Bitcoins are a relatively new form of digital currency and what is special about them is the fact that they work on a peer to peer basis, i.e. they have no central authority to either issue the currency or track the transactions. They have also been termed by many as a form of cryptocurrency. They were launched in the year 2009 by a person called “Satoshi Nakamoto”. An interesting fact about bitcoins is that transactions involving them cannot be reversed, neither do they carry traces of any personal information. They are created through a technique called “mining” and this system has been designed in such a way that no more than 21 million bitcoins can ever be created. Any individual with access to a computer system that is connected to the internet can participate in the “mining” process. The process itself involves compiling recent bitcoin transactions into ‘blocks’ with various computer systems trying various logical combinations in order to solve a computationally difficult and complex logical puzzle. The computer system that is first able to solve the puzzle gets to place the next ‘block’ on the ‘blockchain’ and therefore claim a bitcoin.
There have been allegations that because of the secrecy that bitcoin transactions offer, they are often used for terrorist activities, money laundering and several other illegal activities. This coupled with the recent spike in the valuation of bitcoins has made the Indian Government and financial institutions uncomfortable.
The Finance Ministry had issued a notification in December, 2017 declaring that bitcoins will not be considered lawful or legal tender in India. The same was reiterated by the Finance Minister in the Parliament in January, 2018 . However, not being legal tender does not mean that bitcoins are illegal. It simply means that nobody is bound to accept them as tender. However one who is willing to accept them, may do so, on the lines of gold and other precious metals. The Indian Government seems to be treating bitcoins as a commodity rather than as tender.
The Reserve Bank of India went one step further and declared that any entity regulated by it cannot deal with any individual or business dealing in virtual currencies . What this essentially means is that banks will not allow transactions to purchase or sell bitcoins through their payment systems. A three month window has been offered by the RBI within which regulated entities may liquidate their virtual currency positions. Once this period is over, conversion of bitcoins to Indian Rupees will not be possible through the banking system in India. This leaves bitcoin exchange platforms based in India only with two options, either wind up business or move to the international market. Another scenario that the financial authorities in India did not possibly think of is the emergence of a cash-based bitcoin trading system. In such circumstances, the emergence of a parallel black economy due to lack of KYC (Know Your Customer) authentication while trading bitcoins in cash seems imminent.
Bitcoins may be termed as “goods” within the meaning of Section 2(7) of the Sale of Goods Act . The relevant provision of the Act includes “every kind of moveable property except money and actionable claims” and therefore bitcoins may be covered under it. However, they cannot come under the ambit of the Act when used as consideration since the Act only provides for consideration in the form of price and not in kind.
One might argue that bitcoins can be classified as ‘currency’ within the meaning of FEMA . However, the Act defines ‘currency’ as currency notes, postal notes, postal order, money orders, cheques, drafts, letters of credit and other such instruments as may be notified by the Reserve Bank of India (RBI) . However, the Indian Government has made it clear that bitcoins are not legal tender and therefore cannot be classified as ‘currency’ under the said Act.
Bitcoins may be classified as ‘capital assets’ under the Income Tax Act . The Act defines a ‘capital asset’ as ‘a property of any kind held by a person’ . The term ‘property’ as used in the said Act has no statutory meaning. However, it may mean every possible interest that a person may acquire, hold or enjoy. Therefore, bitcoins could be classified as a ‘capital asset’ under the said Act. In furtherance of the same, any gains made because transfer of a bitcoin should be taxable as capital gain. Assuming that gains from transfer of bitcoins are taxed as capital gains, they may further be classified into ‘short-term capital gain’ and ‘long-term capital gain’ , depending on the period of having the bitcoins in possession. If the bitcoin is kept for more than 36 months then it will be classified as a ‘long term capital asset’ and gains from it will be classified as ‘long term capital gain’ . If it is held for duration of less than 36 months then it will be classified as a ‘short term capital asset’ and gains from it will be classified as ‘short term capital gain’ .
Moreover, if the person concerned is trading in bitcoins, the income should be taxable as ‘business income’ . In such circumstances, bitcoins that are collected through the ‘mining’ process should also be taxable as ‘business profits’.
However, the entire basis of taxability of bitcoins extracted through the ‘mining’ process depends on whether bitcoins are classified as ‘capital assets’ or not. When classified as such, extracted bitcoins may be beyond the tax net. Under such circumstances, they are likely to be classified as ‘self generated capital assets’. Considering the fact that there is no clear cut cost of acquisition of the extracted bitcoins, the judicial principles laid down by the Supreme Court of India in the case of Commissioner of Income Tax vs. B.C. Srinivasa Setty may be relied upon.
It was held that when the cost of acquisition of an asset cannot be computed, the machinery for computation of capital gains will fail and under such circumstances, no capital gain taxes can be levied on transfer of such assets. This would essentially mean that bitcoins extracted through ‘mining’ are exempt from taxes.
Another important factor when analysing the taxability of bitcoins is their ‘situs’. The term ‘situs’ is used to denote the location of a property or object for purposes of legal jurisdiction or taxation . Situs of an intangible asset is usually decided by the sinus of any tangible property with which it is closely connected. Since bitcoins are intangible assets, their situs can be linked with the location of the operating server being used to host the bitcoin blockchain and the entire ‘mining’ process. However, another legal convention is that situs of an intangible asset should be based on the situs of the individual owning it. Under such circumstances there seem to be no single opinion so as to the determination of situs of bitcoins.
A Public Interest Litigation (PIL) was filed in the Supreme Court of India by Advocate Dwaipayan Bhowmick seeking a regulatory framework to be laid down on virtual currency including bitcoins and also demanded that virtual currencies be made accountable by the exchequer . After admitting the petition, the Supreme Court issued notices to the Ministry of Finance, Ministry of Law & Justice, Ministry of Information Technology, Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) seeking a reply from them regarding the same. No further progress has been made in this case at the time of writing this article.
Therefore it can be safely concluded that bitcoins in India besides other such forms of cryptocurrencies are in a regulation vacuum under the present laws in India. However, it would be wrong to assume that the Indian Government has not taken note of the immense potential that they hold for the economy as a whole. The Government has certainly realized the threats they pose in terms of the anonymity that they offer besides the economic bubble that they may create and their actions reiterate the same. The Indian Government along with the Reserve Bank of India needs to implement a regulatory framework for governing bitcoins and other cryptocurrencies as soon as possible. If properly regulated, bitcoins might help enhance the digitalization of the economy as envisaged by the present Prime Minister of India besides serving as a convenient form of payment.