Taxation of Virtual Digital Assets – Ramification for Non-Resident
1. The Proposed Legislative Regime: Finance Bill, 2022
The Finance Minister in the Budget speech on 1st February 2022 stated that there has been a phenomenal increase in transactions in virtual digital assets. The magnitude and frequency of these transactions have made it imperative to provide for a specific tax regime. The following proposed sections have been introduced in the Income-tax Act, 1961 to govern transactions of virtual digital assets:
Statutory Definition: Section 2(47A)
Proposed Section 2(47A) contains an expansive definition of the term “virtual digital asset”:
(a) any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;
(b) a non-fungible token or any other token of similar nature, by whatever name called;
(c) any other digital asset, as the Central Government may, by notification in the Official Gazette specify:
Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein.”
Section 115BBH: Flat 30% Tax
Provides that any income from transfer of any VDA shall be taxed at the rate of 30%. No deduction in respect of any expenditure or allowance shall be allowed except direct cost of acquisition. Further, loss from transfer of VDA cannot be set off against any other income.
Section 194S: 1% TDS on Consideration
In order to capture transaction details, it is proposed to provide for Tax Deduction at Source (TDS) on payment made in relation to transfer of VDA at the rate of 1% of such consideration above a specified monetary threshold.
Section 56(2)(x): Taxation of Gifts
Amendment proposed in section 56(2)(x) to tax gifts of virtual digital assets in the hands of the recipient. The definition of the term “property” is expressly amended to include VDAs.
2. Taxation of Non-Residents: Basis of Charge & The Situs Conundrum
India follows a residence basis of taxation: residents are taxed on their worldwide global income, while non-residents are taxed strictly on India-sourced income. Under domestic tax law, the following categories of non-resident income are subject to tax in India:
- Income received or deemed to be received in India;
- Income accrues or arises, or is deemed to accrue or arise, in India.
If income from the transfer of a VDA is received in India or accrues or is deemed to accrue in India, then the income earned by the non-resident from such transfer shall be chargeable to tax in India. Consequently, the existence of the situs of the asset in India is pivotal in determining whether income from the transfer of a VDA can be said to accrue or arise in India.
Identification of Situs: The Mobilia Sequuntur Personam Principle
Identification of the situs of an intangible asset like a VDA is notoriously challenging. A VDA is comparable to an intangible asset, and guidance can be availed from judicial precedents relating to intangible property.
The Delhi High Court in CUB Pty Ltd. v. Union of India [2016] 71 taxmann.com 315 (Delhi) held that the location of an intangible asset (trademark) owned by a non-resident is not in India. The High Court relied upon the well-accepted international legal principle of ‘mobilia sequuntur personam’, according to which the situs of the owner of an intangible asset represents the closest approximation of the situs of the intangible asset itself. Reference may also be made to CBDT Circular No. 3 (WT) of 1957 (dated 28-9-1957) issued in the context of wealth tax, which deals with the location of intangible assets.
Characterization: Capital Asset vs Stock-in-Trade
The taxability in the hands of the non-resident will also depend on whether the VDA is held as stock-in-trade or as a capital asset. Characterization of income from sale of securities has historically provoked extensive litigation; judicial precedents and CBDT circulars can be applied by analogy to VDAs, as the proposed domestic regime does not categorically classify VDAs as capital assets.
While domestic taxation under Section 115BBH levies a flat 30% tax regardless of characterization, this distinction is critically decisive for applying the provisions of Double Taxation Avoidance Agreements (DTAAs / Tax Treaties).
3. VDA Held as Stock-in-Trade: Domestic Law vs Treaty Relief (Article 7)
A. Domestic Law Position
“Business” is defined under Section 2(13) of the Act to include any trade, commerce, manufacture, or any adventure or concern in the nature of trade. A trader who regularly and frequently buys and sells VDAs to extract profit from short-term market fluctuations holds VDAs as stock-in-trade.
Under the domestic Act, gains realized by such a trader are taxable under Section 115BBH at the flat rate of 30%.
B. Tax Treaty Relief: Article 7 (Business Profits)
By virtue of Section 90(2) of the Act, a non-resident has the statutory option of adopting tax treaty provisions if they are more beneficial.
Generally, Article 7 provides that business profits of a non-resident enterprise shall be taxable only in the resident State, unless it carries on business in India through a Permanent Establishment (PE). If it has an Indian PE, only profits directly attributable to that PE are taxable in India.
Force of Attraction (FOA) Rule Nuance:
Non-residents holding VDAs as stock-in-trade are taxable in India only if they maintain a PE in India and VDA profits are attributable to that PE. However, select Indian treaties (e.g. with Belarus, Canada, Slovak Republic, Denmark, Indonesia, Italy, Mongolia, New Zealand, Poland, Spain, and the USA) contain a Force of Attraction (FOA) clause under Article 7, the applicability of which must be evaluated where the enterprise engages in concurrent Indian activities.
4. VDA Held as Capital Asset: Article 13 & Residuary Treaty Exemption
Under Section 2(14) of the Act, a capital asset encompasses property of any kind held by an assessee, whether or not connected with business or profession. Under domestic law, gains from alienation of VDAs held as capital assets are taxed at 30% under Section 115BBH.
Tax Treaty Framework: Article 13 (Capital Gains)
If the VDA is held as a capital asset, the income arising from its transfer is governed by the Capital Gains Article (Article 13) of the applicable tax treaty. Typically, Article 13 allocates specific taxing rights across five asset categories:
- Alienation of immovable property (taxable where property is situated);
- Alienation of movable property forming part of the business property of a PE;
- Alienation of ships and aircraft operated in international traffic;
- Alienation of shares;
- Alienation of any other property (The Residuary Clause).
The Residuary Clause Exemption for Non-Residents:
It can be convincingly maintained that VDAs such as cryptocurrencies and tokens do not qualify as immovable property, nor do they constitute shares. Where the VDA does not form part of the movable property of an Indian PE, the alienation falls squarely under the residuary clause of Article 13.
Under the residuary clause of treaties with jurisdictions such as Singapore, Mauritius, the Netherlands, and the Swiss Confederation, capital gains arising from the alienation of “any other property” are taxable exclusively in the resident State of the alienator. Consequently, non-residents can lawfully invoke treaty protection to claim total exemption from Indian capital gains tax on VDA transfers.
5. Income from Other Sources & TDS Obligations under Section 195
Article 21/22: Income from Other Sources
If under domestic law provisions, income from the transfer of a VDA is classified under ‘Income from other sources’, it would be governed under the Other Income Article of the tax treaty. Treaties adopting the UN Model provide for source-State taxation of other income (conferring taxing rights on India), whereas treaties patterned after the OECD Model grant exclusive taxation rights to the residence State.
Section 194S vs Section 195: Withholding on Non-Residents
Proposed Section 194S mandates 1% TDS on consideration paid to a resident; it does not apply to payments made to non-residents. Payments to non-residents for VDA transfers remain governed exclusively by Section 195 of the Act.
Section 195 Withholding Scenarios:
- (i) A resident acquiring VDA from a non-resident;
- (ii) A non-resident acquiring VDA from another non-resident (under Explanation 2 to Section 195).
The Landmark Ruling in GE India Technology Centre:
Where the income of the non-resident is not chargeable to tax in India by relying on favourable tax treaty provisions (e.g. Article 7 or Article 13 residuary clause), the purchaser can rely on the Supreme Court ruling in GE India Technology Centre Private Ltd v. CIT (2010) 327 ITR 456, which established that where a payment is not chargeable to tax in India, there is no statutory obligation to withhold tax under Section 195.
Practical Exchange Impasse: If the buy-sell transaction occurs through a digital asset exchange, complying with Section 195 is practically impossible because buyer and seller identities are completely anonymous and unknown to each other.
6. Obligation of Non-Residents to Withhold TDS: Section 194S & Extraterritoriality
The Broad Reach of “Any Person” under Section 194S
Section 194S casts a statutory obligation on ‘any person’ responsible for paying consideration to a resident on transfer of a VDA to deduct tax at source @ 1%. The terminology ‘any person’ is sufficiently wide to encompass non-residents. Consequently, non-residents acquiring VDAs from Indian residents are technically liable to withhold tax under Section 194S.
The Vodafone Extraterritoriality Dilemma & Legislative Amendment:
On the basis of the Supreme Court observations in Vodafone International Holding B.V. v. UOI [2012] 17 taxmann.com 202 (SC), a non-resident with no presence in India can argue that Indian TDS provisions cannot be applied extraterritorially.
However, subsequent to the Vodafone judgment, the Finance Act, 2012 retrospectively amended Section 195 by inserting Explanation 2, clarifying that withholding obligations apply to non-residents irrespective of whether they possess a place of business, residence, or business connection in India. This affirms the legislative policy of extending withholding obligations to offshore entities.
Nevertheless, when order matching executes anonymously on digital exchanges, the non-resident buyer cannot ascertain the residency or PAN of the counterparty seller, rendering physical execution of withholding tax legally and practically unworkable.
7. Conclusion & The Road Ahead
Substantial ambiguities permeate the proposed taxation regime for virtual digital assets. As per media reports, the Central Board of Direct Taxes (CBDT) is expected to issue comprehensive guidelines shortly to clarify critical aspects of taxation.
The precise boundary of the definition of VDA itself, the statutory determination of the situs of digital tokens, and the practical implementation of TDS / TCS mechanisms across decentralized and centralized exchanges require definitive administrative illumination. Until the CBDT releases detailed circulars, cross-border taxpayers and global investors must maintain continuous vigilance and exercise prudent caution in structuring VDA transactions.