As the year ends and the holiday cheer begins, we bring a round-up of the discussion this year around crypto regulation in India. Despite expectations, the government has not introduced any regulations on cryptocurrency in the winter session of Parliament. This has left the crypto industry in a state of flux, with the lack of regulation being both a source of optimism and concern among the industry. This blogpost discusses when regulations on cryptocurrency can be expected, what the regulations may contain and how the industry and regulators are reacting to recent developments.
CHRISTMAS CRYPTO ROUND-UP
1. Context
The winter session of Parliament has concluded, with no legislation on cryptocurrency being introduced. The government had listed the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 (Draft Bill) for introduction in the winter session of the Parliament, which had the same name and description as the legislation banning private cryptocurrency listed for introduction in the budget session of 2021. However, the Finance Minister, Nirmala Sitharaman clarified in Parliament that the Draft Bill which will be tabled is a “new Bill” as compared to the one listed in the budget session and takes into account changes that have occurred in the cryptocurrency industry.
2. Expectations on the release of the Draft Bill
Reports suggest that the government is unlikely to make progress on the Draft Bill till April, because of competing legislative priorities. The Union Cabinet is yet to approve the Draft Bill and are likely to conduct further consultations with stakeholders on the contents of the Draft Bill. However, it is unlikely that these consultations will be completed before the next session of Parliament, the budget session, which usually commences on 1 February. The Finance Ministry is expected to pause work on the Draft Bill to focus on the financial budget for the financial year 2022-23.
The Parliament will reconvene after the budget session for the monsoon session which usually commences in July. However, a former Secretary in the Department of Economic Affairs of the Finance Ministry, Subhash Garg, said that he does not expect the Draft Bill to be introduced in the monsoon session since it will take some time for it to be finalised. After the Finance Ministry finalises the Draft Bill, Prime Minister Modi is likely to have the final say on the approach, akin to other important legislation.
3. Government policy in the past
In 2018, the Reserve Bank of India (RBI), which is the Indian central bank, prohibited regulated banking entities from dealing in cryptocurrencies or providing services to entities that dealt with them, effectively banning the trade of cryptocurrency in India. However, the Supreme Court struck down the RBI order in March 2020, terming the order unconstitutional. You can read our summary of the Supreme Court judgment here.
In 2019, a draft of ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019' (2019 Draft Law) was released by the Indian government. This bill proposed an outright ban on all cryptocurrency activities but was never introduced in Parliament. Following this, in January 2021, the Indian government announced that it will introduce a bill to ban ‘private crypto-currencies' and create a sovereign digital currency in the budget session of the Parliament. However, the Indian government did not introduce the bill, nor did it release a publicly available copy of the bill.
Later, in March 2021, Finance Minister, Nirmala Sitharaman said that the government was considering regulating cryptocurrency, taking a “calibrated approach” so India does not miss out on the opportunities in the sector. She also indicated that a regulatory sandbox approach may be taken to allow “experiments.”
4. Developments on cryptocurrency regulation
a. Indications on the content of the Draft Bill
Reuters has reportedly seen a summary of the legislation to be introduced by the government, which imposes a “general prohibition on all activities by any individual on mining, generating, holding, selling, (or) dealing” in digital currencies as a “medium of exchange, store of value and a unit of account”. The legislation thus seeks to prohibit cryptocurrency being used for the three functions which establish a currency. This summary is in line with older reports which suggested that the government will not allow cryptocurrency to be used as a currency or as legal tender. A Cabinet Note that has been accessed by NDTV suggests that cryptocurrency may described as ‘cryptoassets' in the Draft Bill to avoid any confusion that it can be used as legal tender.
Legal trading. It was suggested earlier that the government may create a list of pre-approved currencies which will be the only ones that are allowed to be held or traded on exchanges though recent reports do not make mention of this proposal. It is also suggested that cryptocurrency can be traded only through existing crypto exchanges regulated by the SEBI. A cutoff date will be set for investors to declare their cryptocurrency holdings and transfer them to one of the exchanges regulated by the SEBI.
Categorisation. Another report suggests that cryptocurrency exchanges have been advocating for the Draft Bill to define different types of crypto assets, which has reportedly been shared with the PM's Office. According to the report, the current version of the Draft Bill does not sub-categorise crypto assets based on their application or the technology employed. The Draft Bill only speaks of a broad framework without going into specifics.
Know Your Customer (KYC) norms and disclosure. It has been suggested that the Draft Bill will impose uniform Know Your Customer (KYC) norms on crypto exchanges and will require KYC data to be shared with the SEBI, the RBI and the Income Tax Department of India. The Draft Bill will also likely mandate stringent disclosure norms and may be compliant with recent Financial Action Task Force (FATF) guidelines. Reports suggest that the Prevention of Money Laundering Act will be amended and applied to cryptocurrency transactions to prevent terrorism financing.
Taxation. The government is contemplating amending income tax laws to cover cryptocurrencies, which could be introduced in the budget session of Parliament in 2022. Reports suggest that the government is planning to reclassify crypto exchanges as e-commerce platforms, levying one percent Goods and Services Tax (GST) collected at source on them. The tax collected at source is likely to be set off against investors' tax liability. Crypto exchanges may be reclassified into three categories which are platforms that act as a facilitator, the brokerages that allow buying and selling, and the trading platforms that provide an interface for trading. Reports suggest that investors will have to pay over 40% tax on crypto gains so far. Cryptocurrency will also likely be brought under s 26A of the Income Tax Act which will require taxpayers to disclose their cryptocurrency investments both in India and abroad.
Penalties. Reports suggest that investors not transacting on regulated exchanges after the cutoff date or using cryptocurrency as a method of payment may face penalties in the range of INR 5 to 20 Crores and may also be imprisoned. Reports also suggest that imprisonment for using cryptocurrency as a method of payment will be allowed without a warrant and will be non-bailable.
Other suggestions. Reports suggest that the legislation on cryptocurrency is likely to prescribe investment ceilings for individuals, in line with those on overseas remittance. The government is also deliberating prescribing a minimum threshold for investing in cryptocurrency to protect small investors. Other reports suggest that the Draft Bill will likely ban self-custodial wallets that allow people to store digital currency outside crypto exchanges. Reports also suggest that legislation on cryptocurrency might contain provisions requiring every crypto exchange to appoint a grievance officer. Finally, the Draft Bill will likely red-flag investment schemes in cryptocurrency which are similar to chit funds, multi-level marketing and systematic investment plans.
b. RBI's position on the Draft Bill
Reports suggest that a majority of the members of the RBI's central board are opposed to legalising private cryptocurrencies and would like to completely ban them, due to concerns over financial stability. Senior officials of the RBI, in a presentation to its central board highlighted issues including the traceability of crypto transactions, the price volatility, and issues with identifying actors in the crypto transaction chain.
The RBI has also raised concerns over stablecoins, saying that any crypto asset pegged to a foreign currency may undermine the Indian Rupee. The RBI said that allowing stablecoins could affect its ability to control currency fluctuations and volatility, concerns it has also expressed to the government.
c. Prime Minister's position on the Draft Bill
The Prime Minister has been an advocate for international cooperation on the regulation of cryptocurrency, taking a cautious stand on the matter in speeches made at international events. Speaking at the Sydney Dialogue, he said that democratic nations need to work together on regulating cryptocurrency to ensure that the youth does not fall prey to its risks. At a virtual summit hosted by the US President, Prime Minister Modi said that countries should jointly shape norms for cryptocurrency so that they empower democracy and don't undermine it.
d. International consultations
Reports suggest that the government is studying the approach taken by other countries to the regulation of cryptocurrency and is waiting to see the evolution of global standards on the matter. The Finance Ministry has also consulted the Bank of International Settlements on the regulation of cryptocurrency. Finally, the International Monetary Fund's Chief Economist, Gita Gopinath has met with Prime Minister Modi and officials of NITI Aayog, discussing cryptocurrency regulatory frameworks with officials from NITI Aayog. Gita Gopinath has previously called for countries to regulate rather than ban cryptocurrency, noting that it will be difficult to enforce a ban on cryptocurrency.
e. Reactions to the developments on the Draft Bill
In anticipation of legislation regulating and not banning cryptocurrency, Kotak Mahindra Bank has allowed WazirX, a crypto exchange, to open an account with it. This account will be used by WazirX to accept money from and pay money to users on its exchange. This development comes after an eight-month payment freeze by big banks of crypto exchanges and may signal a change in the approach of banks towards crypto exchanges. We recently authored an op-ed in The Print discussing why banks and payment gateways are denying services to crypto-businesses and that this could be challenged in courts.
Taking a skeptical approach, Chief Economic Advisor, Krishnamurthy Subramaniam said that any decision to grant private cryptocurrencies the status of financial assets must be done after careful examination. He said that he valuation of private cryptocurrencies can be easily swayed by speculation, causing volatility which may adversely impact retail investors. Additionally, in response to a question in the Lok Sabha, the Minister of State for Finance, Pankaj Chaudhary, said that the government has no plans for boosting the cryptocurrency sector in India.
In response to the government's concerns on advertising by crypto exchanges, the Advertising Standards Council of India (ASCI), a self-regulatory body for advertising in India, is reportedly in discussions with the government to refresh the guidelines related to advertising of cryptocurrency. These guidelines may mandate adequate disclosure of risk, ensuring that customers are aware cryptocurrency is not legal tender, and are not misled by exaggerated claims or unfair comparisons with regulated classes of assets as an investment opportunity. The ASCI already has a set of guidelines on advertising for cryptocurrency, the effectiveness of which are being examined by the government currently. A few exchanges have applied to become members of the ASCI.
The Confederation of Indian Industry (CII) has made a representation to the government and the Parliamentary Standing Committee on Finance, advocating for the Securities and Exchange Board of India (SEBI) to be the regulatory authority for cryptocurrency. CII suggested that India adopt a specific provision for declaration of cryptocurrency holdings and transactions, akin to the US and has also recommended that cryptocurrency be treated as a capital asset for tax purposes. It also suggested that India impose obligations on intermediaries on reporting for tax purposes.
5. Implications
The Draft Bill is likely not to be introduced in Parliament until July 2022 and may be delayed even further depending on the extent of consultations conducted by the government. Some reports had suggested that the government may impose tax measures on cryptocurrency gains and on crypto exchanges in the budget session of 2022. However, tax measures may also be delayed due to the Draft Bill not being introduced in 2021.
The Draft Bill will almost certainly prohibit any use of cryptocurrency payments. If the Draft Bill regulates rather than ban cryptocurrency, it may introduce regulation on the approved currencies and exchanges on which trading can occur, KYC norms required, advertising by crypto exchanges, and tax liability on gains made through trading of cryptocurrency. The government will likely introduce legislation to bring cryptocurrency under the tax net and may recategorize crypto exchanges to have one percent GST deducted at source. The banning of payment transactions through cryptocurrency may hinder payment of gas fees for completing blockchain transactions. We have advocated on several fora that the government may need to carve out an exception for this purpose.
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