Cryptocurrencies and taxation challenges

Cryptocurrencies have been in the news recently as tax authorities believe they can be used for money laundering and tax evasion. Even the Supreme Court appointed Special Investigation Team on Black Money recommended that trade in such currency should not be encouraged. While China is said to have banned some of its biggest bitcoin trading operators, countries like the US and Canada have laws restricting trading in cryptocurrency stocks.

What is cryptocurrency?

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

How are cryptocurrency transactions made?

When a transaction is initiated by one user, her computer sends a public code or public key that interacts with the private code of the person receiving the currency. If the recipient accepts the transaction, the initiating computer attaches a piece of code to a block of several such encrypted codes that is known to every user in the network. Special users called ‘Miners’ can attach additional code to a 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 also be used on mobile devices to make purchases. All you have to do is let the receiver scan the QR code from the app on your smartphone or face it face to face using near field communication (NFC). Note that this is very similar to regular online wallets like PayTM or MobiQuick.

Die-hard users swear by BitCoin for its decentralized nature, international acceptance, anonymity, transaction durability, and data security. Unlike paper currency, no central bank controls inflationary pressures on cryptocurrencies. Transaction ledgers are stored in a Peer-to-Peer network. This means that every computer chip 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 that 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 traced to a specific person. This means that we do not know whether the transactor acquired the store of value legally or not. The recipient store of the transaction is similarly suspicious because no one can tell what compensation was given for the currency received.

What does Indian law say about such virtual currencies?

Virtual currencies or cryptocurrencies are usually considered pieces of software and are therefore classified as goods under the Sale of Goods Act of 1930.

Because they are good, they would be subject to indirect taxes on their sale or purchase, as well as VAT on services provided by miners.

There is still considerable confusion over 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 approved buying and selling through this medium of exchange.

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

India has allowed bitcoin trading on 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 who invest in bitcoins, for example, are subject to tax on dividends received.

Capital gains from the sale of securities that include virtual currencies are also subject to taxation as income and consequent filing of IT returns.

If your investments in this currency are large, it is better to get help from a personalized tax service. Online platforms have made the tax compliance process much easier.