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Ethereum 2.0: What is it and how will it be taxed in the Indian ecosystem?

Key Takeaways

  • Currently, Ethereum can execute and support around 30 transactions per second. Ethereum 2.0 is a reboot from the current network with some extensive upgrades and efficiency. 
  • The complete upgrade from Ethereum to Ethereum 2.0 is expected to be completed by 2023. 
  • Since all Ethereum users will then be migrated to Ethereum 2.0, the transaction will be a swap transaction and users are concerned about their tax liability in such a scenario. 
  • In this article, we’re going to cover the tax implications for investors from Ethereum to Ethereum 2.0, so continue reading to know more. 

Ethereum is the second largest cryptocurrency in the market in terms of market capitalization. While many investors hold Bitcoin as a store of value, Ethereum is often used for transactional purposes too because of its consensus mechanism. The consensus mechanism is a method used by blockchain networks wherein transactions are approved by taking the votes of the members. Hence, ‘consensus’. 

Currently, the Ethereum network executes around 30 transactions per second, which by itself is pretty good speed. But the capabilities of Ethereum can be explored quite a bit more. Which gives rise to Ethereum 2.0. 

Ethereum 2.0, also known as Eth2 or “Serenity,” is an upgrade to the Ethereum blockchain. The upgrade aims to enhance the speed, efficiency, and scalability of the Ethereum network so that it can avoid bottlenecks and process more transactions simultaneously. Ethereum 2.0 will also use a proof of stake consensus mechanism to verify transactions via staking.

Ethereum 2.0 also aims to execute 100,000 transactions per second from the current 30 transactions. A massive promise from the Ethereum Foundation, but if they’re able to deliver the promise, it will be a gamechanger in the ecosystem. The full transition from Ethereum to Ethereum 2.0 is expected to take place by 2023, according to the Ethereum Foundation.

Is converting ETH to ETH 2.0 a taxable event? 

No. Currently, the transition from Ethereum to Ethereum 2.0 is the transition from one virtual digital network to another and therefore, there is no need to pay tax on the transition. 

This is the short version of the answer. Read on further to know more about how the process could be executed and why investors will not be required to pay tax on the transition. 

ETH to ETH 2.0

Once the Ethereum 2.0 conversion is complete, every holder that has Ethereum will now have Ethereum 2.0. When the forking is taking place, the old Ethereum will be replaced by the new Ethereum 2.0 at the same value of 1:1. The old Ethereum will then get burned, and all holders will have the new, advanced, faster, and efficient Ethereum 2.0. This transition is known as soft forking. 

Also, for the knowledge of our readers, there are two main types of forking: Hard Forks and Soft Forks. 

A hard fork occurs when the original protocol continues to operate apart from the newly “forked” protocol. This was the case with the Bitcoin Cash hard fork in 2017 (when holders of Bitcoin received Bitcoin cash). 

In the scenario mentioned above, holders of BTC received additional coins apart from holding  BTC known as Bitcoin cash (BCH). Since they received certain additional coins, the event could be taxable. However, we’re not talking about hard forks in this article. In case you wish to know more about forking and taxation in India, here’s our short explainer on it. 

Unlike Bitcoin Cash (BCH), the ETH 2.0 token is completely replacing the old ETH. No new value is being created, and thus no gains are being observed. Thus, Ethereum 2.0 falls outside of the scope of this hard fork definition, and the protocol is more accurately going through an ‘upgrade’ which can be deemed as a soft fork.

To know more about hard forks and soft forks, read our article on it. 

Moving onto ETH 2.0

In the above example of transitioning from ETH to ETH 2.0, no new coins are created, and thus no value or gain in being observed. Since this does not meet the definition of ‘Transfer’ under Section 2(47) of the Income Tax Act and therefore receipt of ETH 2.0 via a soft fork is not chargeable under Section 115BBH introduced via the Finance Act 2022, and accordingly, the same will not be applicable here.

In short, an entire event is a non-taxable event. 

However, when and if the ETH 2.0 is sold in the future – investors need to note that your cost of acquisition from your original ETH holdings will transfer over to your ETH 2.0 upon conversion (soft fork) and whenever you sell your ETH 2.0 in the future, a taxable event is created. 

If an investor sells their ETH 2.0 in the future and receives gains on their investment, the investor is required to pay tax on that transaction. Just like they would for any other crypto transaction gains. 

The gains shall be taxable under Section 115BBH at 30% (plus applicable Surcharge and Cess) as per the newly introduced provisions of the Finance Act 2022. The taxpayer, in this case, can claim deductions for the cost of acquisition (i.e., cost of original ETH purchased) of the asset transferred.

This is everything one needs to know about Ethereum 2.0, its features, when the transition will be complete, and how the entire event will be taxed in India. The calculator for taxes on crypto can be a tedious task, especially in cases of soft and hard fork events. This is where Binocs comes in and does the tax calculation for you. Check out our super cool software here

Frequently Asked Questions 

1. What is Ethereum 2.0? 

Ethereum 2.0 is a new version of the Ethereum blockchain that will use a proof of stake consensus mechanism to verify transactions via staking.

2. Is Ethereum 2.0 a soft fork, and how is it taxed? 

Yes. Ethereum 2.0 is considered a soft fork event, and since no new coins or value is created, no tax is required to be paid on the forking transition from ETH to ETH 2.0. 

3. In case I sell my ETH 2.0 do I need to then pay tax? 

If you sell your ETH 2.0 for a profit, then like any other crypto transaction, you need to pay income tax according to the Indian tax laws at a flat 30% rate plus cess and surcharge as applicable under Section 115BBH of the Income-tax Act.

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