A Guide to Crypto Tax Calculation

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What are Crypto Currencies?

Cryptocurrencies are digital assets that can be used as a medium of exchange. These digital use strong cryptography to secure financial transactions, regulate the mining of cryptocurrencies and validate transactions. A cryptocurrency meets 6 conditions.

  • The system does not have central control, it is regulated through distributed consensus.

  • The system has a ledger containing cryptocurrency units and their ownership.

  • The system defines the production of the cryptocurrency. If new units of a cryptocurrency are produced, the system will determine the point of origin and the ownership of these new units.

  • Cryptocurrency ownership can only be proven cryptographically.

  • Transaction statements are only issued by entities that prove the current owner of the cryptocurrency.

  • If two different instructions are provided for the same units of cryptocurrency, the system will perform only one instruction.

What is Crypto Tax?

Due to the uncertainty around the cryptocurrency market in India and its future, there isn’t a crypto tax in place in India, but transactions made with cryptocurrency are still taxed, and one should know how to report crypto taxes. The Income Tax Department does not care where your money comes from, they care that you pay your taxes on all incomes. So even though there is no specific Crypto Tax in India yet, any profits or gains you make through these transactions are taxable under law. Cryptocurrencies can be loosely classified under the definition of Capital Assets as defined under Section 2(14) of the Income Tax Act, 1961

The period for which the cryptocurrency is held will determine whether it should be taxed under short-term capital gains or long-term capital gains. Like any other asset, if the cryptocurrency is held for a period longer than 36 months from the date of purchase, any gains on it would be considered long-term capital gains. Long-term capital gains are taxed at a flat rate of 20% with the benefit of indexation. If the cryptocurrency is held for a period of less than 36 months any profits on the transfer or sale of the units will be considered short-term capital gains and will be taxed in accordance with the taxpayer’s tax liability. However, if you make frequent transactions with cryptocurrencies this will be considered profit from the sale of cryptocurrencies and will be taxed under the head of Income from Business. 

How do cryptocurrencies work?

Cryptocurrencies are based on a system called blockchain. Blockchain uses an open ledger system, where all the participants in the network share a single ledger and all transactions are authenticated by the participants, thereby, removing any centralized control of the system. A set of such transactions is called a “block”. Blocks are immutably linked to one another creating a chain, therefore, the name blockchain. One of the major advantages of this system is that to alter any transaction within the chain, the entire chain will need to be altered.

What is Bitcoin?

When you hear the word “cryptocurrency” the first thing to pop up in most people’s heads is Bitcoin. Bitcoin is one of many cryptocurrencies available, others include Litecoin, Etherium, Ripple and many more. Bitcoin was the first digital Cryptocurrency created by a person who goes by the name of Satoshi Nakamoto, it was created as an incentive for people to use their computing power to authenticate transactions on the Bitcoin network. Every time a computer authenticates a transaction it is rewarded with a certain number of Bitcoins, this process of authenticating transactions to earn Bitcoin is also called mining. And one thing to note here is that certain countries apply taxes on bitcoins at different tax rates.

Crypto Tax in Detail

Acquiring Crypto Currencies

Most people are under the impression that cryptocurrencies in India are illegal to procure or hold, this is not true. The RBI issued a notice to Indian banks preventing them from facilitating such transactions. Therefore, to procure cryptocurrencies you might need to use some form of peer to peer trading or use a P2P matching facility offered by Indian Crypto Exchanges.

Income Generation

There are broadly three events that can lead to a generation of taxable income from Cryptocurrencies. 

  • When a cryptocurrency is exchanged for a Fiat currency.

  • When one cryptocurrency is exchanged for another.

  • When cryptocurrency is used to procure goods or services.

The taxable income will be calculated by using the formula

Taxable Income = Value received at the time of exchange – Cost of acquiring the cryptocurrency

There are two instances where income generated from cryptocurrencies are not taxable

  • When a Fiat currency is used to procure Cryptocurrency.

  • When a cryptocurrency is transferred between wallets.

Income Classification

The income generated from cryptocurrencies will be classified based on:

  • Average Holding Period

  • Intent of use

  • Frequency in Transactions

The table below shows how income from cryptocurrencies is classified.

Cryptocurrency Mining

Cryptocurrency mining is a process by which a specialized rig is used to authenticate transactions on the network. For each authentication, the mining rig earns some amount in cryptocurrency. For income generated from cryptocurrency mining operations, you will need to either classify it under profits from business or casual income depending on.

  • Investment in the mining pool versus the operation of the mining facility

  • Time and energy expended for the purpose of mining

  • Size of mining rig

Trading on Foreign Crypto Exchanges

Many Indian cryptocurrency investors conduct transactions on their cryptocurrencies through foreign exchanges. If you hold cryptocurrencies in such exchanges you will be deemed to be in possession of a foreign asset. Any foreign income or foreign asset needs to be disclosed in your annual income tax return as per the Black Money and Imposition of Tax Act, 2015.

As India prepares to become one of the largest digital economies in the world, cryptocurrencies, whether Indian or foreign, are going to become the norm. Make sure you are paying all your taxes on these investments so that you don’t lose out when they take off here.

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