Cryptocurrency and Tax Challenges

Cryptocurrencies have been in the news recently as tax authorities believe they can be used for money laundering and tax evasion. Even the Supreme Court had appointed a Special Investigation Team on Black Money which recommended curbing the trade in such currency. While China has reportedly banned some of the largest Bitcoin trading operators, countries such as the US and Canada have laws restricting cryptocurrency exchange trading.

What is cryptocurrency?

Cryptocurrency, as the name suggests, uses encrypted codes to carry out the transaction. These codes are recognized by other computers in the user community. Instead of using paper money, the online ledger is updated with regular accounting records. With such currency, the buyer’s account is debited, and the seller’s account is credited.

How are transactions carried out in cryptocurrency?

When a transaction is initiated by a user, his computer sends a public password or public key that interacts with the private password of the recipient of the currency. If the recipient accepts the transaction, the initiating computer adds the piece of code to a block of several such encrypted codes known to every user on the network. By solving a cryptographic puzzle, dedicated users called “Miners” can add additional code to a publicly shared block and earn more cryptocurrency in the process. Once the miner has confirmed the transaction, the entry in the block cannot be changed or deleted.

For example, BitCoin can be used both on mobile devices and to make purchases. All you need to do is allow the receiver to scan the QR code from the app on your smartphone or bring them face-to-face using Near Field Communication (NFC). Note that it is very similar to regular online wallets like PayTM or MobiQuick.

Die-hard users swear by BitCoin for its decentralized nature, international acceptance, anonymity, transaction continuity and data security. Unlike paper currency, no Central Bank controls inflationary pressures on cryptocurrency. Transaction ledgers are stored in a Peer-to-Peer network. This means that every computer chip with computing power and database copies are stored on every such node in the network. Banks, on the other hand, store transaction data in central repositories held by individuals employed by the firm.

How to use cryptocurrency for money laundering?

The lack of any oversight over cryptocurrency transactions by Central Banks or tax authorities means that transactions cannot always be traced back to a specific person. This means that we don’t know if the transactor obtained the store of value legitimately or not. The recipient’s store is equally suspect, as no one can tell what is considered for the currency received.

What does Indian Law say about such virtual currencies?

Virtual currencies or cryptocurrencies are commonly seen as software and are therefore classified as goods under the Sale of Goods Act of 1930.

They will be subject to good, indirect taxes on their sale or purchase as well as GST on services rendered by Miners.

There is still considerable confusion over whether cryptocurrencies are valid as currency in India, and the RBI, which has jurisdiction over clearing and payment systems and prepaid negotiable instruments, has certainly not allowed trading through this exchange.

Any cryptocurrencies received by a resident of India will thus be governed by the Foreign Exchange Management Act, 1999 as an import of goods into that country.

India has allowed BitCoin trading on Dedicated Exchanges with built-in safeguards for tax evasion or money laundering activities and enforcement of Know Your Customer norms. These exchanges include Zebpay, Unocoin and Coinsecure.

For example, those who invest in BitCoins are liable to account for dividends received.

Capital gains from the sale of securities involving virtual currencies should also be taxed as income and consequently related to online filing of IT returns.

If your investments in this currency are large, it is better to seek the help of a personalized tax service. Online platforms have made the tax compliance process much easier.