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ACCOUNTING OF REVENUE GENERATED FROM SALE OF NFTs: REGULATORY BLIND SPOT

Author: Kannu Upadhyaya, V year of B.A.,LL.B.(Hons.) from SVKM's NMIMS School of Law, Mumbai


We cannot start a discussion on Non Fungible Token (NFT) without talking through what it actually means. A NFT in simplest terms is a cryptographic asset backed with an unique identification number generated through blockchain network which allows the user to buy rare digital artifacts. As of now the concept is mostly applied to collectible arts. NFTs are becoming a popular platform for Indian artist to sell their art and generate revenue. Recently, from indie pop iconRitviz to legendary actor Amitabh Bachchanto captain of Indian Cricket team, Rohit Sharma made it to the news selling their NFTs for a whopping consideration as high as Seven Crore Indian Rupees[1]. Even the NFT backed cryptocurrency, like MANA, ENJ and similar sorts are all trading at an all-time high.The world’s largest platform for selling NFTs, OpenSea, saw trade volume surge 950% in the last 30 days to hit $1.22 billion[2]. With everyone jumping in the sea of NFT it's hard not to question the accounting of revenue generate through sale of NFT for the purpose of taxation.


At present there are no accounting standards or statutory provisions specifically governing the accounting of revenue generate from saleof NFTs but it is pretty evident that revenue from sale of NFT would be a capital gain and hence would fall under income arising from capital receipts and not revenue receipts. The general principle of taxability of receipts under the Income Tax Act, 1960 (IT Act) is to tax income and not receipts[3] and hence as general principle capital receipts are not taxed unless specifically provided for under section 45 of the IT Act. Section 45 of the IT Act contemplates that “any profits or gains arising from the transfer of a capital asset affected in the previous year will be chargeable to income-tax under the head Capital Gains”. First question that arrives in mind after reading the definition is what constitutes capital assets. In light of section 2(14) of the IT Act capital asset means“property of any kind held by an assesses, whether or not connected with his business or profession”. The definition provided by the legislature is wide enough to encompasses almost all types of assets. For the purpose of taxation the Act further classifies assets into two sub categories of tangible and intangible assets. Revenue arising from intangible asset has always been a question of deliberation among the circle because, With the increasing complexities of business structures and ever growing technology many new varieties of intangible assets keeps popping up and revenue from sale arising out of novel intangible digital assets, like NFT, consumer list and similar sorts end up escaping taxation altogether.It cannot also be denied,for all practical purposes that the Act cannot contemplate all types of capital receipts that would accrue; hence parliament keeps updating the Act to include new categories of intangible assets. Section 92(B) of the IT Act provides a list of intangible assets that in turn might help the assessors to determine what “transfer of capital asset” under section 45 of the IT Act would mean. However it is pertinent to note here that Section 92(B) of IT Act only provides an idea or helps in interpretation as this section applies to transfer pricing and not receipts particularly.


Since there is no statutory and judicial authority to regulate capital receipts arising out of sale of NFT. It brings us to an imperative issue, that whether in absence of any regulation how cana capital receipts transfer arising out of sale of NFT be valued or assessed for taxation. To better rephrases the last sentence and narrow down the scope even more, can the present jurisprudence of Section 45 of the IT Act assessa capital receipt arising out of sale of NFT. Section 45 of the IT Act mandates that two conditions must be satisfied in any transaction of a capital nature in order to lead to taxation under head of capital gain. Foremost, that the transaction must lead to transfer of capital asset, either by sale or exchange or relinquishment of right or any asset or by compulsory acquisition under any law. Second, capital gains shall be determined in accordance with a formula as envisaged under Section 48 of the IT Acti.e. capital gains equals to sale consideration, less cost of acquisition less cost of improvements.


With respect to NFT being a self-generated asset it becomes nearly impossible to determine, cost of acquisition and without cost of acquisition no capital gain arises. The Hon’ble Supreme Court in case of PNB Finance ltd v/s. CIT[4] while citing a previous judgment of itself in CIT v/s B.C. Srinivas Shetty[5] held that all transactions as encompassed by section 45 of the IT Act on which capital computation of capital gains as provided under Section 48 of the IT Act i.e., capital gains equal to sale consideration, less cost of acquisition less cost of improvements, could not be applied, it must be regarded as “never intended as Section 45 to be a subject of charge”.


Till now, the only limited power that the government can exercise to charge tax on capital receipt arising out of sale of NFT is through the assessor as he can invoke the “substance over form” test. The underlying assumption in applying substance over form test is that the transaction engaged by a person or business entity should not hide its true intent[6]. When it comes to NFT the intent can be excessively hard to determine as none of the companies and/or individuals are engaged in the business of selling or buying collectibles NFTs.In addition, the Government very recently introduced General Anti Avoidance Regulation (GAAR), to deal with particularly those transaction which are entered into by entities, with sole purpose of tax avoidance. GAAR could be very difficult to implement in case of NFT as it applies only on transactions with a commercial purpose. In case of Buying and selling of NFT it becomes nearly impossible to ascertain a commercial purpose as it's a one off transaction having a bonafide purpose. The Government of India has recently proposed to bring forward The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 which inter alia seeks to prohibit all private cryptocurrencies in India. The bill can be a powerful tool to bring forth the regulation or some sort of clarity in buying and selling of collectibles NFT. Alternatively in the upcoming budget of 2022,IT Act can be also be amended to bring in NFTs or cryptocurrency backed assets as intangible assets. Currently there exists no clarity on taxation of income from sale of NFTs and Government is also losing on huge tax revenue. It would be interesting to observe what steps the Government takes to regulate revenue generation.

[1]CNBC TV 18, December 2021, https://www.cnbctv18.com/cryptocurrency/from-amitabh-bachchan-to-salman-khan-why-are-indian-celebrities-clamouring-to-release-nfts-11930422.htm [2]Gill, Business Insider, India, https://www.businessinsider.in/investment/news/openseas-nft-trade-quadruples-to-10-billion-in-under-three-months-but-axie-infinity-continues-to-be-the-crowd-favourite/articleshow/87609137.cms [3]Smarak Swain, Loophole Games, Commercial law publisher (India) Pvt. Ltd. [4]PNB Finance ltd v/s. CIT, 2008 13 SCC 94 [5]CIT v/s B.C. Srinivas Shetty, 1981 AIR 972 [6]Natrajh Ramakrishna, Substance over form, BSCA Online, https://www.bcasonline.org/BCAJ%20Golden%20Content%202018-19/Articles/Jul%202018/43%20-%2048%20Article%20substance%20form.pdf