The world has been witnessing an upsurge of digital assets across industries. While there has been no law in India to confirm the status of a digital asset as legal or illegal, the recent amendment to the Income tax Act, 1961 defines “virtual digital asset”. In the Union Budget 2022-23, the finance minister clarified the rate of tax 30% (thirty percent) on any income from the transfer of virtual digital assets. The first cryptocurrency was introduced in January 2009 by its pseudonymous creator Satoshi Nakamoto.
- RBI on Digital Assets
In 2013, as investments in crypto currency picked up in India, the Reserve Bank of India (RBI) issued a circular to caution the users, holders and traders of virtual currencies including bitcoins, about the potential financial, operational, legal, customer protection and security related risks that they are exposing themselves to.1 Indian banks however, continued to allow transactions on crypto currency exchanges. In 2018, the RBI issued a circular prohibiting entities which are regulated by RBI to deal in virtual currencies or provide services for facilitating any person or entity in dealing with or settling in such virtual currencies.2 RBI provided these entities with a time period of 3 (three) months to adhere to its circular (“RBI Circular”).
In 2019, after RBI prohibited any dealing in crypto currency, Inter-Ministerial Committee proposed the Bill, which bans cryptocurrencies, criminalizes activities associated with cryptocurrencies in India, and provides for the regulation of official digital currency.3 Any person who held crypto currencies would have to, within a period of 90 (ninety) days from when the bill came into power, make a declaration in respect of cryptocurrency in such person’s possession and shall dispose of the same within the aforesaid period.
- Supreme Court on Digital Assets
The ban by RBI was a massive setback in crypto exchanges existing at that point, which was challenged through a writ petition filed in the Supreme Court. On 4 March 2020, in the case of Internet and Mobile Association of India v. RBI4the Hon’ble Supreme Court set aside the RBI Circular on the grounds that it failed to meet the test of proportionality and reasonableness while curbing a fundamental right (Article 19 (1) (g)) under the Constitution. Following the Supreme Court order, RBI issued a notification stating that its circular prohibiting crypto currencies is no longer valid from the date of the Supreme Court judgement. Despite setting aside of the RBI Notification, banks (Indian banks as well as branches of overseas banks) restricted their banking infrastructure for cryptocurrency transactions.
It is relevant to mention that an application5 was filed under the Right to Information Act, 2005 asking whether the RBI has prohibited any banks from providing the bank accounts for crypto exchanges, companies, or crypto traders. In response to the query, the RBI on May 22, 2020, had replied that “as on date, no such prohibition exists”. Despite the clarification from the RBI, banks are yet to facilitate transactions through their payment systems for the cryptocurrency ecosystem in India.
- SEBI on Digital Assets
While trading in digital assets it is critical to determine if a cryptocurrency exchange is a stock exchange.
A stock exchange in India is regulated by the Securities and Exchange Board of India (SEBI) and the regulations thereunder. The term ‘securities’ under Securities (Contract Regulation) Act 1956 (SCRA) provides an inclusive definition which does not cover crypto currencies or any other digital assets. Currently, there has been no guidance from SEBI on the application of the term securities in the context of cryptocurrency. However, from a bare perusal of the definition of securities under the SCRA, cryptocurrencies do not fall within the purview of such definition since the items under the definition derive their value from an underlying asset. The value of a cryptocurrency or virtual currency is purely determined based on supply and demand factors on the crypto exchange. Therefore, it appears that SCRA is not applicable to a cryptocurrency exchange. It follows that if cryptocurrency is not security, SEBI shall not recognize cryptocurrency exchange as a stock exchange.
Consequently, cryptocurrencies listed on a cryptocurrency exchange are unregulated and don’t need to comply with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. While SEBI has not sought a ban on cryptocurrencies, it has maintained a view that the decentralized nature of cryptocurrencies makes them harder to regulate.
- Guidelines for Advertising Virtual Digital Assets and Linked Services
On 23 February 2022, the Advertising Standards Council of India (ASCI) set out guidelines for all advertisements for digital assets.6 It stated that all ads for virtual digital asset (VDA) products and VDA exchanges, or featuring VDAs, must carry the following disclaimer:
“Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions.”
The font, colour, positioning and speed of reading out these guidelines must be as specified by ASCI. The circular further stated that the words “currency”, “securities”, “custodian” and “depositories” may not be used in advertisements of VDA products or services.
The Cable Television Network (Regulation) Act, 1995 read with the Cable Television Network Rules, 1994 state that “No advertisement which violates the Code for self-regulation in advertising, as adopted by the Advertising Standard Council of India (ASCI), Mumbai for public exhibition in India, for time to time, shall be carried in the cable service”. A contravention of this act shall be punishable with an imprisonment for a term which may extend to 2 (two) years or with fine which may extend to INR 1,000/- (Rupees One Thousand) or with both for first offence. For every subsequent offence, imprisonment for a term which may extend to 5 (five) years and with fine which may extend to INR 5,000/- (Rupees Five Thousand).
- Foreign Exchange Management Act, 1999 (FEMA) and Digital Assets
As a thumb rule, FEMA is involved in transactions where one party is an Indian party, and the other party is a foreign party.
Parties partake in transactions involving digital assets which include non-fungible tokens, cryptocurrencies, metaverse and utility tokens. These transactions can take the following colour:
Scenario 1 - Payment of digital assets in lieu of imports of goods and services
Scenario 2 - Receipt of digital assets in lieu of export of goods and services
Scenario 3 - Purchase of digital assets by paying fiat currency
Scenario 4 - Sale of digital assets by receiving fiat currency
Scenario 5 - Swap of digital assets
- Transactions in Digital assets
FEMA transactions usually fall into two types of transactions, viz. capital account transactions and current account transactions.
1.1. Capital account transactions
- According to Section 2 (e) of FEMA, a capital account transaction is a transaction which alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India or alters the assets or liabilities in India of persons resident outside India.
- Digital assets are stored in digital wallets, which may or may not be held by entities registered / incorporated in India. Hence, there is lack of clarity on the place of registration of these digital wallets where the digital assets are held by persons resident in India. There are wallets in India, however they are not regulated and hence their legality is a grey area.
- We cannot conclusively say whether a transaction involving buying or selling of digital asset is a capital account transaction or not.
- Assuming it is a capital account transaction, as per section 5 of FEMA, capital account transactions are prohibited unless permitted. Transactions involving buying or selling of digital assets do not fall under permissible transactions, hence they are prohibited. Accordingly, the 5 (five) scenarios as mentioned in paragraph E are prohibited capital account transactions.
- The definition of current account transaction under Section 2 (j) of FEMA defines a current account transaction inter alia as “a transaction other than a capital account transaction and without prejudice to the generality of the foregoing such transaction includes (i) payments due in connection with foreign trade, other current business, services, and short-term banking and credit facilities in the ordinary course of business.”
- Section 5 of FEMA states that any person may sell or draw foreign exchange to or from an authorised person if such sale or drawal is a current account transaction. Therefore, it seems to be that current account transactions are permitted unless prohibited.
- Transactions in digital assets may be classified as a current account transaction.
- However, banks do not recognize transactions in digital assets as current account transactions.
- Classification of Digital Assets
The terms goods and services are relevant for classification of digital assets. Neither of these terms have been defined in Master Direction on Import of Goods and Services or Master Direction on Exports of Goods and Services.
2.1 Digital assets as services
Section 2 (zb) of FEMA defines services, and digital assets do not come under the definition of services under FEMA.
2.2 Digital assets as goods
- FEMA does not contain the definition of ‘goods’, and the same is also not contained in the General Clauses Act, 1897.
- Assuming we may take guidance from a case law, in Tata Consultancy Services v. State of Andhra Pradesh7, a three-part test for classification of goods was laid down - Goods may be tangible property or intangible property. It would become goods provided it has the attributes thereof having regard to (a) its utility; (b) capable of being bought and sold; and (c) capable of transmitted, transferred, delivered, stored, and possessed.
- Accordingly, digital assets may be classified as intangible goods.
3.1. In transactions relating to import and export of goods and services, money received or paid should be routed through AD banks as a mode of payment.
3.2. In the various scenarios for transactions in digital assets mentioned in paragraph E of this article, we have come to the following conclusion:
Scenario 1 - Payment of digital assets in lieu of imports of goods and services: As digital assets are not considered as legal tender in India; an AD may not recognize digital assets as a mode of payment.
Scenario 2 - Receipt of digital assets in lieu of export of goods and services: As digital assets are not considered as legal tender in India; an AD may not recognize digital assets as a mode of payment.
Scenario 3 - Purchase of digital assets by paying fiat currency: Payment of fiat currency for purchase of digital assets may be permissible as it does not have a legal impediment. However, no individual imports digital assets under the Master Direction on Import of Goods and Services. Imports are routed through the Liberalised Remittance Scheme - a scheme by RBI for permissible for current and capital account transactions. While importing digital assets under the LRS, an individual may be misrepresenting the category under which the import falls.
Scenario 4 - Sale of digital assets by receiving fiat currency: Receiving fiat currency for sale of digital assets may be permissible as it does not have a legal impediment. However, as of yet, digital assets are not exported from India. Transactions have been domestic. In case of export of digital assets from India, if a digital asset is created in India, its owner will be in India, and it will be sold in lieu of fiat currency. The digital assets which are used for transactions, have not been traced to the root to identify the actual owner of the assets and may be referred to RBI for action.
Scenario 5 - Swap of digital assets: As digital assets are not considered as legal tender in India; an AD bank may not recognise digital assets as a mode of payment. Additionally, there have not been permitted transactions relating to import of digital assets.
- Transactions in digital assets may legally be classified as current account transactions.
- Digital assets may be treated as intangible goods.
However, this may not be in line with the view taken by AD banks when dealing with digital asset transactions.
- Application was filed by Mr. B. V. Harish, co-founder of Unocoin, an Indian cryptocurrency exchange service provider