FUTURE OF NON-FUNGIBLE TOKENS (NFTS) IN INDIA
NFTs are fast becoming the next big thing and could result in various complexities in the future By Sai Prashanth and V. Baratwaj
"Dhoooni!!.. finishes it off in style, a magnificent strike into the crowd, India lift the World cup after 28 years, the party starts in the dressing room and it is an Indian captain who has been absolutely magnificent on the night of the finals "
These words from Ravi Shastri and the six that M.S. Dhoni smashed to seal the World Cup in 2011 will be etched in the memory of every Indian cricket fan.
What if there is a possibility to own the digital reel of these winning moments of the World Cup? That is now made possible by Non-Fungible Tokens (NFTs), which has been making the news in the last few months.
Fungibility of an asset refers to the ability to interchange/substitute the same with some other asset. For instance, shares of a company, currency notes of the same denomination and even cryptocurrencies such as Bitcoins, Dogecoin, etc., are all fungible in nature. On the other hand, land, jewelry, paintings, etc. are examples of non-fungible assets, as each item has its unique quality.
NFTs are digital representation of real-world assets like art, videos, etc. held in the form of tokens by a unique owner which cannot be interchanged with any other asset. Some of the NFTs which have made news recently include unique artworks themed on Bollywood superstar Amitabh Bachchan's life and career, first tweet of Twitter's CEO Jack Dorsey in 2006, digital art reel of the last ball six by Indian cricketer Dinesh Karthik in the Nidahas Trophy Final in 2018. Since NFTs are linked to real life assets, the value of a NFT is dependent on the value of the underlying asset which the NFT holds.
But how do NFTs operate? And how is the safety of the NFTs ensured? When NFTs are sold, will there be any tax implications? This article focusses on understanding the basics of NFTs, and its tax implications.
Operation of NFTs
Real assets like gold or diamond jewellery can be protected and kept safe in a locker. NFTs being digital assets are secured using the blockchain network.
A blockchain is a specialised digital database, containing information on transactions executed through the chain. The technology used in the blockchain ensures the authenticity of the assets and protects the ownership of the NFT holder. This ensures that the NFT cannot be held by any other person since it requires authentication from the blockchain network.
Ownership of NFTs provides rights over the original edition of the asset underlying the NFT. The owner of a NFT may use the same personally, hold them as a collectible or as an investment to be sold in the future. The ownership, however, does not provide Intellectual Property rights over the underlying asset. The right to commercially use the underlying asset requires a license from the person holding the copyright.
Therefore, there could be millions of duplicate editions of the digital reel of six hit by Dinesh Karthik, but only one owner of the same at any point in time.
Legality of NFTs- Will NFTs be banned in India?
Very recently, the Bill on Cryptocurrency was listed to be taken up for discussion in the winter session of the Lok Sabha. Titled as "The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021", the Bill proposes to create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India and prohibit all private cryptocurrencies in India. The Bill could, however, not be introduced in the winter session of the Parliament.
Apart from a bird's eye view of the Bill, there is no information on what the Bill constitutes. Going by the initial propositions, it seems that the Government is looking to legalise only digital currency issued by the RBI and ban private cryptocurrencies.
NFTs are usually purchased using cryptocurrencies or dollars. Therefore, a ban on private cryptocurrencies will also have an impact on trading of NFTs. However, it will be interesting to see if the digital currency proposed to be issued by the RBI could be used to purchase NFTs.
Trading in NFTs – Income Tax implications
a. Gain on Sale of NFTs- Capital Gains or Business Income?
When holder of a NFT sells the same, the income so derived is taxable. At first blush, NFTs could be regarded as capital assets and the gains therefrom could be taxable as capital gains. However, a litigious issue could be whether the gain could be taxable as 'business income' since the term 'business' is defined to also include an adventure in the nature of trade. As an investor, classifying the gain as business income has its benefits since the business expenses could be adjusted against the sale price and only the net amount is taxable as business income.
The Central Board of Direct Taxes (CBDT) vide an Instruction in 1989 laid down tests to determine whether shares would be regarded as 'stock-in-trade' or 'investment'. The tests included factors such as substantial nature of the transactions, magnitude of purchases and sales, ratio between purchases and sales and holdings, etc. The CBDT vide a Circular in 2016 provided an option to assessees to treat shares as either 'business income' or 'capital gains' with the condition that a stand once taken shall be applicable for all assessments in the future.
Similar clarifications/instructions could also be issued for NFTs in the future.
b. Whether intra-day trading in NFTs could be regarded as speculative?
A 'speculative transaction' has been defined as a transaction in stocks and shares without involving actual delivery or transfer. For speculative transactions, the losses can only be adjusted against speculative income. When NFTs are being traded on a day-to-day basis by a person, the gain/loss may be regarded as speculative
c. Two taxable events- at the time of both purchase and sale of NFTs?
Apart from the taxability of gain on sale of NFTs, there could be an interesting income tax implication at the time of its purchase too. As explained earlier, NFTs are purchased mainly using cryptocurrency. Therefore, to purchase NFTs, a person must sell the existing cryptocurrency and the gain on such a sale may also be subject to income tax.
d. Equalisation levy
Equalisation levy is levied at the rate of 2% on a non-resident e-commerce operator on the consideration received for transactions facilitated. In the context of NFTs, it may be applicable when non-resident online exchange facilitates the trading in NFTs.
As discussed earlier, NFTs are digital form of real assets. As per the Sale of Goods Act, 1930, Goods mean every kind of movable property including stocks and shares. Thus, NFTs could be regarded as 'goods'.
In case NFTs are regarded as 'goods', when they are sold through online exchanges operated by non-residents, they could be subject to equalization levy. The companies usually pass on the burden to the consumers which increases the cost of purchase and sale of NFTs.
e. TDS and TCS implications
In case NFTs are considered as goods, they may be subject to TDS/TCS implications.
The online exchange (both residents and non-residents) may be liable to deduct TDS at 1% of the sale consideration under Section 194-O subject to the conditions and the prescribed thresholds.
Similarly, the purchaser of a NFT may be liable to deduct TDS under Section 194-Q at 0.1% on the consideration paid to the seller subject to the conditions and the prescribed thresholds. Corresponding to Section 194-Q, Section 206C(1H) requires a seller to collect tax at the rate of 0.1% from the purchaser subject to the conditions and the prescribed thresholds.
GST implications
NFTs could be regarded as 'goods' under GST. Therefore, sale of NFTs could have GST implications if it is in course or furtherance of business. Thus, while classifying trading in NFTs as business could be useful under Income Tax Law, the transaction could be subjected to GST. Having said that, the nature of NFTs may depend largely on the nature of the underlying asset.
Further, the online exchange facilitating sale of NFTs could be liable to collect 1% tax at source and other compliance requirements in terms of Section 52.
NFTs as Securities?
The Government is considering regulating crypto assets as could be seen from the Bill proposed to be introduced in the Parliament. There could be a possibility that NFTs could be declared as "securities" by the Central Government. Consequently, sale of NFTs will not be leviable to GST. The purchase and sale will be subject to Securities Transaction Tax (STT). While the rate of STT may be lower than the rate of GST, there could be additional compliances under the SEBI Act, 1992, Securities Contract Regulation Act, 1956, etc.
Conclusion
NFTs are fast becoming the next big thing and could result in various complexities in the future. As discussed earlier, if NFTs are regarded as goods, there could be implications under Income Tax and GST Law. The complexities include situs of taxation since it may be difficult to determine where the NFT is located. This could create issues across countries and across various Laws. For instance, determining place of supply under GST, determining whether the income is Indian income or foreign income, determining existence of business connection or Permanent Establishment (PE) under Income Tax, etc.
While the Government is proposing to introduce a Bill on cryptocurrency in the Parliament, there are reports which state that the Government may consider bringing in an ordinance and the Cryptocurrency Bill is sought to be introduced after detailed deliberations on the same. Recently, the Hon'ble Prime Minister launched blockchain based digital degrees at IIT Kanpur. Thus, blockchain as a concept is not completely frowned upon by the Government. We will have to wait and watch how NFTs will be treated by the Government.