APPLICABILITY OF DIRECT AND INDIRECT TAXES ON CRYPTOCURRENCIES
Applicability of Direct Taxes:
The income of the corporations and individuals is taxed under the Income Tax Act, 1961 (‘ITA’). ITA has the provisions to tax the Indian residents on their worldwide income and non- residents on their income which originated in India. But such treatment of non- resident income is subject to Double Taxation Treaty or Tax Treaty of India with various countries.
We need to analyse ITA in order to determine whether the income arising from trading, or exchanging virtual currencies shall be treated as profits or gains of profession or business, or they are subject to be treated as capital gains. If the exchange chooses to follow a direct trading business model, or non- Peer to Peer (the ‘P2P) model, through which exchange is by itself providing liquidity, the income would be taxed as part of the business income arising out of gain or loss from the business. Hence, it would be taxed as business income.
In case the Exchange is following the P2P model, it is not acting as a holder and cannot gain in the cryptocurrencies, and hence does not come under the ambit of Direct Taxes under ITA. But if the Exchange executes some trades, but not in capacity of its business, the gain on the transactions would be brought under the ambit of Capital Gains Tax.
In other instances, the case would have to be decided on case to case basis.
Applicability of Indirect Taxes:
The applicable laws with respect to GST are the Central Goods and Services Tax Act, 2017, the Integrated Goods and Services Tax Act, 2017 and the respective State Goods and Services Tax Acts, with each having different jurisdictional ambit. GST is payable on:
i.sales of goods where goods are sold within one state in India;
ii.sales of goods where goods are transported from one state to another state;
iii.the provision of services within a state in India; and
iv.the provision of services from one state to another state in India.
For dealing with the aspect of Current account transactions, it is necessary to understand the nature of Cryptocurrencies or Virtual Currencies, i.e., whether these will fall into the category of a Good (product).
Under Section 2 (7) of the Sale Of Goods Act, 1930 the term “goods” has been defined to mean every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale.
In Tata Consultancy Services v. State of Andhra Pradesh, the Supreme Court of India held that the term goods as used in the Constitution of India and under the relevant Act is ‘very wide and includes all types of movable properties, whether those properties be tangible or intangible.’ The Court also iterated ‘…the term ‘all materials, articles and commodities’ includes both tangible and intangible/incorporeal property which is capable of abstraction, consumption and use and which can be transmitted, transferred, delivered, stored, possessed etc.’
The Tariff Schedule for GST Rates Tariffs for Goods does not explicitly contain the ‘crytocurrency’ item but it does contain a residuary clause ‘Goods which are not specified in Schedule I, II, IV, V or VI.’(18%) Hence, the cryptocurrencies will fall under the ambit of ‘Goods’ and hence these cryptocurrencies transactions would be charged GST if the transactions are done in the furtherance of a business.
The people selling these cryptocurrencies in the course of furtherance of their business and requiring the GST (registration) number, based on the annual revenue threshold, would have to include GST in their transactions. It is also pertinent to note that the different cryptocurrencies would be treated differently. The exchange would not be liable for any GST liability if the exchange is working only as a guarantee or intermediary.
GST must be paid by the service providers on the amount of services that they provide. In essence, a cryptocurrency exchange must charge 18% GST to its customers based on the commission that the exchange charges because it would come under the ambit of ‘services’. It is also pertinent to note that a person would not be liable under any GST consequence if he/ she is not transacting in cryptocurrencies in course of their business. People would also not be liable under GST regime if they start selling their cryptocurrencies which were held by them as investment(s).
Applicability of TDS:
There was no TDS on capital gains. But, the Ministry of Finance, via Clause 80 of the Finance Bill 2020, proposed to insert a new section -- 194K, under which mutual funds will be required to deduct TDS on capital gains arising on redemption of units.
According to Section 194K of the Income Tax Act, "any person responsible for paying to a resident any income in respect of units of a mutual fund specified under clause (23D) or units from the Administrator of the specified undertaking or units from the specified company, will at the time of credit of such income to the account of the payee deduct income-tax thereon at the rate of 10 per cent."
We need to determine whether the new amendment would be applicable on all the capital gains. Central Board of taxes clarified that the Mutual fund income over Rs 5,000 will be subject to 10 per cent TDS on dividend payment only and that no tax will be deducted on income on capital gains.- (https://www.businesstoday.in/current/economy-politics/10-tds-applicable-on-dividend-payment-only-not-on-capital-gains-clarifies-cbdt/story/395467.html) Therefore the income in nature of capital gains would not be subject to TDS and hence, the cryptocurrency exchange would not be liable for any TDS.
Note: If the transaction is in cryptocurrencies, and the commission is in percentage of the transaction money, or the cryptocurrency to cryptocurrency model, the taxation liabilities would be determined on the price of cryptocurrencies when the transaction took place.
Also, note: There is no definitive stand of the government under these laws and this is based on the author’s interpretation of indirect and direct taxation laws.
CHAPTER XVII: APPLICABILITY OF SECURITIES AND INVESTMENT LAWS ON CRYPTOCURRENCIES
Based on the Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies, the cryptocurrencies like Bitcoin or Ether are unlikely to be brought under the ambit of regulations relating to securities. The Securities Contracts (Regulation) Act, 1956 (SCRA) provides a non-exhaustive definition of securities. There has been no notification from the relevant regulatory authorities such as SEBI regarding the same. The cryptocurrencies do not fall under the ambit of any of the enumerated items enlisted in the non-exhaustive definition of the ‘Securities.’ The items enlisted have a major characteristic, i.e., they derive their value from some underlying asset. But the value of cryptocurrency depends on the demand-supply economics. Because the cryptocurrencies are a by-product of distributed ledger technology, there is no identifiable issuer of the same while other items on the list have a clear identifiable issuer.
Securities are defined in Black’s Law Dictionary to include instruments evidencing a holder’s ownership rights in a firm or a holder’s creditor relationship with a firm (or government). It also states that securities indicate an interest based on investment in a common enterprise. But the cryptocurrencies in general do not give the holder of cryptocurrencies any ownership rights in a firm, creditor relationship with a firm, or investment in a common enterprise. Therefore, the cryptocurrencies are unlikely to fall under the ambit of the definition provided in Black’s Law Dictionary.
But there might be exceptions to this rule. According to the Report of the Committee to propose specific actions to be taken in relation to Virtual Currencies, the regulation of digital coins or tokens depends on the characteristics and the purpose for which they are being issued. Depending on the objective of issue, tokens can be grouped into two broad categories:
(i). Utility tokens: Utility tokens offer investors access to a company‟s products or services. They are not to be treated as investment in a company.
(ii). Security tokens: Security tokens represent investment in a company. Just like shareholders in a company, token holders are given dividends in the form of additional coins every time the company issuing the tokens earns a profit in the market.
What makes a token a security? The Howey test by the U.S. Securities and Exchange Commission (SEC) provides an objective framework to distinguish between utility tokens and security tokens. In order for a financial instrument to be considered a security and fall under the ambit of the SEC, the instrument must meet these four criteria:
a. It must be an investment of money;
b. With an expectation of profit;
c. In a common enterprise; and
d. With the profit to be generated by a third party.
If the issuer of the tokens is identifiable and the tokens have some identifiable underlying asset(s), or the token in question passes the Howey test, the tokens can be brought under the ambit of The Securities Contracts (Regulation) Act, 1956 (SCRA). These tokens would fall under the ambit of the Companies Act, 2013, SEBI(Security and Exchange Board of India Act, 1992) and the SCRA. The securities which fall under the ambit of the SCRA can only be traded on the licensed exchanges, and an exchange trading such securities might be held retrospectively liable under the SCRA.
The Exchange might be subjected to other regulations against the Tokens which are not ‘securities.’ To analyse the same, we have to look at the specific provisions of the Companies Act and Companies (Acceptance of Deposits) Rules, 2014. In the latter Act, ‘deposit’ is defined as- “any receipt of money by way of deposit or loan or in any other form, by a company, but does not include..” We also need to determine whether these transactions would fall within the ambit of ‘deposits’ and consequently, if specific provisions of the Companies Act, RBI compliances and other regulations under other regulatory and/ or statutory bodies would be applicable on the same. This would be judged on case to case basis.
But in the generic scheme of Cryptocurrency exchange, any amount received in the course of, or for the purposes of, the business of the company, as an advance for the supply of goods or provision of services accounted for in any manner whatsoever provided that such advance is appropriated against supply of goods or provision of services within a period of three hundred and sixty five days (365 days) from the date of acceptance of such advance would not come under the ambit of ‘deposits.’
Under The Banning Of Unregulated Deposit Schemes Act, 2019, “deposit” means ‘an amount of money received by way of an advance or loan or in any other form, by any deposit taker with a promise to return whether after a specified period or otherwise, either in cash or in kind or in the form of a specified service, with or without any benefit in the form of interest, bonus, profit or in any other form, but does not include…’. To escape the ambit of this Act, the cryptocurrency token issuers and the cryptocurrency exchanges would need to ensure that any money received should not be liable to be returned.
CHAPTER XVIII: APPLICABILITY OF COMMODITIES LAWS ON CRYPTOCURRENCIES
If the Cryptocurrencies are classified as ‘commodities,’ the exchanges which facilitate the trading of cryptocurrencies might be governed as the ‘commodity’ exchanges, which can have implications under various regulations such as foreign direct investment (FDI), Consolidated FDI Policy Circular of 2017, and Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) (Amendment) Regulations, 2019 (TISPROI).
There are two kinds of commodity exchanges, commodity spot exchange- which facilitate purchase and sale of specified commodities, including agricultural commodities, metals and bullion by providing spot delivery contracts in these commodities, and commodity derivative exchanges, which deals with the derivative contracts.
As per the guidelines issued by Government of India Ministry of Commerce & Industry Department of Industrial Policy & Promotion SIA(FC Section), a composite ceiling for foreign investment of 49% was allowed with prior Government approval, subject to the condition that investment under the Portfolio Investment Scheme will be limited to 23% and that under the FDI Scheme will be limited to 26%. Further, no foreign investor/entity including persons acting in concert will hold more than 5% of the equity in these companies.
An exhaustive list of commodities was notified under SCRA, and this list does not include the cryptocurrencies. This notification has to be read with clause (bc) of section 2 of the Securities Contracts (Regulation) Act, 1956 (amended), (42 of 1956). The said notification can hence be concluded to only deal with derivative trading market and not with the spot/ ready delivery market.
In IMAI vs RBI, the Supreme Court of India opined that, “The argument that other stakeholders such as the Enforcement Directorate which is concerned with money laundering, the Department of Economic Affairs which is concerned with the economic policies of the State, SEBI which is concerned with security contracts and CBDT which is concerned with the tax regime relating to goods and services, did not see any grave threat and that therefore RBI’s reaction is knee-jerk, is not acceptable. Enforcement Directorate can step in only when actual money laundering takes place, since the statutory scheme of Prevention of Money Laundering Act deals with a procedure which is quasi-criminal. SEBI can step in only when the transactions involve securities within the meaning of Section 2(h) of the Securities Contracts (Regulation) Act, 1956. CBDT will come into the picture only when the transaction related to the sale and purchase of taxable goods/commodities. Every one of these stakeholders has a different function to perform and are entitled to have an approach depending upon the prism through which they are obliged to look at the issue. Therefore, RBI cannot be faulted for not adopting the very same approach as that of others. ….”
This judgment has given ample of power to the SCRA to classify the cryptocurrencies as commodities in the future and they are classified as commodities in USA. In 2015, the Commodity Futures Trading Commission or CFTC settled charges against online facility Derivabit and its founder for offering Bitcoin options contracts without complying with the commodity exchange act or CFTC regulations. The provisions of CFTC regulations were applied retrospectively to the cryptocurrencies and the cryptocurrency exchange was held liable with respect to infringement of CFTC guidelines.
The SCRA notification, in all probability should serve as the benchmark with respect to the list, and if the cryptocurrencies are classified as commodity, it would, with respect to this interpretation, only have prospective effect. However, the central government may at any time choose to notify virtual currencies (in general, or any class of them) as commodities under the above notification. This would bring derivatives contracts in virtual currencies within the SCRA (and hence, SEBI’s jurisdiction). For spot trading, foreign direct investment would then be restricted to 49 percent of the capital. There is currently no separate licensing regime for commodities spot exchanges. But it should be kept in mind that the central government might issue such notification retrospectively, and the liabilities might be retrospective in nature as was the case in USA with respect to Derivabit.
As the cryptocurrency(ies), till date, cannot be considered as securities (subject to this interpretation), the derivative and spot trading in cryptocurrencies perse is not illegal.
CHAPTER XIX: APPLICABILITY OF FEMA ON CRYPTOCURRENCIES
The risk relating to Foreign Exchange Management Act, 1999(FEMA) has been highlighted by the RBI ample number of times. In P2P transfers, while the exchange provides a portal to match the orders of a seller and buyer, the consideration would flow directly from the buyer to the seller without the exchanges being an intermediary for this leg of the trade. The exchanges would only act as the intermediary for the storing the VCs till the time the transfer of the consideration from the buyer to the seller is complete. In other words, the exchanges act as an escrow agent for the transaction between the buyer and the seller. The buyers in the P2P transaction transfer the consideration directly to the seller’s bank account. The exchanges allowed their customers to transfer VCs to foreign wallet addresses, even before the issuance of the Circular, exposing the customers to the risks of violating FEMA, AML/CFT guidelines.
This means the RBI recognizes that the transfer of cryptocurrencies in the wallets, held by the foreign exchanges or persons, or held on the foreign servers would be brought under the purview of the same. The entities facilitating such transactions are also under the ambit of the FEMA. For the question pertaining to FEMA, we would be referring to section 3 of FEMA which reads as under:
“Dealing in foreign exchange, etc.—Save as otherwise provided in this Act, rules or regulations made thereunder, or with the general or special permission of the Reserve Bank, no person shall—
(a) deal in or transfer any foreign exchange or foreign security to any person not being an authorised person;
(b) make any payment to or for the credit of any person resident outside India in any manner;
(c) receive otherwise through an authorised person, any payment by order or on behalf of any person resident outside India in any manner. Explanation.—For the purpose of this clause, where any person in, or resident in, India receives any payment by order or on behalf of any person resident outside India through any other person (including an authorised person) without a corresponding inward remittance from any place outside India, then, such person shall be deemed to have received such payment otherwise than through an authorised person;
(d) enter into any financial transaction in India as consideration for or in association with acquisition or creation or transfer of a right to acquire, any asset outside India by any person.
Explanation—For the purpose of this clause, “financial transaction” means making any payment to, or for the credit of any person, or receiving any payment for, by order or on behalf of any person, or drawing, issuing or negotiating any bill of exchange or promissory note, or transferring any security or acknowledging any debt.”
In some cases the cryptocurrencies might be deemed to be securities but they would always fall under the ambit of assets.
As per the definition of “Asset” given in the 10th edition of Black Law Dictionary, asset means an item that is owned and has value. It is perinent herein to note that Bitcoin is an asset which is owned by a person on the payment of its price and therefore, buying of Bitcoins in India and sending the same to another Country would fall under the ambit of Section 3 clause (d) and is prohibited, as there is no rule or regulation in force permitting the same and RBI has not given any permission for such transactions. Therefore, the ground taken regarding the issue pertaining to P2P transactions have legislative backing and cannot be termed blatantly arbitrary.
Also, Supreme Court iterated that “...We are not in favour of general bans on cryptocurrencies or barring the interaction between cryptocurrency business and the formal financial sector as a whole, such as is the case in China for example. That would go too far in our opinion. As long as good safeguards are in place protecting the formal financial sector and more in general society as a whole, such as rules combating money laundering, terrorist financing, tax evasion and maybe a more comprehensive set of rules aiming at protecting legitimate users (such as ordinary consumers and investors), that should be sufficient.”
The exchange, by itself would not be subjected to direct violation of FEMA laws if it operates only in India but it would be at risk of giving a platform to it’s clients who might violate the FEMA provisions by sending cryptocurrency to the foreign wallets. But because the Exchange would have direct control over the cryptocurrencies and security of the cryptocurrencies (Exchange acting as a safekeeper of the cryptocurrencies), it might be subject to a direct violation under FEMA.
CHAPTER XX: CROSS-BORDER TRANSACTIONS WITH CRYPTOCURRENCIES
Sending a virtual currency outside India by Indian residents as payment for services rendered or goods (which includes virtual currencies) sold by a non-resident entity, then the transaction is likely to be characterised as an export of goods regulated under the Foreign Exchange Management (Export of Goods & Services) Regulations, 2015 and the Master Directions on Export of Goods and Services (together, Export Regulations).
The Export Regulations require that the full value of any exports be received only via authorised banking channels (i.e., in fiat currency) and that any set-off of import payments against export receivables only happen through a process facilitated by the authorised bank.
The result is that a cross-border barter would not be permitted. Thus, the cross-border transfer by Indian residents of virtual currencies without receiving fiat currencies through authorised banking channels is likely to violate the Export Regulations.
It needs to be highlighted that the cross-border related obligations discussed above are on the exporter, i.e., the one who ships the goods to be sold. As we have analyzed, because the cryptocurrencies are identified as goods, taking or giving cryptocurrencies as contractual considerations (the cryptocurrencies would be said to be exported if they are transferred to a wallet which is held by a foreign person or entity), the person would be liable both-ways, whether he receives or send the cryptocurrencies in place of fiat currency.
But it needs to be understood that because the RBI circular ceased to exist after the Supreme Court judgment, import related provisions under FEMA can be used as justification for outward remittance of fiat currency for the purpose of purchasing cryptocurrencies.
CHAPTER XXI: FDI AND CRYPTOCURRENCIES
The FDI is regulated under FEMA Act. The FDI Policy and TISPRO, made under FEMA, regulate FDI in Indian entities. The Exchange would be regulated either as Non-banking finance and asset management companies or E-commerce platforms which allows 100% foreign investment without approval from the government. But if they are deemed as commodities, the FDI would be restricted to 49%.
The relevant provisions for reaching the conclusions are as follows:
1. Subject to provisions of FDI Policy, e-commerce entities would engage only in Business to Business (B2B) e-commerce and not in Business to Consumer (B2C) e-commerce.
2. E-commerce means buying and selling of goods and services including digital products over digital & electronic network.
Subject to our discussion before, we conclude that the cryptocurrencies could be deemed to be ‘goods’ and hence would come under the ambit of e-commerce websites. Even if they are deemed to be digital assets, the definition is wide enough to bring cryptocurrencies under it’s ambit.
CHAPTER XXII: APPLICABILITY OF PAYMENT AND SETTLEMENT SYSTEM
The mission statement of RBI for payment and settlement system states that the endeavour would be “to ensure that all payment and settlement systems operating in the country are safe, secure, sound, efficient, accessible and authorised”. The Payment and Settlement Systems Act, 2007 (‘PSS Act, 2007’), legislated in December 2007, governs and regulates all the modes of payment systems used in India. Under the PSS Act, 2007 the RBI is given the power to direct and regulate the payment systems and the payment system participants in India. The PSS Act, 2007 has been enacted to govern and regulate the activities which involve payment and settlement of transaction in substitute of paying or settling a transaction by cash or other means of physical movement of payment instruments to settle a transaction.
“Netting” means the determination by the system provider of the amount of money or securities, due or payable or deliverable, as a result of setting off or adjusting, the payment obligations or delivery obligations among the system participants, including the claims and obligations arising out of the termination by the system provider, on the insolvency or dissolution or winding up of any system participant or such other circumstances as the system provider may specify in its rules or regulations or bye-laws (by whatever name called), of the transactions admitted for settlement at a future date so that only a net claim be demanded or a net obligation be owned.
“Payment obligation” means an indebtedness that is owned by one system participant to another system participant as a result of clearing or settlement of one or more payment instructions relating to funds, securities or foreign exchange or derivatives or other transactions;
“Settlement” means settlement of payment instructions and includes the settlement of securities, foreign exchange or derivatives or other transactions which involve payment obligations;
The proposed Crypto Bill prohibits the direct or indirect use of any cryptocurrency,
a. as a payment system under the Payments and Settlements Systems Act, 2007;
b. to buy or sell or store cryptocurrency;
c. to provide cryptocurrency related services to consumers or investors;
d. to trade cryptocurrencies with Indian currency or any foreign currency;
e. to issue cryptocurrency related financial products;
f. as a basis of credit;
g. as a means of raising funds; and
h. as a means of investment.
To understand the implications of the above further, the below definitions from THE PAYMENT AND SETTLEMENT SYSTEMS ACT, 2007 shall be taken into consideration.
“Electronic funds transfer” means any transfer of Short title, extent and commencement Definitions funds which is initiated by a person by way of instruction, authorisation or order to a bank to debit or credit an account maintained with that bank through electronic means and includes point of sale transfers; automated teller machine transactions, direct deposits or withdrawal of funds, transfers initiated by telephone, internet and, card payment;
Payment system” means a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange;
“Explanation.- For the purposes of this clause, “payment system” includes the systems enabling credit card operations, debit card operations, smart card operations, money transfer operations or similar operations;
Because the definitions above are inclusive non-exhaustive definitions, we need to apply the principle of ejusdem generis to determine the ambit of the definitions. Both the definitions take into their ambit, the fiat money. It means both the definitions are limited in their power with respect to the fiat money. Therefore, anything outside the scope of fiat money cannot be governed under the ambit of this Act. Therefore, RBI has no natural jurisdiction under The Payment and Settlement Systems Act, 2007 to bring under it’s ambit the payment systems governed by the cryptocurrencies under the principles of interpretation of statutes.
To bolster the position above, we refer to one of the statements filed by the RBI, which states, “The impugned decisions were necessitated because in the opinion of RBI, VC transactions cannot be termed as a payment system, but only peer-to-peer transactions which do not involve a system provider under the Payments and Settlement Systems Act. Despite this, VC transactions have the potential to develop as a parallel system of payment.”
Therefore, we can conclude from the RBI reply that our understanding above is correct and cryptocurrencies do not form a part of ‘payment system’ under the Payment and Settlement Systems Act, 2007.
Indian payment system is not governed by any other Act, except for law of contracts. The consideration for a Contact is not restricted to fiat only, it can be in kind as well. Therefore, local Indian payments using crypto are allowed as there is no statutory prohibition with respect to the same.
CHAPTER XXIII: APPLICABILITY OF ANTI MONEY LAUNDERING LAWS ON CRYPTO EXCHANGES
In IMAI vs RBI, the Supreme Court of India opined that, “The argument that other stakeholders such as the Enforcement Directorate which is concerned with money laundering, the Department of Economic Affairs which is concerned with the economic policies of the State, SEBI which is concerned with security contracts and CBDT which is concerned with the tax regime relating to goods and services, did not see any grave threat and that therefore RBI’s reaction is knee-jerk, is not acceptable.
Enforcement Directorate can step in only when actual money laundering takes place, since the statutory scheme of Prevention of Money Laundering Act deals with a procedure which is quasi-criminal. SEBI can step in only when the transactions involve securities within the meaning of Section 2(h) of the Securities Contracts (Regulation) Act, 1956. CBDT will come into the picture only when the transaction related to the sale and purchase of taxable goods/commodities. Every one of these stakeholders has a different function to perform and are entitled to have an approach depending upon the prism through which they are obliged to look at the issue. Therefore, RBI cannot be faulted for not adopting the very same approach as that of others. ….”
Money laundering is an additional offense, meaning thereby that commission of a schedule offence as mentioned in the Prevention of Money Laundering Act, 2002(PMLA) is a precondition. The schedule under PMLA mentions a list of offenses under different laws. If any of the scheduled offense is committed and the money is generated and laundered through any of those offenses, and then this generated money when given another color leads to commission of offense under PMLA.
For example, a government officer accepts kickbacks, it is an offense under the Prevention of Corruption Act. Now, these kickbacks are used to either purchase a house or jewellery, the offense of money laundering is completed as the money has changed it's form and color. So, this is how the offense of money laundering could be understood to be additional offense as it requires commission of a predicate offense.
Regarding the recent debates if the purchase of bitcoins would be a criminal offense under PMLA? The answer to this would be prima facie it is not an offense. Only when one purchases crypto-currencies from the money generated from the predicate offense would imply that the purchase of crypto- currencies amounts to money laundering.
If bitcoin is purchased through white/ legitimate money, then offense of money laundering is not committed. Hence, Anti Money Laundering Laws will be applicable only in certain peculiar circumstance i.e. on actual commission of a predicate offense.
CHAPTER XXIV: APPLICABILITY OF KYC NORMS ON CRYPTO EXCHANGES
The cryptocurrencies pose a challenge to the regulatory authorities owing to their pseudonymous nature. It means that although the identities of the specific wallets of cryptocurrencies in which transactions took place could be traced, the specific identities of the person who owns the wallet cannot be easily determined. This ability to transfer something of value over the internet that can evade the conventional financial monitoring framework has raised alarm in the eyes of regulators, as they are unable to track the flow of funds that could be used for money laundering purposes.
Know Your Customer (KYC) and Anti-Money Laundering laws are governed by various statutes and RBI directions. None of these norms are applicable to the businesses relating to the cryptocurrencies. The Prevention of Money-Laundering Act, 2002 and the RBI Master Direction – Know Your Customer (KYC) Direction, 2016 are only applicable to the entities regulated by the RBI and other statutory regulators such as SEBI. Only the cryptocurrencies which come under the ambit of Howey’s test or their characterization is subject to their regulation from some statutory authorities, the entities under which subject themselves to KYC or AML norms would come under the direct scrutiny of KYC and AML regulations. Otherwise, the cryptocurrency exchanges are not subject to such norms.
However, because the Cryptocurrency business lies in a grey area, it is advised that the entities dealing with cryptocurrencies follow strict and elaborate AML, KYC and Data protection systems.
CHAPTER XXV: DISPUTE RESOLUTION - JURISDICTION
Now, we would try to identify the jurisdictional issues relating to the Blockchain technology. We are now confident with respect to our understanding of the Blockchain technology and for the sake of simplicity, while understanding the jurisdictional challenges, let us iterate the definition of Blockchain as a Distributed Ledger Technology (the “DLT”) having digital transaction records that are shared between multiple computers (the, “nodes”) on a decentralized network. Now lets us understand how this lack of centralization would end up creating jurisdictional issues.
The concept of Blockchain in itself requires that the ledger is not located at a single location. Instead, the ledger must be distributed and therefore located at multiple nodes. These nodes can be located anywhere, and they do not have any territorial demarcations. There is no uniform method to understand where the presence of the DLT can be attributed to, and this would lead to a lot of disagreements with respect to the location of the ledger in the future.
For example, suppose the nodes are present in India, China, and the USA, all these countries would try and assert dominance and jurisdiction over the Blockchain network. If all these governments require compliances by the Blockchain network (the “network(s)”) with respect to their laws and regulations, the network could be subjected to multiple and even conflicting laws and regulations. The difficulty of such compliance would lead the Blockchain technology to become inefficient, or maybe completely useless and unviable. These issues could be circumvented by the networks allowing the nodes to operate only from a single jurisdiction. Or, an alternate solution could be the creator of the network could choose the site of law which could apply to the whole network and shift the liability to nodes that operate in conflict with such laws. The author’s recommendation in such a case would be to bide the node to comply with the stricter law, for example, the creator of the network creates a provision that the nodes must comply with Indian laws and regulations. And suppose there is no requirement of complying with the energy source required for the operation of nodes. But in the USA, the nodes are required only to use renewable sources of energy for the operation; the node would be obligated to follow the stricter provision in their country of jurisdiction. So, the energy requirement might not be relevant to the node operating in India, but if it is operating from the US, it would have to adhere to stricter provision, i.e., using renewable sources of energy for the operating nodes.
As the widespread use of Blockchain technology increases, the expansive and cross border nature of the Blockchain technology would result in increased jurisdictional disputes regarding the governance of DLTs.
To exacerbate the problem, the location for the adjudication of the disputes would not be easily determined. For a Court to exercise its authority, the cost must have the subject matter and personal jurisdiction. Because nodes are not limited to a single jurisdiction, and a consistent procedure has not been established for determining where they are located, it may be unclear whether the court has jurisdiction over the dispute. For example, in order for the Delhi Court to exert territorial jurisdiction in a civil matter, the dispute must have a value of at least INR 20 lacs, and the cause of action must have arisen in Delhi. But where can the cause of action be said to have occurred when dealing with a Blockchain network? The concept of cause of action in itself does not translate well when applied to a DLT system. The cause of action pertaining to an asset constituted on a DLT—which by definition is distributed—is not immediately obvious. A network can span several jurisdictions and—in the case of a ledger that is fully decentralized—there is no central authority or validation point.
Some other questions which might be pertinent to our discussion are as follows:
1. If a plaintiff were to sue a DLT that was maintained on multiple nodes, including a node located in the plaintiff’s state, would the node’s presence in the plaintiff’s state destroy diversity jurisdiction?
2. What if multiple nodes, or even the majority of the nodes, maintaining the DLT were located in the same state as the plaintiff?
3. Moreover, if the nodes are located in multiple states or countries, it may be unclear which court(s) has personal jurisdiction over the DLT. In other words, is the presence of a single node sufficient to create personal jurisdiction over the entire DLT? What about multiple nodes? If multiple nodes are required to establish a presence in a state, how many nodes must be present?
4. What are the legal nature and effects against third parties of a disposition of an asset recorded on a DLT system?
5. What are the requirements—if any—for the realization of an interest in an asset recorded on a DLT system?
6. Does a disposition of an asset recorded on a DLT system extend to entitlements to dividends, income, or other distributions, or redemption, sale or other proceeds?
7. What are the legal nature and effects against the transferor of a disposition of an asset recorded on a DLT system? And
8. What are the circumstances in which a person’s interest in an asset recorded on a DLT system will extinguish or have priority over another person’s interest?
The understanding and adoption of Blockchain technology are still in nascent stages. It is unclear how the jurisdictional issues would be resolved. The governments, therefore, might attempt to enforce their laws on DLTs maintained on nodes within their borders. In the future, the Courts might struggle with the jurisdictional issues pertaining to the Blockchain technology. Therefore, the one working on Blockchain technology must be aware of such issues to safeguard one’s creation.
Before abandoning this discussion, it is important to note that where DLT arrangements purport to be dispositive of title to tangible property, and immovable property, in particular, it appears unlikely that a court will apply any law other than the cause of action (according to Civil Procedure Code (“CPC”), 1908) for the underlying asset. The conflict of laws analysis in respect of a DLT system need not necessarily, then, be radically different just because there is new technology underpinning a transaction. In fact, in some contexts, a traditional conflict of laws analysis may be the most appropriate route to the answer.