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Regularity Uncertainty

Lack of regulations governing cryptocurrencies an impediment for ICOs in India.

Regularity Uncertainty

With the rapidly evolving digital world of cryptocurrencies, global investors and startups are now being lured to a new form of investment and fund raising opportunity, the Initial Coin Offerings (ICO). Like Initial Public Offering (IPO), ICOs are means for raising money from public investors to fund a startup. However, under ICOs digital 'tokens' are allotted in lieu of shares, which represent an informal ownership share in business of the startup which is being funded.

Raising money through IPOs in India requires business ventures to adhere to the compliance norms of Securities Exchange Board of India (SEBI). When it comes to ICOs, many countries, including India, have not yet formulated any rules and regulations. Hence, ICOs do not require compliance with any norms and as such are means to circumvent the rules prescribed for raising funds through IPOs or other legitimate processes.

In April 2017, the Indian government had formed an inter-disciplinary committee to prepare a report on existing regulatory framework on cryptocurrencies in India as well as in various other countries. The report has been submitted to the finance minister.

It would, nevertheless, be worthwhile to understand the operations of cryptocurrencies since they are legal in countries such as Japan, Switzerland and Singapore. From a regulatory perspective, ICO tokens are generally of two categories - payment tokens and asset-based tokens. Payment tokens under ICOs have cryptocurrencies (bitcoins, ethereum, etc) as the underlying asset. During his Budget speech, the finance minister had specifically mentioned that the government does not recognise cryptocurrencies as a legal tender and efforts would be taken to eliminate their use in financing illegitimate activities or as part of the payment system.

While there is no clarification on taxation of cryptocurrencies in the Finance Act 2018, the same would be governed by the normal provisions of income tax law. The common view is that where cryptocurrency is represented by underlying assets such as bitcoins, the same may be treated as capital asset (unless held as stock-in-trade) and taxed as short-term capital gain (for assets held for three years or less) at the normal tax rates. In case the asset is held for more than three years, the long term capital gains after indexation benefit are subject to tax at 20 per cent. In case it is a derivative transaction, the same is subject to normal tax rates. It may be noted that in case of Indian residents, the gain on sale of cryptocurrencies is taxable in India even if arising outside India. It is also necessary to report foreign assets in schedule FA section of the income-tax returns for the resident investors, who have already invested in cryptocurrencies. Further, it is well settled that even in case of an illegal activity, the gains are subject to tax. The income tax department has already issued notices to various investors for declaring their income earned through cryptocurrencies.

The applicability of GST on purchase and sale of cryptocurrencies is another contentious subject. The investments made by Indian residents outside India need to be reviewed under FEMA regulations issued by the RBI. Interestingly, the RBI has instructed, with immediate effect, that entities regulated by RBI shall not deal with or provide services to any individual or business entities dealing with or settling VCs. Regulated entities that already provide such services shall exit the relationship within a specified time.

Most countries are in the process of forming a regulation governing cryptocurrencies, ICOs and blockchain technology. Swiss Financial Regulator FINMA's guidelines to regulate ICOs focus on the economic function of tokens, and states that regulation will not apply to all ICOs. On the other hand, China has put an official ban on all ICOs. With the government all set to wage a war against cryptocurrencies, there could be serious litigations in times to come.

 

The writer is Founder, RSM Astute Consulting Group

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