India's crypto taxation framework: How does it fare globally?

The growing prominence of Web3 is a clear indicator of its transformative potential, highlighting its ability to bring about significant change. Like any emerging technology, achieving a balance between fostering innovation and ensuring financial stability is thus of paramount importance. Given this, integrating the evolving landscape of virtual digital assets (VDAs) into a well-structured tax system is a key consideration, regardless of how the VDA landscape unfolds.

India’s taxation framework and the intent behind it
In recent years, India has found itself amid a promising Web3 landscape, characterized by a remarkable surge in startups. This evolution, however, has been accompanied by a taxation framework, one that has created implications within the country's Web3 ecosystem.

The Finance Act, 2022 introduced Section 194S, which imposed TDS at the rate of 1% on sale of VDAs in India from 1st July 2022. Further, a high rate of income tax of 30% was also introduced on any income from transfer of VDA from 1st April. There are also further restrictions on available deductions and treatment of losses, with no setoffs allowed against other crypto gains.

The objective behind these measures was three-fold: tracking VDAs transactions by Indian residents, discouraging speculation and trading, and building guardrails around VDAs for safeguarding Indian interest and ensure financial stability.

India’s engagement with VDAs remains unchanged
While India has made significant steps to standardise taxation, a high rate of TDS has caused a flight of volumes and users to platforms in foreign jurisdictions and the grey market. Following the announcement of a new tax regime, there was a shift of around Rs 32,000 crore of trade volume from domestic VDA exchanges to foreign ones from Feb-Oct 2022. Contribution of Indians to the volume on foreign VDA exchanges enabling peer-to-peer transactions was to the tune of Rs 80,000 crore between July and Oct 2022. In addition, the daily volume at compliant Indian exchanges has reduced by over 70-90%.

This proves that the TDS requirement has not suppressed crypto activities in India. It has only shifted volumes to unsupervised and many-a-times non-compliant channels with high counterparty risks, has left the consumer protection frameworks implemented painfully by VDA service providers redundant.

Competitiveness, on the other hand, of Indian Web3 firms has reduced
Taxation frameworks should fundamentally support ecosystems that are driving compliance and encourage more participants in supervised and monitored transactions, rather than impose punitive measures and drive participants out of such systems.

However, in India, the tax framework continues to be a hurdle most companies in the space must deal with when setting up or running an organisation. The high rate of income tax of 30% delegitimizes the VDA ecosystem as a genuine technology and business, and instead places it at par with activities considered to be against the social fabric. A high rate of TDS also creates a liquidity crunch at Indian VDA platforms and for end users suffering poor execution prices.

Many emerging web3 business models generate their profits in crypto. A wide-ranging taxation approach runs the risk of hampering legitimate businesses which are unable to offset their operational expenses. This has also led to many web3 businesses leaving India, despite Indian founders and developers being at the centre of innovative web3 startups.

Countries around the world embracing Web3
Several countries, such as Germany, Singapore, Switzerland, Hong Kong, and UAE, have embraced Web3 and VDAs, as is evident in their favourable policies. Singapore stands out for its tax advantages, with no capital gains tax on VDA investments and exempting individual earnings. Switzerland treats VDAs as assets, usually exempting gains from VDA trading but taxing commercial activities. Hong Kong adopts a similar approach, exempting VDA investors from tax but taxing business gains. Certain regions like Puerto Rico offer more accommodating policies with no capital gains tax for investors and a 4% income tax for qualified businesses. Monaco, Malta, Seychelles, Thailand, and Vanuatu also have no capital gains tax for VDA investors.

In addition to a nurturing tax structure, these countries have also implemented progressive, forward-looking regulatory frameworks which complement their tax policies to leverage the opportunity at hand. In practice, this has translated into rapid economic growth through VDAs in the presence of an encouraging environment.

The need for clarity and certainty
India’s Web3 landscape, once teeming with potential, is at a crossroads due to the complex taxation structure. As businesses and users seek refuge in more tax-friendly shores, India faces the risk of losing out on technological innovation and economic growth. The need for a tax framework that supports legitimate technology and business ventures within the Web3 space therefore remains a pressing issue.

Hence, a careful recalibration of the tax framework is crucial to ensure that India remains a global player in the Web3 revolution. Ultimately, the path forward for India's Web3 ecosystem and its taxation framework requires a careful recalibration to ensure that it continues to attract innovation and participation while addressing the concerns raised by the evolving landscape of VDAs.