Direct Tax Updates & Legal Developments - Q4 2024

Himanshu SinhaPartner

Aditi GoyalPartner

Aishwarya PalanSenior Associate

Key Developments

• Income Tax Appellate Tribunal characterises cryptocurrency as a capital asset and holds gains arising from transfer of cryptocurrency taxable as capital gains

  The Income Tax Appellate Tribunal (ITAT), in a recent case,¹ addressed the characterisation of income arising from cryptocurrency under the Income Tax Act, 1961 (ITA) for the period prior to 1 April 2022. In this case, Raunaq Prakash Jain, the taxpayer, sold Bitcoins (cryptocurrency) and treated the resultant gains as long-term capital gains. Thereafter, the taxpayer set-off losses from transfer of shares from such gains and also claimed a tax exemption on account of utilising the proceeds from such gains for acquiring a residential house property.² The balance amount was offered to tax at the rate of 20%.

  Upon scrutiny, the tax officer re-characterised the gains from the sale of Bitcoins as ‘income from other sources’ by holding that Bitcoins do not qualify as a property and hence, cannot be classified as a capital asset. The taxpayer’s claim of tax exemption was thus not allowed.

  The Commissioner of Income Tax (Appeals) upheld the order of the tax officer and the matter travelled to the ITAT. The taxpayer contended that Bitcoins qualify as ‘property’ and the ITA defines a ‘capital asset’ to include ‘property of any kind’. Further, the taxpayer relied on the provisions of the Finance Act, 2022 (FA 2022) which introduced (i) a scheme for taxation of cryptocurrency, (ii) a definition for ‘virtual digital asset’ (VDA) (i.e., cryptocurrency) and (iii) a new provision (Section 115BBH) to tax income from VDA. The taxpayer contended that section 115BBH itself recognises that VDA may qualify as a capital asset. The taxpayer also relied on Supreme Court rulings to contend that where two reasonable constructions of a taxing provision are possible, then the construction which favours the taxpayer must be adopted. Based on these arguments, the taxpayer contended that even before 1 April 2022, cryptocurrency should qualify as a capital asset.

  On the other hand, the tax department contended that cryptocurrency does not qualify as ‘property’ and, therefore, was not a ‘capital asset’ under the ITA. It was argued that a property needs to have inherent benefit, which endows it with value, and this was not the case with cryptocurrencies.

  The ITAT noted that the ITA defines ‘transfer’ in relation to a capital asset to include the sale, exchange or relinquishment or extinguishment of any right therein. Therefore, gains arising from the sale of Bitcoins are taxable as ‘capital gains’. In holding so, the ITAT:

  • accepted the taxpayer’s arguments that even before the introduction of a specific tax regime for VDA in 2022, Bitcoins would qualify as a capital asset;
  • took note of assessment orders passed in other cases wherein cryptocurrency was treated as a capital asset;
  • noted that the taxpayer had invested in shares and cryptocurrency intending to hold them for long term; and
  • relied on the settled principle of law that when there are two views possible, the view that is favourable to the taxpayer must be considered.

  The ITAT also allowed the claim of exemption of capital gains to the extent of investment of the sale proceeds in the acquisition of a residential house property.

  This is a significant ruling as it clarifies the taxation of cryptocurrency for the pre-amendment period and offers guidance to taxpayers who had invested in this emerging asset class in the early stages. Taxpayers who earned gains from the sale of cryptocurrency before 1 April 2022 should carefully evaluate their tax positions in light of this decision. While this ruling is in the context of Bitcoins, it may also serve as a precedent for other categories of VDAs. Given the rapid growth in investments in new-age financial instruments and the evolving legal and regulatory landscape, it will be fascinating to observe the evolution of judicial interpretation in this context.

• Switzerland withdraws ‘most-favoured nation’ benefit under the India-Switzerland tax treaty

  The ‘most favoured nation’ (MFN) clause in a tax treaty allows importing benefits into a tax treaty between India and a member of the Organization for Economic Cooperation and Development (OECD) from a tax treaty signed subsequently by India with another member of the OECD. In this context, ‘benefits’ relate to granting lower tax rates for certain incomes, restricting the scope of income, etc.

  On 13 August 2021, Switzerland’s Federal Department of Finance (FDF) had issued a statement allowing the applicability of the MFN clause under the India-Switzerland tax treaty (Treaty) on account of Lithuania's and Colombia’s admission to the OECD pursuant to which Switzerland restricted the tax rate on dividend income to 5% (instead of 10%). Consequently, tax year 2018 onwards, Indian tax residents could claim a refund of tax withheld in excess of 5% on dividend income in Switzerland. This statement also clarified that Swiss tax residents receiving dividends from Indian sources would be entitled to foreign tax credit (FTC) at 5% from tax year 2021 onwards.

  Recently, on 11 December 2024, the FDF issued another statement (Statement) withdrawing its earlier statement allowing the applicability of the MFN clause under the Treaty. The Statement mentions that the Swiss authorities have noted the decision of the Supreme Court of India in the case of Nestle SA,³ which held that the issuance of a notification by the Indian government is necessary for invoking the benefits of MFN clause in India. (To read our detailed analysis of the Nestle SA decision, click here.)

  In light of the Nestle SA decision, the Swiss authorities acknowledged that their interpretation of the applicability of MFN clause is not shared by India. In the absence of reciprocity, the Swiss authorities have suspended their unilateral application of the MFN clause. Accordingly, with effect from 1 January 2025, dividends arising to Indian residents from Switzerland will be taxed at 10% without giving effect to the MFN clause. Correspondingly, dividends arising to Swiss residents from India will be eligible for higher FTC of up to 10%. The Statement also clarified that the lower tax rate of 5% will continue to apply for tax years 2018 to 2024.

  It is pertinent to note that the review petitions filed against the Nestle SA decision were dismissed by the Supreme Court and the decision has thus attained finality. Given this, even though the Statement allows the applicability of lower rate for tax years 2018 to 2024, the Indian tax authorities may seek to apply the Nestle SA decision to past transactions to deny benefit of the MFN clause. Therefore, it is possible that for these years, the position of the Indian and Swiss authorities regarding the application of the MFN clause would remain incongruent.

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