In India, cryptocurrencies have emerged as a popular investment choice for private citizens. However, their path in India has been anything but stable. From being completely banned to now coming under strict regulatory scrutiny, these virtual assets have faced a series of challenges and uncertainties. Nevertheless, the promise of high returns continues to captivate investors, especially millennials.

With over 100 million cryptocurrency investors reside in India now, surpassing the entire number of stock market participants. The following article will explain cryptocurrency, its tax and legal framework in India, tax law loopholes, the effects of these problems, and how to close these gaps within the current legislation to support the future expansion of our economy as a whole.

Understanding Cryptocurrency: Definition

A cryptocurrency is a kind of digital or virtual currency that depends on the technology known as blockchain for security and transparency and was created to be used as payment for goods and services made online. In contrast to other payment systems (like conventional notes, bank accounts, etc.) which are regulated by governments and financial institutions, cryptocurrency has no central authority and is unaffected by third parties, meaning that it is not issued or managed by either of these entities.

Cryptocurrency is revolutionizing finance and banking around the world, it has influenced and impacted an enormous number of people worldwide.

A few well-known cryptocurrencies include Dogecoin (DOGE), Bitcoin (BTC), Binance Coin (BNB), Tether (USDT), Ether (ETH), Litecoin (LTC), and several others are among the most recognized cryptocurrencies.

Cryptocurrency Taxation in India

The Indian government addressed the absence of formal legal status for cryptocurrency by defining "Virtual Digital Asset" (VDA) within the Income Tax Act, 1961 through the Finance Bill, 2022. The Finance Ministry clarified the taxation framework for VDAs, classifying them as digitally represented values created via cryptographic methods, applicable to investments and financial transactions.

This includes non-fungible tokens. According to provisions in Section 194(S), by March 20, 2023, Rs 157.9 crore was collected in direct taxes via tax deduction at source for the fiscal year 2022-2023, marking a step toward legitimizing cryptocurrencies in India.

Navigating Crypto Taxation in India's Regulatory Framework

Let's examine the intricacies of India's cryptocurrency tax laws and how you can maximize your investments while being compliant with the law.

• Tax Rate on VDAs [Section 115 (BBH)]:
  This section mandates a 30% tax on income from selling or transferring VDAs, applied uniformly regardless of income amount. Taxpayers can only deduct the buying cost, with no allowances for other expenses or loss adjustments. This provision aims to tax VDA income separately, discouraging speculative trading and ensuring tax compliance clarity.
   
• Tax Deduction at Source (TDS) on transfer of VDAs [Section 194S]:
  This section enforces a 1% tax deduction on payments for transferring Virtual Digital Assets (VDAs). Tax is withheld upon fund crediting or payment execution. Payers must ensure tax payment prior to VDA transfer, regardless of payment method. No TDS is required for transactions of ₹50,000 or less paid by individuals or ₹10,000 or less by non-specified persons. Payments to suspense accounts incur TDS, supporting small traders while encouraging compliance.

 

Loopholes in India's Digital Asset Taxation and its Impact

Even though levying taxes on cryptocurrencies in India is a step in the right direction, the legislation still has plenty of errors and discrepancies which restrict its efficacy and the emergence of the cryptocurrency ecosystem. Correcting these obstacles can promote development and economic growth in addition to increasing compliance. A breakdown of the issues and its impact on the digital world is provided below:

• Elevated Tax Rates (30% on Earnings)
  • Issue: Traders and regular investors are deterred by the standard 30% tax rate on all virtual gains, irrespective of the earnings bracket generated, and the ban on deductions for any expenses.
  • Impact: Buyers are forced onto uncontrolled platforms or foreign exchanges in an effort to evade paying excessive taxes, which reduces transparency and tax revenue.
• 1% TDS on Every Transaction
  • Issue: Imposing 1% TDS for every cryptocurrency transaction leads to delay in liquidity.
  • Impact: It deters involvement in the bitcoin business and limits expansion by increasing compliance burdens. Amateur traders and investors working on tight margins are disproportionately impacted.
• No Offset of Losses
  • Issue: In contrast to traditional investments like stocks, cryptocurrency losses cannot be offset from other sources of income.
  • Impact: This restricts risk-taking abilities and discourages involvement in the digital currency market due to the absence of tax relief.
• Restriction on Carry Forward of Losses
  • Issue: Unlike losses from conventional assets like equities, losses from cryptocurrencies cannot be carried forward to future years.
  • Impact: Investors are less able to recover from losses, which discourages risk-taking and reduces market participation.
• Lack of a Dedicated Regulatory Authority
  • Issue: There is no single regulatory body for cryptocurrencies; RBI, SEBI, and the Ministry of Finance currently manage compliance inconsistently.
  • Impact: This creates confusion and hesitancy among investors and businesses, delaying the growth of the crypto economy in India.
     

Outlook for India's Cryptocurrency Policy

• Clear Regulatory Framework: The proposed 2021 Cryptocurrency and Regulation of Official Digital Currency Bill is yet to be passed. It aims to balance economic growth and regulation and should be prioritized.
• Rationalized Tax Structure: High tax rates (30% income, 1% TDS) restrict trading volumes. Rational amendments could increase domestic investment and reduce capital flight.
• Balanced Risk Management: RBI and SEBI aim to ensure stability while fostering innovation. Excessive regulation could hinder creativity and weaken India's global crypto standing.
• Anti-Money Laundering Compliance: On March 7, 2023, the Ministry of Finance brought all VDA transactions under the Prevention of Money Laundering Act to combat illicit activities and enhance oversight.
• Global Collaboration: India is working with the G20 and FATF to create global crypto regulations, recognizing that digital assets transcend borders and require unified international cooperation.

Conclusion:
In conclusion, India's cryptocurrency taxation policy marks a significant step in defining the crypto industry but also exemplifies overregulation. The establishment of a tax framework via the Income Tax Act, 1961 and the classification of virtual assets provide crucial clarity. However, the system remains overly rigid and investor-unfriendly, featuring a fixed 30% tax rate, a 1% TDS on all transactions, and restrictions on offsetting losses.

This discourages participation, particularly from individual investors and startups, pushing them toward unregulated channels. Nevertheless, India's proactive stance in global regulatory discussions and the inclusion of digital currency under the PMLA highlight an awareness of digital assets' importance. A more balanced strategy, including lower tax rates, risk allowances, and a dedicated regulatory body, could facilitate a thriving cryptocurrency market.

Successful implementation of these measures could transition cryptocurrencies from a regulatory issue to a contributor to India's GDP growth. The government prioritizes international collaboration to ensure the legitimization and security of digital assets while combating illegal activities.