The 1% Crypto Tax in India, Explained

Crypto tax

On Feb 1st 2022, India’s Union Budget imposed a 30% capital gains tax on income earned from the sale of Virtual Digital Assets (VDAs) and 1% tax deducted at source (TDS) for transactions involving VDAs.

Consequently, prices of various crypto tokens shot up, transaction volumes rose and crypto exchanges saw a 30–50% boost in new registrations owing to this newfound legitimacy.

However, investors are now getting wary. The taxation of digital assets, though confers regulatory legitimacy, also risks turning investors away by adding friction to the transactions.

The 1% TDS levy, in particular, is expected to kill the industry stone dead. Many, including some members of the Parliament, have appealed to the Government to reconsider this problematic proposal. Let’s see why this particular tax has become a brazen boon for the crypto industry in India.

Nischal Shetty tweet

(NB: Nischal Shetty is the founder of WazirX, India’s top cryptocurrency exchange.)

How Will the 1% Tax Work?

At the outset, one must remember that TDS is a specific amount that is deducted when a certain payment (e.g. salary, commission, rent, interest, professional fees) is made. The person who makes the payment deducts the tax and the person who receives the payment has the liability to pay tax.

Now, crypto traders, similar to traders in other fields (like equity etc.) usually trade for short-term returns. They make money by trading frequently, keeping their profits biggest and booking their losses early. Bear with us while we try to look at this mathematically.

Let’s say that trader A executed 10 trades in total making a gross profit of ₹10,000 and a loss of ₹5,000. The net profit here is ₹5,000. Considering that this is a trade in crypto assets, A will have to pay a tax of ₹3,000 (at 30%) leaving ₹2,000 as profit i.e. 10,000x (1–30%)-5,000. In comparison, if this was an equity trade, his tax would be ₹750 (as per the rules on short-term capital gains under Section 111A, IT Act) leaving him ₹4,250 as profit i.e. (10,000–5,000)x (1–15%). Equity gets the benefit of absorbing losses as well falling under a lower tax rate.

Having said that, there is yet another pain for A in the form of TDS. On every trade in crypto, he incurs a cost of 1%. So more the number of trades for the same realised gains, more is the tax burden. For example (and from a simplistic perspective), in 10 trades, it will be equivalent to 10% of the money initially invested for trading.

Assuming an optimistic return of, say, 10% on investment, A invests ₹100,000 in total to generate a profit of ₹5,000. A TDS of 1% on each trade of ₹100,000 for 10 trades would add up to ₹10,000. So, in the end, after incurring both the taxes, the Government would have made a hefty sum of ₹13,000 (₹3,000 from capital gains + ₹10,000 from TDS).

And that would still be fine because taxation, although burns a hole through a wealth-generating pocket, still ensures that the pocket is legal. But what the traders don’t like is not being allowed to set off losses against the profits from another trade.

More Harm Than Good?

Although all stakeholders stand to lose considerably under this new tax regime, cryptocurrency exchanges will be affected greatly in the long-term as they allow such trading to take place.

Note that we’re referring here to centralised exchanges only, such as the likes of WazirX, CoinDCA, Bitstamp etc. Decentralised exchanges, on the other hand, which allow peer-to-peer exchanges through digital marketplaces are out of regulatory reach and thus would be exempt from the current taxation framework. This is a glaring discrepancy that arose on account of the gaps in policy making.

Also, the Government says that the 1% tax levied at the source is intended to keep a track on crypto transactions which would, in turn, enable it to record the amount of investments flowing into digital assets. That may be so, but one must wonder if such a policy was necessary at an individual level to begin with. Tracking crypto transactions falls under the ambit of exchanges and therefore these taxes could have been levied at an exchange-level and not on individual transactions.

Not to forget, the practical implementation of such a TDS obligation could be challenging as well, considering the manner in which the current crypto ecosystem operates. One wonders if the officials in the Central Board of Direct Taxes (CBDT) are trained optimally to deal with taxation in such a highly speculative asset. Plus, a holistic legislation to regulate the cryptocurrency sector is still awaited along with the answers to a number of questions that still seek clarification.

For instance, there are still open areas in the regulatory framework for VDAs like the application of GST on brokerages and the application of the equalisation levy on VDA purchases by Indian residents on foreign crypto exchanges. If these applications take effect then the tax burn will be too real for the trader’s pocket, indeed.

(Originally published April 7th 2022 in the TRANSFIN E-O-D Newsletter)

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