Synopsis
India’s 1% TDS and 30% tax on VDAs led to a 97% trading volume drop, 81% user decline, and migration to offshore exchanges. NALSAR and Meyappan Nagappan report tax losses and suggest reducing TDS to 0.01%, allowing loss offset, and revising the 30% tax rate. Current tax policy hampers India’s digital economy and causes brain drain.
In February 2022, India introduced a significant change to its tax policy by imposing a 1% Tax Deducted at Source (TDS) on the transfer of Virtual Digital Assets (VDAs), alongside a flat 30% tax on income from these transactions. The Budget also did not allow for set off and carry forward of losses. The taxation framework aimed to monitor VDA transactions, discourage speculative trading, and ensure steady tax revenue. However, recent analyses indicate that these objectives have not been met, prompting calls for urgent reform.
Unintended Consequences of the 1% TDS
The introduction of the 1% TDS has led to a substantial decline in trading volumes and active users on Indian VDA exchanges. According to a report titled “TDS on Virtual Digital Assets: A report on the effect of the 1% TDS on tax revenue and user trends” by the Centre for Tax Laws at NALSAR University of Law and Meyappan Nagappan, Partner- Trilegal, the total volume of VDAs traded on Indian exchanges fell by approximately 97% within two years during the period between 1st February 2022 and 31st January 2024. Active users on these platforms dropped by about 81% during the same period.
One of the primary reasons for this decline is the migration of traders to offshore exchanges. This shift not only undermines the original intent of tracking VDA transactions but also results in significant revenue loss for the Indian government.
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Financial Impact and Loss of Revenue
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View Details »The financial implications of the 1% TDS are stark. Several studies and reports since the application of the TDS have shown that the core issue is the high rate of the TDS, which is higher than the margins and profits made by traders, particularly high frequency/volume traders that are the source of liquidity to the VDA markets. This high TDS rate (and the consequent TDS withheld by platforms/exchanges) results in the capital of these traders getting dried up after successive trades and this makes it unviable for traders to conduct their business from Indian tax-paying VDA platforms. It also results in the government becoming burdened with the liability of large volumes of income tax refunds, together with the accompanying interest, which is avoidable. This creates an additional burden on the Income Tax department and the exchequer.
The report also estimates that the Indian exchequer potentially lost INR 2,489 crore in tax revenue from February 2022 to January 2024 due to reduced trading volumes on Indian exchanges. If the current TDS policy continues, the government may lose around INR 5,100 crore in tax revenue over the next three years.
Therefore, it appears that while the intended policy objectives of the TDS implementation could not be achieved, it resulted in tax refunds and loss of revenue for the government and pushed VDA traders and users to trade from foreign platforms outside the government’s oversight, resulting in capital flight.
Recommendations for Policy Reform
Given the adverse effects of the current TDS regime, several key recommendations have been proposed:
Reduction of TDS Rate: Lowering the TDS rate from 1% to 0.01% would alleviate the administrative burden on traders and reduce capital flight. This change is projected to increase government revenue to approximately INR 5,100 crore over the next three years.
Allow Set-Off of Losses: Permitting the offset of losses from VDA transactions, similar to other asset classes, would create a more equitable tax framework and encourage domestic trading.
Reevaluate the Flat 30% Tax Rate: Revising the flat 30% tax rate on VDA income to align with other income sources would prevent the exodus of traders to offshore platforms and support the growth of the domestic VDA market.
Broader Implications for the Digital Economy
The stringent tax regime on VDAs has broader implications for India’s digital economy. It hampers the development of emerging technologies like Web3 and blockchain, which are crucial for the country’s digital transformation. A more supportive tax policy could contribute significantly to India’s GDP. A report by the US-India Strategic Partnership Forum and Crosstower estimates that embracing VDAs could add USD 1.1 trillion to India’s GDP by 2032.
Moreover, the current tax policy has led to a brain drain, with many VDA businesses and professionals moving abroad to more favorable jurisdictions. This migration not only results in loss of talent but also diminishes India’s potential as a hub for digital innovation.
Conclusion
The taxation structure on VDAs, while well-intentioned, has not achieved its goals and has instead resulted in significant market distortions and revenue losses. By adopting the recommended reforms, India can foster a more vibrant and compliant VDA ecosystem, enhance government revenues, and position itself as a leader in the global digital economy. The time to act is now, to ensure that India does not miss out on the opportunities presented by the burgeoning VDA market.
(This article is authored by Dilip Chenoy, Chairman, Bharat Web3 Association)
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)
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