Taxation of Cryptocurrency : Navigating the uncharted waters

15th January, 2024 - 6:50 am Categories: TAX Technology 0 Comments

Introduction

Cryptocurrencies have developed in the form of a revolutionary force in the financial sector across the globe, and this has taken place through the introduction of decentralized digital assets far and beyond the traditional banking infrastructure. However, the popularity and widespread acceptance of this financial innovation globally, have made governments grapple while dealing with the taxation of cryptocurrencies. The digital uniqueness of these assets is berserk with consequential challenges for taxation authorities throughout the world, prodding the requirement for developing a regulatory infrastructure that acclimatizes with the dynamic financial sector that is rapidly changing its shape and form and area which it occupies tends to expand constantly.

The Biography – Cryptocurrency

Cryptocurrency is the creation of a digital or virtual asset by cryptographic techniques and regarded as currency, and rests upon the technique for secure credit-debit process and its control-cum-creation of new units, also the validity of transfers is regarded under the same technique. However, the standard network of operation for these currencies is decentralized, and based on blockchain technology. These currencies are aimed at bestowing completely secure, crystally transparent, and unfathomably borderless peer-to-peer transactions, without the established intermediaries like banks and other regulatory institutions. In complete opposition to the conventional legal tenders issued by respective authorities under their respective governments. As per the present scenario, cryptocurrencies are beyond the scope of governance and regulation of any core central body under the government, and neither do the governments control it directly. Bitcoin being the prime and well-known example in this line was introduced in 2009, thereafter a plethora of similar models of currencies joined the financial sphere. Characteristically each of these coins is unique in its features and purpose. Blockchain technology fundamentally ensures the integrity and immutability of transactional records, and this facilitates an infrastructure for innovation of the modern financial landscape and the breeding of cryptocurrencies. The inception of Bitcoin in 2009 marked the beginning of a new era in finance. Unlike traditional currencies, cryptocurrencies leverage blockchain technology to enable secure, transparent, and decentralized transactions. Since the evolution of digital assets, the crypto-market has expanded exponentially, around the globe and this mammoth growth has interlinked the financial infrastructure of all the states under a common sphere facilitating peer-to-peer transactions to powering decentralized applications.

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Challenges in Taxing Cryptocurrency

Taxing cryptocurrencies poses various challenges for governments and tax authorities worldwide. The unique character of these assets being digital, and their dematerialized, and pseudonymity form is the root cause for the taxation job to be adventures for the various governments around the globe. Moreover, the cross-border transactional nature of cryptocurrencies like Dogecoin and Bitcoin cast a novel challenge in the realm of taxation. Also, the operation of these assets is decentralized which means their operation is beyond the ambit of established traditional financial institutions, making it a cumbersome task for these institutions to track and regulate these assets and manage the transaction in the loop.

Cryptocurrencies are widely known for their notorious behavior in price volatility making it challenging for the taxation authorities to determine the actual fair market value (FMV). In contravention to the conventional assets that have a developed infrastructure for regulation and an established market, the valuation of cryptocurrencies can vary fourfold and at an unascertainable rate within a short span of time-frame, making the accurate assessment of their valuation difficult.

The decentralized and pseudonymous nature of many cryptocurrencies allows for Blockchain transactions to be cryptographically more private than the established conventional transactions hence it poses a challenge in the identification of individuals and institutions in these crypto transactions raising concerns about tax evasion and money laundering. These digital assets operate cross-borders creating complexities in determining the jurisdiction for the incidence of tax, hence, these cross-border financial transactions involving crypto digital assets present challenges in cooperation and coordinate regulation of taxation among different governments. The void present in adopting a standardized approach to tax these assets globally adds to the complexity. Governments around the globe have different perspectives on the classification of these digital assets, a large number of nations are of the view to treat cryptocurrency as commodities while a significant number of governments also hold the view of them as either securities or currencies, interestingly, some jurisdictions consider them as capital gains also. The clarity in classification would help in determining the applicable tax treatment.

Monitoring and control of cryptocurrency transactions requires technological intelligence and expertise that is generally not present with conventional taxing authorities. The convoluted blockchain technology seen with the constantly evolving financial ecosystem of cryptocurrency makes financial education about these assets and adaption to the new financial infrastructure a must for the taxing authorities, and these adaption and intellectual development will guide us to clarity on the subject and will eventually provide for an established framework for the taxation of digital assets.

Resolving the Conundrum

With the evolution of these new assets, virtual and digital, along with the establishment of new financial infrastructure and, the requirement of reporting and notifying of the exchange of cryptocurrency governments are eyeing enhancing transparency and addressing anonymity concerns. The government of India has made these efforts by linking PAN with the DEMAT accounts and platforms used for crypto transactions. These measures provide for a procedure of reporting by individuals to their respective regulatory authorities about their crypto transactions, also, considering the prime importance of mining and staking in the crypto market, taxation authorities on the world map are in the process of developing a regulatory framework for taxing the rewards generated through these activities. However, the challenge still lies in the determination of FMV of newly evolved digital assets (coins and tokens), but, this can be resolved by developing a standard global financial infrastructure and protocol for exchange and governments are actively engaging in international collaboration to harmonize tax regulations. Organizations like the OECD (Organisation for Economic Co-operation and Development) are working towards establishing common standards for the taxation of digital assets. Recognizing the technological complexity involved, tax authorities are investing in educational initiatives to enhance the understanding of blockchain technology and cryptocurrencies among their staff. This proactive approach aims to bridge the knowledge gap and enable more effective regulation.

Conclusion

Taxing cryptocurrencies is undoubtedly a task of touching the seabed or navigating the uncharted waters. The evolution of the crypto-market has been so sudden that governments around the globe have not been able to track its significant character and have to eventually look out on the convoluted task of casting the balance between revenue generation and the challenges presented by the uniqueness and virtual nature of these digital assets. However, the regulatory infrastructure’s continuous evolution has paved the way for global collaborations between nations and presented systematic clarity on the classification of these assets. Also, the espousal of new innovative technologies in the financial infrastructure will play a crucial role in shaping a framework that ensures fair and effective taxation of cryptocurrencies. It is important for all the stakeholders, including individuals having these digital assets, businesses, government, and international regulatory bodies to be active participants in this ongoing adaptation process. Importantly, only a comprehensive procedure and well-informed regulation can allow society to harness the benefits of the crypto market, and anticipate and mitigate the unforeseen risks and challenges. As the world becomes increasingly interconnected through blockchain technology, finding common ground on the taxation of cryptocurrencies will be essential for a sustainable and harmonious global financial ecosystem.

Author: Mohanish Shukla, in case of any queries please contact/write back to us via email chhavi@khuranaandkhurana.com or at Khurana & Khurana, Advocates and IP Attorney.

References

1. Crypto-Asset Reporting Framework and amendments to the common reporting standard – OECD. Available at: https://www.oecd.org/tax/exchange-of-tax-information/crypto-asset-reporting-framework-and-amendments-to-the-common-reporting-standard.pdf (Accessed: 04 January 2024).
2. Taxing virtual currencies: An overview of tax treatments and emerging tax policy issues– OECD. Available at: https://www.oecd.org/tax/tax-policy/taxing-virtual-currencies-an-overview-of-tax-treatments-and-emerging-tax-policy-issues.htm (Accessed: 04 January 2024). 

3. Taxing cryptocurrencies, WP/23/143, July 2023 – IMF. Available at: https://www.imf.org/-/media/Files/Publications/WP/2023/English/wpiea2023144-print-pdf.ashx (Accessed: 04 January 2024).

4. The legal mosaic of cryptocurrency regulation, Available at: https://www.vidhikarya.com/legal-blog/the-legal-mosaic-of-cryptocurrency-regulation (Accessed: 04 January 2024).