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One of the arguments of Bitcoin community is that the fiat currencies which carry the backing of a Government are being produced without any consideration to the inflationary aspects. After the de-linking of the Gold standard, the supply of fiat currency has become an administrative decision of the political party in power. With deficit budgeting being the order of the day, each year large quantities of currency are simply printed out from the Government mints and released to the market. Additionally, in countries like India, fake currencies printed in Pakistan also enter circulation. As a result the inflation becomes uncontrollable.

The latest development in India that adds to this inflationary push is the decision of the Aam Admi Party (AAP) in Delhi to provide electricity subsidy. So far other political parties have been doling out TVs, laptops, free power to agriculturists etc. Now AAP has introduced competitive sop distribution to the cities also. This will be as dangerous as the policy of division of the society based on castes with Mr V.P.Singh introduced into the Indian politics.

With some Congress members demanding a similar subsidy in Mumbai, it is likely that many other Governments may consider free power as a part other political agenda. With the Lok Sabha elections due in 2014, it is expected that there will be many more Sops announced by ruling parties in all states to attract the voters.

Already the populist schemes such as the Food Security Bill has drained the resources of the Government completely. Now with the fresh bout of sops for the urban population spearheaded by AAP, the supply side of currencies is completely under political influence and there is no limit to the new stock of currencies that will reach the Indian markets by 2015.

In this context the Crypto Currency system which comes with a cap on the total stock assumes a special value.  However it must be remembered that while each crypto currency comes with a cap dictated by the respective protocol, there could be no limit on the number of Crypto coins that may come into the market. However it is not going to be easy for different crypto coins to gain the critical acceptability of the community to gain in status as a credible currency. Bitcoins which has already established a certain level of credibility has only 9 million more units to be mined across the globe. This “limitation” may itself contribute significantly to the increase in the value of Bitcoins in the coming days.

Naavi

One of the doubts that the Bitcoin community in India face is its taxability. They wonder how will the Income Tax department treat Bitcoin transactions for tax purpose.

While it is the prerogative of the Income Tax department to interpret the taxability in whatever manner they think fit, our views on the same are as follows.

1. A Merchant receiving Bitcoins as revenue:

When a merchant receives Bitcoins either online or offline in exchange of his services, the Bitcoins will become part of his revenue. In the event he converts it into Rupees before the end of the financial year, the realized value may be booked just like any rupee sales.

If there is a  time gap between the date of sale and the date of conversion, the value of the Bitcoin might have varied during this period and it is open to the IT (Income Tax) department to treat the value on the date of sale as the realized sale proceeds and the difference upto the date of conversion as “investment profit/loss”. There can therefore be a business revenue and short term gain or loss on investment.

In other words, if the seller has a quote for his services in Rupees as on the date of the sale, the IT department can consider it as the “Notional Sale Value” and the difference in the  actual realized sale value as short term gain/loss.

In case the merchant does not convert the Bitcoin holding into rupees before the end of the financial year, he may declare it as an “Inventory” of “Stocks” and value it in terms of rupees using any of the exchange rates available in major Bitcoin exchanges. If IT department wants to be harsh, it may take the highest quote of the day for valuation. If they are reasonable, they may accept the weighted average price of a basket of quotes from top exchanges. The constitution of the basket needs to be decided.

The Merchants may file their returns on the basis of the US dollar quote from MtGox converting the dollar to rupee as per their Banker’s dollar purchase rate and let the department dispute the valuation if they want.

If a trader receives Bitcoins and then sells it in an exchange and realizes a foreign currency and then converts the foreign currency back to rupees, the transaction may be deemed as an “Export”. The exchange will be paying in fiat currency on behalf of the buyer though the choice of the exchange was that of the Merchant.

This transaction may have similarity to a situation where a buyer says “I will receive the goods through a courier but the Merchant can decide on which courier to use”. A delivery of goods in such case will be acceptable as a constructive delivery when the goods are handed over to the courier by a Merchant. Similarly the trader uses MtGox at his choice for exchange of Bitcoins to dollars but Mt Gox may be deemed to exchange the Bitcoins to dollars at the instance of the buyer rather than the Merchant.

2. Traders/Investors

Trading in Bitcoins is like any other commodity trading and the profits and loss are computed on the basis of cost of purchase plus related expenses and the realized or realizable value (as discussed in the previous paragraph).

If a person buys Bitcoins by paying in any currency other than Rupee, then it would amount to an “Import” of Bitcoins. To the extent Bitcoin may not be in the restricted list of imports it may be considered that the import does not require specific license. However the call has to be taken by the Authorized dealer who coverts the rupee to the foreign currency.

3. Miners

Mining of Bitcoins is deemed as a “Production Activity”. It will generate Bitcoin stocks which will have realizable value as discussed earlier. There will be a cost of production that includes direct expenses if any and the depreciation of computers and other resources used.

If the mined coins are sold, it may be either a domestic sale or an export. If it is held as inventory at the end of the financial year, then the usual rules regarding advance taxation based on the realizable value or on cash basis on sale can be adopted.

Probably more clarity will emerge as the days go by.

Naavi

The RBI advisory of 24th December 2013 has set an agenda for the Bitcoin community as to the future of Bitcoin industry in India.

The advisory was fine as far as the public was concerned since it was the duty of RBI to warn the  individual investors about the FEMA risk and the volatility risk involved in buying or selling Bitcoins.

The advisory was completely silent on the “Miners”.

The advisory was some what negative on the business entities since it hinted at a possible review of the guidelines in future.

When the advisory was followed by the ED action on two of the Ahmedabad based traders, the Advisory assumed a more threatening meaning.

The statement of the Dy.Governor of RBI, Mr K.C.Chakravarthy in Coimbatore in which he has assured that RBI is not having intentions of regulating the Bitcoins at present has eased the situation to some extent.

However, if any businessman wants to invest a couple of lakhs or more on setting up a high end mining facility or for developing a trading platform or for a VC to consider financing such ventures, the current vagueness in the RBI’s policy is not acceptable. They would like to have a more categorical statement from RBI that they consider Bitcoins as outside the laws applicable to the currencies in India either under the RBI act or Indian coinage act or Payment and Settlement act. Similarly SEBI needs to clarify that trading of Bitcoins and other crypto coins is outside its regulatory area.

At this point of time if a clarification is sought, it is unlikely that either RBI or SEBI will commit on either the acceptability or non acceptability of the cryptocoin system or its exchange platforms.

Also the industry need to always keep a watch on “Retrospective Legislation” and other players like the Income Tax authorities suddenly springing a surprise and pushing a business to the brink of a collapse.

The industry should therefore pursue its efforts to extract a clear mandatory guideline from RBI, SEBI and Income Tax authorities on how they would deal with Cryptocoins in the future.

If the guideline is considered unfair it would be necessary for the industry to approach the appropriate courts in India to seek a clarification on

a) whether the guidelines are within the powers of RBI,

b)Whether they are not an infringement of the Constitutional rights of Indians and

c) Whether they infringe on the Human Rights in general.

Such a judicial clarification is essential for the industry to raise necessary finance and  would also be good for RBI and other institutions to resolve the issue without executive responsibility.

Even while the process of getting such clarification is on, the industry can move proactively to cause the setting up of  a “Regulatory Body” and start addressing the issues raised by RBI in its advisory. This will pave the way for a favourable response from RBI when it considers responding to any query on clarifications.

If we analyse the RBI advisory then the following action points may be required.

1. Security Concerns: The web platforms that provide services for wallets and trading etc need to ensue that they adopt the best information security practices on the lines adopted by Banks and other organizations. This will require policies and procedures to be established for the purpose. It will have to meet the laws such as ITA 2000/8. It will be on the lines of the  Total Information Assurance program suggested by Naavi in the past for Banks.

2. Grievance Redressal Mechanism: Being a peer to peer system the grievances also have to be resolved by the same system. It is possible to device a means by which an “Ombudsman” can be appointed for the purpose of interacting with the public and resolving the conflicts. He can be supported by an appropriate back end support system to ensure that disputes will be resolved within the provisions available int he protocol.

3.Financial Risk due to volatility: This is the inherent nature of the commodity and will get resolved over a time. What needs to be ensured now is only following of ethical practices by operators so that public donot get mislead by tall claims. This is a public education issue and can be effectively met by an appropriate overreach program.

4. Legal Jurisdiction Issue of foreign trading platforms: At present users in India may tend to trade on foreign exchanges like MtGox or BTCChina etc because there are no such exchanges in India. Once a sophisticated exchange based in India becomes operational, the issue would be resolved. Until then just as we deal with foreign E-Commerce sites such as Amazon or E Bay, we need to manage the situation under the existing laws. By linking the approved grievance redressal mechanism to such services it is possible to address the issue.

5. AML and FEMA Issues: It is necessary to ensure compliance of available laws on AML or FEMA by the traders through appropriate policies and procedures. This is part of the Total Information Assurance program. A suitable customized techno legal information security framework for Bitcoin community (On the lines of Indian Information Security Framework- IISF proposed by Naavi earlier) can address this issue.

Thus every one of the concerns expressed by the RBI can be addressed if there is a willingness of the Bitcoin community.

Naavi’s proposition is to create a private  voluntary society to which all the Bitcoin members will get themselves accredited under a commitment of a common ethical commitment and to seek the support of RBI/SEBI/IT authorities to recognize such a body as a trustworthy ally of the regulators.

If such a program has to succeed, the body has to be insulated from vested business interests.

The business interests can however be represented by a separate agency of the business entities while the regulatory issues can be handled by the independent voluntary society.

The model is similar tot he Indian Banking system where RBI is the regulator but IBA is the industry representative. IBA takes up business interests with RBI and problems are resolved by mutual discussion.

Similarly the current business groups associated with Bitcon can be the industry representative body while the voluntary society can be formed now to take care of the regulatory concerns.

However the industry players have to whole heartedly support and participate in such a voluntary endeavour as if it is a “Self Regulating Body” of the industry. If this bottoms up approach is not initiated, there may be a possibility of a similar regulatory body being hoisted by the regulators on the industry.

In such an endeavour there will be issues that we normally see in any organization such as jockeying for power, fighting for resources, individual egos etc. If the Bitcoin community in India can effectively address all these issues and come together, then regulators would be happy to come up with an industry friendly policies at the national level.

Let’s start a debate on this idea. Suggestions from interested persons are  welcome.

Naavi

Dr K.C.Chakaravarthy, Dy Governor of RBI has always been pragmatic when it comes to security issues in the Bank. He has also been always pro-customer minded when dealing with Banking issues.

True to his reputation, he has come up with an honest admission that at this point of time RBI has no plans to come up with a regulatory framework for Bitcoins. He says that RBI is neither supporting the system or coming up with any adverse regulation. He is candid to admit ..”Whether it is legal or illegal, we don’t know”.

See details here

We hope the ED shows the same pragmatism in dealing with the raids they have already conducted.

Naavi

Related Report in domainb.com