• Varun Chablani (International Tax Lawyer), Shubham Tiwary (Final-Year Student, GNLU)

Taxing Virtual Assets, implied legalization, a tryst with cautious optimism.



Ever since their inception, Crypto-assets have been a source of great chatter. They operate upon consensual distributed ledger platforms, also known as ‘blockchain’ technology. The assets have been thought of as the key to formulating a model of Decentralized Finance (DeFi). However, at present, a plethora of issues exist concerning the nature of crypto-assets, primarily regulation and taxation issues. This article will deal with the legality and taxability of crypto-assets in India.

On 1st February 2022, one of the key highlights of the budget speech by the Finance Minister was the proposal to tax “any income from transfer of any virtual digital asset” at a rate of 30 percent (excluding surcharge and cess, if any) and impose a 1 percent Tax Deduction at Source (TDS) on transactions. The speech of the Finance Minister was a watershed moment for the Indian Crypto sphere, which was thought to have brought finality to the much-debated position of the Government towards crypto-assets.

The speech and the subsequent proposals made under the Finance Bill of 2022 will result in taxing Virtual Digital Assets (VDAs). By way of introduction of section 2(47A), 115BBH, and 194S to the Income Tax Act, 1961, it raised the question whether cryptocurrencies such as Bitcoin, Ethereum, and other allied cryptographic assets such as Non-Fungible Tokens (NFTs) have been granted an implied legal status in the country.

Confusion and development of law prior to the budget The RBI in 2018 had issued a circular on account of the associated risks, that all entities regulated by the Reserve Bank will not deal in Virtual Currencies (VCs) or provide services for facilitating any person or entity in dealing with or settling VCs. The definition of services being rendered included maintaining accounts, registering, trading, settling, clearing, giving loans against virtual tokens, accepting them as collateral, opening accounts of exchanges dealing with them, and transfer/receipt of money in accounts relating to purchase/ sale of VCs.

In March 2020, a significant development took place in the Indian Crypto sphere. The Supreme Court in the case of Internet and Mobile Association of India v. Reserve Bank of India [1] had implicitly allowed trading in the crypto market by setting aside this RBI circular. While ruling in favour of the Petitioner, the Court’s rationale was that even though the RBI has wide powers and plays an essential role in the upliftment of the Indian economy, they were unable to prove that any damage would be caused to the functioning of these institutions through the use of cryptocurrencies.

The court relied on the judgment in the case of State of Maharashtra v. Indian Hotel and Restaurants Association[2], where the Apex court held that there must exist some empirical data regarding the degree of harm that the regulated entities would suffer, absent any such regulation. Through this ruling, the Supreme Court affirmed the crypto currency exchanges’ fundamental right to engage in trade and business, a right that has been guaranteed by the Constitution of India.

Another important development with regards to crypto currencies was the notification issued by the Ministry of Corporate Affairs. This notification amended Schedule III of the Companies Act, 2013, and directed that the companies would now have to disclose any investments in crypto currencies or virtual currencies. This move was lauded by entities dealing with crypto currencies as it would mandate Indian companies to include these virtual assets on their balance sheets.

All of this ought to be considered against the backdrop of the Press Release dated 10.06.2021 of the Enforcement Directorate. A Show Cause Notice was issued to the Crypto-currency Exchange WazirX (owned and operated by M/s. Zanmai Labs Private Limited) for alleged contravention of Section 3(a) of the Foreign Exchange Management Act, 1999, for transactions involving crypto-currencies worth nearly INR 2800 crores.[3] One sentence in this document states ‘This leaves WazirX in clear violation of the basic AML/CFT precaution norms and FEMA guidelines which are also applicable to Virtual Currency Exchanges.’[4]

Again, this sentence may just have given implied recognition to the business form of a crypto-exchange (while of course, alleging other contraventions). However, this itself would not have meant that the crypto-business is legalized yet but only that laws tackling AML and Financial Terrorism are applicable to crypto transactions.

Additionally, the taxation regime in India for such transactions was very much in dependent upon the discretion of the Assessing Officer and viability of the Assessee (as far as the head of income under which the income ought to have been taxed is concerned).

Budget Amendments 2022

The Finance Bill, 2022 introduces section 2(47A) which defines virtual digital assets.[5] The proposed section 115BBH seeks to impose tax on income earned from virtual digital assets. Many crypto traders are looking at this as an implied legalization of crypto currencies and allied virtual assets such as NFTs. Although such inferences might be persuasive, they should be taken with a pinch of salt. The reason being that they are mere assertions, without any legal backing. In fact, the number of user signups on cryptocurrency platforms had jumped between 30% and 50% immediately since the budget speech.[6]

Does taxation of VDAs imply legal recognition?

There have been confusing statements from within the Government, from the date of the budget speech till publication of this article.

On one hand, Revenue Secretary Mr. Tarun Bajaj in an interview with ThePrint stated that crypto transactions are not illegal, because had they been illegal, then government agencies would have already been knocking at the doors of the crypto exchanges.[7] However, the Finance Secretary Mr. TV Somanathan stated “They are in a grey area. It's not illegal to buy and sell crypto”.[8] Subsequently, even the Finance Minister herself stated in the Parliament that the Government is working on a cryptocurrency bill, which would be substantially different from the 2019 version, which outright banned crypto related activities. Additionally, it was clarified by her on 11th February 2022 in the Rajya Sabha,

“I am not doing anything to legalise it or ban it or not lelgalise it or anything at this stage.....Banning or not banning will come subsequently when the consultations give me input …….. would you rather have me not tax it and allow the profits to be there and then tell me I have not even taken a corrective action? So legitimate or illegitimate is a different question but I will tax it because it is a sovereign right to tax.”[9]

Again, one can surmise that there would be some sort of regulation that would come up in the 2021 bill, which is quite different, we are told, from the 2019 bill (the bill lapsed twice because it could not be introduced or tabled before the Parliament so far).

These somewhat confusing stands from within the Government also makes it difficult to assess whether till date, crypto transactions are legal or not. The only certain clue which is available is the Supreme Court judgment discussed earlier.

If we were to try to get into the mind of the Government of the day (without looking at any of the existing bill related literature, as they are not available in the public domain) one way to think of the way forward is with the reference to the term ‘corrective action’. One can extrapolate that the corrective action referred to herein regards the confusion existing till date on the relevant head of income under which cryptocurrency related profits ought to have been taxed (i.e., capital gains, income from business/ profession/ other income). Currency for this interpretation can be seen in terms of the view of the Government that income arising out of crypto-transactions ought to be treated akin to winnings from gambling. This is probably the reason that no deductions (except for cost of acquisitions) have been allowed on such income.

It is important to highlight that one of the legislative intents of the Income Tax Act, 1961 is to increase the net income taxable by the government. In furtherance of this intent, income even from illegal sources are taxed under the ambit of this Act. The Supreme Court was first faced with this issue in the case of Commissioner of Income-tax, Gujarat v. S.C. Kothari.[10]The Hon’ble Supreme Court held that any illegality tainting the earning has no bearing on its taxability. This case was subsequently relied upon by the Supreme Court in the case of Commissioner of Income Tax v. Piara Singh,[11]where a smuggler was taxed on his income, even from illegal smuggling, under the ambit of the Income Tax Act, 1961. Various High Courts have also regularly upheld the taxation of income gained by illegal means.

Therefore, it is evident that the position of law is clear in this regard - the profits made even from illegal sources are to be assessed as income under the Income tax Act, 1961, and are taxable. Hence, taxation of virtual assets merely implies that the government is expanding its tax net to tap into the gains being made by the transfer of VDAs. Such expansion, however, in no way evinces or suggests that the government is legalizing the transactions or entities involved in the crypto space.

Existing analysis of the law post budget 2022 and Our views

As on the date of this publication, plenty has already been said on open issues on the taxability of cryptocurrencies. One article that covers most of the issues quite succinctly is available in TaxSutra.[12]

Since we are at a nascent stage of implementation / regulation of crypto-assets, it is useful to examine the OECD report on Taxing Virtual Currencies: An Overview of Tax Treatments and Emerging Tax Policy Issues.

As per our knowledge, there is not much literature comparing the documents available post Budget 2022, with the International Guidelines. In this regard, we would like to point out one issue not talked about in detail earlier - tax implications of exchange of cryptocurrencies (eg., exchange of bitcoin against ethereum). Section 194S does mention a situation where a cryptocurrency is transferred in kind, (i.e., against goods or services). Most likely, this phrase can cover within its ambit exchange between two cryptocurrencies. When read in the backdrop of what OECD recommends in its Report (p. 55):

“...... excluding exchanges between different types of virtual currencies from income tax consequences may also ease compliance requirements, while still ensuring that gains are taxed when tokens are converted into fiat currency or used to purchase goods and services. However, in making any simplifications to these rules to promote compliance, governments would also need to balance tax planning risks that could be created by these changes.”

As seen above, the OECD recommends (from a compliance perspective), to not bring to the tax ambit, an exchange of one cryptocurrency against another, whereas the Indian Government implicitly does bring it under the tax ambit. Ideally, the Government should consider this report and defer the taxability until either converted into fiat currency or otherwise exchanged against procurement of goods or services. We understand that the Government is looking to protect against tax evasion measures, and probably it is in this context that Finance Minister referred to corrective actions. Still, the prerogative of the Government ought to balance on one hand, protection against tax evasion structures, and on the other hand, fairness in terms of triggering of a taxable event and ease in compliance. We hope that the Government addresses this issue in the near future.


The Finance Minister has repeatedly indicated that consultations for comprehensive crypto-asset related legislation is in the pipeline. At the same time, she is not disclosing just yet whether such transactions are legal per se as of today. Still, given that she has said that the new bill will be substantially different from the 2019 version (which banned cryptocurrency transactions), that itself does create a mood of cautious optimism in the crypto industry, even at the cost of a high level of taxation.

Certainly, more clarifications will be issued in the future including (hopefully) considering international guidelines. We hope that in line with the objectives of the Government of the day (Digital India, Start-up India, $ 5 Trillion economy, etc.), appropriate regulations are brought out that balances innovation in this sector, ease of doing business, and at the same time, protects investors and compliance with money laundering/terror financing provisions.

Bibliography [1] 2020 SCC Online SC 275 [2] 2019 (3) SCC 429, AIR 2019 SC 589 [3] Though this discussion is not strictly speaking in line with the broader question of legality of crypto transactions, it is still useful to see the intention of the Government, pending any concrete legislation. The allegation made by the Enforcement Directorate is that as part of the onboarding process, the exchange collected only a selfie photo, PAN and Aadhar scan image, without any physical verification or proper due diligence of clients. Similarly, transactions were not documented properly (for example through A1/A2 forms), nor was the KYC conducted on the non-WazirX wallets. [4] Notification of ED Notice accessed from https://www.tbstat.com/wp/uploads/2021/06/ED_WazirX_notice.pdf [5] Section 2, Clause, Income Tax Act, 1962 (proposed to be included through the Finance Bill, 2022). [6] https://economictimes.indiatimes.com/tech/tech-bytes/signups-jumped-30-50-on-budget-day-crypto-exchanges-say/articleshow/89297335.cms [7] Crypto trade isn’t illegal. Otherwise our agencies would’ve acted by now: Revenue Secy Bajaj, < accessed from : https://theprint.in/economy/crypto-trade-isnt-illegal-otherwise-our-agencies-wouldve-acted-by-now-revenue-secy-bajaj/822331/> [8] Cryptocurrency tax: Budget proposal spurs talk of legality, 'grey area' < accessed from : https://www.business-standard.com/article/economy-policy/cryptocurrency-tax-budget-proposal-spurs-talk-of-legality-grey-area-122020200703_1.html> [9] Ms Nirmala Sitharaman reply to Ms. Chhaya Verma, Rajya Sabha Debates, 11th February, 2022. [10] 1972 AIR 391, 1972 SCR (1) 950 [11] 1980 AIR 1271, 1980 SCR (3)1122 [12] https://www.taxsutra.com/dt/experts-corner/crypto-taxation-one-step-forward


Cite this Article - Varun Chablani, Shubham Tiwary, Taxing Virtual Assets, implied legalization, a tryst with cautious optimism. (Tax Terminal Blog, 24th February 2022 ) taxing-virtual-assets-implied-legalization-a-tryst-with-cautious-optimism https://www.taxterminal.in/post/taxing-virtual-assets-implied-legalization-a-tryst-with-cautious-optimism

Taxing Virtual Assets, implied legalization, a tryst with cautious optimism.
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