[Meghana R and Amogh Tiwari are undergraduate students at IFIM Law School, Bangalore]
Starting relatively unheard of with Etheria in 2015 to witnessing a humongous surge in the digital domain, Non-Fungible Tokens (NFTs) have mustered an incredible investor-attention in the recent times. Nonetheless, this dramatic swell was soon followed by a colossal drop in prices, creating both confusion and curiosity vis-à-vis the future of NFTs. While some describe these tokens as craze, others visualise it as the future of digital art, captivating the passion of artists, designers, digital composers, etc. The researchers, through this article, aim to critically analyse the Indian stance with regard to the classification and taxation of the Non-Fungible Tokens. It is evident that India shares an erratic relationship with cryptocurrencies and individuals dealing with NFTs in India thread on thin ice. Thus, it is germane to adopt alternative means of consideration until the Indian economy is prepared to embrace digital currencies.
For the purposes of definition, NFTs can be seen as units of digital tokens that operate on a public blockchain, representing ownership of a unique item which is not innately interchangeable with similar other digital assets. Collectibles such as a limited-edition poster, baseball cards, and even memes can be considered as traditional examples of these non-exchangeable cryptographic tokens. In the virtual sphere, innovations manoeuvred by the underlying distributed ledger system has facilitated the creation of these eccentric value-holding investments. In essence, NFTs are akin to physical collector’s items, but in lieu of an oil painting or a canvas to hang on your wall, for instance, you receive a JPG file. They represent visual artistic works, musical assets, audio and video-centred creative pieces etc. in the form of digital tokens.
The mechanism of a NFT design involves uploading a file onto the NFT marketplace, wherein it gets converted and logged on a decentralised digital ledger as a Non-Fungible Token. They can either be created by developers or users through third-party marketplaces such as OpenSea, and eventually are purchased or bid using Cryptocurrencies. The intermediary at the auction-market charges a ‘gas-fee’ for every transaction, which essentially is the price to be paid for the energy consumed to complete a specific transaction. This fee fluctuates from time to time and is directly sent to the miners who run the blockchain network. The creator might also secure a commission/royalty every time there is a resale of the token.
The most recent popularity of these digital tokens is ascribable in no small measure to the purchase of digital creations, particularly the piece titled ‘Everydays: the First 5000 days’ by Beeple, which eventually stemmed a path for NFT artists to upload their creative pieces into tokens for sale. Further, globally recognised brands and Multinational Companies have also announced adoption of NFTs to facilitate ease of transactions. According to the recent industry data, the NFT market has escalated by 299 percent in 2020, clocking more than $250 million worth value of transactions. Given this boom, it is essential to comprehend the classification of NFTs under the Indian legislation and their potential tax implications.
Classification of NFTs
The taxonomy of NFTs is imprecise in the present Indian scenario, owing to the ill-defined legal framework for the derivative value of a non-financial asset. Notwithstanding this vagueness, NFTs can be deemed as derivatives as they have no value of its own and derive value based on its underlying assets. Moreover, they might be envisaged as Intellectual Property, where the buyer is only restricted to own the art digitally with no right to reproduce. Fundamentally, NFTs merely represent the product and its value fluctuates based on the change in demand and supply of the underlying asset, be it a digital art or an immovable piece of land.
As Currency: Unlike Crypto-assets and traditional currencies, NFTs do not qualify as ‘money’ as they are not fungible in nature, viz. they do not act as a means of exchange which can be used to barter with an Indian legal tender of another denomination or as a consideration to settle an obligation.
As Securities: NFTs per se cannot be construed as ‘securities’, neither under §2(101) of CGST Act, 2017 nor under §2(h) of the Securities Contracts (Regulation) Act, 1956. Nonetheless, they may be deemed so depending on the nature of its underlying assets. For example, trade of NFTs representing shares of a company will be subject to Indian Securities laws in contrast to the CGST Act, 2017.
As Goods or Services: NFTs, as digital tokens, can be deliberated ‘goods’ since they hold value, largely set by market demand, and can be transacted just like any substantial art. A scrutiny of the definition clauses of the CGST Act, 2017 clarifies NFTs ‘goods’ as they are movable and intangible. In essence, NFTs transacted at the auction-market are sold or traded in exchange for consideration and in the course of furtherance of business they are in conformity with the definition of ‘supply’ under §7 of the Act. Furthermore, taking into account the wide realm of the definition of supply, NFTs under §2(102) may also be envisioned as ‘services’, yet again depending on the underlying asset.
Potential Tax Recursions
Albeit NFTs have struck the cord with its unique force after 2020, they exemplify a technological approach that has existed for almost a decade and yet the Indian legislation remains nebulous. Presently, inclination of interpreting the tax liabilities of NFTs is largely based on the general principles of our Indian jurisprudence. The various implications of NFTs both under Direct and Indirect taxation laws arise when they are crafted by the creators or transacted on the marketplace amongst the buyer and the seller.
Direct tax implications
The treatment of NFTs under direct tax regime is chiefly governed by the Income Tax Act, 1961 in India. §194-O of the ITA mandates Tax Deduction at Source (TDS) obligations on the marketplace intermediaries, irrespective of whether the sale consideration flows through them or not. Paradoxically, the same cannot be effectuated for NFTs as the discharge of consideration is automated through smart contracts. Thus, it is a pressing priority to amend this provision whilst it instigates statutory complications on such marketplaces as they are obliged to withhold tax on gross consideration, regardless of their role in the transaction. Likewise, Tax Collection at Source (TCS) obligations are unclear with regard to liability of the parties. In essence, while Section 206C discharges the seller from his liability, provided the buyer withholds tax, Section 194Q imposes withholding obligation on the buyer regardless of seller’s liability.
Furthermore, the Supreme Court in CIT v. B.C. Srinivasa Setty, elucidated that NFTs representing securities may be subject to Capital Gains tax and Securities Transaction tax when the cost of acquisition is determinable. The onus of tax may be higher contingent on the volumes, consideration amount of these tokenised transactions and its association with collectable gain tax. Therefore, all the aforementioned complications coupled with communication impediments manifest that while these Direct Tax obligations may be germane to customary marketplace transactions, it is impractical to apply the same to a NFT marketplace due to the prevailing penumbra.
Indirect tax Implications
Under the GST regime of our country, an NFT marketplace may be considered as an intermediary. Classification of ‘supplies’ for GST purposes is contingent on the underlying asset and GST appliance would also depend on the location of these intermediary platforms. For example, NFT transactions by offshore sellers via offshore NFT marketplace to Indian buyers may be subject to a two percent Equalisation Levy (EL) on the entire consideration and not just the ‘gas fee’ amount retained by the intermediaries, as per Finance Act 2021. Thus, it is imperative for intermediary platforms to clearly delineate the various expenses of the buyer so as to limit their liability only to the extent of their sales commission.
Furthermore, the cross-border nature of NFT’s is likely to raise regulatory impediments owing to the disparity in the definition of an ‘e-commerce operator’ under the EL regime, the partial obscurity in imposing the levy and the impracticality in accessing the transaction costs, given the complicated nature of smart contracts.
NFTs have revolutionised the digital artistic world and have grown to comprise billions of dollars of economic value despite only a cursory analysis of the conceptual design and legalities. Whereas India is yet to uncover the value of decentralised blockchain technology, the imaginative uses of this technology is swelling exponentially. If the upward graph of NFTs continue in the same pace, it will undeniably constitute a substantial avenue of the blockchain technology, primarily leading to the doorsteps of Indian tax jurisprudence they will soon be under the radar of tax authorities owing to the high prices at which they are transacted. But, the transnational character of these decentralised digital tokens discords the municipal character of the Indian taxation laws where centralised agencies are entrusted with tax collection. Whilst the legislative framework of crypto-asset network is oblivion in India, it is crucial that parties engaging in NFT transactions evaluate and conform to the tax onuses so as to avoid legal impediments.