possibilities, we can’t afford flight of capital and human capital. Starting with VDAs. High taxation won’t only break the backbone of a startup sector and its investor-users, but might drive it to other welcoming economies.

Dr. Srinath Sridharan - Author, Policy Researcher & Corporate Advisor 

Twitter : @ssmumbai