Taxation of Virtual Digital Assets: Legal Ambiguities and Policy Challenges

Abstract

The emergence of Virtual Digital Assets (VDAs)  including cryptocurrencies, non-fungible tokens (NFTs), and other blockchain-based assets has fundamentally transformed the global financial ecosystem. India’s taxation framework for VDAs, introduced under the Union Budget 2022–23, marked a watershed moment in the country’s approach to regulating digital assets. Section 115BBH of the Income-tax Act, 1961, imposes a flat 30% tax on income from the transfer of VDAs, accompanied by a 1% Tax Deducted at Source (TDS) under Section 194S. Despite these measures, significant ambiguities persist regarding the nature, classification, and valuation of VDAs for tax purposes. Moreover, the absence of a comprehensive regulatory framework and the lack of clarity on issues such as cross-border transactions, losses, and decentralized ownership have created complex policy and enforcement challenges. This article critically examines the taxation of VDAs in India, explores the underlying legal ambiguities, and proposes a policy roadmap for reconciling technological innovation with fiscal accountability.

Keywords – Virtual Digital Assets, Cryptocurrency Taxation, Income Tax Act, Blockchain, 115BBH, 194S, Digital Currency, India, Legal Ambiguities, Policy Challenges.

Introduction

The advent of blockchain technology saw a proliferation of digital tokens that performed the functions of both an investment asset as well as a medium of exchange. From Bitcoin to NFTs, such Virtual Digital Assets have disrupted conventional ideas of money and property. India, like most jurisdictions, was initially non-clear on the legal treatment of such assets. The fiscal treatment likewise remained hazy, but that has changed with the Union Budget 2022–23.

Under Section 115BBH of the Income-tax Act, 1961, income derived from the transfer of any VDA is taxable at a flat rate of 30%, without any deduction for expenses (other than cost of acquisition) or allowance for set-off of losses. Additionally, Section 194S mandates a 1% TDS on payments for the transfer of VDAs. While these provisions signal the government’s intent to formalize VDA taxation, they have raised several questions regarding compliance, enforcement, and fairness.

Given the rapid evolution of the digital economy, the twin imperatives of regulating innovation while ensuring tax equity and revenue certainty have come to confront India. This paper contextualizes the VDA taxation complexities and argues for a more nuanced, principle-based policy approach aligned with international best practices.

1. Understanding Virtual Digital Assets (VDAs)

The Finance Act, 2022, inserted clause (47A) in Section 2 of the Income-tax Act, defining a Virtual Digital Asset as:

“Any information, code, number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, providing a digital representation of value, which can be transferred, stored or traded electronically.”

This broad definition covers cryptocurrencies, NFTs, and other similar digital instruments. This does not distinguish between the various asset types, thereby creating ambiguity. Unlike securities or commodities, VDAs are neither recognized as legal tender nor regulated by the RBI.

The introduction of the Digital Rupee under the RBI’s Central Bank Digital Currency, or CBDC, has further blurred lines between state-backed digital currency and privately issued VDAs. This definitional overlap fuels uncertainty in both tax and regulatory domains.

1. Statutory Framework for Taxation of VDAs in India

1. Section 115BBH – Income Taxation

Section 115BBH(1) states that income from the transfer of any VDA shall be taxed at 30% irrespective of the holding period or nature of the asset.

No deductions are allowed except the cost of acquisition.

No set-off of losses from one VDA against another.

Losses cannot be carried forward beyond the current year.

This rigid approach reflects the intent of the government to deter speculative trading. However, it also discourages legitimate investment and raises concerns of over-taxation compared to traditional asset classes like equities or mutual funds.

2.  Section 194S – TDS on Transfer

194S: It provides for deduction of TDS at the rate of 1% on payments against VDA transfers if the aggregate value of such transfer exceeds ₹10,000 (₹50,000 for specified persons).

While devised to track digital asset transactions, this provision has caused high-frequency trading issues with liquidity and compliance headaches for exchanges and peer-to-peer platforms.

3. GST Implications

Till now, there is ambiguity over the GST treatment concerning VDAs. Their explicit classification has not been provided by the CBIC. However, VDAs are supposed to fall under intangible goods or services. Lack of uniform guidance led to disparate tax administration.

III. Legal Ambiguities and Jurisprudential Issues

1. Classification Ambiguities

The main challenge is determining whether VDAs represent currencies, securities, or commodities.

The RBI insists that cryptocurrencies do not constitute legal tenders.

SEBI has not classified VDAs as securities yet.

The Finance Ministry treats them as taxable assets without defining their economic substance.

Such fragmentation propagates regulatory arbitrage and judicial uncertainty. The absence of uniform classification also impacts the treatment of transactions under other laws, for instance, the Foreign Exchange Management Act (FEMA) and Prevention of Money Laundering Act (PMLA).

1. Valuation and Reporting Issues

Evaluation of VDAs is fraught with practical difficulties. Their values are highly volatile and change significantly from one international exchange to another. The Income-tax Act is silent about whether the fair market value, spot rate, or transaction price must be adopted for computing taxable income.

Further, there is no standard reporting framework for taxpayers holding VDAs on foreign platforms, which can create enforcement gaps or even double taxation.

1. Cross-Border Transactions

Given the decentralized nature of VDAs, cross-border transactions are challenging to track. Identification of the place of accrual of income and residency of exchanges poses many complex jurisdictional issues. For example, it is not clear whether a transaction between two Indian residents through a foreign exchange constitutes an offshore transfer or not.

1. Treatment of Losses and Airdrops

Inequities arise because of the prohibition against loss set-offs by Section 115BBH(2)(b). A trader who incurs losses in one VDA and gains in another has to pay tax despite incurring an overall loss. Likewise, there is chaos regarding airdrops and staking rewards considered as income since there are no guidelines on valuation timing.

1. Comparative International Perspective

1. United States

The IRS has categorized cryptocurrencies as property. Capital gains tax applies to sales, with short-term and long-term distinctions. Losses can offset gains. Although there is some clarity here, challenges still exist when it comes to valuation and DeFi income.

2. United Kingdom

HMRC treats crypto assets as capital assets. Taxation is distinguished based on whether it is trading or an investment. The guidance by the UK is inclusive, with comprehensive valuation rules and recognition of loss carry-forward provisions.

3. Singapore

Singapore has exempted the VDA capital gains but charges business income tax on trading profits. The Monetary Authority of Singapore focuses on regulation through anti-money laundering compliance rather than fiscal penalties.

4. Australia

The ATO in Australia treats all VDAs as a form of property subject to the rules of CGT. It classifies Personal Use Assets and determines explicit requirements in recordkeeping.

5. Comparative Insights

At 30% flat rate on gains with no provision for offsetting losses, India’s rate is singularly severe compared to global standards. While intended to stop speculation, this may force innovation to go abroad and discourage compliance by small investors.

1. Judicial and Constitutional Considerations

Although the Indian courts have not directly adjudicated VDA tax issues, earlier cases on digital transactions and economic liberties offer insight into this.

In Internet and Mobile Association of India v. Reserve Bank of India, 2020 10 SCC 274, the Supreme Court invalidated RBI’s ban on crypto-related banking services, relying on the principles of proportionality and freedom of trade under Article 19(1)(g). This judgment therefore suggests that excessive fiscal restrictions, which unduly stifle innovation in relation to the state’s fiscal goals, would be subject to constitutional scrutiny on similar lines.

The principle of taxation certainty, articulated in Commissioner of Income Tax v. B.C. Srinivasa Setty, (1981) 2 SCC 460, underscores that taxable events must have ascertainable computation mechanisms. Given the valuation uncertainties in VDAs, arbitrary assessments could be contested on grounds of Article 14 and Article 265 of the Constitution.

1. Policy and Enforcement Challenges

1. Compliance and Record-Keeping

Most VDA transactions take place on DEXs, which normally do not have any KYC mechanisms in place. In such systems, the actual enforcement of TDS or checking on transfers is fairly impossible to carry out. The government depends a lot on centralized exchanges for data, thus leaving the direct peer-to-peer and wallet-to-wallet transactions with lapses.

2. Double Taxation and Jurisdictional Overlap

The prospects of double taxation between the GST and Income Tax laws result in a lot of confusion. Also, while transacting across borders, users may face problems of double taxation in the absence of treaty alignment with DTAA.

3. Investor Protection and Economic Impact

Harsh taxation without corresponding legal recognition deters legitimate adoption. The flight of capital to crypto-friendly jurisdictions such as Dubai or Singapore testifies to this. A predictable, transparent, and innovation-oriented taxation policy will be necessary for India to become a global digital hub.

4. Technological Complexity

Pseudonymity of blockchain challenges the identification of beneficial owners. Mixers and privacy coins further complicate tax enforcement. The RegTech frameworks need to be strengthened for efficient monitoring.

VII. Policy Recommendations

1. Revisiting Section 115BBH

Introduce a progressive tax structure that differentiates between investment and trading income. Loss set-offs should be allowed to ensure tax equity.

2. Classification Clarification

Enact a comprehensive Digital Assets Act, properly defining and classifying VDAs distinctly from CBDCs and securities.

3. Standardized Valuation Framework

Based on recognized exchanges, establish a reference price index for VDAs in order to ensure consistency in the computation of fair market value.

4. GST Harmonization

Issue comprehensive circulars by CBIC on VDA classification under GST to avoid dual taxation.

5. Cross-Border Tax Cooperation

Include VDAs in OECD’s Crypto-Asset Reporting Framework for international data exchange.

6. Encouraging Self-Regulation

Empower industry associations to develop self-regulatory codes for transparency and investor protection.

7. Legal Certainty and Judicial Guidance

Establish appellate mechanisms for crypto-related tax disputes to ensure predictability and fairness.

Conclusion

India’s VDA taxation approach represents a bold yet cautious attempt at integrating emerging technologies into the formal economy. While the 30% flat rate and 1% TDS denote a clear fiscal stance, overbreadth and ambiguity characterize this framework. The persistence of legal uncertainty on issues of classification, valuation, and cross-border treatments has undermined compliance and innovation.

Such a policy will need to achieve a fine balance between the protection of revenue and enabling innovation, thereby aligning the Indian framework with the best international practices. Well-defined definitions, transparent valuation mechanisms, and rational tax structures are essential to ensure better compliance, besides enhancing India’s credibility as a leader in the digital economy.

References 

1.Income-tax Act, 1961, ss. 2(47A), 115BBH, 194S.

2. Finance Act, 2022 (No. 6 of 2022). 

3. Internet and Mobile Ass’n of India v. Reserve Bank of India, (2020) 10 SCC 274

4. Commissioner of Income Tax v. B.C. Srinivasa Setty, (1981) 2 SCC 460. 

5. Central Board of Direct Taxes, Circular No. 13 of 2022, Clarifications on Taxation of VDAs.

6. Reserve Bank of India, Concept Note on Central Bank Digital Currency (2022). 

10. OECD, Crypto-Asset Reporting Framework and Amendments to the Common Reporting Standard, 2022.
11. HM Revenue & Customs, Cryptoassets Manual (UK: HMRC, 2021) 
12. Internal Revenue Service, Notice 2014-21, 2014-16 I.R.B. 938 (U.S.). 
13. Australian Taxation Office, Tax Treatment of Crypto Assets, 2023. 1990: Elizabeth Jarrett Andrew.
14. U.S. Internal Revenue Service (IRS), Notice 2014-21: Virtual Currency Guidance (2014).
15. Monetary Authority of Singapore, Guidelines on Digital Token Offerings (2019).
16. Ministry of Finance, Press Release, “Clarification on Taxation of Virtual Digital Assets” (Feb. 2022).
17. N. Menon, “Virtual Currencies and Constitutional Rights,” National Law School Review, Vol. 35 (2022).
18. World Bank, Fintech and the Future of Financial Regulation in Emerging Economies (2022).

16. Central Board of Direct Taxes (CBDT), Circular No. 13 of 2022, Guidelines for Tax Deduction on Transfer of Virtual Digital Assets under Section 194S.
17. S. Krishnan, “Taxing Cryptocurrencies: The Indian Experience,” Indian Journal of Tax Law, Vol. 14, No. 2 (2023).
18. A. Chaturvedi, Cryptocurrency Regulation in India: Legal and Economic Challenges, Oxford University Press (2023).