Abstract
This article explains the concept of Non Fungible Tokens (hereinafter, “NFTs”), their relationship with cryptocurrency and the surrounding legal framework in India and analyses the impact of the Government’s announcement during the Union Budget, 2022 related to taxation of NFTs on digital artists in India.
Keywords
NFT, cryptocurrency, digitalart, incometax, nfttax
Introduction
In recent times, a ubiquitous topic in the media is Non-Fungible Tokens or NFTs. NFTs seem to be taking over the digital world in a way that cannot be ignored, particularly by the world of art. At first glance, it appears that artists have struck gold with this emerging digital asset and prefer selling their work using NFTs as they seemingly provide innumerable benefits, not only to the artist but also to the buyer. On closer examination, however, this may not necessarily be the case. This article delves into what an NFT is, its relationship with cryptocurrency, its association with digital and traditional art and the surrounding legal framework in India.
What are NFTs?
NFTs are cryptographic assets, representing data stored on a blockchain. Each NFT has characteristic identification codes and metadata enabling it to be distinguished from another. In simpler terms, NFTs are data stored in blocks that are chained together using blockchain technology. NFTs provide for tokenization, having the unique ability to commoditize digital assets, the sale of which have hitherto been inconceivable, be it Jack Dorsey’s first ever tweet , Chris Torres’ Nyan Cat , or even just clip art of rocks.
Although NFTs can be used to store any data, they usually contain records of economic transactions, rendering them to often be erroneously compared to cryptocurrency. Cryptocurrency or ‘crypto’ can be described as a digital payment system , that does not rely on external authority (such as banks) to verify transactions, making it decentralized money. Such currency, like NFTs, is secured by encryption, making it nearly impossible to counterfeit or double spend because of the inherent quality of blockchain technology, which provides proof of origin. However, while both NFTs and crypto use blockchain technology, NFTs are fundamentally different from crypto as they are “non-fungible”, which means they cannot be exchanged. Crypto on the other hand, like Bitcoin , or Ether are fungible, which means they are mutually interchangeable; or to put it simply, one Bitcoin can be substituted with another Bitcoin. Another likely contributor to this erroneous comparison may be that most NFTs are part of the Ethereum blockchain, which also hosts Ether, the cryptocurrency, and are most often traded using Ether as the medium of exchange. However, while the relationship between cryptocurrency and NFTs is undeniable, unlike cryptocurrency, each NFT serves as a certificate of authenticity.
Unsurprisingly, this ability of NFTs is increasingly rendering them useful as instruments of transfer of digital assets. NFTs exist on a blockchain, which serve as digital ledgers, recording details of ownership and transactions. This serves as a public record and is akin to registration of contracts with appropriate authorities to evidence proof of ownership and to provide a public record of the same. However, as the blockchain technology allows each bit of data to retain its distinct cryptographic code, it eliminates the need for certification of such data by an external authority to prove legitimacy. This attribute has resulted in the world of digital art becoming one of the largest markets for NFTs.
Art as NFTs
Digital artists are increasingly minting their work into NFTs because it provides undeniable proof that the artwork was created by a particular artist, without the need for active demonstration of authenticity. Further, NFTs are programmable into ‘smart contracts’ which allow for automation of a variety of manual transactions, such as payment of royalty to the artist on a second sale of the artwork. Such smart contracts also allow complete anonymity of both the buyer and the seller, which is a significant attraction of crypto among netizens. Further, the absence of middlemen allows artists to be the direct beneficiaries of the consideration for such work; which their patrons are more than willing to provide. As an example, the sale of Beeple’s “Everydays: The First 5000 Days” has set the record for one of the highest priced artwork sold of a living artist.
However, the popularity of NFTs is not limited to merely to digital artists and their patrons. Sotherby’s and Christies, two of the most famous auction houses in the world, which have dealt in and been the mediators for sale of some of the most exquisite pieces of traditional and contemporary art, are participating in this gold rush . From rudimentary clipart collectibles and single red pixels to digital homes , NFTs are being sold for millions of dollars, and the wave does not end here. Traditional artworks are now being converted into works that can be sold as NFTs, and among the first to be auctioned in this way is the work of graffiti artist, Banksy.
Musicians and music labels are not far behind in trying to claim a slice of this pie. The rock band, Kings of Leon, launched an NFT project named NFT Yourself as a part of which limited-edition digital copies of the band’s latest album were sold as NFTs, which included, inter alia , digital art, collectible vinyl records and lifetime front-row tickets to the band’s shows. Musician Shawn Mendes too launched a line of digital wearables as collectible NFTs that can be adorned by digital avatars. Even T-Series, India’s largest music label, is set to launch NFTs in the near future.
Rights of NFT Holders
Considering the vast sums of money being exchanged for NFTs, it is not incomprehensible to expect basic protection from the biggest risk associated with anything digital, namely, infinite copying. However, NFTs don’t prevent the data they store from being copied . A simple right-click and save allows any internet user to enjoy an artwork that the NFT holder paid millions of dollars for. What it does give the owner of the NFT is the right to say that she owns that NFT; akin to the right to say that a Monet hangs on the walls of one’s private home where prints of the same painting are distributed freely in the market for the public to enjoy. The only difference here is that with digital art, the owner of the NFT and an illegal downloader view the subject artwork in exactly the same way – on a screen.
One may then wonder whether the NFTs carry any additional rights with them; intellectual property in the underlying data, perhaps? Unfortunately, the answer to this musing too, is in the negative. Much like traditional art, the sale of an NFT alone does not render the data in it the intellectual property (IP) of the transferee. The copyright in any underlying work of art remains with the author of the work, or in cases where copyright has been transferred to a person other than the author, such subsequent owner of the copyright, unless the copyright is expressly assigned to the buyer of the NFT under the terms of the sale. To clarify, the sale of an NFT does not transfer ownership of the underlying work, just the NFT. An analogy would be to compare an NFT to a new phone. While the ownership of the instrument is transferred to the buyer, the ownership of the built-in software is not – it is there merely for the operator of the phone to enjoy. An NFT itself is nothing more than a one-of-a-kind container holding a good.
It is, of course, possible for the ownership of the underlying work stored in an NFT to be transferred, so long as such transfer meets the basic requirement of law, which in case of copyright law is assignment of copyright requiring such assignment to be in writing and signed by the assignor or his agent. However, the anonymity of the parties that often envelopes digital transactions, renders signed writing of such assignment impossible, thus posing a practical challenge. An additional hurdle is the lack of clarity on the legality of NFTs in India.
Indian Legal Framework on NFTs
The exponential growth in the popularity of NFTs and crypto has led to the establishment of various trading platforms like WazirX and CoinDCX that facilitate trading in crypto and WazirX NFT Marketplace for trading NFTs. However, as on date, there are no explicit legal provisions in India that legalize or ban NFTs.
Given the nature of NFTs, the author believes that the controlling legal provisions for NFTs would be contingent on the asset stored in the NFT. For instance, if such asset was a work of art or music, then the transfer would be governed by intellectual property law. However, the opinion of experts is divided on this aspect. While some believe that the lack of legal regulations means that NFTs would be treated as any other good and therefore subject to provisions of basic contract law, others believe that NFTs are derivatives under the Securities Contracts Regulation Act, 1956 (“SCRA”), making trading in NFTs in India illegal unless traded on a recognized stock exchange.
Even in the case of contract law one of the fundamental criteria to consider while transacting with NFTs is whether such a transaction fulfills the primary requirements of contract law, i.e., the presence of three elements determinant of a contract – offer, acceptance and consideration. While the first two elements are easily satisfied, the final element, consideration, may be a challenge with NFT transactions.
As mentioned earlier, NFT transactions usually involve the exchange of cryptocurrency as consideration. However, the fate of cryptocurrency in India is currently ambiguous. So far, the Indian government has not acknowledged the legitimacy of cryptocurrency. In fact, the Reserve Bank of India (“RBI”) issued a circular dated April 06, 2018 prohibiting dealings in virtual currencies. However, this circular was set aside by the Supreme Court in Internet and Mobile Association of India vs. Reserve Bank of India vide judgement dated March 04, 2020, where the Supreme Court noted that in the absence of legislative provisions banning cryptocurrency, imposing restrictions on the same violated the fundamental right to freedom of trade, espoused in Article 19(1)(g) of the Constitution. The RBI subsequently issued a circular confirming the invalidity of its previous circular on virtual currency in light of the Supreme Court judgement. In November 2021, the Union Finance Minister, Ms. Nirmala Sitaraman, categorically stated that Bitcoin would not be considered legal tender in India. Instead, the government proposed to introduce the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 (the “Bill”) in the winter session of the Lok Sabha. The objective of the Bill is two-fold– (i) creation of a facilitative framework for introduction of the official digital currency to be issued by the RBI; and (ii) prohibit all private cryptocurrencies in India with certain exceptions “to promote the underlying technology of cryptocurrency and its uses”. Although the bill is yet to be introduced in the Parliament as on date, the most recent development in this sphere has been the announcement of the Union Finance Minister during the Annual Budget Session on February 01, 2022, wherein she stated that starting 2022-23, the RBI will issue a new digital rupee, powered by blockchain technology. The government further announced that any income from transfer of virtual digital assets will be taxed at the rate of 30%, without the benefit of offsetting losses against other income.
Implications of the Government’s Announcement
This announcement gives insight into the government’s stance on crypto and other virtual digital assets. The government is seemingly discouraging the use of virtual digital assets, while simultaneously trying to engage with the technology, so as to not lose out on the opportunity it presents. Its stance on taxation of virtual digital assets makes it clear that cryptocurrency, like NFTs, will be viewed as assets, rather than legal tender. This clarifies that while NFT transactions can be considered contracts under Indian law, such a transaction would likely not be considered as being one involving money, rather, it may be considered a barter.
Further, the Government’s announcement explicitly states that proceeds from sales of NFTs will be treated as income under the head of Income from Other Sources (“IFOS”), which is a clear disincentive for digital artists. This is especially so since no distinction has been made between the sale of freshly minted NFTs and resale of NFTs. This becomes significant when a comparison is made between the treatment of earnings from sale of conventional artworks (paintings, sculputres, etc.) under the Income Tax Act (“IT Act”) either as stock-in-trade or as a capital asset. Although not clearly stated in the IT Act, the artwork created by artists is treated as “goods” under the Central Goods and Services Tax Act, 2017 and is taxed at 12%. Consequently, under the IT Act, such artworks would be considered inventory and earnings from sale of such artworks would be taxed under the head of Profits and Gains from Business and Profession (“PGBP”). Alternatively, artworks held as personal effects are considered capital assets and gain from sale of such artworks are considered as long or short term capital gain, depending on the holding period of the asset. Similarly, for a digital artist, their artwork created and minted as NFTs ought to be classified as digital inventory, if not services, and consequently, earnings from such art/NFTs, ought to be treated as income under the head PGBP. The treatment of such earnings as IFOS will cause a significant increase in the income tax payable by such artists, who are ostensibly being penalized for creating and selling art using non-traditional media. It is also unclear if such sales will be further subject to the goods and services tax.
Finally, the issue of digital rupee as a cryptocurrency is unlikely to excite regular users of crypto as it is most likely to be monitored, making it unfavorable for anonymous transactions. The allure of crypto is its characteristic of being decentralized currency, which is lost in the case of the digital rupee.
Conclusion
With the boom in NFTs and the increasing participation of governments across the world in the issue of cryptocurrency, it is clear that these digital assets are here to stay. However, the conservative stance adopted by the Indian government may make it challenging for digital artists in India to actually benefit from the current global phenomenon. There is an urgent need to clarify the legality of both cryptocurrency and NFTs in India in the face of the burgeoning global crypto economy. Failure to do so would not only result in India losing out on a potential goldmine in terms of technological advancement and investment, but also result in the illegal use of virtual assets. Interestingly, the stance of the government in considering crypto as assets theoretically paves the way for a return to the barter system of trade.
