This article has been written by Manika Singh pursuing a Diploma in Corporate Litigation course from LawSikho. 

This article has been edited and published by Shashwat Kaushik.

Abstract

This article examines the role of cryptocurrency, how cryptocurrency works, and there are different classifications of cryptocurrencies that help to determine the taxability of such cryptocurrency. There is a brief discussion about the taxability of cryptocurrency in the counties, where countries like India and China have not accepted cryptocurrency as a legal tender but any income earned from such transactions is taxable. On the other hand, countries like the UK and the US have accepted the cryptocurrency and made laws for its regulation. There is also a brief discussion about the issues regarding the taxability of cryptocurrency. The issue mainly is about international taxation, as there are few tax treaties, which lead to weak regulation systems and the creation of unwanted situations and problems, also leading to double taxation.

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Introduction

Satoshi Nakamoti introduced bitcoin in 2009 as a cryptocurrency, and in actuality, cryptocurrency was developed before 2009. There was eCash developed by the DigiCash company in 1990. The working of eCash was based on the ‘Blinding Formula’. The purpose of this formula was simple: to encrypt the information between the individuals, which meant that there was no involvement of a third party. Then, in 1991, there was the evolution of blockchain by Stuart Haber and W. Scott Stornetta. Stuart Haber and W. Scott are both research scientists. At first, they were searching about making backups of digital documents, and later, they aimed for timestamps on the documents to make them more secure, and by doing so, they witnessed the evolution of cryptocurrency. Later, there is the evolution of cryptocurrency, which is digital cash and is very popular among people. The reason for such popularity is simple: because of its decentralisation, people feel secure; they feel that their transactions are not watched by third parties, as usually in any online transaction there is involvement from the bank. This security is attracting people to invest in cryptocurrencies, but it is also attracting money laundering cases. It will get difficult for the government to trace the transactions in cryptocurrencies, and people will take advantage of this technology. This is the reason why many countries have not legalised it, and India is one of them. 

What is cryptocurrency

It is simply a digital payment system where banks play no role as intermediaries, which means that the transaction is peer-to-peer. This runs on a technology known as blockchain, where the record of the transaction is with the currency holder; no other party or third party has information about such a transfer. The tax on cryptocurrency is known as a crypto tax; it simply means an amount paid to the government or authority for earning income through cryptocurrencies. Now, the question might arise about what kind of income is generated from cryptocurrency, which is taxable because usually cryptocurrencies are for transactions, so how is income generated from them? 

There are various ways by which a crypto holder can earn income or gains from such cryptocurrencies, which can be capital gains, mining, stakes, airdrops, and forks. 

Capital gain is simple; it means the profit earned by selling the crypto assets. The profit amount will be taxable, not whole. In crypto mining, the miner has to solve a complicated math problem and then guess a number. He can guess as many numbers as he wants, and then the number is verified, according to which he earns the income. This process is complicated and also requires a high-tech computer and high-power electricity. 

Staking rewards are earned when the holder locks up cryptographic assets for a period of time. In exchange for locking up the assets and participating in the network, the validator gets the reward. This is done when your cryptocurrency uses a proof-of-stake blockchain and you are eligible to stake your tokens. 

Airdrops and hard forks

Airdrops are earned when the holder of crypto assets receives a token directly in their wallets. Hard forks occur when there is a split in the blockchain. This split occurs when there is a change to the code that creates two paths. These above-mentioned are the incomes from cryptocurrencies; whether they are taxable or not will depend from country to country.

India 

On April 5, 2018, the Reserve Bank of India (RBI), the central bank of India, issued a press release expressing concerns about the protection of consumers against virtual currency and announced a ban on cryptocurrency transactions. This decision sent shockwaves through the Indian cryptocurrency community and raised questions about the future of digital assets in the country.

The RBI’s ban on cryptocurrency was based on several factors, including concerns about money laundering, terrorist financing, and the volatility of cryptocurrency prices. The central bank also argued that cryptocurrency transactions were not backed by any underlying asset and, therefore, posed a significant risk to consumers.

The cryptocurrency ban was met with strong opposition from the Indian cryptocurrency community, which argued that the RBI’s decision was arbitrary and would stifle innovation in the fintech sector. Several petitions were filed in the Supreme Court of India challenging the RBI’s ban.

In March 2020, the Supreme Court of India lifted the RBI’s ban on cryptocurrency, ruling that the central bank had no authority to impose such a ban. The court’s decision was a significant victory for the Indian cryptocurrency community and paved the way for the growth of digital assets in the country.

It is important to note that the Supreme Court’s decision did not legalize cryptocurrency in India. Cryptocurrency remains unregulated in India, which means that there is no specific legislation governing the use, trading, or mining of digital assets. This lack of regulation creates some uncertainty for cryptocurrency businesses and investors.

Despite the lack of regulation, the Indian cryptocurrency market has grown rapidly in recent years. Several cryptocurrency exchanges have been established, and the number of cryptocurrency investors has increased significantly. The Indian government is currently considering the possibility of regulating cryptocurrency, and it is likely that specific legislation will be introduced in the future.

The issue arises: is any income earned from the cryptocurrency taxable or not? The answer is yes, they are taxable, because in India, it does not matter if income is earned from legal or illegal methods; it will be taxable.

To determine the taxability of income from cryptocurrency in India, it is essential to understand the residential status of the assessee. The Income Tax Act, 1961, specifically addresses this in Section 6, which defines the residential status of an individual.

Residential status:

  • An individual who is a resident of India, as per Section 6 of the Income Tax Act, is subject to tax on their worldwide income, including income earned from cryptocurrency. This means that if a resident Indian receives cryptocurrency income in India or outside India, it will be taxable in India.
  • A non-resident Indian, on the other hand, is only taxable on income earned in India. Therefore, if a non-resident Indian earns cryptocurrency income outside India, it will not be taxable in India.

Holding period:

In addition to residential status, the holding period of the cryptocurrency asset also plays a role in determining the taxability of gains.

  • Short-Term Capital Gains (STCG): If an individual holds the cryptocurrency asset for less than 36 months and then sells or trades it, the gains are considered short-term capital gains and are taxed as per the individual’s income tax slab. The tax rate for STCG from cryptocurrency trading is 30%, plus a 4% cess.
  • Long-Term Capital Gains (LTCG): If an individual holds the cryptocurrency asset for more than 36 months and then sells or trades it, the gains are considered long-term capital gains and are taxed at a flat rate of 20%, with no additional cess.

It’s important to note that these tax provisions are subject to change, and it’s advisable to consult with a tax professional or refer to the latest Income Tax Act and relevant notifications for the most up-to-date information on cryptocurrency taxation in India.

Cryptocurrency taxation

UK

The United Kingdom’s tax authority, His Majesty Revenue & Customs (HMRC), oversees the taxation of cryptocurrency transactions within the country. Cryptocurrency has been recognised as legal tender in the UK since its inception, and the UK parliament is currently working on implementing specific laws and regulations related to cryptocurrency.

In terms of taxation, the UK government has established a framework that determines the taxability of cryptocurrency gains. These gains are divided into two distinct categories:

Earnings Below 50,270 Pounds

If an individual’s cryptocurrency earnings fall below 50,270 pounds (approximately $67,800) during a tax year, they will be subject to a 10% tax rate. This tax rate applies to any profits or gains realized from buying, selling, or exchanging cryptocurrencies. It is important to note that the 10% tax rate is levied on the net gain rather than the total transaction amount.

Earnings Above 50,270 Pounds

For individuals whose cryptocurrency earnings exceed 50,270 pounds in a tax year, a higher tax rate of 20% will be applicable. This tax rate applies to the same range of cryptocurrency transactions as the 10% rate. It is crucial for taxpayers to accurately track their cryptocurrency transactions and maintain detailed records to determine their tax liability correctly.

It is worth noting that the UK government’s approach to cryptocurrency taxation aligns with its broader tax policy objectives. The government aims to strike a balance between encouraging innovation and ensuring that the tax system remains fair and equitable for all taxpayers. As the cryptocurrency landscape continues to evolve, HMRC may further refine and update its tax policies to reflect changes in technology and market practices.

US

Along with the UK, America has also legalised the transaction of cryptocurrency. The Internal Revenue Service (IRS) is the authority that administers and enforces the tax laws. 

Taxability of cryptocurrency by the IRS: the authority treats the cryptocurrency as a property, and by this, it is divided into parts:

  1. Taxability as capital gains: when a cryptocurrency is sold or used at a higher value than the purchase value, the assessee will pay tax on the gained amount. 
  2. If you receive crypto as payment for business purposes, it is taxed as business income. 
  3. If crypto mining, or crypto, is awarded for work done on a blockchain, then it will be taxable as ordinary income. 

China

The State Taxation Administration (STA) serves as the preeminent taxable authority in China, vested with the responsibility of overseeing and enforcing tax regulations. Despite China’s decision not to recognise cryptocurrency as legal tender, the government retains the authority to impose taxes on cryptocurrency transactions. This stance stems from concerns that Bitcoin transactions, characterised by their anonymous nature, could potentially facilitate money laundering and other illicit activities.

China’s refusal to embrace cryptocurrency as a legitimate form of currency aligns with its broader approach to regulating digital assets. The Chinese government has adopted a cautious stance towards cryptocurrency, viewing it as a potential source of financial instability and a threat to its centralised control over the financial system. This cautious approach is reflected in a series of measures implemented by the Chinese government, including restrictions on cryptocurrency exchanges and initial coin offerings (ICOs).

While China has refrained from granting cryptocurrency legal tender status, the government recognises the potential tax revenue that can be generated from cryptocurrency transactions. By levying taxes on cryptocurrency transactions, the Chinese government can capture a portion of the economic value created by the cryptocurrency industry. This approach enables the government to benefit from the growth of the cryptocurrency market without having to fully embrace it as a legitimate currency.

The taxation of cryptocurrency transactions in China is not without its challenges. One of the primary challenges lies in tracking and monitoring cryptocurrency transactions, given their decentralised nature and the potential for anonymity. To address this challenge, the Chinese government has implemented a number of measures, such as requiring cryptocurrency exchanges to register with the government and to implement anti-money laundering and know-your-customer (KYC) procedures. These measures aim to increase transparency and facilitate the tracking of cryptocurrency transactions, thereby enhancing the government’s ability to tax these transactions effectively.

Overall, China’s approach to cryptocurrency taxation reflects its broader stance on digital assets. While the government has refrained from recognising cryptocurrency as legal tender, it has acknowledged the potential tax revenue that can be generated from cryptocurrency transactions. By imposing taxes on cryptocurrency transactions, the Chinese government can benefit from the growth of the cryptocurrency market without having to fully embrace it as a legitimate currency.

Japan

The National Tax Agency (NTA) serves as the tax authority in Japan, overseeing the administration and enforcement of the country’s comprehensive tax system. Central to this system is the progressive tax structure, characterised by increasing tax rates as income levels rise. This progressive approach aims to ensure fairness and equity in the distribution of tax burdens across different income brackets.

One notable aspect of Japan’s tax system is the treatment of cryptocurrency. Cryptocurrency gains are subject to taxation similar to regular income, with tax rates ranging from 15% to 55%. The specific tax rate applicable depends on the individual’s overall income level.

To facilitate the reporting of cryptocurrency gains, the NTA has established two forms: Form A and Form B. Form A is intended for individuals reporting miscellaneous income, including cryptocurrency gains obtained through personal activities such as trading or mining. On the other hand, Form B is used by individuals engaged in business activities related to cryptocurrency, such as professional traders or cryptocurrency exchanges.

When completing Form A, taxpayers must declare their cryptocurrency gains under the “Miscellaneous Income” section. This form requires detailed information about the cryptocurrency transactions, including the type of cryptocurrency, the date of acquisition and disposal, and the amount of gains or losses incurred.

For individuals using Form B, cryptocurrency gains are reported as part of their business income. They must maintain accurate records of their cryptocurrency transactions, including invoices, receipts, and any other relevant documentation. The tax liability is then calculated based on the business’s overall income and expenses.

It’s important to note that the tax treatment of cryptocurrency in Japan is subject to ongoing developments and may evolve over time. Taxpayers are advised to stay informed about any changes or clarifications issued by the NTA to ensure compliance with the latest tax regulations.

Issues with the taxability of cryptocurrency 

The countries have provided for the taxability of cryptocurrency, but still, there are some issues with the taxation of cryptocurrency, which include the difficulty in classifying income. There are times when it gets difficult to determine the cryptocurrency as an asset or transaction because different countries have different understandings. 

The next issue is international transactions, as the concept is not adopted in many countries, due to which there is a lack of tax laws and treaties regarding taxation on cryptocurrencies, which leads to double taxation or evasion concerns. 

We know that the transaction of cryptocurrency is encrypted between the individuals, due to which arises the issue of determining the holding period of cryptocurrency because this holding period is essential for the classification of cryptocurrency. Due to this, many tax authorities are facing challenges on a daily basis. 

Conclusion

Cryptocurrency is a technology that is popular among people but not accepted by governments due to its complex nature of transactions, classifications, and such, leading to many other problems. But there is no doubt that in the future it will become more popular and will be used in daily life. 

The solution to the issues of taxability is simple: the government needs to understand cryptocurrency and make laws regarding its taxability to reduce the issues. 

References

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