How the Indian Income Tax Department Tracks Crypto

The Income Tax Department (ITD) employs a multi-pronged approach to track transactions involving Virtual Digital Assets (VDAs) within India and by Indian residents globally. This comprehensive surveillance framework leverages various statutory provisions, regulatory mandates, and technological capabilities to ensure compliance with the Indian Income Tax Act and other relevant financial regulations.

Tax Deducted at Source (TDS) on VDA Transfers

One of the primary mechanisms for the ITD to gain visibility into VDA transactions is through the implementation of Tax Deducted at Source (TDS) under Section 194S of the Income Tax Act, 1961. This provision mandates the deduction of TDS at the rate of 1% on the consideration paid for the transfer of a VDA.

• Applicability: The TDS provision applies to all transfers of VDAs, irrespective of whether the consideration is paid in fiat currency or another VDA.
• Payer's Responsibility: The responsibility for deducting TDS lies with the person paying the consideration. In scenarios involving VDA exchanges, the exchange is typically responsible for deducting TDS. For peer-to-peer (P2P) transactions, the buyer of the VDA is obligated to deduct TDS and remit it to the government exchequer.
• PAN Linkage: Deduction of TDS necessitates the Permanent Account Number (PAN) of the transferor (seller). This directly links the transaction data to an identifiable taxpayer.
• Form 26AS: The TDS deducted and deposited is reflected in the seller's Form 26AS, providing a direct trail for the ITD to monitor VDA transaction volumes against declared income. Non-compliance by the buyer in P2P transactions can lead to penalties and disallowance of expenses.

Financial Intelligence Unit - India (FIU-IND) Reporting

The Ministry of Finance, under the Prevention of Money Laundering Act (PMLA), 2002, has officially designated VDA activities as "reporting entities." This brings VDA Service Providers (VASPs), including exchanges, custodians, and wallet providers, under the purview of FIU-IND.

• Reporting Entities (REs): Entities facilitating VDA transactions are mandated to register with FIU-IND and comply with stringent reporting requirements.
• Types of Reports: These REs are required to file various reports, including Suspicious Transaction Reports (STRs), Cash Transaction Reports (CTRs) for transactions exceeding prescribed thresholds, and Cross-Border Wire Transfer Reports (CBWTRs) for international remittances.
• Data Sharing: Information collected by FIU-IND is shared with various law enforcement agencies, including the Income Tax Department, to identify potential tax evasion, money laundering, and terror financing activities related to VDAs.

Income Tax Return (ITR) Disclosures

The ITD relies on mandatory self-disclosure by taxpayers in their Income Tax Returns (ITR).

• VDA Income Declaration: Taxpayers are required to declare income arising from the transfer of VDAs. Such income is taxed at a flat rate of 30% under Section 115BBH of the Income Tax Act, with no deduction allowed for any expenditure (other than the cost of acquisition) or allowance, and no set-off of losses from VDA transfers against any other income.
• Foreign Assets (Schedule FA): For Indian residents holding VDAs on foreign exchanges or in foreign wallets, disclosure is mandated in Schedule FA (Foreign Assets) of the ITR. This requires reporting details of all foreign financial assets, including VDAs held outside India. Failure to report foreign assets can lead to severe penalties under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.
• Capital Gains/Business Income: Depending on the frequency and nature of VDA transactions, income may be classified as capital gains or business income. The ITD scrutinizes ITRs to ensure accurate classification and reporting.

Information Exchange Agreements and International Cooperation

The ITD leverages international tax treaties and agreements for the exchange of information to track VDA holdings and transactions by Indian residents in foreign jurisdictions.

• Common Reporting Standard (CRS): While VDAs are not yet explicitly part of the CRS framework, the broader intent of international financial information exchange allows tax authorities to request information from partner jurisdictions concerning assets held by their residents.
• Requests for Information: The ITD can issue specific requests for information to foreign tax authorities if it suspects that an Indian resident is holding undeclared VDA assets abroad.

Data Analytics and Blockchain Forensics

The ITD and associated agencies increasingly utilize advanced data analytics tools and blockchain forensics to monitor VDA transactions.

• On-chain Analysis: Publicly available blockchain data can be analyzed to trace transaction flows, identify large transfers, and potentially link wallet addresses to known entities or individuals through cross-referencing with off-chain data.
• Cross-referencing: Transaction data from TDS filings, FIU-IND reports, and ITR declarations are cross-referenced with bank account statements, PAN data, and other financial footprints to detect discrepancies and inconsistencies. Artificial Intelligence and machine learning algorithms are deployed to identify suspicious patterns and anomalies.

Banking Channel Surveillance

Traditional banking channels serve as crucial gateways for fiat-to-crypto and crypto-to-fiat conversions, providing additional points of surveillance.

• Bank Reporting: Banks are mandated to report large cash transactions or suspicious transactions to FIU-IND. Any significant fiat transactions to or from VDA platforms trigger scrutiny.
• Linkage to Accounts: The ITD can access bank statements and scrutinize transactions linked to VDA exchanges or P2P trades, identifying individuals involved in substantial VDA activities.

Enforcement Actions and Notices

Based on information gathered through the aforementioned channels, the ITD initiates enforcement actions.

• Notices and Summons: The Department routinely issues notices under Section 133(6) (power to call for information) or Section 142(1) (inquiry before assessment) of the Income Tax Act to individuals suspected of VDA transactions or holdings. These notices compel taxpayers to provide details of their VDA activities, including acquisition cost, sale proceeds, transaction dates, and wallet addresses.
• Assessments and Re-assessments: Discrepancies between declared income and information obtained from various sources can lead to re-assessments, imposition of penalties, and prosecution for tax evasion.