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Executive Summary: This Article authored by our Founder Director Sh. Mayank Mohanka, FCA, captures all the nuances of the RBI Digital Currency (CBDC) and explains the probable unintended taxation implications arising out of the usage of such digital rupee in the light of the structure, design, nature, features and issuance mechanism of such digital rupee.
The launch of the first pilot for retail digital Rupee (e₹-R) on 1.12.2022, by RBI, has created a lot of buzz in all financial circles and fintech industry. Interestingly, this launch constituted the third step of the ‘three-step graded roll-out strategy’ to launch ‘Central Bank Digital Currency’ (CBDC) by RBI, pursuant to the announcement of introduction of sovereign digital rupee, by the hon’ble FM, in the Union Budget 2022. The release of Concept Paper on CBDC on 7.10.2022 and the launch of the first pilot for digital rupee in wholesale segment on 1.11.2022, respectively constituted the first and second steps, which somehow went not so noticed. Suitable amendment in the Reserve Bank of India Act, 1934, has also been made with insertion of new section 2(aiv) extending the ambit of ‘bank note’ to include digital form also.
The key motivations for exploring the issuance of CBDC in India among others include reduction in operational costs involved in physical cash management, fostering financial inclusion, bringing resilience, efficiency, and innovation in payments system, adding efficiency to the settlement system, boosting innovation in cross-border payments space and providing public with uses that any private virtual currencies can provide, without the associated risks.
Friends, in this Taxalogue, I am making an honest and sincere attempt to analyse and decode this watershed moment of evolution of sovereign digital currency in India, slightly from a different angle i.e., the taxation angle. But yes ofcourse, this in turn invariably and inevitably requires a deep understanding of the exact nature, form, design, type, technology and issuance mechanism/model of this new digital avatar of Indian Rupee.
Well Friends, before You dismiss my present deliberation as a stupid discourse, on the ground that how can a sovereign currency be taxed, let me clarify that yes ofcourse, the holding of and or transacting in a sovereign currency, in digital form or otherwise, will not give rise to any taxable event, and will not generate any direct income tax or GST liability, with ‘currency’ being categorically placed outside the scope and ambit of ‘capital asset’ u/s 2(14) and virtual digital asset u/s 2(47A) in the Income Tax Act and ‘supply of goods or services’ in the GST Act. However, at the same time, the possibility of some unexpected and unassumed but intriguing tax implications, can’t be ruled out though.
So let us begin our joy ride.
The Reserve Bank of India has broadly defined CBDC as the legal tender issued by a central bank in a digital form. It is akin to sovereign paper currency but takes a different form, i.e., digital form, exchangeable at par with the existing currency and shall be accepted as a medium of payment, a legal tender and a safe store of value. CBDCs would appear as liability on the central bank’s (RBI) balance sheet.
The RBI Concept Paper on CBDC issued on 7.10.2022, explains in detail, the key design choices to be considered, for issuing CBDCs viz., (i) Type of CBDC to be issued (Wholesale CBDC and/or Retail CBDC), (ii) Models for issuance and management of CBDCs (Direct, Indirect or Hybrid model), (iii) Form of CBDC (Token-based or Account-based), (iv) Instrument Design (Remunerated or Non-remunerated) and (v) Degree of Anonymity.
All these design choices have a direct bearing on the probable tax implications, arising out of the implementation and usage of this new digital avatar of Indian Rupee, so it will be worthwhile to understand these in brief.
i) Type of CBDC to be issued:
CBDC can be classified into two broad types viz. general purpose or retail (CBDC-R) and wholesale (CBDC-W). Retail CBDC would be potentially available for use by all viz. private sector, non-financial consumers and businesses while wholesale CBDC is designed for restricted access to select financial institutions. While Wholesale CBDC is intended for the settlement of interbank transfers and related wholesale transactions, Retail CBDC is an electronic version of cash primarily meant for retail transactions.
As mentioned earlier that RBI has already launched two pilots, one for launch of digital rupee in wholesale segment and one for digital rupee in retail segment, on 1.11.2022 and 1.12.2022 respectively.
ii) Model for issuance and usage of CBDC:
There are two models for issuance and management of CBDCs viz. Direct model (Single Tier model) and Indirect model (Two-Tier model). A Direct model is the one where the central bank is responsible for managing all aspects of the CBDC system viz. issuance, account-keeping and transaction verification. In an Indirect model, central bank and other intermediaries (banks and any other service providers), each play their respective role. In this model central bank issues CBDC to consumers indirectly through intermediaries (banks) and any claim by consumers is managed by the intermediary as the central bank only handles wholesale payments to intermediaries.
The Indirect model is akin to the current physical currency management system wherein banks manage activities like distribution of notes to public, account-keeping, adherence of requirement related to know- your-customer (KYC) and anti-money laundering and countering the terrorism of financing (AML/CFT) checks, transaction verification etc.
The RBI has opted for the Indirect Model for issuance and usage of digital rupee in retail segment and has clarified that such digital rupee would be distributed through intermediaries, i.e., banks. Users will be able to transact with e₹-R through a digital wallet offered by the participating banks and stored on mobile phones/devices.
iii) Forms of CBDCs:
CBDC can be structured as ‘token-based’ or ‘account-based’. (iv) A token-based CBDC system would involve a type of digital token issued by and representing a claim on the central bank and would effectively function as the digital equivalent of a banknote that could be transferred electronically from one holder to another. A token-based CBDC is a bearer- instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them. In contrast, an account-based system would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances.
The RBI has opted for the ‘token-based’ form for issuance and usage of digital rupee in retail segment and has clarified that the e₹-R would be in the form of a digital token that represents legal tender. It would be issued in the same denominations that paper currency and coins are currently issued. It would be a fungible legal tender for which holders need not have a bank account.
iv) Technology Choice:
The infrastructure of CBDCs can be on a conventional centrally controlled database or on Distributed Ledger Technology. The Concept paper has clarified that while crystallising the design choices in the initial stages, the technological considerations may be kept flexible and open-ended in order to incorporate the changing needs based on the evolution of the technological aspects of CBDCs.
v) Instrument Design:
CBDCs can be structured as ‘remunerated’ i.e., interest bearing or ‘non-remunerated’ i.e., non-interest bearing. The RBI has chosen the non-interest bearing design for digital rupee and has clarified that as in the case of cash, it will not earn any interest and can be converted to other forms of money, like deposits with banks.
vi) Degree of Anonymity:
In its Concept Paper, RBI has clarified that for CBDC to play the role as a medium of exchange, it needs to incorporate all the features that physical currency represents including anonymity, universality, and finality. Ensuring anonymity for a digital currency particularly represents a challenge, as all digital transactions would leave some trail or digital footprint. In this regard, reasonable anonymity for small value transactions akin to anonymity associated with physical cash may be a desirable option for digital rupee in retail segment.
So Friends, based on our above discussion, I am tempted to infer that this newly launched avatar of digital rupee, more particularly in the retail segment, supposedly, carries with it, all the essential characteristic features of physical currency or cash. Like the physical currency or cash, the Central Bank- RBI will issue it, and it would be distributed through intermediaries, i.e., banks. It would be in the form of a digital token and not account based and as such it would be different from the electronic bank balance in current/saving bank accounts. It would be a fungible legal tender for which holders need not have a bank account.
It would be issued in the same denominations that paper currency and coins are currently issued. Users will be able to transact with e₹-R through a digital wallet offered by the participating banks and stored on mobile phones/devices, and a reasonable degree of anonymity will also be provided in the transactions involving such digital rupee. And unlike your saving bank account balance, it will not earn any interest income.
And so, the fact that this digital rupee, although nomenclatured as ‘digital’, but infact resembles or is akin to physical currency or cash, may bring the financial transactions involving the usage of such digital rupee, within the realms and ambit of the restricted/prohibited category of cash transactions, in the Income Tax Act, under following ‘audit-popular’ sections like:
a) Section 40A(3) providing for 100% disallowance of any expenditure payment made in cash in excess of Rs 10,000/-.
b) Section 43 providing for 100% disallowance of depreciation on any capital expenditure in excess of Rs. 10,000/- for the purpose of its consideration as actual cost of such asset.
c) Section 269SS prohibiting a taxpayer from taking/accepting loans or deposits for a sum of more than Rs.20,000 in cash, and consequential penalty equivalent to such cash loan or deposit.
d) Section 269T prohibiting a taxpayer from repaying any loans or deposits for a sum of more than Rs.20,000 in cash, and consequential penalty equivalent to such cash loan or deposit.
d) Section 269ST stipulating that no person can receive an amount of INR 2 Lakhs or more in cash:
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in aggregate from a person in a day;
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in respect of a single transaction; or
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in respect of transactions relating to one event or occasion from a person.
e) Section 271DA providing for levy of penalty equivalent to the amount of such cash receipt in excess of Rs 2 lakhs.
f) Donations made in cash in excess of Rs. 2,000/- to a registered trust or a political party, are not allowed as deduction u/s 80G.
g) Any payment made in cash on account of premium on health insurance facilities is not allowable as deduction u/s 80D.
h) Deduction of TDS u/s 194N @ 2% on cash withdrawals ranging from Rs. 20 lakhs to one crore, in cases of non return filers for last three years and @ 5% on cash withdrawals in excess of Rs 1 crore in a year from bank account.
i) Non availability of Tax Audit relaxation of higher threshold turnover limit of Rs 10 crores, if total payments and receipts of a business are in excess of 5% of total payments and receipts.
And the irony would be that the users may not be knowing that the usage of digital rupee by them in undertaking such specified restricted financial transactions, may actually be treated and considered as cash transactions, in the Income Tax Act.
Thus, unless and until, the usage of the digital rupee in the above specified restricted categories of financial transactions, is categorically prescribed by the Legislature in the Income Tax Act, as an acceptable digital mode of executing such transactions, like the electronic clearing system or UPI presently, there is a serious and eminent cause of worry and concern, that all the above discussed penal provisions in the Income Tax Act, pertaining to cash transactions, would be equally applicable to all such transactions involving the usage of digital rupee. Further, the capturing, identification and scrutiny of all such financial transactions will surely become more easier as the digital rupee will inevitably leave its digital footprints, whether or not, any degree of anonymity is being provided to it.
So, ironically, the well-intended measures of RBI, to make the digital rupee akin or similar to the physical currency or cash, may result in unintended consequences of attracting the above specified penal income tax provisions applicable in respect of the specified restricted/prohibited cash transactions, and as such the digital rupee may eventually turn out to be a costlier proposition from the taxation point of view.
This Article has also been published in Taxmann with the Citation [2022] 145 taxmann.com 343 (Article)
