Aditya Ajgaonkar, Advocate

The last decade has seen an explosion in the world of technology saturated with innovation that is the direct result of accessible computational power in the hands of ordinary people spurring a technological revolution. The mobile phone as of today is a magical device that not only is used for making and receiving calls but as percolated down to our day-to-day lives. The facilities that are now available by the proliferation of technology could not be imaginable just a few years back. But just as technology has the power to be used it is also susceptible to abuse. Virtual Digital Assets (VDAs), being the product of technology similarly lends themselves to the intention of the users.

Section 2 (47A) of the Income-tax Act, 1961 defines VDAs. It reads as follows:

“Virtual digital asset” means—

(a) any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically;

(b) a non-fungible token or any other token of similar nature, by whatever name called;

(c) any other digital asset, as the Central Government may, by notification in the Official Gazette specify:

Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein.

Explanation. — For the purposes of this clause, —

(a) “non-fungible token” means such digital asset as the Central Government may, by notification in the Official Gazette, specify;

(b) the expressions “currency”, “foreign currency” and “Indian currency” shall have the same meanings as respectively assigned to them in clauses (h), (m) and (q) of section 2 of the Foreign Exchange Management Act, 1999 (42 of 1999);]

Though the legal status of VDAs is still precarious, the government has in the last few years chosen to go in for regulation rather than an outright ban. Section 194 (s) of the Income-tax Act imposes the responsibility for deduction of tax at source, on the transfer of VDAs and section 115 (BBH) provides for tax on VDAs at a flat rate of 30 per cent. Moving beyond the Income-tax Act, recently the 7th march notification of the Ministry of Finance has brought VDAs within the ambit of the anti-money laundering laws. The headline that this notification brings VDAs into the ambit of the PMLA can be a bit confusing as most people tend to view the Prevention of Money Laundering Act,2002 (PMLA) as a criminal legislation. The Supreme Court in the case of Vijay Madanlal Choudhary v. Union of India 2022 SCC Online SC 929 has explained that the Prevention of Money Laundering Act, 2002 is not only a law to investigate and punish the crime of money laundering but also to carry out the essential function of the ‘prevention’ of the activity of money laundering. An essential function of preventing money laundering would be gathering of financial intelligence. This is where the Financial Intelligence Unit- India (FIU-IND) plays a pivotal role.

The FIU-IND as per its website, is the central, national agency responsible for receiving, processing, analysing and disseminating information relating to suspected financial transactions. It is also responsible for coordinating and strengthening efforts of national and international intelligence, investigation, and enforcement agencies in pursuing the global effort against money laundering and financing terrorism. While the Directorate investigates the offence of money laundering and prosecutes offenders under the PMLA the FIU-IND held in the prevention of the activity of money laundering by gathering financial intelligence through compliance. The main function of FIU-IND is to receive cash and suspicious transaction reports, analyse them and as appropriate, disseminate valuable financial information to Intelligence/Enforcement Agencies and Regulatory Authorities. The functions of FIUIND are:

  • Collection of Information
  • Analysis of Information
  • Sharing of Information
  • Act as Central Repository
  • Coordination
  • Research and Analysis

Due to the inherent nature of VDAs, the lack of regulation can pose a significant risk to national security and society as there is a high possibility that they can be used for illicit activities. Cryptocurrencies, Nonfungible Tokens (NFTs) etc. were created to be anonymous and easily transferable, making them susceptible to be used for activities such as drug, human and arms trafficking. The virtual nature of these VDAs makes them highly transferrable and due to the lack of a necessity for physical medium of transfer moneys worth can be transferred across large geographic distances instantly. The concerns of a government with the nature of these VDAs are not too far to seek. There have been uncertainties associated with the acceptance and legality of these VDAs for quite a while in India. While the government pondered on the pros and cons of allowing such VDAs to exist, they went mainstream, especially in the form of crypto currency. It did not take long for NFTs to follow. A significant number of persons in India have sought to cash in on the surging VDA marketplace. The forgone conclusion, therefore, is that if VDAs are not to be banned, the regulation of this industry would have to necessarily follow.

The 7th march notification of the Ministry of Finance puts certain activities when carried out for or on behalf of another natural or legal person in the course of business that carry out the activities of exchange between VDAs and fiat currencies, exchange between one or more forms of VDAs, transfer of VDAs, safekeeping or administration of VDAS or instruments enabling control over VDAs and participation and provision of financial services related to an issuer ‘s offer and sale of a VDA as a ‘designated business or professions’.

Section 2(1) (sa) of the PMLA defines “ person carrying on designated business or profession ” as follows:

  1. A person carrying on activities for playing games of chance for cash or kind, and includes such activities associated with casino;
  2. Inspector-General of Registration appointed under section 3 of the Registration Act, 1908 (16 of 1908) as may be notified by the Central Government;]
  3. Real estate agent, as may be notified by the Central Government;
  4. Dealer in precious metals, precious stones and other high value goods, as may be notified by the Central Government;
  5. Person engaged in safekeeping and administration of cash and liquid securities on behalf of other persons, as, may be notified by the Central Government; or
  6. Person carrying on such other activities as the Central Government may, by notification, so designate, from time to time;

It can therefore be seen that being notified as a person carrying on designated business or profession puts the notified activities concerning VDAs on a similar footing to entities like banking companies, financial institutions/intermediaries, casinos, real estate agents, dealers in precious metals, precious stones etc. the list of designated business or professions is telling these are historically those sectors that have been used by the wealthy to park their funds. Such persons carrying on designated business or profession are included within the ambit of definition of reporting entities as defined under Section 2 [(wa) “reporting entity” means a banking company, financial institution, intermediary or a person carrying on a designated business or profession;]

Section 12 of the PMLA requires every reporting entity to:

  • maintain a record of all transactions (five years from the date of the transaction between a client and the reporting entity), including information relating to transactions covered under clause (b), in such manner as to enable it to reconstruct individual transactions;
  • furnish to the Director within such time as may be prescribed, information relating to such transactions, whether attempted or executed, the nature and value of which may be prescribed;
  • maintain a record of documents (five years after the business relationship between a client and the reporting entity has ended or the account has been closed, whichever is later) evidencing the identity of its clients and beneficial owners as well as account files and business correspondence relating to its clients.

While Section 12 AA of the PMLA deals with enhanced due diligence for specified transactions, Section 13 provides the Director with the power to impose fines and get an audit or records as specified done by a Chartered Accountant on the Government Panel. Section 13 reads as under:

Powers of director to impose fine.

13. (1) The Director may, either of his own motion or on an application made by any authority, officer or person, [make such inquiry or cause such inquiry to be made, as he thinks fit to be necessary, with regard to the obligations of the reporting entity, under this Chapter].

[(1A) If at any stage of inquiry or any other proceedings before him, the Director having regard to the nature and complexity of the case, is of the opinion that it is necessary to do so, he may direct the concerned reporting entity to get its records, as may be specified, audited by an accountant from amongst a panel of accountants, maintained by the Central Government for this purpose.

(1B) The expenses of, and incidental to, any audit under sub-section (1A) shall be borne by the Central Government.]

[(2) If the Director, in the course of any inquiry, finds that a reporting entity or its designated director on the Board or any of its employees has failed to comply with the obligations under this Chapter, then, without prejudice to any other action that may be taken under any other provisions of this Act, he may—

  1. issue a warning in writing; or
  2. direct such reporting entity or its designated director on the Board or any of its employees, to comply with specific instructions; or
  3. direct such reporting entity or its designated director on the Board or any of its employees, to send reports at such interval as may be prescribed on the measures it is taking; or
  4. by an order, impose a monetary penalty on such reporting entity or its designated director on the Board or any of its employees, which shall not be less than ten thousand rupees but may extend to one lakh rupees for each failure.]

(3) The Director shall forward a copy of the order passed under sub-section (2) to every banking company, financial institution or intermediary or person who is a party to the proceedings under that sub-section.

[Explanation.—For the purpose of this section, “accountant” shall mean a chartered accountant within the meaning of the Chartered Accountants Act, 1949 (38 of 1949).]

It can be clearly seen that Section 13 contemplates that in case of non-compliance with the reporting obligations, the Director has multiple powers including issuing a warning, directing compliance as well as imposing a fine. The criminal prosecution of the financial intermediary for non-compliance with reporting obligations does not seem to be contemplated by Section 13. In fact, Section 14 of the PMLA states “Save as otherwise provided in section 13, the reporting entity, its directors and employees shall not be liable to any civil or criminal proceedings against them for furnishing information under clause (b) of sub-section (1) of section 12.]” . Therefore, the Act also protects the reporting entity from civil and criminal action in discharge of its reporting obligations. Section 14 of the PMLA would not grant immunity to the reporting entity if it is accused of being involved in the activity of money laundering as the protection is explicitly for ‘furnishing informaton’. One may conclude that the failure to comply with reporting requirements shall result in a warning, a direction to comply or a fine being imposed, however, no criminal prosecution is attracted unless it can be shown that the reporting entity was involved in the offense of money laundering.

Concerns seem to have been raised as to whether mining/creating or dealing in Cryptocurrencies, NFTs and other VDAs would attract the offense of money laundering. It is important to note that the 7th March Modification has not made any changes to the schedule under the PMLA. The commission of a scheduled offense is the sine qua non for the provisions of the PMLA to be applicable. It is also important to note that the insertion or deletion of offenses into or from the schedule can only be done by an amending Act of the parliament. Therefore, simplicitor trading in or creating VDAs would not by itself tantamount to an offense under PMLA unless it can be brought out that either doing so gave rise to a scheduled offense or that doing so is connected with the proceeds of crime as contemplated by Section 3 of the Act.

The Indian Government has had a rocky relationship with VDAs, especially cryptocurrencies. They posed a technological challenge and were widely unregulated and unknown. In 2018, after multiple warnings, the Reserve Bank of India had sought to indirectly ban cryptocurrencies and the enabling platforms by asking the banking system not to provide services to them. The Supreme Court in Internet & Mobile Association of India v. RBI (2020) 10 SCC 274 has held that “It is no doubt true that RBI has very wide powers not only in view of the statutory scheme of the three enactments indicated earlier, but also in view of the special place and role that it has in the economy of the country. These powers can be exercised both in the form of preventive as well as curative measures. But the availability of power is different from the manner and extent to which it can be exercised. While we have recognised elsewhere in this order, the power of RBI to take a pre-emptive action, we are testing in this part of the order the proportionality of such measure, for the determination of which RBI needs to show at least some semblance of any damage suffered by its regulated entities. But there is none. When the consistent stand of RBI is that they have not banned Virtual Cureencies and when the Government of India is unable to take a call despite several committees coming up with several proposals including two draft Bills, both of which advocated exactly opposite positions, it is not possible for us to hold that the impugned measure is proportionate”. The Circular dated 06-04-2018 was set aside.

The Indian government has been undecided over the years with respect to VDAs. In the recent years, it seems to have opted for increasing scrutiny over these VDAs but has stopped short of an outright legislative ban. RBI has from time to time expressed its apprehensions about VDAs in the form of cryptocurrencies. In this backdrop, regulation for VDAs should be welcome to genuine investors as opposed to an outright ban by the government. Though dealing in VDAs would not by itself constitute the offense of money laundering but these reporting requirements will help the government fulfil its international obligations to combat money laundering. The Financial Action Task Force (FATF) has issued global standards to prevent the misuse of virtual assets for money laundering and financing terrorism with support from the G20. An unregulated VDA market can pose a danger to public order as well as the sovereignty of the country due to its scope for abuse. As an added plus for the government, these compliances may also help to tighten the tax with regards to these VDAs. This measure of the Government of India may cause some difficulty to the intermediaries who have had reporting obligations thrust upon them but it shall held reduce tax evasion and money laundering. More importantly, regulation seems to be the only way that the VDAs remain legal in India and is the way towards the future.

One is the war we wage against injustice and the other we fight against our own weaknesses.

– Sardar Vallabhbhai Patel