The Technological Revolution of the 21st Century brought with itself an avalanche of challenges for the legal fraternity. However, the degree of such challenges have tremendously amplified since the introduction of Cryptocurrencies and its underlying blockchain technology. In this context, this article attempts to reconcile the nature of cryptocurrencies with the laws and requirements of indirect taxation under the Central Goods and Services Act, 2017 (‘CGST Act’). Further it also examines if Goods and Services Tax (‘GST’) could be charged on the use of cryptocurrencies in our jurisdiction. The scope of this article would be strictly limited to examining the nature of cryptocurrencies for the purpose of GST. This means that it would not go into the nuances of direct taxation requirements under the Income Tax Act,1961. Moreover, because bitcoins are the most famous and most valued type of cryptocurrency, this article would pivot its discussion on bitcoins only. However, the same arguments presented in context of bitcoins could also be logically extended to all forms of cryptocurrencies. Lastly, the article would refrain from commenting on normative questions vis-à-vis the cryptocurrency technology itself and would consider the existing structure as it is rather than arguing for any change on the technical or theoretical front. The focus of the article at all times would be the taxation possibility of the current bitcoin regime.
Understanding Blockchain, Cryptocurrency and Bitcoins
After the Government of India announced its demonetization policy, the investments in bitcoins have seen a massive escalation. However, before we understand what a bitcoin is, we must understand what is blockchain technology. A blockchain essentially is a “distributed ledger” that records transactions between parties in a transparent way. Because this ledger is not centrally governed and is distributed among all the stakeholders, everyone can see the new transactions and update it in their ledger. This information is stored in “blocks” and each new block is connected to the previous block. Therefore, if someone attempts to tamper with the information of a block, the data of the entire block would be altered as every block is connected. Hence, blockchains are unalterable and no change would slip by the eyes of people because even a microscopic change would trigger a cascade of mutations throughout the blockchain.
This blockchain system gives rise to a digital asset that is designed to be used as a medium of exchange between everyone who uses this technology. This is called cryptocurrency. It works on the same basis of a distributed ledger and without any central control. Bitcoin, is the most famous type of cryptocurrency which was introduced in 2009 by someone with a pseudonym of Satoshi Nakamoto. These bitcoins are generated by a complex computer algorithm and the process of extracting bitcoins from such system is called “mining”, while the people who do this are known as “miners”. Every new bitcoin is registered in the public ledger that is distributed to every miner so that everyone can monitor that. There is no central authority that manages bitcoins and unlike normal currencies, bitcoins do not have any intrinsic value in themselves.
It should be noted that the creation of a new bitcoin can also be fake. Therefore, the most important task in this process for miners is to verify (using hash algorithms) whether the new coins created are genuine or not. Whichever miner does this before others, is rewarded with a predefined number of bitcoins and he can then use them. New coins get added to the network by the addition of new blocks and all the miners aim at verifying new coins so as to declare them “trusted”. Whenever a miner verifies a new block, this verification is then tested by other miners and once it is declared to be genuine, the miner earns bitcoins as a reward of this verification. However, the value of this bitcoin does not stay constant and as more and more miners enter the ecosystem, it becomes increasingly difficult for miners to earn bitcoins because of soaring competition.
Mining is one way of earning bitcoins. However, a person can also earn bitcoins by exchanging it for a fiat currency (like INR converted into bitcoins). The last method of acquiring bitcoins is when one can provide some goods or service in exchange for consideration in bitcoins.
What Propelled the Need for Bitcoins?
Humans started transactions with the barter system and then came to money (currency) and ultimately started using bitcoins. It should be noted that each system, was born because of a certain number of limitations of the previous system. For instance, barter system had the limitations of being a system that required mutual demands from both sides, lacked a common value of measure, was indivisible in transactions, did not allow for easy storing of wealth, was not viable for deferred payments et cetera. These limitations were adequately addressed by bringing in the currency system. Now with money, the requirement of mutual wants vanished and it became easy to store. The value became more stable and one could now divide and defer payments. However, even this system was marred with a few deficiencies. Transactions in money inherently bring trust issues and therefore it becomes impossible to run this system without the use of intermediaries like Central Banks, credit card companies et cetera. It is these intermediaries who issue credits and currencies and ipso facto possess the power to monitor, override and freeze our money. It is in this context that bitcoins come in and remove precisely these limitations from the transaction system. Unlike traditional currencies, no one issues bitcoins. They are generated by algorithms and are based on blockchain system that engages a distributed ledger to maintain authenticity. This means that anyone can neither trace/monitor the coins, nor can someone freeze or control it. Complete anonymity is maintained and no intermediary is required to generate or use the currency (obviously people can use intermediaries for convenience if they want, but the bare function of it does not strictly require a regulator or intermediary).
Brief History of Regulatory Regime of Bitcoins in India
Approach of the RBI and the Government
The Reserve Bank of India (RBI) in December 2013 issued a press release by virtue of which it cautioned the traders, users and holders of virtual currencies against the potential legal, financial and other risks that dealing in such currencies exposes them to. The notification categorically stated that the Central Bank has not authorised any creation or usage of virtual currencies and therefore it shall not be considered a valid legal tender in India. RBI also mentioned that such currencies are being used for money laundry purposes and for funding terrorism and that the present regime of regulations are unable to cope up with this new technological advancement because of the anonymity it provides in peer-to-peer trading.
Subsequently, the 2015 and 2016 Financial Stability Report of RBI mentioned the rapid advancements of the blockchain technology but no substantial directions for the use of bitcoins was found in them. However, in February 2017 the RBI again issued a press release through which it cautioned the traders, users and holders of bitcoins. This notification was followed by the creation of an inter-disciplinary committee by the Ministry of Finance (the inter-disciplinary committee comprised of Special Secretary (Economic Affairs) and representatives of the Financial Services, Revenue, Departments of Economic Affairs, Electronics and Information Technology, Home Affairs, RBI, NITI Aayog, and State Bank of India). This committee recommended that it be clearly informed to the people that the government does not consider such virtual currencies as legal tender and that people be warned against using them and offload any currency that they already have.
The RBI again issued a press release on 05/12/17 in which it reiterated the issues that it had highlighted in previous notifications. Following this, the Ministry of Finance also issued a notification on 29/12/17 wherein it stated that potential investors should avoid trading in bitcoins as the government does not accord legal status to it. On 01/02/18, the Finance Minister in his budget speech mentioned that the government will take all necessary steps to eliminate Virtual Currencies (‘VCs’) from financing terrorism and from the payments system and that the Government of India does not consider it to be legal tender. The government also submitted a draft bill in 2018 (Crypto Token and Crypto Asset (Banning, Control and Regulation) Bill, 2018) and then a fresh bill by the name of ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’. The fate of these bills is not yet final.
However, the main shock for the cryptocurrency sector came when the RBI in April 2018 issued a circular though which it did not put a direct ban on cryptocurrency, but placed an indirect ban on it by disabling the banks from providing services to any person/entity dealing with cryptocurrencies. This practically thwarted the business of the bitcoin exchange agencies and imposed an indirect ban on the use of cryptocurrencies.
Supreme Court’s Judgement
The Internet and Mobile Association of India (IMAI) approached the Supreme Court against the April 2018 circular of the RBI. The Supreme Court quashed the circular of RBI in March 2020, on grounds of violation of fundamental rights under Art. 19(1)(g) of the constitution. The court discussed in detail the role and power of RBI vis-à-vis regulation of virtual currencies and tried to pin down the final character of bitcoins. It said that as long as there exists certain institutions that accept bitcoins as a payment method, the RBI could regulate these currencies.
This judgment did not primarily deal with the taxation aspect of bitcoins. However, earlier this year, the Government of India issued notices to over 5 Lakh people who were supposed to be dealing with bitcoins. Upon this notification, India’s top 7 bitcoin exchanges approached the Authority for Advance Ruling (‘AAR’) to seek clarity upon the issue. However, the same has not been conclusively decided yet.
Proposal by the Government
It was in February 2020 that the first bit of clarity on the taxation aspect of bitcoins came. However, this was done by the Direct Tax Department. What this section concerns itself with is not the proposal by the Direct Tax Department but the proposal of the Central Board of Indirect Taxes and Customs that it plans to put before the GST Council. The key points of the proposal can be summarised as below:
- Mining of Cryptocurrency will be treated as a service for the purposes of GST.
- Wallet Service providers, miners of bitcoins and bitcoin and cryptocurrency exchanges may be required to become registered entities under the GST Act.
- 18% GST may be levied upon the trading of bitcoins.
- IGST can be levied in cross border transactions.
- Rules have also been proposed vis-à-vis finding the place of supply for different transactions.
(This post has been authored by Ayush Mishra. He is an alumnus of the NALSAR University of Law, Hyderabad and is currently working as an Advocate at the Hon’ble High Court of Allahabad)
Cite as: Ayush Mishra, ‘Taxation of Cryptocurrency under the GST Regime (Part I)‘ (The Contemporary Law Forum, 11 October 2020) <https://tclf.in/2020/10/11/taxation-of-cryptocurrency-under-the-gst-regime-part-i> date of access.