When the government of India unveiled a plan to tax crypto assets in February, it was the 30% rate on income from digital asset investments that grabbed the headlines. But it is a different tax that has the industry warn of a potentially destabilizing liquidity crunch.
Along with the capital gains fee, the Treasury announced a 1% tax deduction at issuer, or TDS, on all digital asset transfers over a certain size, starting July 1. Bassin, founder of crypto asset tax advisory firm Quagmire Consulting.
Crypto exchange executives, lawyers, and tax analysts are warning that the withholding tax will suck liquidity from the market by forcing high-frequency traders to cut back dramatically. Combined with the government’s decision not to allow commercial losses in digital assets to be offset, it threatens to accelerate the exodus of crypto firms and workers from India, they say.
Nischal Shetty, CEO of WazirX, India’s largest crypto exchange, described TDS as a “worst case scenario for the industry.”
“There will be no liquidity left in the markets,” said Manhar Gargrat, chief policy officer at cryptocurrency exchange CoinDCX. “Deals by buyers will not be executed as efficiently as they are today, and this inefficiency will eventually erode the entire ecosystem.”
The tax package and the ban on compensation for losses – which only applies to cryptocurrencies – represent the latest wave by a government that has not yet clearly stated that it will allow cryptocurrency. India, with an estimated 15 million active cryptocurrency users, has been stuck in regulatory limbo since the Supreme Court in 2020 overturned a central bank directive banning regulated entities from working with digital asset firms.
Sandeep Nailwal, co-founder of Indian blockchain startup Polygon, warned this month that thousands of developers, investors and entrepreneurs are moving toward more crypto-friendly destinations as a result of the uncertainty.
When the government first revealed cryptocurrency fees, the announcement was met with relief as it was interpreted as a sign that there would not be a total ban on cryptocurrency trading. That changed as the industry absorbed the specifics of TDS.
Under the new system, the buyer of the crypto-asset must deduct 1% TDS on behalf of the seller if the transaction exceeds 10,000 rupees (about $132). According to Bhasin, small trades will also be taxed if they exceed Rs 50,000 cumulative in the financial year.
Investors are entitled to a refund if the total amount allocated to TDS during the fiscal year exceeds their total tax liability for that period.
capital is suffocating
When doing this on a centralized exchange, Bhasin said, the exchange’s responsibility is to deduct the tax payable for trading. On a decentralized trading platform where buyers and sellers interact without a middleman, people usually trade anonymously, which makes collecting TDS complicated.
While the capital gains tax reduces the attractiveness of cryptocurrencies to investors, the value-added tax (TDS) poses a threat to the very foundations of the market, say critics. India does not impose such tax on stock trading.
A high-frequency trader could see 60% of his capital withheld for TDS payments after just 100 trades, estimates Garegrat, who is also a member of the Board of Blockchain and Crypto Assets in India.
“The way the tax has been set is going to lead to people leaving the country,” said Dinesh Kanabar, CEO of Dhruva Advisors, a tax and regulatory advisory firm.
Speaking at the Lower House of Parliament on March 25, Finance Minister Nirmala Sitharaman said the comprehensive income tax would allow the government to track transactions and was not an additional tax. But executives and experts dismiss that if that was the only intention, it could also have been achieved at a much lower price without disrupting trading.
As with decentralized exchanges, implementing a TDS system would be nearly impossible when it comes to offshore trading platforms, Garegrat said. He added that the tax would essentially drive trade outside of the local exchanges where the Indian government has the most visibility.
The system is becoming more challenging for traders in cryptocurrency pairs, such as Bitcoin/Ether, according to Quagmire’s Bhasin. That’s because each transaction involves two separate transactions – for example, buying Bitcoin from a counter party, then selling it and buying Ether from another party.
“At one point, you will lose 1% because you are selling BTC and at the next step you will be responsible for deducting 1% TDS because you are buying ETH from another seller,” he said. “Accounting is going to be pretty crazy for this.”