Does Govt's Move To Tax Crypto Assets Mean Legalisation? Not Necessarily

Courts have held that even income from illegal activities can be taxed, so 30% tax in Budget 2022 is inconclusive.

5 min read
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Edited By :Tejas Harad

One of the big announcements of Union Budget 2022 was that the government plans to tax transfers of 'virtual digital assets' like cryptocurrency at the rate of 30 percent.

Finance Minister Nirmala Sitharaman announced in her speech to Parliament on Tuesday, 1 February, that there "has been a phenomenal increase in transactions in virtual digital assets. The magnitude and frequency of these transactions have made it imperative to provide for a specific tax regime."

The proposal would include TDS of 1 percent on payments above a certain threshold, and taxation of gifts in the hands of the recipient as well. Losses from transfer of virtual digital assets cannot be set off against other income.

This proposal has created some amount of confusion since the Centre has previously indicated that it wants to prohibit all private cryptocurrencies in India barring some exceptions.

The order of business for last year's Winter Session of Parliament included a Cryptocurrency and Regulation of Official Digital Currency Bill, that was described as seeking "to prohibit all private cryptocurrencies in India."

While this bill was not finally introduced, a 2019 draft of the bill included provisions to ban the mining, holding, selling, trade or even use of any private cryptocurrency in the country.

But if the government is planning to tax transfers of cryptocurrency assets (which would fall within the definition of virtual digital assets, as would NFTs), does this mean the Modi government has changed its mind and is no longer going to ban trading in private cryptocurrencies?

While that may seem logical, it's not necessarily the case. This is because of a curious feature of tax law, where even income earned from illegal activity can still be taxed by the government.

What Courts Have Held in the Past

There are a number of judgments from Indian high courts and even a few from the Supreme Court which acknowledge that income earned from illegal activity is still taxable, and that the revenue authorities can send a person a tax notice for them.

However, most of these cases don't actually involve any challenge to the idea that income from illegal activities can be taxed.

Instead, quite amusingly, most of them deal with requests by the person who committed the illegal activity asking to be allowed to deduct expenses and offset losses that went into the illegal enterprise, like money spent on bribes or the amount of money confiscated when trying to carry out a cross-border gold smuggling operation!

While this may seem bizarre, the courts have actually held that those losses and deductions should be allowed as they spring directly from the business whose proceeds are being taxed and are incidental to them.

In very few cases have the courts had to deal with a challenge from the offender to the assessment of income tax from their illegal activities. One such case was Commissioner of Income Tax vs K Thangamani, decided by the Madras High Court in 2008.

In that case, a tax consultant had been claiming and receiving income tax refunds by filing bogus TDS certificates. After an inquiry by the Income Tax Department, he was assessed for tax on the money he'd made through this scam.

The Madras High Court went through the Supreme Court judgments dealing with deductions and expenses, and case law from the United Kingdom which had delved into the question a bit further.

Eventually, it confirmed that income from illegal activities could be taxed, explaining that the income tax authorities are not concerned with the manner or means of acquiring income.

"Illegality tainted with the earning has no bearing on its taxability," the judgment says. The division bench rebutted the idea that if a person pays tax on income from an illegal activity, the State becomes a party to the offence, which the Irish courts had considered to be a reason the income can't be taxed, explaining:

"In case of allowing such income to escape the tax net would be nothing but a premium or reward to a person for doing an illegal trade. In the event of taxing the income of only those who acquired the same through legal manner, the tendency of those who acquired income by illegal means would increase."

The judges noted that the Income Tax Act's definition of income looks at all the income a person has earned, regardless of where it has come from, and indeed specifies which things cannot be considered income – money from illegal activities is not one of them. "There is nothing like an illegal income so far as the Tax Collector is concerned," they explained.

So Trading in Cryptocurrencies Could Still Be Banned by the Govt?

The current legal position in India is therefore quite clear, that taxability and legality have no connection. At this point, therefore, the inclusion of this budget proposal doesn't give us any indication of what the Centre is going to do about cryptocurrency trading going forward.

The Economic Times reports that the cryptocurrency regulation bill is unlikely to be introduced during the ongoing Budget Session of Parliament, so full clarity on that may take a while.

In terms of the taxation issue, though, there may be scope to revisit this slightly strange position in the future, maybe using the issue of taxation of crypto trades, as even in cases like the Thangamani one, the arguments were not particularly extensive.

It is possible that if cryptocurrencies are banned, it could be argued that any earnings from trade in them should not be taxable, using more innovative arguments. For instance, it could be argued that this violates the right against self-incrimination as a person would technically need to declare such income in their tax returns.


The United States Supreme Court has actually held that legislations that seek to tax specific illegal activity would violate the right against self-incrimination in United States v. Leary, (1969 - possession of marijuana); Haynes v. United States, (1968 - possession of a sawed-off shotgun); and Grosso v. United States, (1968 - wagering).

There is even a US Supreme Court case which held that taxation of an illegal activity can, in some circumstances, amount to double jeopardy, since it means being punished twice for the same crime.

The Indian courts are still likely to hold that any such income is taxable, but at the very least, there might be some amusing cases about what will count as a valid deduction in such matters.

The finance minister explained in Parliament on Tuesday that only costs of acquisition will be considered a valid expenditure for deductions, but this could potentially include expenses for VPNs or to smuggle in a mining rig.

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