Trading in Virtual Currencies: An analysis under foreign exchange laws of India

The cryptocurrencies or virtual currencies (“VC”) [see Endnote 1] can be defined as a type of digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank. There are many forms of VC such as bitcoins, ethereum, ripple, NEM and litecoin. The VC are based on blockchain technology. Blockchain may be described as a tamper-evident ledger shared within a network of entities, where the ledger holds a record of transactions between the entities. To achieve tamper-evidence in the ledger, blockchain exploits cryptographic hash functions [see Endnote 2].

The VC are traded through online exchanges or platforms and the value of VC depends upon the demand and supply of VC traded in such online exchanges or platforms. Such online platforms facilitate exchange of VC for another currency including a fiat currency such as USD.

In order to determine the applicability of foreign exchange laws of India for trading in VC, it is important to understand the classification of VC.

Classification of VC as ‘currency’ under Foreign Exchange Management Act:

The FEMA [see Endnote 3] provides an inclusive definition of the term ‘currency’ to include all currency notes, postal notes, postal orders, money orders, cheques, drafts, travellers cheques, letter of credit, bills of exchange and promissory notes, credit cards or such other similar instruments, as may be notified by the Reserve Bank of India. Further, the term ‘currency notes’ means and includes cash in the form of coins and bank notes [see Endnote 4]. It be noted that RBI has not notified VC as ‘currency’.

The term ‘coin’ is defined under the Coinage Act, 2011 (“Coinage Act”) to mean any coin which is made of any metal or any other material stamped by the Central Government or any other authority empowered by the Central Government in this behalf and which is a legal tender including commemorative coin and Government of India one rupee note. Since the VC are not issued by the Central Government or any other authority empowered by the Central Government, VC are not coins under the Coinage Act. Section 22 of the Reserve Bank of India Act, 1934 (“RBI Act”) states that the RBI shall have the exclusive rights to issue bank notes in India. Since the bitcoins are not issued by the RBI in India, bitcoins are not ‘bank notes’.

Therefore, VC do not fall under the purview of the term ‘currency’ under the FEMA and the RBI Act as it is not (i) covered under any types of currencies enumerated under Section 2(h) of the FEMA and (ii) notified by the RBI as currency.

Classification of VC as ‘foreign exchange’ under FEMA:

The FEMA defines a foreign exchange as a foreign currency [see Endnote 5]. A foreign currency is defined as a currency other than an Indian currency [see Endnote 6]. The VC are not currencies under the FEMA, therefore, the VC are not foreign currencies and thereby, not a ‘foreign exchange’ under the FEMA.

Classification of VC as ‘foreign security’ under the FEMA:

The FEMA defines the term ‘foreign security’ as any security, in the form of shares, stocks, bonds, debentures or any other instrument denominated or expressed in foreign currency and includes securities expressed in foreign currency, but where redemption or any form of return such as interest or dividends is payable in Indian currency [see Endnote 7].

Section 2(za) of the FEMA defines the term ‘security’ as shares, stocks, bonds and debentures, Government securities as defined in the Public Debt Act, 1944, savings certificates to which the Government Savings Certificates Act, 1959 applies, deposit receipts in respect of deposits of securities and units of the Unit Trust of India established under Section 3(3) of the Unit Trust of India Act, 1963 or of any mutual fund and includes certificates of title to securities, but does not include bills of exchange or promissory notes other than Government promissory notes or any other instruments which may be notified by the RBI as security.

VC do not fall under any of the aforesaid items and therefore, it is not covered under the term ‘securities’ and thereby are not covered under ‘foreign security’.

Classification of VC as “prepaid payment instruments’ under the Payment and Settlement Systems Act, 2007:

Section 2(1) (i) of the Payment Systems Act defines the term ‘payment system’ as a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange and includes the systems enabling credit card operations, debit card operations, smart card operations, money transfer operations or similar operations.

Section 18 empowers the RBI to regulate issuance of payment system instruments and accordingly, the RBI has issued ‘Master Direction on Issuance and Operation of Prepaid Payment Instruments’ dated October 11, 2017. It defines the term ‘prepaid payment instruments’ as payment instruments that facilitate purchase of goods and services, including funds transfer, against the value stored on such instruments.

The value of the VC depends upon the value as provided under the VC exchanges and such values are dynamic depending upon the demand and supply in the VC market. However, in case of a prepaid payment instrument, the value stored on such instruments are constant and is equal to the amount of money paid to the payment system providers. Therefore, VC cannot be termed as a ‘prepaid payment instrument’ under the Payment Systems Act.

Classification of VC as ‘property’:

In terms of Section 29(c) of Benami Transactions (Prohibitions) Act, 1988, property means property of any kind, whether movable or immovable, tangible or intangible, and includes any right or interest in such property. This is an inclusive definition of property, where both movable and immovable properties are included. VC is movable and intangible and accordingly, it can be called a property as per the aforesaid definition.

In this regard reliance can be made on a case [see Endnote 8] where the Supreme Court held that the term ‘property’ includes everything that has an extendable value. It includes the item in question and all rights and liabilities associated with it. An element which is material to the expression is ‘ownership’. While the property has all interests in it, it is the ownership that lets the owner exercise such interest, where the interest extends to doing everything, an owner is capable of doing to exercise his right in the property.

Further, it be noted that VC are in non-physical form i.e. intangible. Therefore, VC can be classified as rights in intangible movable property.

Jurisprudence in Australia:

The Australian Government published a public ruling [see Endnote 9] on determination of tax in case of a bitcoin, which is a VC (“Public Ruling”). In terms of the Public Ruling, it was held that Bitcoin holding rights involve an inherent excludability because the Bitcoin software restricts control of a Bitcoin holding to the person in possession of the relevant private key. As the Bitcoin software prescribes how the transfer and trade of bitcoin can occur and transactions are verified through the Bitcoin mining process, Bitcoin holding rights are definable, identifiable by third parties, capable of assumption by third parties, and sufficiently stable as per the Ainsworth test. In weighing all these factors, it is considered that Bitcoin holding rights amount to property within the meaning of paragraph 108-5(1)(a).

In terms of the Public Ruling, property refers not only to a thing but also to legal relationship with a thing. Accordingly, in Australia, the bitcoin, is a form of VC, is classified as property.

Classification of VC as ‘goods’ under the Sale of Goods Act, 1930:

Section 2(7) of the Sale of Goods Act defines the term ‘goods’ to mean every kind of movable property other than actionable claims and money; and includes stock and shares, growing crops, grass, and things attached to or forming part of the land which are agreed to be severed before sale or under the contract of sale. Section 3(36) of the General Clauses Act, 1897 (“Clauses Act”) defines the term ‘movable property’ to mean property of every description, except immovable property. Further, Section 3(26) of the Clause Act defines the term ‘immovable property’ to include land, benefits to arise out of land, and things attached to the earth, or permanently fastened to anything attached to the earth.

VC are not covered under the definition of term ‘immovable property’ under the Clauses Act. Therefore, VC are rights in movable property and thereby are intangible ‘goods’ under Section 2(7) of the Sale of Goods Act.

Implications under foreign exchange laws for trading in VC from a person resident outside India:

VC are classified as rights in intangible movable property. Therefore, if a person resident in India [see Endnote 10] enters into transactions i.e. purchase and sale of bitcoins, with a person resident outside India, such transactions will be considered as import and export transactions, respectively and the provisions of FEMA will be attracted. Under FEMA, all the transactions with a person resident outside India are categorised as capital account transactions and current account transactions.

Classification of transaction in VC as capital account transactions:

Section 2(e) of the FEMA defines capital account transactions as a transaction which alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India or assets or liabilities in India of persons resident outside India, and includes transactions referred to in Section 6(3) of the FEMA.

In case of purchase of VC by the buyer from a person resident outside India, the VC gets transferred into the wallet of the buyer and the buyer will have exclusive rights over such VC. In such a case, the situs i.e. the location of assets (i.e. VC) for legal purposes, will be India. Therefore, the purchase of VC does not alter the assets or liabilities outside India of the buyer and accordingly, purchase of VC by the buyer who is a person resident in India do not fall under the category of capital account transactions.

In case of sale of VC by the seller to a person resident outside India, the VC gets transferred to such person resident outside India and the seller will not have any rights over such VC. In such a case, the assets (i.e. VC) will no longer be assets of the seller. Therefore, sale of VC to a person resident outside India does not alter the assets or liabilities outside India of the seller and accordingly, sale of VC by the seller who is a person resident in India to a person resident outside India, do not fall under the category of capital account transactions.

Classification of transactions in VC as ‘current account transaction’ under the FEMA:

Section 2(j) of the FEMA defines current account transactions as a transaction other than a capital account transaction and includes (a) payments due in connection with foreign trade, other current business, services, and short-term banking and credit facilities in the ordinary course of business, (b) payments due as interest on loans and as net income from investments, (c) remittances for living expenses of parents, spouse and children residing abroad and (d) expenses in connection with foreign travel, education and medical care of parents, spouse and children. It be noted that bitcoins are classified as rights attached to intangible movable property which are used for the purpose of foreign trade. The aforesaid foreign trade may be in the following manner:

• (a) Purchase of VC from person resident outside India through foreign exchanges on payment in fiat currencies such as USD to person resident outside India (“Category 1”); or
• (b) Payments by VC to person resident outside India for purchasing goods or procuring services from person resident outside India (“Category 2”); or
• (c) Payment by VC to person resident outside India in consideration of acquiring other cryptocurrencies from person resident outside India (“Category 3”).

Therefore, any payment made or received in connection with purchase or sale transactions of bitcoins by an Indian resident with a person resident outside India under Category 1, Category 2 or Category 3, will be considered as payment made or received in lieu of foreign trade and thereby, come under the purview of ‘current account transaction’ under the FEMA.

VC are not legal tender in India:

The VC are not considered to be legal tender in India and accordingly, it will not be treated as recognized mechanism for making any payment and receiving any payment, in India. In this regard, reference can be made to the following:

• (a)   Caution notices issued by the Reserve Bank of India stating the potential financial, operational, legal, customer protection and security related risks associated with dealing with cryptocurrencies;
• (b)   Press Release issued by the Ministry of Finance stating that dealing in cryptocurrencies may be considered as ponzi schemes. In case the Government or Reserve Bank of India, going forward declares cryptocurrencies including bitcoins as ponzi schemes, then dealing with cryptocurrencies shall be completely banned and consequently, the person dealing with cryptocurrencies shall be punishable in terms of the Prize Chits and Money Circulation Schemes (Banning) Act, 1978;
• (c)    In the forty-sixth report of standing committee on finance (2016-2017) on March 17, 2017, on being asked about the legality of bitcoin, a representative of ‘Ministry of Finance’ submitted while deposing that bitcoin is illegal; and
• (d)   The statement of Hon’ble Finance Minister of India in budget speech for the year 2018, wherein he has stated that the Government of India does not consider cryptocurrencies as legal tender or coin and will take all measures to eliminate use of these crypto assets in financing illegitimate activities or as part of the payment system.

Further, the implications under the FEMA for trading in VC can be analysed hereinbelow:

Implications for purchase of VC from person resident outside India:

Import or export of goods and services is being allowed into India in terms of Section 5 of the FEMA read with FEMA (Current Account Transaction) Rules, 2000 (“Current Account Transaction Rules”). With respect to import of goods and services, RBI has issued Master Direction on Import [see Endnote 11]. Further, the Foreign Exchange Management (Manner of Receipt and Payment) Regulations, 2016 (“Payment Regulations”) prescribes the mode of payment for import transactions. The acceptable mode of payment of imports are (a) payment made in a currency appropriate to the country of shipment of goods; or (b) payment made in foreign exchange through an international card held by him / in rupees from international credit card / debit card through the credit / debit card servicing bank in India against the charge slip signed by the importer or as prescribed by RBI from time to time, provided that the transaction is in conformity with the extant provisions including the Foreign Trade Policy.

The VC are not covered under the term ‘foreign exchange’. Therefore, it can be inferred that in case of any imports made by person resident in India under Category 1, the payment cannot be made in VC under the Payment Regulations. For making payment in any other mode other than those prescribed in the Payment Regulations, prior approval of the RBI is required and it is unlikely that RBI will grant such prior approval since VC have not yet been recognised under the Indian laws and are not considered to be legal tender in India.

Further, the Master Direction on LRS [see Endnote 12] was issued by RBI as a liberalization measure to facilitate resident individuals to remit funds abroad for permitted current or capital account transactions or combination of both. The remittance by individual under Category 1 is not a permitted current account transaction under the Master Direction on LRS and prior approval of the RBI is required for remittances not permitted under the Master Direction on LRS. It is unlikely that RBI will grant such prior approval since VC are not considered to be legal tender in India. Additionally, form A2 is required to be submitted to the authorised dealer bank for any remittance under the Master Direction on LRS. However, form A2 does not cover remittances for the purpose for acquisition of VC.

Implications for sale of VC to person resident outside India through Indian or foreign exchanges:

Sale of VC to a person resident outside India under Category 2 or Category 3 will constitute as export of rights in intangible movable property and accordingly, the provisions under the foreign exchange and RBI regulations will be applicable for such transactions.

Regulation 2(2) of the Payment Regulations provides that for export transactions, receipt shall be made in (i) currency appropriate to the place of final destination as mentioned in the declaration form irrespective of the country of the residence of the buyer or (ii) any other mode of receipt of export proceeds as prescribed by the RBI from time to time. The VC are not recognised as legal tender in India by the RBI and the RBI has not recognised VC as a mode of receipt of export proceeds. Therefore, in case of sale of VC under Category 2 or Category 3, the Indian resident seller cannot receive VC as export proceeds.

Conclusion:

In a nutshell, VC are not considered to be legal tender in India. In recent times, the Enforcement Directorate have also raided many VC exchanges operating in India for violations of foreign exchange laws. Therefore, a person resident in India entering into transaction with person resident outside India for trading in VC shall be doing so in violation of the foreign exchange laws of India. While in many jurisdictions, the VC are recognized as legal tender and proper regulations are in place, in India, the regulators are yet to formulate a law or to provide classification to regulate VC transactions both in the domestic as well as international market.

[The authors are Executive Partner and Associate, respectively, in Corporate law Practice, Lakshmikumaran & Sridharan, New Delhi]