Excessive Tax has Consequences for Crypto Holders and the Government

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Last February, when the government of India recognised digital assets, including cryptocurrency as taxable assets, the country’s crypto ecosystem was inundated with varying sentiments. For some, it was an assurance that cryptocurrency as well as other virtual assets were no longer in the legal grey zone. But the legal status came at a price many in the country say could be the beginning of the end of crypto’s growth in India, spurring questions by the global crypto community: are governments excessively taxing cryptocurrencies?

Although there is no official figure on the size of India’s crypto market, there are 15 million to 20 million crypto investors with total crypto holdings of 400billion rupees ($5.37billion). The industry has thrived in the last two years, fuelled by increasing demand as virtual asset’s popularity grew. The market in India, according to Chainalysis, grew by 641% from July 2020 to June 2021.

The boom in crypto has now caught the attention of the government and is imposing a 30% tax on trade profit from digital asset transactions regardless of how much is earned and one percent tax deducted at source, TDS, every time an asset is transferred.

Charles Kolstad, international tax lawyer and partner at Withers Bergman LLP, told Arweave News that 2022 would be the year tax authorities ensure the crypto industry pays its share of taxes. Although he agrees that 30% tax may be too high, he believes one percent TDS could help in tracking and collecting taxes.

“Nobody, including owners of cryptocurrencies, likes to pay taxes at all. The 30% tax may be too high. Even in the US, 30% will be too much because if you hold crypto long enough, you pay 20% not 30%. As per one percent deduction at the source, it’s a way to ensure that some revenues get collected as opposed to waiting for people to voluntarily pay taxes.”

The policy which is set to become effective in April this year, has triggered criticisms by the crypto community in India who not only want the tax reduced, but complained that provisions, including not allowing loss from the sale of one digital asset to be set off from the profit of another giving the volatility in crypto trading shows the government has deficient knowledge of how cryptocurrency works.

Sidharth Sogani, founder of CREBACO Global, a research, intelligence and rating company focused on blockchain and cryptocurrencies, who has had interactions with officials of the Indian government, told Arweave News that the government has a general idea of how crypto works.

“But they had a lot of questions as they did not know how liquidity came in, how the industry functions, how much Bitcoin is in circulation in the country,” Sogani said, recalling when he and a few stakeholders in India’s crypto industry were invited by the parliament last November for a meeting. “So we were expecting a crypto bill but the bill did not come. The bill is still in process and I believe it will come by the end of this year.”

Why the finance minister, Nirmala Sitharaman, initiated a tax policy before a crypto bill which would incorporate what members of parliament learned from stakeholders in crypto was passed is not clear, but a statement by Sitharaman that “the magnitude and frequency of these (crypto) transactions have made it imperative to provide for a specific tax regime” suggests that the government sees cryptocurrency as a money-making machine which must be explored fast with little or no consideration for its impact on innovation.

“They (crypto tax rules) are quite difficult to comply with. For instance, if there is TDS, the circulating supply of crypto gets a direct hit because in every transaction, one percent is getting stuck in the system,” said Sogani, who also noted that not allowing loss set off “is difficult because it will reduce exposure to high risk assets and people who are depending on this to invest in startups in the crypto space”.

Although holders and traders of Bitcoin and other cryptocurrencies in India generally have aversions for the tax policy, there is no consensus on what should be done. While some want the tax, including the TDS reduced or some amount of profit from crypto transactions exempted from tax in order to encourage adoption by the Indian masses, others want the policy rescinded, with reasons that cryptocurrency is in its early stage and countries including Thailand and Korea were ditching plans to tax crypto.

“I think crypto should be treated like every other asset. No better and no worse,” Kolstad said. “It should not be up to the government to determine who wins and who loses and the market forces should determine who gets tax breaks and who does not.”

Indeed, there are countries with favourable crypto tax policies, including Portugal, Malta, Switzerland, Puerto Rico and Germany and the result is evident. Some of them have become top destinations for crypto startups looking for business-friendly regulations and Bitcoin nomads looking to escape excessive taxation by their home countries.

However, friendly taxation for crypto comes with certain conditions. In Portugal for example, while individuals who are not professional traders are not charged value added tax, VAT, and personal income tax on their crypto earnings, businesses that provide cryptocurrency services are taxed between 28% and 35% on gains. How much crypto tax one pays in Germany is dependent on the size of the transaction and how long a digital asset is held.

Cryptocurrency transaction process seeks to bypass third party regulators to make transactions fast and takes power from statutory authorities, an objective some governments are not happy about, resulting in it being banned. Some observers say unfavourable tax policies such as excessive tax could be a prohibitive tactic to discourage the adoption of crypto as in the history

“In the U.S., crypto is seen as property by the IRS or the Internal Revenue Service and it’s taxed like every other asset. So it’s not as if crypto gets unfair treatment, at least in the United States. There are questions about timing issues such as if you mine Bitcoin, when you should be taxed on that,”Kolstad said. “Crypto has lots of good uses. It is a delicate balancing act. Like, how do you make sure holders of crypto pay taxes while ensuring that innovation is not stifled?”

A country’s disposition towards crypto tax is influenced by how much it desires to control its citizens and its tolerance for the growth of disruptive technologies that by design, challenge conventional technologies. For India, the consequences of its crypto tax policy outweigh the benefits. 

“Software developers are moving out of the country because of the tax laws. If there are no startups here, why would resources be here? I believe a massive brain drain is happening. If the government does not impose better tax regulations and ease of doing business in the crypto space, all the smarties will move out,”Sogani said.

“The implication of the tax policy is going to be catastrophic and India will lose the race of pioneers in the crypto space.”

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