With the rise of cryptocurrencies and virtual digital assets (VDAs), the tax implications surrounding these assets have become a complex and crucial aspect for taxpayers. The Income Tax Act outlines specific rules regarding the set-off and carry forward of losses from VDA transactions. However, the intricate nature of these provisions has raised concerns and confusion among taxpayers. In response, the government has taken steps to provide further clarifications and guidelines to alleviate these concerns.

In this blog, we will delve into the complexities of the Income Tax Act and its implications on the set-off of losses from VDAs.

What is set-off and carry forward of losses?

Section 70 of the Income Tax Act has laid down the provisions dealing with the set-off of losses. The term set-off of losses, as the name suggests, is adjusting the losses of a particular financial year with the taxable income or profit of that specific year. 

In the light of the situation where a taxpayer’s losses exceed his taxable income for a particular financial year, the unadjusted losses can be carried forward to the subsequent year and adjusted thereon.

Intra-Head Set Off of Loss

Intra-Head set-off is the adjustment of loss from an income source against the profit from another income source under the same head. For example, a set-off of loss from self-occupied property against profit from another rented house property is an intra-head set-off.

Inter-Head Set Off of Loss

Inter-Head set off is the adjustment of loss under an income head against the profit under another income head. For example, set off of loss from self-occupied House Property against income from Capital Gains. Before making the inter-head set-off, the taxpayer has to first make the intra-head set-off.

Adjustment of losses arising from VDAs

The Union Budget 2022 introduced Section 115BBH, which dealt with taxation provisions concerning Virtual Digital Assets (Cryptocurrencies & NFTs).

Section 115 BBH(2)(b) provides that no set-off of loss from the transfer of the virtual digital asset computed shall be allowed against income computed under any other provision of this Act to the assessee. Such loss shall not be allowed to be carried forward to succeeding assessment years. It is pertinent to note that the capital losses from the transfer of virtual digital assets cannot be set-off against any income under any provision of the Income Tax Act.

Hence as per clarifications issued by the Ministry of Finance following set-offs are prohibited:

• Losses from VDA transactions can not be set off from any other source of income or profit,
• Losses from VDA transactions can not be set off from income or profit from VDA transactions.

Let us understand this with the help of the following example:

Mr. A purchased 5 ETH at a price of ₹100000/ETH and 2 BTC for 10,00,000/BTC on 15 July 2020. He transferred all the ETH and BTC in the previous year, 2022-2023. The taxation implications of such transactions will be as follows:

In the above case, Mr. A is not allowed to adjust the loss of 2,00,000 from the transaction on 1/04/2022 with the profit of 5,00,000 on 31/12/20222. Hence Mr. A will have to pay tax @ 30% on a profit of  5,00,000.

Moreover, in the example mentioned above, if Mr. A generated capital gains from mutual funds or the same VDA (ETH), the procedure for adjusting losses remains the same, as the Income Tax Act disallows the offsetting of losses from Virtual Digital Assets (VDAs) against any other source of income.

Therefore, the taxpayer must ensure that all transactions, including those resulting in losses, are fully disclosed while filing the Income Tax Return (ITR). Set-off of losses from VDA transactions will be considered as non-compliance with provisions u/s 115BBH resulting in significant legal consequences.

Conclusion

In conclusion, the taxation implications surrounding virtual digital assets (VDAs) have become a complex matter for taxpayers, particularly when it comes to the set-off and carry-forward of losses. Taxpayers have expressed confusion and concerns regarding the complex provisions stated in the Income Tax Act. Nonetheless, the government has made efforts to alleviate these worries by offering clarifications and guidelines.

One tool that can assist taxpayers in navigating the complexities of tax regulations, such as set-off and carry-forward rules, is TaxNodes. TaxNodes provides comprehensive guidance and solutions for tax-related matters, including those pertaining to VDAs. By staying informed about the regulations and leveraging tools like TaxNodes, taxpayers can navigate the complexities of tax implications surrounding VDAs and ensure proper compliance with the Income Tax Act.