Key Takeaways:
- No new assets are received by taxpayers in the Soft Fork. Hence, taxation will not be applicable on Soft Forks.
- Hard Forks are taxable as the holder of the original Cryptocurrency asset gets a newly forked Cryptocurrency.
What are Forks in Cryptocurrency?
Cryptocurrency operates on Blockchain technology, which is an online distributed ledger shared and controlled by a peer-to-peer network of computers. This requires members of the network to follow some common protocols to maintain the history of transactions in the online ledger of the network. Any change in protocols requires accord from all the members. When all the members are not in agreement, a split may occur, forming a forked chain from the original Blockchain. These are called Forks.
There are 2 types of Forks:
1. Soft Fork – Soft Fork is a temporary split in the chain. In a soft fork, only the previously valid transaction blocks become invalid. They are known to be backwards-compatible as the old nodes recognize the new nodes to be valid. In simple terms, Soft Forks do not create a new blockchain and just results in an upgraded version of the original Cryptocurrency.
2. Hard Fork – This sometimes happens when there is a fundamental change in the Blockchain network’s protocol. This requires all nodes in the network to accept the new rule and get upgraded. However, if there is a group of nodes, which continue to use the old software, it results in a permanent split in the blockchain. The two blockchains are not compatible with each other and thus result in two different Cryptocurrencies. In the hard fork, members of the original Blockchain get tokens for the new Blockchain as well.
An example of a Hard fork is Bitcoin (BTC) and Bitcoin Cash (BCH), which was implemented due to disagreement in the network on how to increase the volume of transactions per second to meet the increased demand.
Another example of a Hard Fork was that of Ethereum (ETH) and Ethereum Classic (ETC), which were executed to reverse the hack on the DAO and fix a vulnerability in the code of the original blockchain.
Are Cryptocurrency Forks a taxable income in India?
Section 115BBH of the Income Tax Act introduced by Finance Act 2022, does not explicitly state the treatment of Cryptocurrency Forks. We recommend the taxpayers take the following approach for Soft and Hard Forks from a tax perspective:
1. Tax implications for Soft Fork– The above explanation clearly indicates that Soft forks are just an upgrade of existing virtual digital assets, and therefore no new assets are received by the taxpayer. Since this does not meet the definition of ‘Transfer’ under Section 2(47) of the Income Tax Act and therefore, it is not chargeable under Section 115BBH introduced by Finance Act 2022 and accordingly the same will not be applicable here.
2. Tax implications for Hard Forks– Under this, the holder of the original Cryptocurrency asset gets a newly forked Cryptocurrency. While the newly introduced provisions on taxing income from the transfer of virtual digital assets under Section 115BBH of the Income Tax Act introduced by Finance Act 2022 does not specifically mention Forks, but it is reasonable to assume receipt of new coins as Income from Other Sources, taxable under Section 56(2)(x) of the Income Tax Act.
For this purpose, the taxpayer’s income will be assumed to be the Fair Market Value of the New Coin(s) received and will be taxed at normal rates applicable to the taxpayer (if the aggregate value of such incomes exceeds Rs 50,000 during the financial year).
3. Tax implication for Hard forks, which are later transferred to virtual digital asset– However, if the recipient of the Forked coin later transfers such virtual digital assets, 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 of the asset transferred. For this, the Fair Market Value of the coin at the time of its receipt (on which tax was paid on receipt of the new coin under Section 56(2)(x) mentioned above) can be taken as its cost of acquisition.
Consider this example for better understanding. Varun owns 5 Bitcoins (BTC), and as a result of Hard Fork, he gets 5 Bitcoin Cash (BCH), with a Market value of Rs 5 Lakh. In this case, the market value of 5 BCH, i.e. Rs 5 Lakh, will be chargeable at normal rates applicable to Varun on the basis of his individual tax slab.
If Varun later sells his 5 BCH to his friend John for Rs. 6 Lakh, he will have a chargeable income of Rs. 1 Lakh and tax would be payable under Section 115BBH of the Income Tax Act at 30% plus applicable Surcharge and Cess. {6 lakhs (sale amount) – 5 lakhs (cost of acquisition) = 1 lakh (income). This 1 lakh can be considered on payment of taxes. These taxes are applicable on Income chargeable under Section 56(2)(x) on receipt of the new coin}.
Binocs can easily track all your Forked Cryptocurrencies and calculate tax liabilities arising at the time of its receipt as well as when you transact them.
Want to track your Forked Cryptocurrencies and save them from taxes?
We are here for you- https://binocs.co/
Leave a Comment