INCOME TAX ON BITCOINS: WILL BUDGET 2025 HIKE TAX ON BITCOIN ETF TO FLAT 30% FROM 12.5% CURRENTLY?

The year 2024 ended with two significant news events: the USA elected its 47th President, Donald Trump, and the Bitcoin price triumphed at US$ 1,00,000 .

So what's the correlation between India's Budget 2025, Donald Trump and Bitcoin? The correlation is strong.

Before that, let's start with the context. Bitcoin is a cryptocurrency known for its vulnerability, encryption, anonymity and being an asset without intrinsic value. The price of Bitcoin spiked following the news that Donald Trump won the 2024 US Presidential Election. Trump's election promise to hold onto the Bitcoin owned by the federal government and establish a national Bitcoin reserve boosted investor confidence.

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What are Bitcoin ETFs, and how do they work?

Until January 2023, investors could invest in Bitcoin only directly through unregulated or semi-regulated exchanges. Afterwards, investors got an alternative method of investing in Bitcoins through Bitcoin Exchange-Traded Funds (ETFs). Bitcoin Spot ETFs are different from Bitcoin futures ETFs. The Spot ETF holds Bitcoin, while futures-based ETFs create positions through derivatives.

The Bitcoin ETF allows investors to take exposure to Bitcoin without holding the cryptocurrency directly in digital wallets or hard disks. This will eliminate concerns about potential cyber hacks and the intricacies of managing complex passwords when stored on hard disks. Bitcoin ETFs are listed on the Nasdaq and NYSE.

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No clarity on income tax on Bitcoin ETFs

A crucial question regarding tax implications arises for an Indian resident investing in Bitcoin ETFs in the US market. The issue is whether the capital gains arising from the sale of Bitcoin ETFs should be subject to taxation under Section 115BBH, Section 50AA, or Section 112 of the Indian Income Tax Act, 1961. Section 115BBH is a special provision introduced by the Budget 2022 to tax income earned from the sale of Virtual

Digital Assets (VDA), including cryptocurrencies such as Bitcoins.

Section 50AA is a special provision first introduced in the Budget 2023 to tax the income from specified mutual funds that do not allocate more than 35% of their total proceeds to equity shares of domestic companies. Subsequently, its scope was enlarged by the Budget 2024 to tax the income from specified mutual funds that invest more than 65% of their total proceeds in debt-based securities, such as debt instruments and money market instruments.

Section 112 operates as a residual provision, encompassing the taxability of long-term capital gains from any capital asset not covered by the special provisions. As per Section 112, short-term capital gains from any asset other than those covered under Section 111A (i.e., listed equity shares, etc.) are taxable as per the applicable tax rate.

Let's evaluate each provision separately.

Section 115BBH: Tax on income from virtual digital asset

This provision provides that income arising from the sale of virtual digital assets is taxable under Section 115BBH. The income is taxed at a flat rate of 30%. A "virtual digital asset" is defined to include cryptocurrencies, NFTs and any other digital asset as notified. The units of Bitcoin ETFs may not be covered within the meaning of VDA as investors have not invested directly in the cryptocurrency. Instead, the Asset Management Companies (AMCs) may be taxed under this provision. Given that these USA AMCs are not subject to taxation in India, investors are not obligated to pay tax under Section 115BBH in this scenario.

However, if the government notifies Bitcoin Spot ETF as VDA in the third class mentioned above, the resultant gains can be taxable under this provision. Until that happens, this provision may not apply.

Section 50AA: Tax on capital gains from specified mutual funds

Section 50AA contains provisions for computing capital gains arising from transferring units of a Specified Mutual Fund ("SMF"). The specified mutual fund means a mutual fund (including ETF) that invests more than 65% of its total proceeds in debt-based securities, such as debt instruments and money market instruments. Given that Bitcoin ETFs do not invest in debt instruments, they should be excluded from the purview of taxability under Section 50AA.

Section 112: Tax on long-term capital gains

Section 112 is a residuary provision to tax long-term capital gains arising from transferring any capital asset. This provision applies when other special provisions are not invoked to tax long-term capital gains. According to Section 112, long-term capital gains arising from transferring a long-term capital asset on or after July 23, 2024 are taxable at 12.5% without indexation benefit. Where the capital asset is transferred on or before July 22, 2024, the long-term capital gain shall be taxable at 20% after the indexation benefit.

In the context of Bitcoin ETFs, units held for more than 24 months (after July 23, 2024) but before the date of sale should be regarded as long-term capital assets. If sold on or before July 22, 2024, the holding period shall be 36 months.

Conclusion

Section 50AA may not apply to tax gains arising from the transfer of such units because they are not covered within the definition of "specified mutual funds". Similarly, Section 115BBH may only apply if the CBDT issues a notification explicitly including Bitcoin ETFs within the meaning of VDAs.

As per current income tax laws, it appears that long-term gains arising from the sale of Bitcoins ETFs will be covered under Section 112 of the Income Tax Act. Therefore, the long-term capital gains would be taxable at 12.5%. Further, the short-term capital gains will be taxed at tax slabs applicable to the taxpayer's income.

However, the intention of the government at the time of introducing Section 115BBH in Budget 2022 was to discourage Indian investors from investing in Bitcoins and other cryptocurrencies.

Hence, in this Budget, the Government should clarify whether the current interpretation of the provision is correct that LTCG on Bitcoin ETFs is taxable under Section 112 at a lower tax rate of 12.5% or whether the gains are taxable at a flat 30%, which is applicable on the gains arising from the sale of bitcoins and other cryptocurrencies.