Trading Cryptos on International Exchanges - Is It Worth the Risk?

  • Cryptocurrency Analysis

Crypto assets, by design, are decentralized, open-sourced, and permissionless. These core characteristics render crypto assets borderless and allow for seamless peer-to-peer transfers between strangers. These features, in turn, allow crypto users to engage with the asset class through a variety of different options. One option that is available to users is peer-to-peer (P2P) transactions, facilitated by foreign centralized exchanges.

This option is particularly popular in India. Reports suggest that cumulative trade volumes of around USD 3,852 million (~INR 32 thousand crores) were conducted by Indians on such foreign platforms, during Feb-Oct 2022. Notably, these platforms do not have any registered presence in India. In this article, I discuss the risks that Indian residents using these platforms might be subjected to.

Tax Laws in India and their impact

Last year, the Government of India introduced specific provisions to tax crypto assets under the Income Tax Framework. While gains from the transfer of crypto-assets were always taxable, the insertion of a specific framework that levied tax at a flat rate of 30% on such gains considerably increased the tax burden. Furthermore, a requirement to deduct tax at the rate of 1%, at source, was also introduced in cases where Indian residents buy crypto assets exceeding a minimum annual threshold.

This second mandate specifically negatively impacted Indian crypto platforms and incentivized Indians to shift their transactions to foreign platforms. As entities registered in India and subject to Indian laws, an overwhelming majority of the total tax deducted under the TDS mandate was made by Indian exchanges. This cost triggered a flight of market makers and liquidity providers from the Indian market, creating an acute liquidity crunch at Indian crypto platforms. As a result, end users began to suffer poor execution prices on compliant Indian platforms, and instead began to prefer P2P transfers on foreign exchanges that do not comply with Indian tax laws.

As per estimates, after the implementation of the new tax regime last year, over 80% of crypto trading volume has migrated from Indian exchanges to foreign ones. However, trading on such channels represents significant risks for Indian residents.

Traders beware

An Indian resident continues to be liable for paying tax under Indian Income Tax Act. This means that any gain/profit from trading through any channel is taxable in India. Further, Indian residents who buy crypto assets also continue to be liable to deduct and deposit TDS, even when the transaction is made through P2P channels. Pursuant to amendments made to the Income Tax Act in this year’s Budget, non-compliance with the TDS mandate may attract severe penalties, both monetary and criminal.

Even in the past, at least as far back as 2018, the IT department has cracked down on crypto users who fail to comply with their income tax liability. According to reports, in 2018, tax notices were sent “to tens of thousands of people” engaging in crypto-assets. In fact, multiple investors have claimed that they have received IT notices on unpaid taxes for profits from 2017-18 as recently as March 2022.

More recently, the Income Tax Department of India was examining high-value crypto transactions and zeroed in on 700 investors. In the period since these reports came back, the transaction monitoring infrastructure, knowledge, and capacity of both VDA industry players and the government has expanded exponentially – as enforcement, particularly related to taxes paid by individuals, is cyclical, there is little doubt the next few months will see a resurgence of similar enforcement actions towards individuals attempting to evade taxes.

In the case of trades on Indian exchanges, the platform conducts the activity of deducting and depositing TDS on the exchange. In such cases, traders do not need to concern themselves with making these deductions or engaging in consequent compliances. However, many traders transacting through P2P channels are not aware of or may choose to ignore this requirement, resulting in significant tax compliance risks.

Regulatory and business Risks:

Besides the tax framework, India recently also covered crypto-asset service providers such as Indian exchanges in its anti-money laundering legislation. Such exchanges are now statutorily required to undertake due diligence and enhanced due diligence to ensure the safety of Indian VDA users and prevent money laundering. It appears that these laws may apply to foreign platforms catering to Indian customers too.

However, given that the platforms in question have no physical presence in India, there is still a lack of clarity on the enforcement of these laws on such platforms. Ultimately, Indian users of the foreign platform are the ones who will bear the brunt of non-compliance. Most recently, innocent Indian users’ bank accounts were frozen when they received funds in exchange for VDA through P2P channels.

It was alleged that the funds in question were proceeds from a separate fraud. It should be noted that following the inclusion of VDA exchanges as reporting entities under PMLA, P2P trades have been specifically called out as red flag transactions, with the burden of filing TDS appropriately falling squarely on the shoulders of traders themselves.

Given that Indian exchanges operate from India, they are required to comply with anti-money laundering laws and conduct the necessary compliance. Failure to do so will attract severe consequences, which may not be the case with foreign platforms. Further, Indian traders are also more likely to get relief in case of any counterparty risk or lack of service/response from Indian platforms, as opposed to foreign ones.

Trading on foreign exchanges may also expose the traders to the risks of foreign currency laws. Although there is a lack of regulatory clarity on this, traders should be cautious due to significant adverse implications. At the very least, traders should expect that, while a regulatory void remains, it is rapidly shrinking – implying that foreign exchanges will begin reporting to relevant Indian authorities sooner rather than later; if precedents from other countries are anything to go by.

Secondly, traders should expect that the VDA exchanges and traders in India will be brought in line with other trading platforms regulated by SEBI and the RBI, meaning that similar reporting requirements will soon become the norm.

A Crypto investor should evaluate the above risks while trading on international peer-to-peer platforms. Also, the Government should seriously consider a significant reduction in the TDS rate so as to protect retail investors from the financial and regulatory risk of trading on International exchanges.

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