Here's how:
Had there been a practice of naming a "financial year", then FY18 would have been christened as the year of cryptocurrencies. In just a couple of month, these virtual currencies had risen from its status of charcoal to diamonds and back to black dust. All the windfall gains earned by investors from cryptocurrencies in the second and third quarters of FY18 have been eroded in the fourth quarter. The most popular cryptocurrency, bitcoin, grew more than 1,000 times in 2017 itself. However, in 2018 prices have crashed. Currently, it is trading at below $8,000 per bitcoin from its highs of $19,783.
Despite several admonishments by various entities like the government, central bank and financial institutions, bitcoins has remained as one of the most popular speculative investments in India. With the fond hope of another bounce back in the price of bitcoins, many investors are still holding on to them, while many others have already booked losses.
Investors with short-term capital gains on equity can look at booking losses from sale of cryptocurencies (if deemed as short-term capital assets) before March 31, 2018 and setting of the latter against the former. This would help them save tax on short-term capital gains on listed equity.
But how do you classify a cryptocurrency when it comes to income tax laws? How do you treat the losses you have made on them?
Capital asset or business asset?
There is no specific provision in the Income-tax Act, 1961 about the taxability of cryptocurrencies. However, keeping in view the general provisions of the Income-tax Act, cryptocurrencies could be deemed as capital assets if they are held as an investment by the taxpayer.
Therefore, any gain arising from it should be taxable as capital gains. If a cryptocurrency is held for more than 36 months from the date of purchase, it will be considered as long-term capital asset. And if held for less than 36 months, it will termed as a short-term capital asset.
On the contrary, if transactions in bitcoins are substantial and frequent, it could be held that the taxpayer is trading in cryptocurrencies and the resultant profits would be taxable as business income.
With the same analogy, losses arising from the transfer of cryptocurrencies shall be deemed as capital losses or business losses. The Income-tax Act allows adjustment of losses incurred by a taxpayer against other taxable incomes subject to some restrictions.
Speculative or non-speculative business?
The Income-tax Act categorizes a business into 'speculative' or 'non-speculative'. Business losses can be set-off against any other income of the taxpayer, while speculative business loss can only be set-off against other speculative business income. In other words, if trading in cryptocurrencies is treated as a speculative transaction, then losses in one cryptocurrency (say, bitcoin) can be set off only against other speculative income or gains from other cryptocurrencies (say, ripple or ethereum).
Section 43(5) of I-T Act provides that a transaction shall be deemed as 'speculative' if it is not followed by an actual delivery. In cryptocurrency trading, the buyers actually get the delivery of underlying cryptocurrency into their wallets. Therefore, these transactions should not be deemed as 'speculative'.
Set-off and carry forward?
The Income-tax Act allows 'set offing' of losses against profit. Losses are first set-off against income under the same head (intra-head adjustment) and if any loss remains after such a set off, it will be done so against income from another head (inter-head adjustment). In other words, before making an inter-head adjustment, the taxpayer has to first make an intra-head adjustment.
If a person is unable to set off his losses in the current year due to inadequacy of profits, he can carry forward the losses to a subsequent year to it set-off against future income. All losses can be carried forward for eight years from the year in which such losses arise. However, losses from speculative business can be carried forward only for four years. Further, it is mandatory to file return of income within the due date to carry forward the losses to subsequent years.
The rule of adjustment of losses against profits has followings exceptions in respect of capital gains and business profits:
A. Long-term capital losses can be adjusted only against long-term capital gains. However, short-term capital losses can be adjusted against both short-term capital gains and long-term capital gains.
B. Losses from speculative business can be set-off only against speculative income
C. Business losses can be adjusted against any head of income except salary income.
D. Capital losses can be adjusted only against capital gains. However, losses under any other head can be set-off against capital gains.
If cryptocurrencies are treated as business assets, losses incurred therefrom can be adjusted against any other income including capital gains (both, short-term and long-term) except salary. In contrast, if they are treated as capital assets, the resultant long-term capital loss can be adjusted only against other long-term capital gains. If the resultant capital loss is short-term, which would be so in most of the cases, it can be adjusted against any capital gains, long-term or short-term. In fact, short-term capital loss from cryptocurrencies can be adjusted against short-term capital gains arising from trading in listed securities. Further, short term capital losses from crypto currencies can also be set off against any capital gains (long term or short term) from immovable property or jewellery etc.
Illustration: Mr. A purchased one bitcoin in Rs 8,00,000 in August 2017 and sold the same in February 2018 for Rs 4,50,000. How this loss shall be treated in the Income-tax Act is illustrated below in four difference scenarios:
Source: Bitcoin Discussion: Save you capital gains tax,Here's how