To the moon - Indian tribunal says pre-2022 bitcoin gains are capital gains

To the moon. A recent income tax tribunal decision marks a bold leap into the future for Indian taxation. In ITA No.1/Jodh/2012, the Jodhpur bench of the tribunal held that bitcoins were capital assets and that gains realized on their sale before April 1, 2022 (i.e., before the cryptocurrency taxation framework took effect), were taxable as capital gains.

Background. In 2022, the Income Tax Act was amended to introduce a framework (the “2022 framework”) for the taxation of cryptocurrency, establishing what many bitcoin maximalists and crypto evangelists consider a draconian tax regime clearly designed to throttle the growth of this fledgling asset class. Under the framework, income from the transfer of a ‘virtual digital asset’ or ‘VDA’ is taxed at a flat 30% rate, irrespective of holding period or income slab. Deductions are limited to the cost of acquisition, with no allowance for expenses like transaction fees or brokerage, and losses from VDAs cannot be offset against other income or carried forward. VDAs are also formally defined, and let’s just say, it’s quite a mouthful. The definition reads: "any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically.”

The issue before the tribunal was deceptively simple: prior to the coming into effect of the 2022 amendments, should gains on the sale of bitcoin be taxed as capital gains or as income from other sources? Though it may not seem like it, the stakes are high. Capital gains benefit from reduced tax rates in certain cases, and unused losses can be carried forward for up to eight financial years but can only be set off against other capital gains. On the other hand, income from other sources is taxed at ordinary slab rates, and while losses under this head can be set off against any other head of income in the same year, unused cannot be carried forward to subsequent years. Although the 2022 framework renders this question moot today, the classification of cryptocurrency gains as capital gains or income from other sources could still carry significant financial implications for the exchequer for periods prior to 2022, especially given the widespread interest in cryptocurrencies observed during the pandemic, when digital assets gained substantial traction as both investments and speculative instruments.

Analysis. I have three critiques. Firstly, are VDAs really capital assets? Many (and I would count myself among them) would argue that the blockchain is here to stay. And I would argue that the 2022 framework under section 115BBF of the Income Tax Act is not. Therefore, understanding how cryptocurrencies should be taxed under the basic provisions of the Income Tax Act is vital. Sadly, I don’t think the tribunal did anything approaching close to the level of analysis required to understand this new technology as would be needed to determine whether it’s really a capital asset. Yes, true, the definition of capital asset is wide, and it does include rights. If I were a betting man, I’d put my money on VDAs being capital assets. But VDAs are defined as any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically.” This is a complex definition, loaded with meaning. Is it likely a virtual digital asset is a capital asset? Probably. Is it obvious? Far from it. Understanding whether the definition of capital asset could encompass a virtual digital asset would also require an understanding of the mechanics that underlies blockchain and cryptocurrency technologies. The Tribunal attempts neither. A missed opportunity in my opinion.

This brings me to my second point, concerning taxpayer certainty. It’s understandable that an individual taxpayer, with limited time and resources, and a tribunal juggling numerous cases, might choose not to delve deeply into such a complex issue. However, what remains perplexing is the lack of a concerted effort by the Tax Department to address this matter comprehensively. Specifically, why has the Department not taken steps to: (1) clearly articulate its position on how pre-2022 cryptocurrency gains should be taxed, and (2) ensure that its officers uniformly apply this guidance? While administrative guidance is not binding on the courts and may still be challenged, it would at least offer taxpayers much-needed clarity and predictability in navigating their obligations.

Instead, the current approach appears to leave decisions on cryptocurrency taxation largely to the discretion of individual tax officers. While I concede there may be legitimate differences in the interpretation of facts, the government must provide a single, coherent interpretation of the law. Anything less risks fostering arbitrary and capricious outcomes, which could potentially violate the fundamental right to equality. To be clear, I recognize the practical challenges of ensuring a uniform approach when implementation relies on numerous individual officers. What is unacceptable, however, is the seeming indifference to this problem, the lack of effort to address it, and the audacity to suggest that the status quo is perfectly adequate.

My last point concerns interpretative certainty and rule established by the Supreme Court in Commissioner of Income Tax v. Vegetable Products [88 ITR 192], which the taxpayer cited in support of his argument, and which is often relied upon in tax matters. In this case, the Supreme Court held:

“The duty of the Court is to read the section, understand its language and give effect to the same. If the language is plain, the fact that the consequence of giving effect to it may lead to some absurd result is not a factor to be taken into account in interpreting a provision. It is for the legislature to step in and remove the absurdity. On the other hand, if two reasonable constructions of a taxing provision are possible, that construction which favors the assessee must be adopted.”

I consider this rule, and its application by courts, to be a cop-out of the most monumental proportions. While it is true that tax statutes should ideally be interpreted literally, it is disingenuous to suggest that two interpretations could ever be precisely equally reasonable. Surely, one interpretation will always emerge as the more logical and coherent, or simply the ‘better’ interpretation? Isn’t it the court’s responsibility to apply the “best” interpretation?

This case is often invoked to undermine the structural integrity of the Income Tax Act. In my view, the ratio should be confined to the interpretation of penalty provisions, which was the specific issue the court addressed in this case. When it comes to substantive law, I would much prefer it if the court adopted the best interpretation and left it to the legislature to sort out the rest. At least we’d have certainty.