Section 194S of the Income-tax Act, 1961 (ITA): Guidelines

Section 194s of the Income-tax Act, 1961 was ushered in by the Finance Ministry, Government of India, under the Finance Act 2022 for imposing tds on the transfer of Virtual Digital Assets (VDAs). The hon’ble Finance Minister mentioned, in her Union Budget 2022 speech, about the enormity and prevalence of digital asset transactions as a strong reason for bringing such assets under the regulatory control of India. Accordingly, the 194s tds rules provide comprehensive specifications on the taxes to be deducted at source when digital assets are being transferred from one entity to another directly or through different intermediaries.Let us deep dive into the key provisions, terminologies, exemptions, and scenarios described by section 194s with regards to the transfer of digital assets.

Section 194S of the Income-tax Act, 1961 stipulates guidelines on the taxability of digital assets when those assets are transferred directly between a buyer and a seller or through an exchange. Under Section 2 clause 47A of the Income-tax Act, the term “VDA'' can refer to any information, code, number, token (not an Indian or Foreign currency) created by cryptographic means (e.g. mining) or any other digital asset notified by the Central Government in the official gazette. Essentially, Section 194s views them as a universal set of digital characterization of value that can be traded, transferred, stored electronically, or used for payment. These differ from physical assets in a way that they are always exchanged electronically and their transfers may not be bound within a particular geographical boundary. The tds 194s guidelines do not officially recognize any digital asset.Moreover, section 194s does not specifically mention further categorization of digital assets, but for the sake of understanding, these could be generally classified into cryptocurrencies and NFTs (non-fungible tokens). Now, the 194s tds section also does not refer to any particular exchanges or mediums through which the transfer of digital assets might take place. For simplifying things, the term “exchange” can be understood as any crypto exchanges in which digital assets are traded between a buyer and a seller.

Section 194s brings all forms of digital assets including cryptocurrencies under India’s taxation framework. Cryptocurrencies have emerged as a digital currency of choice because of their advantages such as decentralisation, ease of accessibility, and alternative asset class for diversification. However, the convenience of digital assets in exchange and transfer are what make them difficult to be incorporated in a country’s regulatory framework. Since these currencies are exchanged or transferred electronically, it is difficult to map them within a particular national boundary. A particular digital asset transaction can hide, within itself, multiple layers of other transactions because of the anonymity offered. This complexity makes a taxation regime on digital assets difficult to implement. The anonymity offered by digital assets often make it difficult to recognise the sender and the receiver, and therefore, ascertaining tax liability could be a laborious task. Digital assets, by virtue of their anonymity, can be used to carry out several illegal activities - money laundering, terrorism funding, drug trafficking, human trafficking, etc. Since such assets operate on the world wide web, they are susceptible to cybersecurity risks. Because of the above issues directly concerning national security, governments have a strong incentive to regulate and track the exchange and transfer of digital assets. Therefore, introducing section 194s has been a key step towards bringing digital assets under the regulatory purview of the government of India. Also Read: Maximizing Tax Savings: Understanding Sections 80C, 80D, and 80CCD

• Guidelines: The 194s tds section specifically mandates a 1% deduction on the entire amount as tax to be paid by a person who is paying the amount to an Indian tax resident in lieu of transfer of a digital asset. This tax deduction must be made when the amount is credited to the account of the resident seller or at the time of payment to the resident seller, whichever is earlier. With the introduction of section 194s, it is important to note that the burden of tds payment has been imposed on the buyer of the asset. If the Permanent Account Number (PAN) is not provided by the deductee or the seller of the asset, then the applicable tds rate would be 20%.
• Exemptions: Exemptions apply to a “specified person” if the overall value of the consideration through transfer of assets does not surpass fifty thousand rupees within a financial year. For persons other than a “specified person”, the limit of such transaction value is ten thousand rupees within a financial year. Also, if a payment gateway has been used to effectuate such a digital asset transfer, the payment gateway need not pay the tds provided that the person who has initiated the transfer has paid the required tds under section 194s.

For the purposes of 194s tds section, a “specified person” has been defined by the Finance Ministry as a person or a Hindu Undivided Family (HUF) who does not generate any proceeds under the bucket “income from profits and gains of business or profession”. Essentially, a “specified person” is an individual or an HUF who would be having an income under the head income from salaries, income from house property, income from capital gains, and income from other sources. For an individual or an HUF who has an income under the category “profit and gains of business or profession”, the total revenue/gross receipts/turnover must not exceed one crore rupees in a financial year. In the case of a profession, the amount should not surpass fifty lakh rupees. To determine the limits, the financial year immediately preceding the financial year of asset transfer will be applicable.

Section 194s is only applicable when a digital asset is purchased from the Indian resident as defined under Income Tax rules. Therefore, the following could be the general arena where section 194s tds guidelines are applicable:

• Trading in Indian Crypto Exchanges: As notified by the Income Tax Department, TDS is liable to be deducted for any trading in Indian Crypto Exchanges (including peer-to-peer, i.e. P2P). Also, the particular exchange will be required to report such transactions to the Income Tax Department in an appropriate format.
• Trading in International Exchange (Crypto to Crypto): Since the general applicability of section 194s comes into the picture only when a digital asset has been bought from an Indian tax resident, it could be argued that transactions taking place in an international exchange are outside the ambit of 194s tds rules because the location of such an international exchange is outside Indian boundaries and therefore no income is realised in the Indian territory. Another case for buttressing the above argument would be that the net proceeds from the sale of such digital assets are not remitted back to India but held in cryptocurrencies and not in INR within a crypto wallet.
• Trading in International Exchange (P2P): If a digital asset is bought via P2P mode using INR, it is obvious that the seller is an Indian tax resident holding an Indian bank account. In such cases, the P2P exchange may not deduct TDS under section 194s guidelines. However, the buyer needs to collect the PAN (Permanent Account Number) of the seller and manually file a TDS return for the transaction.

The Income Tax department has specified “Form 26QE” as the challan-cum-receipt to be filed by the buyer for reporting digital asset transactions and depositing the amount with the central government. Form 26QE has been introduced for specified persons. In case of digital asset transfers through exchanges and brokers, the applicable documentations are Form 26QF and Form 26Q. Form 26QE must be filed within 30 days of the end of the month of transaction when tax has been deducted, and forms 26Q and 26QF must be filed quarterly by the due dates mandated by the Income Tax department. Also Read: Section 234B & 234C: Understanding Interest and Penalties on Advance Tax and Its Calculation

Section 194s goes to great lengths at demystifying the tds burden for associated entities involved in the transfer of digital assets. Such assets could be transferred through an exchange that may or may not involve a broker. On the other hand, they could be directly transferred between a buyer and seller which is called “Peer to Peer (P2P) transfer of digital assets”. It may also happen that the buyer pays for the acquired asset in cash or kind. Keeping in view the above scenarios, the Finance Ministry has issued circulars that clarify the mechanism of tds payment under section 194s. The 194s tds rules mention several scenarios for the process of transfer:

• Case 1: When the exchange makes the payment directly to an owner of the asset and the broker is an owner/not an owner of the asset When the broker is not an owner of the asset under consideration, the only entity which is responsible for deducting the tax and filing Form 26Q is the exchange. When the broker is an owner of the asset, the amount paid by the exchange to the broker (owner) will also be under the purview of tds under section 194s.
• Case 2: When the exchange makes the payment to a owner of the asset through a broker (i.e. the broker is not the owner of the asset) In this case, both the exchange and the broker are equally responsible for deducting the tax at source under section 194s tds rules. If the exchange and the broker have a written agreement that the broker alone shall be deducting the tds, then the burden of tax deduction lies on the broker. The broker has to file Form 26Q and the exchange has to file Form 26QF.

• Case 1: When the buyer directly pays the exchange Since there is no involvement of multiple intermediaries, the buyer is liable to deduct the tax. However, a practical situation could arise wherein the buyer does not know that the exchange, indeed, is an owner of the asset. In such cases, the exchange and the buyer can enter into a written agreement that the exchange shall pay the required taxes under section 194s after receipt of the payment. The exchange needs to file Form 26QF as well as ITR in such cases.
• Case 2: When the buyer pays the exchange through a broker In this case, it is clear that the payment is being made by the broker to the exchange and, therefore, under 194s tds section guidelines, the broker is required to pay the tax. Again, for the ease of regulatory compliance and removal of ambiguity from the mind of the broker regarding ownership of the digital asset, the broker and exchange can agree, in written, that the exchange will be paying the taxes after receipt of payment. As in the first case, the exchange needs to file Form 26QF as well as ITR.

• Case 1: The asset transfer does not happen through an exchange In these cases, asset 1, owned by person 1 might be used as a form of payment for asset 2, owned by person 2. This indicates that both the persons are the buyer as well as the seller. Therefore, the payment in kind, will only be released by the buyer when the seller provides the proof for tax payment. Both the persons will have to file Form 26Q or Form 26QE under section 194s.
• Case 2: The transfer of asset happens through an exchange When an exchange is involved in the asset transfer that is paid for by another asset, it can enter into a written agreement with the buyer and seller, thereby exercising an alternative mechanism where the exchange will be liable to deduct taxes for both phases of the transaction. As always, Form 26Q has to be filed by the exchange.

• Scenario 1: Direct transfer between the buyer and the seller and payment is in cash This scenario happens when the transfer of digital assets happens directly between the buyer and the seller. Also, the amount for such assets is paid in cash. In this scenario, the person responsible for the deduction under 194s tds section is the buyer. Also, the buyer needs to file either Form 26Q or Form 26QE.
• Scenario 2: The transfer of assets takes place through an exchange and the asset is owned by a person other than an exchange There are two possible cases in this scenario:
• Scenario 3: The transfer of asset takes place through an exchange and the asset is owned by the exchange This scenario again gives rise to the following two cases:
• Scenario 4: Transfer of the assets and the payment is in kind (not in cash): This situation of digital asset transfer again involves two possible cases:

• For a specified person, no TAN (Tax Deduction and Collection Account Number) is necessary under 194s tds section rules. Such Indian tax residents will need to login to the income Tax portal and select Form 26QE under E pay tax for filing their TDS return.
• For entities other than specified persons having TAN, Form 26Q needs to be filled up for reporting transactions on which TDS is applicable under section 194s.
• Exchanges need to report digital asset transactions in Form 26QF to Income Tax authorities on a quarterly basis.
• The deductor of the tds issues a TDS certificate to the deductee on Form 16A for the transaction involving a digital asset. The deductee, while filing his Income Tax Return (ITR) , can claim a credit for the tds paid.

Section 194s introduces a taxation framework aimed at tracking the transfer and exchange of digital assets. It represents the government’s commitment of creating a flexible, adaptive, and a transparent regulatory ecosystem. To know more about section 194s, please consult a tax professional. Also Read: A Guide to Tax Saving Under Section 10 (10D) of Income Tax Ready to make the most of your money? Start your tax planning journey now!