India’s cryptocurrency landscape is grappling with a host of regulatory and taxation challenges, as highlighted by a December 2024 report from the Indian technology think tank, Esya Centre. Since July 2022, the government has lost over ₹6,000 crore (approximately $724 million) in tax revenue from virtual digital assets (VDAs) as traders migrate to offshore exchanges to escape compliance burdens and high tax rates.
This article explores the current state of India’s VDA market, the inefficacies of existing policies, and recommendations for addressing the pressing issues hindering the sector’s growth and compliance.
The Evolution of Cryptocurrency Regulation in India
A Shadow Ban Overturned
In 2018, the Reserve Bank of India (RBI) effectively imposed a shadow ban on cryptocurrencies by restricting financial institutions from facilitating crypto transactions. This ban was overturned in 2020 by the Supreme Court, paving the way for the resurgence of India’s cryptocurrency market.
Introduction of Taxation Policies
In 2022, the Indian government introduced a 30% capital gains tax on cryptocurrency transactions, with no provisions to offset losses against gains. Additionally, a 1% Tax Deducted at Source (TDS) was applied to domestic crypto trades to ensure better tax compliance and oversight.
Inclusion Under PMLA
In 2023, virtual digital assets were brought under the Prevention of Money Laundering Act (PMLA). This move was aimed at improving oversight and combating illegal activities, such as money laundering, within the crypto sector.
The Impact of High Tax Rates and Compliance Burdens
Migration to Offshore Exchanges
High tax rates and stringent compliance requirements have driven Indian cryptocurrency traders to offshore exchanges. Between July 2022 and November 2023, Indian users traded over ₹1.03 lakh crore (approximately $12.3 billion) worth of VDAs on offshore platforms, circumventing domestic regulations. This resulted in an estimated ₹3,493 crore ($417 million) in uncollected TDS during this period.
The trend intensified between December 2023 and October 2024, with offshore trading volumes reaching ₹2.63 lakh crore ($31.1 billion). This added another ₹2,634 crore ($311 million) to the uncollected TDS tally.
Decline in Domestic Exchange Activity
While domestic exchanges witnessed some recovery in early 2024, the overall trend indicates a consistent decline in user activity. Web traffic data shows a 34% drop in activity on major Indian crypto platforms since the beginning of the year.
Regulatory Inefficiencies
Despite attempts to regulate the sector, the measures have proven ineffective. Traders bypass restrictions using VPNs to access blocked offshore platforms, while the majority of foreign exchanges remain non-compliant with Indian tax laws.
Current Measures and Their Limitations
Blocking Offshore Platforms
The government has attempted to curb tax evasion by blocking URLs of non-compliant offshore exchanges. However, these efforts have been largely ineffective as traders continue to access these platforms through VPNs.
Inclusion of VDAs Under PMLA
While the inclusion of VDAs under the PMLA has improved oversight, it has not addressed the core issue of tax compliance. The lack of clear mandates for foreign exchanges to establish local subsidiaries or ensure tax deductions has left loopholes in the regulatory framework.
KUcoin’s Compliance Example
KUcoin, a Financial Intelligence Unit (FIU)-registered foreign exchange, began deducting TDS through a local entity in March 2024. However, its contribution to offshore trading volumes by Indian users remains below 5%, highlighting the limited impact of such initiatives.
Missed Opportunities: Uncollected Revenue
The Esya Centre report estimates that uncollected TDS from offshore crypto trading could exceed ₹17,700 crore ($2.1 billion) over the next five years if current trends persist. This represents a significant loss of revenue that could have been utilized for public infrastructure, education, or healthcare.
Industry Response and Recommendations
Calls for Policy Revisions
Industry stakeholders have repeatedly urged the government to revise existing tax policies to make the sector more competitive and compliant. Key recommendations include:
- Lowering the TDS Rate
- Reducing the TDS rate from 1% to 0.01% would alleviate the compliance burden on traders and encourage more activity on domestic platforms.
- A lower rate would also reduce the incentive for traders to migrate to offshore exchanges.
- Allowing Loss Offsets
- Allowing traders to offset losses against gains would make the tax framework more equitable and encourage higher compliance.
- Mandating Offshore Platform Compliance
- Revising Section 194S of the Income Tax Act to make offshore exchanges responsible for TDS deductions, regardless of their physical presence in India, would close significant loopholes.
The Role of the Central Bank Digital Currency (CBDC)
India has been actively developing its Central Bank Digital Currency (CBDC), the Digital Rupee, as a regulated alternative to cryptocurrencies. While the CBDC holds promise for improving digital payments, its focus has diverted attention from resolving issues in the broader cryptocurrency ecosystem.
CBDC vs. Cryptocurrencies
- The CBDC is not a replacement for decentralized cryptocurrencies, as it operates under central bank control.
- However, a successful CBDC rollout could integrate with existing crypto platforms, providing a bridge between traditional and decentralized financial systems.
Global Comparisons and Lessons
Crypto Taxation Worldwide
India’s high crypto tax rates are among the most stringent globally. By comparison:
- United States: Offers loss offsets and has a long-term capital gains tax rate ranging from 0% to 20%.
- Singapore: No capital gains tax on cryptocurrency transactions, fostering a thriving crypto ecosystem.
- Germany: Tax-free crypto gains if held for more than a year.
Encouraging Compliance Through Incentives
Countries like Singapore and Germany demonstrate that favorable tax policies can encourage compliance and attract investments. India could adopt similar measures to retain domestic trading volumes and foster a robust crypto ecosystem.
Potential Benefits of Reform
- Increased Revenue
- A lower TDS rate and provisions for loss offsets would likely increase overall compliance, leading to higher tax revenue.
- Revitalized Domestic Exchanges
- Competitive tax policies would bring traders back to domestic platforms, boosting their activity and growth.
- Improved Global Standing
- A balanced regulatory framework would position India as a leader in the global cryptocurrency market, attracting foreign investments and talent.
- Technological Innovation
- A thriving cryptocurrency ecosystem would drive innovation in blockchain technology, benefiting various sectors of the economy.
Conclusion
India’s current approach to cryptocurrency taxation and regulation has inadvertently driven traders to offshore platforms, resulting in significant revenue losses and declining activity on domestic exchanges. The Esya Centre’s findings underscore the urgent need for a balanced and effective regulatory framework that promotes compliance while fostering growth.
Revising tax policies, mandating offshore platform compliance, and aligning with global best practices could revitalize India’s cryptocurrency market, ensuring it remains competitive in a rapidly evolving global landscape. By addressing these challenges, India can unlock the full potential of virtual digital assets while safeguarding its fiscal interests.
