The first Cryptocurrency – Bitcoin was introduced more than a decade ago in 2009 by the so-called father of bitcoin – Satoshi Nakamoto, and since then there has been a flux of cryptocurrencies getting introduced from time to time. Bitcoin and several other rival cryptocurrencies like Litecoin, Ethereum, Ripple, Dogecoin etc. have experienced path breaking growth in the recent years, leading to lot of complexities into the accounting of such currencies and their tax implications globally.  To any first-time reader here, Cryptocurrency is digital currency that uses encryption techniques, rather than a central bank, to generate, exchange, and transfer units of currency. Unlike cash transactions, no bank or government authority regulates these forms of currency or verifies the transfer of funds. Instead, these virtual transactions are recorded in a digitized public ledger called a “blockchain.” Individual units of the currency are called “coins.”  Now this explanation too may be far troubling to digest for a first timer.  So, lets simply call these currencies as one type of digital asset or investment, value of which varies every second based on the buy and sell of these just like any shares or stocks on any listed exchanges.  There was a minimal involvement initially by people in these cryptocurrency investments, but since the hit of the pandemic in 2020 people have considered sources of building passive incomes.  While there are millions of individuals involved in cryptocurrency investments and trading globally, India reported about 15 million crypto investors in 2021 recently, whereas the USA has been high with over 25 million crypto investors.  These volumes of people dealing in cryptocurrencies today only signifies the importance of having a mechanism to accurately account for these as well as recognize their tax liabilities.

While taxation of cryptocurrencies may vary across the globe, in this article we shall discuss about cryptocurrency tax implications popularly in the United States of America and India.

Taxation of Cryptocurrency in USA

The United States IRS has been one of the foremost tax regulators across the world to address taxation of cryptocurrencies in 2014 and it concluded tax treatment on buy and sell of these as similar to that of any property for tax purposes.  Accordingly, any gain or loss is recognized each time that a cryptocurrency is sold or utilized for purchase or sale of goods or services.  The gain or loss typically is recognized dependent on the type of transaction the crypto was applied to and the period it was held.  The IRS has made it mandatory for all US taxpayers to report crypto transactions of all kinds, no matter how smaller in value they may be.  Every taxpayer shall be required to keep an account of all buying, selling, investing or usage for their cryptocurrencies.  It has warned that incorrect reporting of transactions in these cryptocurrencies shall result in penalties and interests or even criminal proceedings.

Let us understand what type of cryptocurrency transactions are taxed:

Sale of Cryptocurrencies, mined personally and held

For instance, you have mined bitcoins and are holding them, then you shall pay taxes on such transaction. So, the fair market value of such coins on the day they were mined and if held till the end of the tax year, their value shall be included in the gross income of the taxpayer.  Such value of bitcoins included in income will further form the basis of its cost, when they are sold in future and their difference shall be taxed as capital gains (long or short term) based on their holding period.

Sale of Cryptocurrencies, mined personally or bought and sold to a third party

For instance, you have mined bitcoins or have bought them from a recognized stock exchange, or a third party directly, and then sold them to another third party, the difference of the purchase price and selling price on such cryptocurrencies will be treated as capital gains and taxed as per their holding period.

Further, any individual or entity, whose mining operations constitute a trade or business, i.e., you are treating the coins as stock in trade, then you shall be subject to self-assessment tax on income so derived.  The good news here is that if you are in the business of mining and trading, then you can make business expense deductions for equipment and resources consumed in mining which might cut down your tax bill, but you cannot claim such expenses if you are purely mining for your personal gain and treating the cryptocurrencies as your capital assets.

Usage of Cryptocurrencies for buying goods or services

For instance, if you purchase a pizza using bitcoin that you mined at home or even if you purchased them, you must report such transaction to the IRS and the amount of tax here depends on the fair market value of the bitcoin at the time of buying the pizza and the price of the pizza.  Similarly, if you have paid any contractor for his/her services using the bitcoin, the value of the bitcoin at the point of such event shall be considered for deriving your gains.  Again, the nature of tax, will depend on how you have treated these bitcoins, as capital assets, or stock in trade for your business.

Receipt of cryptocurrencies as payment for goods or services

Payroll or Payments received in cryptocurrencies for services or goods are treated as ordinary income for tax purposes.  The value of these currencies as on the day they were released as salary or payments is considered as the basis for their income/cost.

Exchange of one cryptocurrency to another

Any taxpayer who makes coin to coin trades (e.g., Bitcoin to Ethereum) may believe there would be no tax liability since they haven’t realized actual funds and these may be termed as like-kind exchanges, however the IRS has not treated these so and limited its applicability as like-kind exchanges of properties as cryptocurrencies do not become eligible as such due to non-fulfilment of many criteria under the IRS code.  So, this is a moot debate off late and treatment of cryptocurrencies as such will not be theoretically viable.

Hard forks and Airdrops of Cryptocurrencies

Hard forms in any cryptocurrency occurs when blockchain splits happen due to change in protocols while mining.  A new coin is generated as a by-product of its predecessor and as a result holders of the original cryptocurrency may receive new coins.  This is also popularly referred to as airdrop and used my cryptocurrency developers as a marketing trick to induce demand and usage of the newer coins or cryptocurrencies.  The IRS has clarified that hard forks or airdrops do not result into income until the taxpayer has not received such coins into their wallet and when they do, they are treated as ordinary income.

Donating, Gifting or inheriting cryptocurrencies

Cryptocurrency donations are treated in a similar fashion as cash donations. They are tax-deductible. An appraiser will assign a fair market value for the coin based on its market price at that time. The donor is not required to pay any taxes on the price gain. Gifts of cryptocurrency below $15,000 are not subject to income. If the recipient of a crypto gift over $15,000 decides to sell the gift, then their cost basis remains the same as that of the donor. Inherited crypto assets are treated the same way as other assets, meaning they are subject to the same estate regulations as other assets.

Accounting method for cryptocurrencies

Taxation of cryptocurrencies is not as simple as it may seem, the volatility in their prices makes it tough to ascertain their fair market value on their purchase or sale at times.  Also applying the appropriate accounting method for the cryptocurrency taxation is crucial.  Last in First out (LIFO), Highest in First out (HIFO) have the potential to decrease the tax liabilities and the IRS has approved these methods only under few scenarios for crypto traders.  First in First out (FIFO) is the most applied acceptable practice for cryptocurrency account as per the IRS.

So, we trust a brief glimpse in the possible cryptocurrency transactions above and their tax implications has provided you encouraging insights.  For help with your cryptocurrency investments or trading accounting, we at GJM & Co. offer CryptoCounting – our crypto accounting service in order to keep your transactional records up to date thereby helping you report precise possible incomes with the IRS.

Taxation of Cryptocurrency in India

Profits from sale of cryptocurrencies can be taxable as a business income if traded frequently (stock-in-trade) or as capital gains if held for investment purposes.  Taxpayers earning more than INR 5 million annually are required to disclose their holdings of cryptocurrencies in their income tax returns as well.

While the Reserve Bank of India (RBI) has not granted any of the Cryptocurrencies the status of a legal tender in India, there are no clear rules or even guidelines clarifying taxation of these cryptocurrencies. As are result, definite clarifications are long due from the Indian Income Tax department.  But with the increasing amount of individuals involving themselves with crypto investments and trading, skipping payment of taxes of profits from these transactions isn’t advisable.  So, with the popular views adopted in the USA, tax on profits from sale of cryptocurrencies will depend on the nature or form they are held as, i.e., as investments or stock-in-trade.

As business income, the profit can be taxed as per the applicable slab rate. But if it is held for investment purposes, then taxation can be the same as applicable to capital gains.  It also means that if taxpayers utilized their investments before three years, then short-term capital gains according to the relevant tax slabs will be applicable. However, if the redemption happens after three years, then it can be treated as long-term capital gain and can be taxed at 20 percent with indexation.  Meanwhile, some experts believe that profits from cryptocurrencies can be treated as income from other sources, whereas we can also consider profits from frequent trading as income from speculative business income. However, more details and discussion will be required to understand the rules better. 

So, while the same scenario of transactions as applicable for US Taxpayers may be considered applicable to Indian Taxpayers, their taxability may vary slightly.  The ways transactions are undertaken may not change for the Indian taxpayer and so deriving the gains from such transactions will remain pretty much the same.  It is advisable to consult an experienced Chartered Accountant firm such as GJM & Co. in order to understand the implications of your cryptocurrency transactions in India and also use their services for accurate accounting of your transactions, to be tax ready, enquiry ready.

We trust this article was helpful to you in understanding in brief what cryptocurrencies are and how they are taxed.  Should you have any queries or need consultation, Schedule a Call today or write to us at info@gjmco.in.