International Tax Panorama

On 4 March 2020, the Supreme Court of India gave a historic judgement for the cryptocurrency industry by lifting ban on cryptocurrency trade in India. In essence, the order lifted the ban on trading in virtual currency, cryptocurrency, and bitcoins. 

1. Background of the case

1.1. Ban on Cryptocurrency trading by RBI 

On 6 April, 2018, the RBI, India’s Central Bank issued a circular that had virtually banned cryptocurrency trading in India. It directed that all RBI regulated entities were prohibited from providing any service in relation to virtual currencies, including those of receipt or transfer of money in accounts relating to the purchase or sale of virtual currencies.

The central bank gave the regulated entities three months to exit from its banking relationships with businesses or individuals dealing in virtual currency. The overall aim of the ban was to “ring-fence” the country’s financial system from the private virtual currencies, by making them illegal. This very circular was later challenged in the top court. 

1.2. Legal Action by the Internet and Mobile Association of India (IMAI) 

The legal action against the above mentioned circular was initiated by the Internet and Mobile Association of India (IMAI), representing various cryptocurrency exchanges. IMAI is a nonprofit organisation that works to expand and enhance India’s online and mobile value-added services sectors.

The Supreme court gave its final verdict in favour of the petitioners, through a comprehensive analysis of the moot points, as discussed in the next section. 

2. Decision of the Supreme Court

Following are the salient highlights of the decision which led the court to finally lift the ban on cryptocurrency trading. 

2.1. RBI is well within its power to deal with Virtual Currencies (VCs)

The Petitioners argued that the RBI is not within its powers to deal with, regulate or even ban VCs and VCEs. It was contended that VCs are not money or other legal tender, but only goods/commodities, falling outside the purview of the RBI Act, 1934, Banking Regulation Act, 1949 and the Payment and Settlement Systems Act, 2007. 

The court determined the issue at the following two levels: 

(i) Analysing the powers and functions of RBI and (ii) then to investigate what these 

virtual currencies really are. 

1. Analysing the powers and functions of RBI:

The Court analysed the statutory acts from which the RBI drew its power, which are RBI Act, 1934, the Banking Regulation Act, 1949 and the Payment and Settlement Systems Act, 2007. 

Under the RBI Act 1934, section 21 empowers RBI to determine the policy in relation to advances to be followed by banking companies. The determination of policy may be in (i) public interest (ii) interests of depositors or (iii) interests of the banking policy. 

Under the Payment and Settlement Systems Act, section 17 empowers RBI to issue directions to a payment system or a system participant, which, in RBI’s opinion is engaging in any act that is likely to result in systemic risk being inadequately controlled or is likely to affect the payment system, the monetary policy or the credit policy of the country. 

Section 18 of the Payment and Settlement Systems Act, 2007 further empowers RBI to issue directions to system providers or the system participants or any other person generally, to regulate the payment systems or in the interest of management or operation of any of the payment systems or in public interest. 

(ii) Legal qualification of Virtual currency (VCs) :

For the second part of the analysis the Court went to determine whether VCs is a form of currency or commodity. Here the RBI took the stance that VCs are not recognised as legal tender, but they seek to justify the impugned decisions, on the ground that VCs are capable of being used as a medium of exchange. The Court went into detail in analysing how VCs were defined (i) by regulators in different jurisdictions and (ii) by the governments and other statutory authorities of various countries, through statutory instruments and non-statutory directives and (iii) by courts of different jurisdictions.

After a prolonged analysis, the court held that the regulators and the governments of various countries are unanimous in their opinion that though virtual currencies have not acquired the status of a legal tender, they nevertheless constitute digital representations of value and that they are capable of functioning as (i) a medium of exchange and/or (ii) a unit of account and/or (iii) a store of value.

The court went on to analyse the definitions of currency under different acts, amongst which only FEMA had defined currency. However the court relied on the VCs definition under FATF Report 2014, which provides that the VCs is defined as a virtual currency without a legal tender status. Also the court said that it is not necessary for RBI’s role and power can come into play only if something has actually acquired the status of a legal tender. 

Apart from the domestic definitions, the court analysed the judicial definitions from various jurisdictions. Here various courts in different jurisdictions have identified virtual currencies to belong to different categories ranging from property to commodity to non-traditional currency to payment instrument to money to funds. As per the court, such varying definitions might have put RBI in a dilemma. So, the court ruled that VCs are capable of being used as a medium of exchange. They are akin to promissory notes, cheques, bills of exchange etc. which are also not exactly currencies but operate as valid discharge (or the creation) of a debt only between 2 persons or peer-to-peer. Therefore, it is not possible to accept the contention of the petitioners that VCs are just goods/commodities and can never be regarded as real money. 

After concluding that VCs are currencies, the court held that the RBI is well within its power to regulate them. Hence it is not possible to accept the contention of the petitioners that they are carrying on an activity over which RBI has no power statutorily. 

2.2. Impugned Circular does not prohibit trading in VCs

The court observed that the impugned circular does not entirely prohibit the use of or trading in VCs but merely directs the RBI regulated entities not to provide banking services to those engaged in the trading or facilitating the trading in VCs. RBI is well within its power to do so. The prohibition does not affect the VCs trading directly as it is against banking companies, with respect to a class of transactions.

2.3. Ban adversely affects VC Exchanges

Any restriction to the freedom guaranteed under Article 19(1)(g) should pass the test of reasonableness in terms of Article 19(6). 

With such an aim, the Court distinguished between three categories of people involved in cyryptocurrency trade who are hobbyists, traders in VCs and VC Exchanges, based on the existence of profit motive. 

First category which are the hobbyists cannot claim any fundamental right as they are not covered under any profession, occupation, trade or business under Article 19(1)(g). 

Second category comprising of the traders who have made purchase and sale of VCs can perfectly challenge under Art. 19(1)(g) as they are involved in occupation or trade. These are citizens who have taken up the trade of buying and selling virtual currencies (i) either from trading in crypto-to-crypto pairs (ii) or in using the currencies stored in their wallets, to make payments for purchase of goods and services to those who are prepared to accept them, within India or abroad. Here the court held that impugned circular neither prohibited nor indirectly paralysed them as these forms can still find their way to or through the market, despite being prevented from accessing the banking services. 

The Court gave the decision in favour of the third category, who are involved in the business of online exchanges that provide certain services such as the facility of buying and selling of virtual currencies, the storing or securing of the virtual currencies in what are known as wallets and the conversion of virtual currencies into fiat currency and vice versa. These VC exchanges do not appear to have found out any other means of survival (at least as of now) if they are disconnected from the banking channels, unlike VC traders.

VC exchanges through the online platforms are seriously affected by the Circular, since the commission that they earn by facilitating the trade is required to be converted into fiat currency, which is not possible in the absence of any banking channels. Thus the exercise of such a power by RBI, over the entities regulated by it, has caused a collateral damage to some establishments like the petitioners’, who do not come within the reach of RBI’s net. 

After concluding that the impugned circular infringes Art. 19(1)(g) for the VC exchanges, the court went on the analyse the test of proportionality against the circular. On the question of proportionality, the court relied upon the four-pronged test summed up in the opinion of the majority in Modern Dental College and Research Centre v. State of Madhya Pradesh.

These four tests are (i) that the measure is designated for a proper purpose (ii) that the measures are rationally connected to the fulfilment of the purpose (iii) that there are no alternative less invasive measures and (iv) that there is a proper relation between the importance of achieving the aim and the importance of limiting the right.

In relation to these four tests, the court held that the measure taken by the RBI failed to meet the third test as there were less intrusive measures available which were considered as an alternative.

RBI did not consider the availability of alternatives before issuing the impugned circular. The court found that, (i) that RBI has not so far found, in the past 5 years or more, the activities of VC exchanges to have actually impacted adversely, the way the entities regulated by RBI function (ii) that the consistent stand taken by RBI up to and including in their reply dated 04-09-2019 is that RBI has not prohibited VCs in the country and (iii) that even the Inter-Ministerial Committee constituted on 02-11-2017, which initially recommended a specific legal framework including the introduction of a new law namely, Crypto-token Regulation Bill 2018, was of the opinion that a ban might be an extreme tool and that the same objectives can be achieved through regulatory measures. 

Also the European Union Parliament made the ultimate recommendation to not go for a total ban of the interaction between crypto currency business and the formal financial sector as a whole.

Although the VCs are not banned, but the trading in VCs and the functioning of VC exchanges are sent to comatose by the impugned Circular by disconnecting their lifeline namely, the interface with the regular banking sector.

In conclusion the court held that the measure failed to meet the proportionality test as RBI failed to show at least some semblance of any damage suffered by its regulated entities through VC exchanges. 

3. Implications: 

The Judgement is going to be a game changer for the India’s crypto ecosystem which has already witnessed a huge growth potential over the past years. A study released by Crebaco Global Inc. stated that Indian crypto exchanges such as UNocoin, ZebPay and others recorded $5.6 billions as a total trading volume in 2019. Additionally, trade-related activities from Indian IP industry on Binance between January – December 2018 was at 7.9% — a number that clearly shows a booming interest among Indian people when it comes to cryptocurrencies. The study then proceeded to highlight the crypto and blockchain technology has been able to create a huge increase in the number of jobs. For instance, Crebaco’s data suggested in 2019 that around 6,150 individuals were employed as blockchain content writers and coders within India’s local fintech market.

Currently India has a record number of mobile subscribers with around 1.2 billion, while 582 million people are in possession of bank accounts. Thus the ban lift can be seen as a huge opportunity to use digital currencies for financial inclusion. 

With this judgment, decks should be cleared for a regulatory regime of cryptocurrency in India instead of a complete ban.

In a separate bunch of petitions, the Supreme Court is also examining the issues related to regulation of cryptocurrency. The judgment on Wednesday will have an impact on the pending case too.

Thus the judgement will bring in health regulations for cryptocurrency trading in India as the judge’s panel have understood the enormous potential that blockchain and crypto possess and how these technologies can transform the economic and digital landscape of the nation in the coming few years. In all likelihood, 2020 may be the game-changer for the crypto ecosystem in India.

¹ IMAI case at Par. 6.35

² Ibid at Par. 6.48 

³ Ibid at Par. 6.49

⁴ Ibid at Par. 6.59

⁵ Ibid at Par. 6.67, The word “currency” is defined in Section 2(h) of the Foreign Exchange Management Act, 1999 (hereinafter, “FEMA”) to include “all currency notes, postal notes, postal orders, money orders, cheques, drafts, travelers’ cheques, letters of credit, bills of exchange and promissory notes, credit cards or such other similar instruments as may be notified by the Reserve Bank.” 

⁶Ibid at Par. 6.63, RBI has taken a stand in paragraph 24 of its counter-affidavit that VCs do not fit into the definition of the expression “currency” under Section 2(h) of FEMA, despite the fact that FATF, in its report on June 2014 on “Virtual Currencies: Key Definitions and Potential AML/CFT Risks” defined virtual currency to mean “digital representation of value that can be digitally traded and functions as (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but does not have legal tender status.” 

⁷Ibid at Par. 6.86. Nothing prevented RBI from adopting a short circuit by notifying VCs under the category of “other similar instruments” indicated in Section 2(h) of FEMA, 1999 which defines ‘currency’ to mean “all currency notes, postal notes, postal orders, money orders, cheques, drafts, travelers’ cheque, letters of credit, bills of exchange and promissory notes, credit cards or such other similar instruments as may be notified by the Reserve Bank.”

⁸Ibid at Par. 6.90, But as pointed out elsewhere, RBI is the sole repository of power for the management of the currency, under Section 3 of the RBI Act. RBI is also vested with the sole right to issue bank notes under Section 22(1) and to issue currency notes supplied to it by the Government of India and has an important role to play in evolving the monetary policy of the country, by participation in the Monetary Policy Committee which is empowered to determine the policy rate required to achieve the inflation target, in terms of the consumer price index. Therefore, anything that may pose a threat to or have an impact on the financial system of the country, can be regulated or prohibited by RBI, despite the said activity not forming part of the credit system or payment system. The expression “management of the currency” appearing in Section 3(1) need not necessarily be confined to the management of what is recognized in law to be currency but would also include what is capable of faking or playing the role of a currency. 

⁹Ibid at Par. 6.94, Section 36(1)(a) of the Banking Regulation Act, 1949 very clearly empowers RBI to caution or prohibit banking companies against entering into certain types of transactions or class of transactions.

¹0 Ibid at Par. 6.157

¹1(2016) 7 SCC 353 

¹2 Ibid at Par. 6.163. The discussion in paragraph 5.7 of the July 2018 Report of the European Union Parliament also addresses the issue as to whether it is best to introduce an outright ban for some aspects linked to some crypto currencies.