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RISE OF CRYPTOCURRENCIES IN INDIA

EXECUTIVE SUMMARY

In the fast-growing age of technological progressions and Globalisation, one thing is drawing the attention of finance experts, banking authorities, and several New Investors. That is none other than "Cryptocurrency".

"Cryptocurrency is a form of decentralized digital currency secured by Cryptography and based on blockchain technology. The decentralized structure of cryptocurrency allows them to exist outside the control of governments and central authorities."

The prevalence and popularity of Virtual Currencies such as Bitcoin, Ethereum, Cardano, etc. have considerably increased globally in the recent past. Various Investors from India are attending to this phenomenon and wanting to get a fair share of this euphoria.

THE BEGINNING OF CRYPTOCURRENCY

Before the contemporary iterations of cryptocurrencies, numerous attempts were made to bring digital currency into existence but didn’t gain widespread traction. Those include ideas in the early 1980s in Netherlands and United States. The earliest noteworthy digital currency may be 'Digicash', which was unable to convince banks to adopt its technology and eventually filed for bankruptcy in 1998.

Even though many efforts were made to create a digital currency for over a decade, The First fully functional Cryptocurrency namely "Bitcoin" was introduced in 2009 in the form of a 'White paper' that explains the foundations of Blockchain and Bitcoin created by "Satoshi Nakamoto".

After its introduction in 2009, the total value of Bitcoin surpassed $1 Trillion in march 2021, completely reversing the opinion of so many financial institutions and new investors who were initially reluctant to the concept of Digital Currency. Due to the tremendous success of Bitcoin, Various new cryptocurrencies were released using the same blockchain technology termed 'Alt Coins' or 'Alternate Coins'. The most noteworthy Bitcoin alternative is Ethereum, which has the second-largest market cap in the crypto market created by Vitalik Buterin a 27-year-old Canadian programmer. Currently, there are more than 5000 Cryptocurrencies in existence each of which was created to address or resolve the existing challenges of Bitcoin.

All you need to Know About Cryptocurrency Taxation and Accounting In India

LATEST DEVELOPMENTS IN CRYPTOCURRENCIES

The Most recent development in Cryptocurrency adoption is that El Salvador, a small coastal country in Central America announced and passed a bill that makes Bitcoin a Legal tender in that country and became the first country in the world to accept Bitcoin as a legal tender. This move took the world by storm and many countries were looking at the precedent set by El Salvador by adopting a digital currency as Legal tender. Many Institutional investors, investment banks, Technology Companies have continued to support Bitcoin by including the same in their portfolios. For Example, Tesla a global tech giant founded by Elon Musk announced a historic $1.5 billion investment in Bitcoin in February 2021, accounting for 8% of the company's $19.4 billion in cash and liquid assets.

LEGAL POSITION OF CRYPTOCURRENCIES IN INDIA

Even though many countries were positive about using cryptocurrency in their respective financial systems, the situation in India is somewhat cautionary regarding the usage of cryptocurrency. Through a circular in 2018, the RBI had advised the entities regulated by it not to deal with cryptocurrencies or provide services for facilitating any person or entity in dealing with settling them. However, the Supreme court set aside the RBI Circular on March 4, 2020. Since then, many Investors were looking at cryptocurrency as a profitable dimension to invest in. But there are fears that the government may legally ban virtual currencies in the future and the same is preventing many conservative investors from investing in Cryptocurrency. As of now, the government does not consider cryptocurrencies as legal tender.

CRYPTOCURRENCY TRADING IN INDIA

The growing interest in cryptocurrency in India led to the rise of many crypto exchange platforms like WazirX, Coinswitch Kuber, CoinDCX GO, etc., which have made it very easy to buy and sell cryptocurrencies in the country. Unlike stock markets, all of these platforms work 24x7. which enables the users to invest and withdraw money on any day of the week and at any time of the day. Currently in India, Over Rs, 10,000 Crores were invested by many investors in various cryptocurrencies trading on many platforms.

 

RISKS OF CRYPTOCURRENCY

Though Cryptocurrencies have a wide range of utility in this fast-evolving technological era, it has its fair share of Risks associated with its usage. The fact that the transactions are decentralized and cannot be traced by the government is worrisome and the main reason for the reluctancy in adoption of cryptocurrency as an official method of payment or an asset class. The following are few of the many possible risks associated with the usage of cryptocurrencies.

  1. Anonymous Identities: The transaction and accounts are anonymous and not connected to real-world identities. We do not know whom we are dealing with while performing trades, which leaves us with tremendous exposure to the risk of the credibility of the person. In case the person is a fraud there is no way to track him/her down as there is absolute privacy and no regulation.
  2. Decentralized: Neither government nor any authority regulates the cryptocurrency. Being an unregulated market makes it vulnerable for the people’s interest. Other investment options like Financial Markets are comparatively safe as these are regulated markets that are controlled and regulated by authorities that safeguard the public interest. Decentralization can lead to fraud and can be an invitation to threats. Hence, decentralization becomes a major risk in crypto.
  3. Irreversible Transactions: The transactions are irreversible in nature. It takes only a couple of minutes to complete a transaction, quite instant. Once the transaction is performed it cannot be reversed unless the second party is willing to. The identities are anonymous and hence the irreversibility risk increases further.
  4. Peer-to-peer: Users can control their digital wallets versus using a bank, which is a good advantage. However, in case of losing access to the wallet like forgetting passwords or loss of the device can lead to major issues and challenges.
  5. Acceptance: Theoretically speaking, the most popular cryptocurrency - Bitcoin has a worldwide acceptance. But the reality is different, many countries, companies, and exchanges doubt the credibility of it and hence it’s not accepted globally yet.
  6. Uncertainty: Crypto market is one of the most volatile markets in the world. The price fluctuations are quite high. The swings are in 000’s of dollars sometimes. Moreover, there can’t be an accurate reasoning or speculation behind the fluctuations or volatility. Due to the unstable characteristic of crypto, its reliability is questioned which makes it unacceptable globally.
  7. Cyber Frauds: The secrecy and popularity aspects of crypto are drawing attention all over the world. This increasing popularity in an unregulated market is also inviting many cybercrimes and hackers. Though cryptography is strongly encrypted, it’s still vulnerable to hackers who are searching for opportunities to fraud and scam.

FUTURE OF CRYPTOCURRENCY IN INDIA

With the exponential growth and advancements in the field of technology in India, especially with the emergence of COVID-19, the fintech sector has been on a path of constant rise and many investors started investing in Cryptocurrency.

Even in a time of crisis, many people from all over the world came forward to help India to fight against the COVID-19 pandemic by Donating huge amounts in Cryptocurrencies. Recently, Vitalik Buterin, the Founder of the second-largest Cryptocurrency in the world i.e., Ethereum donated Cryptocurrency worth approximately a Billion Dollars to the India Covid Crypto Relief Fund to help India fight against COVID-19 Pandemic.

After the Supreme Court judgment, the Indian government has taken an encouraging step towards regulating digital currencies in India. According to the latest amendments to the Schedule III of the Companies Act, 2013, the Government of India mandated the companies to disclose their profit or loss on transactions involving cryptocurrency, investments in cryptocurrencies during the financial year. This step by the government was considered a positive move towards regulating cryptocurrencies in India.

The Parliament, in the next Lok Sabha session, is proposing to introduce the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 ("New Bill"). The New Bill seeks to create a facilitative framework for the creation of the official digital currency to be issued by the RBI. The New Bill also seeks to prohibit all private cryptocurrencies in India. However, it allows for certain exceptions to promote the underlying technology of cryptocurrency and its uses.

 

ACCOUNTING OF CRYPTOCURRENCY IN INDIA

As of today, there is no accounting standard guiding on how to recognize, Measure and present Cryptocurrency in financial statements. Hence, we are left with the option to refer the existing standards to deal with Cryptocurrencies. The Main practical issue with Cryptocurrency Accounting is the classification of Cryptocurrency. Having many uses cases cryptocurrency cannot be classified under a single type of asset or a commodity or investment. Cryptocurrency's use cases are numerous and many entities use them in different ways. For example, Tesla is holding Bitcoin in its treasury as an investment whereas the second largest Cryptocurrency "Ether" is running the whole ecosystem of Decentralized Finance and Smart contracts on Ethereum blockchain network. Likewise, there are many different use cases and classifications applicable to Cryptocurrencies. Considering the various possibilities and use cases cryptocurrency can be classified as one of the below:

a) Cash & Cash Equivalent

Currently, in India Cryptocurrencies are not a recognized medium of exchange because it does not represent a legal tender. In addition to this Cryptocurrencies are subject to Significant price fluctuation which eliminates the possibility of them being classified into Cash & Cash Equivalents as defined in Ind AS 7 because they cannot readily be exchanged for any good or service.

b) Financial Instrument

Some might argue that cryptocurrency should be accounted as a financial asset in accordance with Ind AS 119. However, it does not meet the definition of a financial instrument because it does not represent cash, an equity interest in an entity, or a contract establishing a right or obligation to deliver or receive cash or another financial instrument. Cryptocurrency is not a debt security, nor an equity security because it does not represent an ownership interest in an entity. Therefore, it appears cryptocurrency should not be accounted for as a financial asset.

c) Intangible Asset

Cryptocurrency meets the closets criteria of Ind AS 38, Intangible Assets. This standard defines an intangible asset as an identifiable non-monetary asset without physical substance.

Ind AS 38 states that "an asset is identifiable if it is separable or arises from contractual or other legal rights. An asset is separable if it is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability".

Therefore, it appears that cryptocurrency meets the definition of an intangible asset in Ind AS 38 as it is capable of being separated from the holder and sold or transferred individually. An entity will also need to assess whether the cryptocurrency’s useful life is finite or indefinite. An indefinite useful life is where there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. It appears that cryptocurrencies should be considered as having an indefinite life for Ind AS 38. An intangible asset with an indefinite useful life is not amortized but must be tested annually for impairment.

d) Inventories

Sometimes entities hold cryptocurrency for sale as a part of the ordinary course of business. In those cases, it might be appropriate to account for cryptocurrencies in accordance with Ind AS 2. IAS 2 defines inventories as "assets:

  • held for sale in the ordinary course of business
  • in the process of production for such sale, or
  • in the form of materials or supplies to be consumed in the production process or in the rendering of services.

Normally, this means the recognition of inventories at lower the cost or NRV. However, if the entity acts as a broker of cryptocurrencies, then Ind AS 2 states that their inventories should be valued at fair value less costs to sell. This type of inventory is principally acquired to sell in the near future and generate a profit from fluctuations in price. Thus, this measurement method could only be implemented in very thin cases where the business model is to sell cryptocurrency shortly to generate a profit from fluctuations in price.

TAXATION OF CRYPTOCURRENCY IN INDIA

With the concept of cryptocurrency being new to the Indian market, the government has not yet implemented the taxability of Cryptocurrency into the statute. At the same time, the levy of tax on Cryptocurrency cannot be ruled out because the Indian income tax laws have always attempted to tax income received irrespective of the form in which it is received. Therefore, the possibility of a tax on Cryptocurrency can be looked at under the following situations:

Scenario A: Cryptocurrency Mining

The cryptocurrency created by mining is self-generated capital assets. Subsequent sale of such cryptocurrency would, in the ordinary course, give rise to capital gains. However, the cost of acquisition of a cryptocurrency cannot be determined as it is a self-generated asset. Moreover, it does not fall under the provisions of Section 55 of the Income-tax Act, 1961 which specifically defines the cost of acquisition of certain self-generated assets. Therefore, the capital gains computation mechanism fails following the Supreme Court decision in the case of B.C. Srinivasa Shetty. Hence, no capital gains tax would arise on the mining of cryptocurrency. This position would hold till such time the government thinks of coming up with an amendment to Section 55 of the Act.

Scenario B: Transfer of Cryptocurrency held as an investment for Consideration

If cryptocurrency is held as an investment and is transferred in exchange for real currency, the appreciation in value would give rise to a long-term capital gain or a short-term capital gain depending on the period of holding of the cryptocurrency. Further, long-term gains would be taxed at a flat rate of 20% while short-term gains would be taxed at the individual slab rate. The cost of acquisition for arriving at long-term capital gains will be determined after giving the benefit of indexation.

Scenario C: Cryptocurrency held as stock-in-trade being transferred in exchange for real currency

The income arising out of bitcoins trading activity would give rise to income from business and accordingly, the profits arising out of such business would be subject to tax as per the individual slab rates.

Scenario D: Cryptocurrency being received as consideration on sale of goods and services

Recently, World's biggest Electronic Car manufacturer Tesla started accepting Bitcoins as a consideration for their electric cars. But due to energy consumption concerns, Tesla temporarily stopped accepting Cryptocurrency as a consideration. If this Scenario ever occurs in India Cryptocurrency being received so shall be treated on par with receipt of money. It would constitute income in the hands of the recipient. Further, since the recipient received this income out of a business or profession, he would be taxed, normally, under the head profits or gains from business or profession. As regards the disclosure requirement of bitcoins in the income tax return forms, there continues to be a lack of clarity.

CONCLUSION: NEED FOR A WELL-STRUCTURED FRAMEWORK AND REGULATION

It is well established that there exists a lack of clarity concerning cryptocurrency regulation in India even though crypto trading platforms already started enabling trading of cryptocurrency to the whole of India. The Cryptocurrency regulation in India requires a well-structured framework with due regard to the statute, the stakeholders involved, and the possible effects on the economy as a whole. There are many other countries such as Japan, Australia, Russia that have made constructive regulations towards the usage of cryptocurrencies. Therefore, it is crucial to understand and consider the models embraced by other countries and implementing a tailor-made framework without imposing a ban on cryptocurrency in its entirety would be a more beneficial solution keeping the interests of all stakeholders in mind.

Footnotes & References

  1. KPMG, Fintech in India - Global Growth Story, June 2016
  2. National Strategy on Blockchain in January 2021, Government of India Ministry of Electronics and Information Technology
  3. RBI Circular (DBR.No.BP.BC.104/08.13.102/2017- 18)
  4. Lok Sabha Bulletin Part - II, General Information relating to Parliamentary and other matters

The author can also be reached at pjnrajesh@gmail.com


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