Cryptocurrency is a decentralized system relying on encryption and blockchain technology to record and verify transactions and issue new units. This mechanism does not require any central issuing or regulating authority and rather utilizes the peer-to-peer system to facilitate its transactions. The recent surge in use and the keen interest shown by investors around the world in virtual currencies and digital assets highlights the need for regulatory norms to safeguard their interests. This article sheds some light on the major steps taken by the Indian regulatory and judicial bodies in this domain.
RBI Cautions Users Against Cryptocurrency
On 24th December 2013, RBI alerted the holders, traders, and users of virtual currencies (hereinafter referred to as "VCs") about the potential operational, financial, customer protection, security related and legal risks attached with the VCs.1 The press release stated that the creation, usage, or trading of these VCs as a payment mechanism is unauthorized and that these entities did not obtain any regulatory approval or registration before carrying out such activities. The RBI further cautioned about hacking of electronic wallets which store these VCs, lack of consumer redressal mechanism, speculative nature causing volatility and exposure to losses, unclear legal recognition in other jurisdictions, and usage of such currencies for illicit activities.
The RBI vide press release dated 1st February 2017 reiterated that it had not issued any license or authorization to any entity to operate such schemes or deal with any VC and warned the users to engage at their own risk.2 On 5th December 2017, the RBI further conveyed these concerns considering the spurt in the valuation of VCs and rapid growth in initial coin offerings.3 These circulars were cautionary in nature and had stopped short of prohibiting or banning VCs.
On 6th April 2018, RBI notified a circular on prohibition on dealing in VCs which disallowed entities regulated by the RBI such as commercial banks, co-operative banks, payments banks and small finance banks from dealing in VCs or providing services for facilitating any person or entity in dealing or settling VCs.4 These services 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 or receipt of money in accounts relating to purchase or sale of VCs. The RBI extended a three month exit period to entities already providing such services.
Inter-Ministerial Committee Releases its Cryptocurrency Report
The Inter-Ministerial Committee, composed of representatives from Department of Economic Affairs, SEBI, RBI and Ministry of Electronics and Information Technology, was formed on 2nd November 2017 and submitted its report to the Ministry of Finance on 28th February 2019.5 The Committee evaluated the status of VCs in India and globally, examined the prevalent legal and regulatory structures governing VCs, and suggested measures to deal with VCs. The Committee recommended that except for cryptocurrency issued by the government, all private cryptocurrencies should be banned in India. The rationale behind this was that these private cryptocurrencies cannot replace fiat currencies and have no intrinsic value as they lack the attributes of a currency - neither act as a medium of exchange nor as any store of value, and are prone to extreme fluctuations in their prices. The report also highlighted the pseudonymity associated with VCs which makes them susceptible to illicit activities and market fraud. The Committee also proposed the "Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019."
Supreme Court Sets Aside the RBI Circular
On 4th March 2020, the Hon'ble Supreme Court of India in Internet and Mobile Association of India v. RBI, allowed the petitions challenging the RBI circular dated 6th April 2018.6 The Court set aside the circular on the grounds of proportionality as RBI's concern is with respect to the entities regulated by it and it could not showcase that any of such entities suffered any adverse effect or loss directly or indirectly, on account of their interface with VC exchanges. Furthermore, this step taken by RBI lacked any rationale as neither were VCs banned in India nor it could be proved that anything was wrong with the way these exchanges functioned. The Court opined that the legal framework recommended by the Inter-Ministerial Committee which pushed for the banning of VCs, is an extreme tool and the same measures could be achieved via regulatory reforms. Although the Court agreed with the notion of VCs not acquiring the status of legal tender, it believed that VCs being digital representations of value had the capability to function as either store of value, medium of exchange and/or a unit of account. Subsequently, RBI released another circular dated 31st May 2021 whereby it informed its regulated entities to not rely on its previous circular in light of it being held invalid.7
Cryptocurrency Under the Tax Regime
The Union Budget delivered on 15th February 2022 and Finance Act, 2022 which came into effect from 1st April 2023, amended the Income Tax Act, 1961 and introduced a new tax regime for virtual digital assets (VDA) in India. VDA has been defined under Section 2(47A) of the Income Tax Act as follows:
(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 a 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 virtual digital asset subject to such conditions as may be specified therein.
Moreover, for the purpose of Section 56 which deals with taxation of income from other sources, VDA is covered within the definition of property. Under Section 115BBH, the tax rate on income from transfer of VDA is calculated at 30% and loss from transfer cannot be set off or carried forward to the next financial year. Section 194S states that 1% TDS shall be deducted in instances where the consideration is over Rs. 50,000 for specified persons and Rs. 10,000 for any other person, in a financial year.
Commencement of the Pilot Phase of the Central Bank of Digital Currency
As of today, there are 130 countries exploring their own Central Bank Digital Currency (CBDC) and are in different phases of exploration - research, development, pilot, and launch.8 The RBI released a Concept Note on CBDC on 7th October 20229 and launched the pilot phase of Digital Rupee Wholesale (e?-W) on 1st November 2022 and Digital Rupee Retail (e?-R) on 1st December 2022. The e?-W, launched with the participation of nine banks, is restricted to financial institutions focused towards enhancing efficiency of interbank transactions. Whereas e?-R caters to the private sector and involves person-to-person and person-to-merchant transactions, but is currently limited a closed user group comprising of customers and merchants from 15 cities with a participation of 13 commercial banks.
Cryptocurrency Under the Money Laundering Radar
The Ministry of Finance vide notification dated 7th March 2023 has expanded the scope of the PMLA to bring transactions related to VDA under the purview of the Act.10 Like banking institutions, cryptocurrency exchanges are required to register themselves as reporting entities and undertake similar reporting and KYC obligations. Specifically, the activities under the ambit of PMLA include - transfer of VDA, exchange between one or more forms of VDA, exchange between VDA and fiat currencies, administration, or safekeeping of VDA, and financial services related to offer and sale of VDA.
The Highly Anticipated Cryptocurrency Bill
The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 was listed for introduction, consideration and passing in the 2021 Winter Session before the Parliament and is expected to be slightly different from its predecessor, Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019.11 The 2021 Bill sought to provide a favourable framework for the creation of an official government regulated digital currency to be issued by the RBI and ban all private cryptocurrencies and related exchanges, while still allowing for certain exemptions in public interest to boost the use of underlying blockchain technology for research purposes. The Bill has not yet been introduced before the Parliament and now, the Ministry of Finance is of the opinion that international collaboration is a prerequisite for any effective legislation.
Conclusion
With the rising volume of trades on cryptocurrency exchanges being attributed to Indian investors and entrepreneurs, an unregulated cryptocurrency market is unfavourable for all stakeholders alike. Thus, the steps taken to introduce a tax regime and include VDA under the ambit of PMLA, are all positive moves towards the acceptance and regulation of cryptocurrency, although one may argue that the tax rates are too high and the inability to set off losses against gains affects the commercial viability of VDAs as an asset class. However, an aggressive move such as an outright and complete ban of cryptocurrencies may push India backwards in the blockchain ecosystem and prove to be detrimental.
Footnotes
1. Reserve Bank of India, RBI cautions users of Virtual Currencies against Risks (December 24, 2013) (Press Release: 2013-14/1261), https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=30247
2. Reserve Bank of India, RBI cautions users of Virtual Currencies (February 1, 2017) (Press Release: 2016-17/2054) https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=39435
3. Reserve Bank of India, Reserve Bank cautions regarding risk of virtual currencies including Bitcoins (December 5, 2017) (Press Release: 2017-18/1530), https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=42462
4. Reserve Bank of India, Prohibition on Dealing in Virtual Currencies (VCs) (April 6, 2018) (RBI/2017-18/154), https://rbidocs.rbi.org.in/rdocs/notification/PDFs/NOTI15465B741A10B0E45E896C62A9C83AB938F.PDF
5. Department of Economic Affairs, Ministry of Finance, Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies (February 28, 2019), https://dea.gov.in/sites/default/files/Approved%20and%20Signed%20Report%20and%20Bill%20of%20IMC%20on%20VCs%2028%20Feb%202019.pdf
6. Internet and Mobile Association of India vs. Reserve Bank of India, Writ Petition No. (Civil) 528/2018, https://main.sci.gov.in/supremecourt/2018/19230/19230_2018_4_1501_21151_Judgement_04-Mar-2020.pdf
7. Reserve Bank of India, Customer Due Diligence for transactions in Virtual Currencies (VC) (May 31, 2021) (RBI/2021-22/45), https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12103
8. Atlantic Council, Central Bank Digital Currency Tracker (June 2023), https://www.atlanticcouncil.org/cbdctracker/#:~:text=130%20countries%2C%20representing%2098%20percent,advanced%20stage%20of%20CBDC%20development.
9. Reserve Bank of India, Concept Note on Central Bank Digital Currency (October 7, 2022), https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/CONCEPTNOTEACB531172E0B4DFC9A6E506C2C24FFB6.PDF
10. Ministry of Finance (March 7, 2023) (S.O. 1072(E))
11. PRS Legislative Research, Parliament Session Alert (November 25, 2021), https://prsindia.org/files/parliament/session_track/2021/session_alert/Parliament_Session%20Alert_Winter%20Session%202021.pdf
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