Mrigank Joshi
The author is a 4th-year student at O.P. Jindal Global University
Introduction
The introduction of the concept of the Metaverse which comes with promises to merge our physical and digital realities as we know them, various facets of our everyday lives can already be seen shifting into the digital world. Cryptocurrencies came in as the first step to creating a virtual currency with an aim to eliminate intermediate parties profiting from online transactions. In the past couple of years, the popularity of digital artworks in the form of Non-Fungible Tokens (NFTs) has rapidly increased. Within the span of a year, the trade market in NFTs has increased from $14.02 billion in 2021 to $21.33 billion in 2022, with a compound annual growth rate (CAGR) of 52.1%. In India, Ritviz and Nucleya were the first musicians/artists to enter the NFT marketplace by selling their photographs, artworks, etc. Conventional artists have started exploring the realms of digital artwork to gain an early advantage by tapping into this up-and-coming industry, where they can sell their art pieces in digital auctions for a high value. However, as is seen in any new development in the technological space, a major point of discussion regarding trade is always in terms of defining it under an appropriate tax regime. In this paper, I will discuss the nuances around the existing regulations regarding the taxation of NFTs.
What are NFTs?
A Non-Fungible Token is simply a digital artwork existing on a Blockchain network by a token of a digitised unit of value. This basically means that a digital artwork, video or picture can be converted into a digital token of a specific value on Blockchain networks using a crypto token standard, the most popular one being the ERC20 standard in the Ethereum infrastructure. In India, NFTs are neither legal tender nor governed under a specific law in terms of contractual obligations or governance of their transactions on Blockchain platforms. However, they can still find protection and legal backing under the existing copyright laws in India. Under Article 2(1) of the Berne Convention, artistic work can avail copyright protection “whatever may be the mode or form of its expression.” Furthermore, even though NFTs or ‘digital artworks’ are not mentioned under the Indian Copyright Act, Sections 13(2) and 13(3) do not mention them as exceptions to copyright either. Thus, it is safe to presume that the legality of NFTs as artistic works can be protected under the Indian legal regime.
Legal framework in India
Before analyzing the statutory provisions potentially taxing NFTs in India, let us determine whether an NFT transaction has the scope to be taxed in the first place or not. It is a common principle of law that in order to tax a product, service, or transaction, there needs to be a financial value attached to the same. When we talk about NFT transactions, there are two major veins through which a ‘monetary’ component is generated. The first and initial process of an NFT transaction is uploading the NFT on the Blockchain network itself. The process of uploading an NFT on the Blockchain is called minting. This process of minting requires the payment of a ‘gas fees’ which is usually in the form of the cryptocurrency governing the platform, i.e. Ethereum, Solana, etc. Once an NFT has been successfully minted, its existence is recorded in the Blockchain network. The second step involving financial consideration is the actual selling of the NFT by the creator/seller to the buyer. Every seller has the absolute right to decide the commercial value of their art, sell it for a determined price, or even decide on a base price and put up the NFT for an auction. Hence, owing to the monetary value associated with NFT transactions, there is clearly a scope to tax the same.
The budget introduced by the Indian government in 2022 for the first-time announced provisions for the taxation of virtual digital assets including cryptocurrencies and non-fungible tokens (NFTs). Section 115BBH of the Income tax was established with an aim to tax the sales of all virtual digital assets undertaken in India. Under section 115BBH, any income from the transfer of virtual digital assets would be taxed at a flat rate of 30% in the hands of the transferor. Section 52(2)(x) further prescribes that in cases where such virtual digital assets are transferred as ‘gifts’, the same would still be taxed in the hands of the receiver.
Prior to the budget 2022, we can still trace back certain provisions governing the taxation of NFTs. Since we established the nature of NFTs to fall within the copyright act, Section 32(1)(ii) of the Income Tax Act could have acted as the closest legal provision governing NFT transactions. Under Section 32(1)(ii), any income arising from the sale of copyrights, patents, licenses, and other commercial transactions of similar nature are defined and taxed as “intangible assets.” However, owing to the digital nature of NFTs in global Blockchain platforms, it becomes essential to pinpoint the exact location where the contract was concluded or where the transaction took place. This issue was discussed in the case of Cub Pty. Ltd. vs. Union of India where the court held that while governing intangible assets, the principle of mobilia sequuntur personam would be followed. This principle basically stipulates that the personal property of a person (including intangible assets such as any copyright) will be governed by the same laws that govern the person. In this case, the residence of the owner of the assets (Australia) was held to be the location of the intangible assets themselves and thus, the same could not be taxed in India.
Analysis
The NFT industry is still in its nascent stage in India and hence, formal recognition of the same by the government (if only for tax purposes) will help in transparent regulation of the same. The only problem with section 115BBH as of now seems to be the high tax bracket that has been stipulated for all NFT transactions. Section 115BBH further categorises NFTs and cryptocurrencies under the same heading of ‘virtual digital assets.’ This may pose a further problem as the two are of a distinct nature. Where cryptocurrencies are a digital form of currencies, Non-Fungible Tokens are of a unique character with each token associated with a unique Token ID and a Blockchain address, usually known as the ‘contract address’ of the NFT. Hence, unlike cryptocurrencies such as Bitcoin and Ripple, NFTs are one-of-a-kind digital artworks. Recognising this distinction, the government even issued a notice dated June 30, 2022, explaining their intention of amending the tax provisions regarding NFTs and giving a more legally enforceable nature to the same by stating that - a non-fungible token whose transfer results in the transfer of ownership of the underlying tangible asset, and the transfer of ownership of such underlying asset is legally enforceable. Such NFTs would be exempted from the tax provisions governing virtual digital assets transactions.
This explanation would still exclude a majority of NFT transactions which, as discussed above, would fall under the definition of an intangible asset. For example, if I create a digital poster online, mint the same as an NFT and further sell it online on NFT marketplaces, the resulting ‘artwork’ would not be considered a ‘tangible asset’ and thus, would remain outside the scope of legal enforceability.
Furthermore, there is a broader scope to tax NFTs under section 165A of the Income Tax Act under the provisions of ‘equalization levies.’ This levy is chargeable to e-commerce operators receiving any amount of consideration as a result of the e-commerce services provided by them. Thus, in a scenario where an e-commerce website or platform offers a digital marketplace for trading in NFTs and receives any sum of money as transaction fees; such an operator (who is a non-resident) can be liable to pay an equalization fee charged at 2% for providing such facilities to Indian entities. This legal setup does not intend to tax the NFT sold, but tax the intermediary who facilitates the monetary transaction between the artwork creator and the buyer.
Conclusion
Taxation of assets being a purely technical in nature from a legal perspective cannot be left open to ambiguities. As the current situation stands in India, courts can merely try to ‘fit in’ the taxation of NFTs and other digital assets within the existing statutory laws rather than being able to rely on distinctive provisions for the same. On a separate vein, more clarity is needed on how the issue of double taxation will be tackled with respect to the tax attached to the sale of an NFT and whether the income arising from the same would be liable to a further income tax. For example, if digital or graphic artists pay a certain amount of tax on the sale of his digital artwork as an NFT, will the income derived from the same be further taxed under the income tax provisions? The absence of a distinctive framework governing taxation of digital assets is felt while deliberating upon such intricacies.
For the time being, the most cautious approach to this issue would be to wait for the NFT market to gain more prominence and solidity in the Indian digital sphere and for the courts to take cognizance of the same when it comes to taxation. Digital marketplaces are ever-evolving and like every new technological advancement, the legal fraternity would need time to interpret these new changes in lieu of the existing provisions or even create newer and more appropriate frameworks to govern the same. Any haphazard or hurried approach towards the same may lead to raw and untested laws which can prove to be detrimental for the future of this field in India.