Many exchanges are questioning the details and consequences of a 30% tax on all cryptocurrency transactions announced last week that initially brought welcome clarity over the legal status of crypto. 

At a meeting last Saturday of the leading cryptocurrency exchange industry association, the Blockchain and Crypto Assets Council, many of the member exchanges shared their view that the rules would stifle traders and exchanges from doing business in the cryptocurrency space.

Sources with knowledge of the meeting who spoke on condition of anonymity said of particular concern is a 1% tax to be deducted at the time of the trade that may be prohibitive for daily traders who make multiple transactions each day. Exchanges are worried that it will hurt their trading volumes since traders might switch to decentralized exchanges or even the traditional financial market, where the tax rates are significantly lower. 

“The 1% withholding on the entire transaction value will make day trading, arbitrage trading, margin trading, etc., challenging, and this may impact order books and volume on crypto exchange,” Sumit Gupta, CEO of CoinDCX, told Forkast in an email. “This would result in the lack of liquidity in the markets, causing inefficiency. India already trades at a premium of 5-7% on global crypto prices, and such a move would increase the premium even further for us.”

The government introduced the 1% tax to be deducted by the buyer for all transactions of or over 10,000 rupees or 50,000 rupees for specific individuals and filed as an advance tax on behalf of the seller. This tax applies to both crypto-to-fiat and crypto-to-crypto transactions.

For transactions carried out on exchanges, however, the buyers do not have enough information to file taxes on behalf of the seller. The required information rests with the exchanges, which means exchanges have to withhold the taxes before transferring the amount to the seller. 

“With respect to crypto-crypto transactions, whether it is for the buyer or the seller, both could be liable to withhold tax on the same transaction, as it is in the nature of a barter,” Gupta told Forkast. Since both parties in a barter transaction receive a token, one cannot distinguish a single buyer or seller. Gupta therefore sees a risk that the transaction would be subject to a double tax.

“In such transactions, there would be a withholding on both sides because everyone is receiving a cryptocurrency,” Rahul Garg, managing partner at tax consultancy firm Asire, told Forkast

Other questions concern what is subject to the law, which leaves crypto companies and traders based in and outside of India to question the government’s motives for the crypto tax. Industry experts, including parliamentarian Sushil Modi, believe the government wants to dissuade Indians from trading in crypto by imposing high taxes. The central bank is planning to launch its own digital currency, and the high tax rates could also be used to drive Indians towards using the CBDC over private cryptocurrencies. 

When regulation is implemented, “Does it mean that Indian tax residents will not be allowed to hold tokens at all in non-custodial wallets?” asked Rahul Gaitonde, a crypto investor and advisor to blockchain companies. “And does that hold true today as well? So, if you were to have an account at an Indian exchange and you were to send the money to a non-custodial wallet, is that a violation?”

Transactions through non-custodial wallets can be difficult to track and tax because these blockchain-based wallets give owners full control of their assets at all times. Therefore, Gaitonde is worried that if the government wants to tax crypto at all points of transaction, it may ban the use of non-custodial wallets to avoid tax evasion — but as of now, there is no clarity. 

Some clarity may be provided once parliament creates a regulatory framework for crypto assets. As it stands, the tax proposal has been presented before the government has defined policy on cryptocurrency and related assets. The definition of virtual digital assets in the Finance Bill, which has yet to be enacted as law, is very wide and includes not only cryptocurrencies but also non-fungible tokens. The definition has been kept broad so that it can encompass the different types of digital assets that may emerge in the future, Garg said. 

But the broad definition has left “multiple gray areas” and does not take into account the different aspects and use cases of crypto, Garg said. For instance, the law does not specify how crypto tokens won as mining rewards are taxed, if at all. According to a report by the Economic Times, the government is currently mulling the implementation of the goods and services tax, a form of indirect tax, on mining activities, which could significantly increase the overall incidence of tax on crypto.

Investors are also unsure about how participation in different decentralized finance projects may be taxed. For instance, in the case of DeFi project Helium, node operators are rewarded based on factors such as using their own computer and software. 

“My question is, is that an investment scheme? We don’t really know … What is the cost of acquisition there?” asked Gaitonde. As per the current tax proposal, the cost of acquisition can be deducted for tax calculations, although it has not been defined, leaving traders confused about what is included and what isn’t. For instance, gas fees can be a significant cost apart from the price of a token. But there is no guidance about whether gas fees are permitted as deductions in tax calculations. What about royalty payments for NFTs? Or exchange fees?

Moreover, ensuring the taxes are paid will require exchanges to undergo massive operational changes that would take time, effort and resources. “The current timeframe we are working with for these far-reaching changes is too short and hence unviable,” Gupta said. The tax laws will go into effect on April 1, 2022.

The exchanges are now waiting for clarity from the government. The BACC plans to hold meetings with lawmakers directly to inform them about the operational challenges of implementing the taxes. 

While the taxation has quelled the fears of a blanket crypto ban, the tax laws answered fewer questions than they raised. The government is still meeting with stakeholders to get consensus on a regulatory approach, but in the meantime, both exchanges and investors must grapple with how to properly pay their taxes.