Virtual Digital Assets under the Union Budget, 2022

On February 1, 2022, the Finance Minister (Mrs. Nirmala Sitharaman) presented the Union Budget 2022 (“Budget”) during which she has announced some important developments in relation to Virtual Digital Assets (VDA). Primarily, the Finance Minister announced the introduction of RBI backed - Central Bank Digital Currency (CBDC) in the financial year 2022-2023 and a tax regime under which virtual digital assets (including crypto-assets and non-fungible tokens) shall be taxed.

The FM has expressed that the introduction of CBDC shall lead to ‘efficient and cheaper currency management’ and shall also give a ‘boost to the digital economy’. While the finance minister has announced that CBDC is due to be introduced in the financial year 2022-2023, no definite timelines have been provided for the digital rupee rollout. It is pertinent to note that the Budget (and the Finance Bill) doesn’t specify whether the CBDC shall be under the category of VDA (and be taxed at the specified rate in the budget) or not.

Another significant development under the budget is the taxation of VDAs. The Finance Bill defines “virtual digital asset” to mean:

(a) any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or unit of account including, its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically

(b) a non-fungible token or any other token of similar nature, by whatever name called

(c) any other digital asset, as the Central Government, may, by notification in the Official Gazette specify

Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of the virtual digital asset subject to such conditions as may be specified therein.

It is evident from this definition that both crypto-assets and NFTs fall under the category of VDAs and have accordingly been brought under the new tax regime. The Finance Bill has provided for a 30% tax on the income generated through virtual digital assets which are applicable from April 01, 2022. The finance bill also provides that no deduction in respect of any expenditure or allowance shall be allowed while computing such income, except the cost of acquisition. While the taxation of virtual digital assets was anticipated in this budget, the tax percentage can be perceived to be a little more harsh than one would be expected. It is imperative to note that the taxation of virtual digital assets is two-fold. The tax shall apply on the income generated through the transfer of virtual digital assets as well as on any gift of virtual digital assets. For taxation of gifts of virtual digital assets, the finance minister expressed that “gifts of virtual digital assets also have to be taxed at the hands of the recipient”.

The finance bill [under Section 115BBH (2)(a) &(b)] provides for computation of tax on virtual digital assets. The relevant provision reads:

(2) Notwithstanding anything contained in any other provision of this Act

(a) no deduction in respect of any expenditure (other than the cost of acquisition) or allowance or set-off of any loss shall be allowed to the assessee under any provisions of this Act in computing the income referred to in clause (a) of sub-section (1)

(b) no set-off of loss from the transfer of the virtual digital asset computed under clause (a) of sub-section (1) shall be allowed against income computed under any other provision of this Act to the assessee and such loss shall not be allowed to be carried forward to succeeding assessment years.”

While the Government has attempted to provide clarification on how VDAs will be taxed, the provision primarily gives rise to two issues –

1. There is a lack of clarity on what would be considered as ‘cost of acquisition’ of a VDA under the statute. The finance bill fails to clarify whether only the inherent value of the virtual digital asset will be considered as ‘cost of acquisition’ or whether the ancillary and incidental expenses thereto (such as brokerage fee) will also be included within this term.

2. While the finance bill provides that no set-off of any loss shall be allowed to the assessee in computing the income, the finance bill fails to clarify whether any loss incurred from the other income heads could be set-off against income from VDAs. Further, the finance bill does not clarify whether a loss incurred through virtual digital assets could be set-off by income from other virtual digital assets. To summarize, no clarifications have been provided on the above-mentioned issues, which potentially creates a vacuum in the separate tax regime allotted to virtual digital assets.

The Budget also provides for tax deduction at source (TDS) at the rate of 1% (one per cent) for payment made in relation to the transfer of virtual digital assets.

The tax regime can be perceived as a positive step in the sense that it will facilitate further regulation of VDAs (including crypto-assets and NFTs) and probably regulation of the VDAs in the future (through specific legislations). Further, while the finance minister has announced the introduction of CBDC, the manner in which such digital currency will be regulated will be interesting to watch out for.