Income Tax on Cryptocurrency Gains: What Do the Rules Say?

Cryptocurrency is a digital asset that can be a medium of exchange. It can be used to pay for goods and services but not as widely as a fiat currency such as an Indian Rupee or American Dollar. Cryptocurrency, as a mode of payment, is at a nascent stage. Still, the promise of incredibly high returns has led many people to invest in the various digital coins available today. More investors are joining the market each day. But apart from the market's volatility, there's another concern weighing on the minds of cryptocurrency investors — how will their gains in cryptocurrency be taxed?

There's no clarity on that yet. In fact, the trade of cryptocurrency was allowed in India only in March last year. But it is not regularised.

The ban and its reversal

In April 2018, the Reserve Bank of India (RBI) issued a circular banning the trade of cryptocurrency in the country. It banned banks and other financial institutions from dealing in cryptocurrency. This effectively resulted in investors not being able to transfer money from their bank accounts to their cryptocurrency-trading wallets.

In March 2020, the Supreme Court struck down the RBI order. The order followed a plea by the Internet and Mobile Association of India (IMAI). The industry body — whose members did cryptocurrency transactions among each other — claimed that the ban had led to a collapse of legitimate business activity via digital coins such as Bitcoin and Dogecoin.

The surge

This provided relief to those who had already invested in cryptocurrency by allowing them to restart trade. Others, too, saw an opportunity to increase the value of their wealth and followed them. Since the cryptocurrency market is not regularised in India, meaning it has no oversight of the country's regulator RBI, there's no official estimate of the number of Indians who have parked their money in the sector.

The taxation

Since the ban on cryptocurrency trading was reversed last year, investors are not sure how to declare their earnings from the trade this year. Some may consider avoiding paying taxes, but that is not advisable. Income Tax rules clearly mention the types of income exempted from taxation and they don't include cryptocurrency.

The tax liability will depend on whether the particular cryptocurrency was held in the form of a currency or an asset. Section 2(14) of the Income-Tax Act says any property held by a person – whether or not connected to their business or profession – is categorised as capital asset. However, if an investor has traded cryptocurrency frequently, he or she can show the gains as business income. If the virtual asset is held for investment, it will be counted as capital gains. Income from cryptocurrency can also be filed under ‘Income from Other Sources'.

The duration for which the cryptocurrency was held is likely to be a factor in tax calculation. If an asset is held for more than three years, it will be taxed as long-term capital gains. If it's held for less than three years, it would be short-term capital gains.

If someone has earned cryptocurrency by mining it, that would come under the self-generated capital asset category. It can be taxed as capital gains.

However, in absence of clear guidelines from the authorities, it's advised that a personal tax adviser be consulted before filing returns.