Crypto Tax Dilemma: Can Striking the Right Balance Unlock Web3’s Full Potential?

Crypto assets represent one of the most disruptive financial innovations of the 21st century. As of 2024, India ranks among the top countries for crypto asset adoption, with millions of investors and businesses actively engaged in trading, decentralized finance (DeFi), and blockchain-based applications. However, the lack of a comprehensive regulatory framework and the introduction of a rigid crypto taxation regime have led to significant concerns over capital flight, reduced market liquidity, and innovation deterrence.

This article critically examines India’s crypto taxation policy, its economic implications, and possible strategies to balance regulatory compliance with sustained industry growth.

The Evolution of Crypto Taxation in India

The Indian government introduced taxation on Virtual Digital Assets (VDAs) in Budget 2022, categorizing crypto under a unique tax regime. Key provisions include:

1. Flat 30% Tax on Gains

○ Any income derived from the transfer of VDAs, including crypto and NFTs, is subject to a flat 30% capital gains tax under Section 115BBH of the Income Tax Act.
○ No deductions or exemptions, other than the cost of acquisition, are permitted.

2. No Offsetting of Losses

○ Losses from one VDA cannot be offset against gains from another or any other source of income.
○ This contrasts sharply with taxation policies for equities and other financial instruments, where losses can be adjusted against gains.

3. 1% TDS on Crypto Transactions

○ A 1% Tax Deducted at Source (TDS) is imposed on every crypto transaction exceeding ₹50,000 (or ₹10,000 in specific cases) under Section 194S.
○ The provision aims to track crypto transactions but has led to unintended consequences, such as reducing liquidity on domestic exchanges and pushing investors to offshore platforms.

Following the implementation of the 1% TDS, Indian crypto exchanges have witnessed a significant drop in trading volume and active users. A report titled “TDS on Virtual Digital Assets: A Study on the Impact of 1% TDS on Tax Revenue and User Trends,” published by the Centre for Tax Laws at NALSAR University of Law and Mayappan Nagappan, highlights the unintended consequences of this policy, which have weakened India’s crypto market.

Also read: Bharat Web3 Association Unveils 100-Day Crypto SAFE Campaign

4. Taxation on Crypto Gifts

○ Gifts received in the form of crypto assets are taxable under “Income from Other Sources” based on the fair market value at the time of receipt.

While these provisions provide clarity, they also create economic inefficiencies that could hinder India’s potential as a crypto hub.

Economic and Market Implications

1. Reduced Liquidity and Market Participation
   One of the most immediate consequences of the 1% TDS rule is a significant drop in trading volume on Indian exchanges. Traders and market makers, crucial for maintaining liquidity, have increasingly moved to offshore platforms where such restrictions do not apply. This shift has caused a decline in domestic trading volumes, reducing potential tax collections and weakening regulatory oversight.
2. Capital Flight to Foreign Exchanges
   The rigid tax regime has led to capital flight, with many Indian investors shifting their activity to unregulated or foreign exchanges. Unlike equities, where the regulatory framework fosters domestic market participation, the crypto tax structure inadvertently encourages offshore trading and underground peer-to-peer (P2P) transactions, reducing the government’s ability to monitor and tax transactions effectively.
3. Disincentivizing Innovation and Web3 Startups
   While India has the potential to be a global leader in Web3 development, stringent taxation policies discourage crypto-related startups from setting up base in India. Many blockchain entrepreneurs are relocating to crypto-friendly jurisdictions like Singapore, Dubai, and the U.K., where tax policies are more accommodating.

Finding a Middle Ground

To ensure that India’s crypto taxation framework supports compliance while fostering industry growth, a balanced approach is necessary. Reducing TDS from 1% to 0.1%would still enable transaction monitoring while preventing liquidity constraints, aligning with securities markets where the Securities Transaction Tax (STT) is considerably lower. Allowing loss set-offs—as is permitted for equities and mutual funds—would enhance market efficiency and encourage responsible trading. A well-defined crypto regulatory framework that categorizes Virtual Digital Assets (VDAs) based on risk and use cases could offer much-needed stability, potentially through the establishment of a Crypto Regulatory Authority. Aligning tax policies with global best practices, such as differentiated taxation based on holding duration, could further enhance India’s competitiveness in the crypto space. A pragmatic tax structure will ensure India benefits from the economic potential of Web3 without driving capital flight or innovation abroad.

The Path Forward

India stands at a crucial juncture in its crypto taxation journey. While the current tax framework provides much-needed clarity, its rigid structure discourages market participation, pushes innovation offshore, and reduces tax revenue due to capital flight. A more adaptive approach, incorporating lower TDS, loss adjustments could foster a more robust crypto ecosystem without compromising compliance.

As other nations refine their policies to accommodate the rapidly evolving digital asset space, India must ensure that its taxation framework supports innovation rather than restricts it. The ultimate goal should be to synchronize compliance with unrestricted growth, positioning India as a leading player in the global Web3 economy.