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Government should enable traceability on crypto-currency investments: IndiaTech.Org

IndiaTech.Org, also known as the Technology Services Industry Association, has advocated for traceability provisions to be introduced for crypto-currency investments and trading to counter money-laundering and illegal activity . In a white paper, submitted to the Indian Government, the industry body representing internet startups said that the government should regulate crypto-currencies by recognising crypto-firms as legal businesses, updating accounting and tax rules, and by treating cryptos as assets and not currencies

“This wouldn’t be the first time India capitalized on emerging trends in technology, to the benefit of business and consumers alike. In the first wave of Indian tech adoption, it became the global hub of IT services, creating more than $250 billion of market cap. In the current wave (consumer internet and SaaS), India is on the verge of creating another $200 billion market cap,” the body said. It said that the $5.5 billion pool of global capital Singapore-based blockchain companies received $744 million in capital, while India received just $11 million or 0.2%.

Five-point framework for regulation:

  1. Define crypto assets and allow local crypto-exchanges to register
  2. Introduce checks and balances in terms of accounting standards and reporting mechanism. Mandate mechanisms to counter suspicious activities and money-laundering/terrorism-financing, and enable traceability
  3. Tax crypto-assets just as other current assets, both directly and indirectly. Permit disclosures and regulate import
  4. Create safeguards to protect retail investors from token issuance
  5. Allow self-regulation, including a defined code of conduct in alignment
    with safeguarding consumers as well as financial stability

Arduous legal and regulatory challenge

Unlike many developed and developing countries, India has been late to the regulation game. In January this year, the government said that it would ban crypto-currency trading, mining and investments, while authorizing the Reserve Bank of India (RBI) to build and deploy a digital currency. Since then, the Finance Ministry has made several public statements assuaging some investor concerns, it is not clear if it has abandoned its earlier position for an outright ban. However, when the legislation does drop, the government has said that it will give investors some breathing room.

That said, the government told Parliament in March that the Goods and Services Tax (GST) and would apply to crypto-exchanges on the fees they earn and that income tax would be levied against investment gains made by individual and institutional investors. It also made a change to company financial rules by mandating disclosures on crypto or virual currency holdings and transactions made by a company in a financial year.

“Crypto has emerged as an exciting area of interest amongst investors, entrepreneurs and consumers. This sector holds huge potential for Indian start-ups in the crypto space to grow from India. The foremost need today is for this sector to be granted the much needed regulatory clarity that it has been seeking,” said Rameesh Kailasam, Chief Executive Officer and President, IndiaTech.Org. “There are perceived risks associated with crypto which may have implications on investor safety and protection which can be addressed through necessary regulatory checks as for other sectors including financial products,” he said.

But the RBI remains unconvinced. A person privy to deliberations between the government, regulators and the crypto-industry told MediaNama that despite assurances by the crypto-exchanges that they will pay taxes and comply with Know-Your-Customer norms, the RBI is still suspicious. “There are probable very large amounts of purchases of illegal items by Indian crypto-users users, money laundering and other issues. The RBI has these concerns, but the government has not been able to answer them effectively,” this person said on the condition of anonymity.

“The regulatory challenge is even bigger when there is a marriage between technology and finance. For any country to understand this space, you need a finance person who understands tech and a tech guy who understands finance,” they added.

Defining crypto assets, ownership requirements, accounting standards

The body says the government should regulate crypto-currencies as digital assets and recognise them like gold, stocks or other securities. “If India considers cryptocurrency as a currency, then it can neither levy income tax nor levy GST on it.” it said. The body says that it may be easier for the government to allow only Indian founders to operate such business from a ‘easier control perspective’

By doing so India will save billions of dollars of revenues that may be payable to foreign exchanges and Indian user’s crypto-assets being controlled by them. It is recommended  that minimum ownership of 26% by Indian founders/entities in crypto-exchanges like the practice followed in the banking sector in India (FDI cap at 74%).

The government should also update the Indian Accounting Standards to set rules for these new financial assets in existing literature and bring them under money-laundering regulations, the body said. It added that the government should also notify a government authority to whom crypto-exchanges can report suspicious activities and transactions. Every crypto-holder registered with a crypto-exchange should follow a Know-Your-Requirement process, and trades should be reported for tax purposes, it said.

Start by recognizing only those crypto-assets that give access to forensic analysis and can be subject to certain defined lawful enforcement trigger already defined for other forms of current assets. Certain privacy focused crypto-assets can be prohibited. For example, crypto-assets such as Bitcoin are completely traceable due to the open ledger blockchain system that they follow.

The organisation said that several developed countries have made Bitcoin legal and treat crypto-currencies like stocks and bonds, and therefore tax investments for capital gains. “In fact, U.S. agencies collaborate with cryptocurrency exchanges such as Coinbase for cryptocurrency investigation tools which enhances their law enforcement capabilities. Furthermore, the U.S. government is taking several steps to enhance innovation while regulating crypto,” it said.

Taxation and Disclosures

On taxation, the body said that government should introduce provisions into Direct Tax laws to levy tax on profits and capital gains depending on the type of crypto-holder and timelines of investment. IndiaTech said that mandatory disclosures under the Income Tax rules for individuals can be introduced, and that tax assistance and programs under the government’s startup could be extended to crypto-startups.

There also exists a possibility that some of crypto assets may possibly be owned by certain individuals/organisations through past mining, these should ideally be treated as self-generated assets in which case the cost of acquisition may be needed to be computed appropriately.

Just as the Goods and Services Tax applies on brokerage and exchange fees in the case of stock markets, GST could be collected from crypto-exchanges, IndiaTech said. Adding that the government could earn Rs 200-600 crore in the next 12 months through just GST.

Crypto as payments and tokens

IndiaTech said that individual or business-2-business trade in goods and services against a crypto-currency should be treated as a “barter transaction” and not as a cash transaction. It said that the government should allow holding, trading, buying, and selling crypto-assets, while prohibiting the use of crypto as a payment instrument.

Though businesses in India accepting crypto might not be economically viable as there is a cost involved to send bitcoins from one address to another. It can be made optional but we should allow companies to build their infrastructure using crypto to make our current payments systems more efficient.

The body said that tokens can be classified as securities, commodities or neither depending on their use-case. “The industry needs a crypto-specific framework that can protect retail investors from the risks associated with tokens,” it said. At present, crypto-exchanges are responsible to ensure due-diligence on tokens and their associated projects since there is no framework for regulating tokens. The exchanges are responsible to evaluate the blockchain code of the crypto-asset, its token-economics and liquidity and its proposed use-cases, IndiaTech said.

Countries such as the US, apply the Howey Test to determine if tokens are securities, it is therefore important to determine the structure and characteristics of, including the rights attached to, a digital token in determining if the digital token is a type of defined financial instrument under Indian law.

Need to appoint self-regulatory body

IndiaTech has asked that the government recognise and accredit a body to implement a self-regulatory code and guidelines for the industry.

There is potential that needs to be rightfully tapped for India to see several startups grow out of this sector. There are associated risks as with any other financial instrument or asset which can be addressed with policies and regulations that do not stifle the underlying innovation that these emerging technologies are built upon.

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