GS Paper: Indian Economy

Context

Notwithstanding the eventual introduction of the Cryptocurrency and Regulation of Official Digital Currency Bill in Parliament, cryptocurrencies continue to proliferate.

Provisions in Income Tax Act 1961 to tax cryptocurrencies

• Cryptocurrencies not mentioned in Income Tax Act, 1961: Although the Income Tax Act, 1961 (“IT Act”) does not specifically mention cryptocurrencies, it does cast a wide enough net to bring crypto transactions under its ambit.
• Capital asset: Trading in cryptocurrency may be classified as transfer of a ‘capital asset’, taxable under the head ‘capital gains.
• Business income: If such cryptocurrencies are held as stock-in trade and the taxpayer is trading in them frequently, the same will attract tax under the head ‘business income’.
• Even if one argues that crypto transactions do not fall under the above heads, Section 56 of the IT Act shall come into play, making them taxable under the head ‘Other sources of income’.

Challenges in taxing cryptocurrencies

• The above provisions in themselves are not sufficient in order to put in place a simple yet effective taxation regime for cryptocurrencies.

[1] Varied interpretations:

• First, the absence of explicit tax provisions has led to uncertainty and varied interpretations being adopted in relation to mode of computation, applicable tax head and tax rates, loss and carry forward, etc.
• For instance, the head of income under which trading of self generated cryptocurrency (currencies which are created by mining, acquired by air drop, etc.) is to be taxed is unclear.
• Since there is no consistency in the rates provided by the crypto-exchanges, it is difficult to arrive at a fair market value.
• Similarly, when a person receives cryptocurrency as payment for rendering goods or services, how should one arrive at the value of the said currency and how should such a transaction be taxed?

[2] Identifying tax jurisdiction

• It is often tricky to identify the tax jurisdiction for crypto transactions as taxpayers may have engaged in multiple transfers across various countries and the cryptocurrencies may have been stored in online wallets, on servers outside India.

[3] The anonymity of taxpayer

• The identities of taxpayers who transact with cryptocurrencies remain anonymous.
• Exploiting this, tax evaders have been using crypto transactions to park their black money abroad and fund criminal activities, terrorism, etc.

[4] Lack of third party information on crypto transaction

• The lack of third party information on crypto transactions makes it difficult to scrutinise and identify instances of tax evasion.
• One of the most efficient enforcement tools in the hands of Income Tax Department is CASS or ‘computer aided scrutiny selection’ of assessments, where returns of taxpayers are selected inter alia based on information gathered from third party intermediaries such as banks.
• However, crypto-market intermediaries like the exchanges, wallet providers, network operators, miners, administrators are unregulated and collecting information from them is very difficult.

[5]  Physical goods/services may change hand in return for cryptocurrencies

• Even if the crypto-market intermediaries are regulated and follow Know Your Customer (KYC) norms, there remains a scenario, where physical cash or other goods/services may change hands in return for cryptocurrencies.
• Such transactions are hard to trace and only voluntary disclosures from the parties involved or a search/survey operation may reveal the tax evaders.

Steps need to be taken

• Statutory provision: The income-tax laws pertaining to the crypto transactions need to be made clear by incorporating detailed statutory provisions.
• Awareness generation: This should be followed by extensive awareness generation among the taxpayers regarding the same.
• Separate mandatory disclosure: The practice of having separate mandatory disclosure requirements in tax returns (as is the case in the United States) should be placed on the taxpayers as well as all the intermediaries involved, so that crypto transactions do not go unreported.
• Strengthen international legal framework: Additionally, the existing international legal framework for exchange of information should be strengthened to enable collecting and sharing of information on crypto-transactions.
• This will go a long way in linking the digital profiles of cryptocurrency holders with their real identities.
• Training tax officers: the Government must impart training to its officers in blockchain technology.
• The United Nations Office on Drugs and Crime’s ‘Cybercrime and Anti-Money Laundering’ Section (UNODC CMLS) has developed a unique cryptocurrency training module, which can aid in equipping tax officers with requisite understanding of the underlying technologies.

Consider the question “What are the provision in Income Tax Act 1961 to tax the cryptocurrencies? What are the challenges in taxing cryptocurrencies? “

Conclusion

It is certain that cryptocurrencies are here to stay. A streamlined tax regime will be essential in the formulation of a clear, constructive and adaptive regulatory environment for cryptocurrencies.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Context

There are three major reasons why the GDP data, and hence any narrative of economic recovery based on it, are questionable.

Background

• The NSO released the current GDP series in 2015, using 2011-12 as its base year.
• Some have argued that the problem in the new series is the real growth rate. This is debatable.
• Scholars have pointed to measurement problems, both in the nominal and real GDP growth rates.

Three issues with the GDP data, and  narrative of economic recovery based on it

[1] Double deflation problem

• The new series entailed a shift from a volume-based measurement system to one based on nominal values, thereby making the deflator problem more critical.
• Simply put, the NSO calculates real GDP by gathering nominal GDP data in rupees and then deflating this data using various price indices.
• The nominal data needs to be deflated twice: Once for outputs and once for inputs.
• But the NSO — almost uniquely amongst G20 countries — deflates the nominal data only once.
• It does not deflate the value of inputs.
• To see why this is a problem, consider what happens when the price of imported oil goes down.
• In that case, input costs will fall and the profits recorded by Indian firms will rise.
• This increase in profits is merely the result of a fall in input prices, so it needs to be deflated away.
• But the NSO doesn’t deflate away the increase in profits.
• Since the cost of inputs is measured by the WPI (wholesale price index), a crude measure of the overestimation caused by the absence of “double deflation” is given by the gap between the WPI and the CPI (consumer price index).
• In the 2014-2017 period, oil prices plunged, causing the WPI to fall sharply relative to the CPI.
• This meant that real growth was probably overstated.
• In the last few months, the exact opposite has been happening. WPI inflation is soaring.
• The rapid increase in the WPI relative to the CPI is imparting an upward bias to the deflator.

[2] Sectoral weight not updated

• When it calculates GDP, it takes a sample of activity in each sector, then aggregates the figures by using sectoral weights.
• To make sure that the weights are reasonably accurate, the NSO normally updates them once a decade.
• It has now been more than 10 years since the weights were changed, and there are no signs of a base year revision.
• As a result, the sectoral weights are still based on the structure of the economy in 2010-11, when in particular the information technology sector was much smaller.

[3] Measurement of unorganised sector

• Measurement of the unorganised sector has always been difficult in India.
• Once in a while, the NSO undertakes a survey to measure the size of the sector.
• In the meantime, it simply assumes that the sector has been growing at the same rate as the organised sector.
• However, starting in 2016 the unorganised sector has been disproportionately impacted by a series of shocks.
• In 2018, the NBFC sector reported serious problems, which in turn impacted unorganised sector firms since they were heavily dependent on NBFCs for funds.
• From 2020 onwards, the pandemic has impacted the unorganised sector more than the organised sector enterprises.
• Despite these shocks, the NSO does not seem to have made any adjustments to its methodology for estimating the growth of the unorganised sector.

Consider the question “Elaborate the issues with India’s GDP data. Suggest the way forward.”

Conclusion

There are serious problems with India’s GDP data. Any analysis of recovery or growth forecast based on this data must be taken with a handful of salt.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Context

The report of the Standing Committee on External Affairs on ‘India and bilateral investment treaties (BITs)’ was presented to Parliament last month.

Factor’s that necessitated the review of India’s BITs

• Investor’s started suing India frequently: Since 2011, when India lost its first investment treaty claim in White Industries v. India, foreign investors have sued India around 20 times for alleged BIT breaches.
• This made India the 10th most frequent respondent-state globally in terms of investor-state dispute settlement (ISDS) claims from 1987 to 2019 (UNCTAD).
• Adoption of new Model BIT: India adopted a new Model BIT in 2016, which marked a significant departure from its previous treaty practice.
• Negotiating new BITs: India is in the process of negotiating new investment deals (separately or as part of free trade agreements) with important countries such as Australia and the U.K.

Recommendations of the Committee

• 1] Speed of the existing negotiations: India has signed very few investment treaties after the adoption of the Model BIT.
• It recommends that India expedite the existing negotiations and conclude the agreements at the earliest because a delay might adversely impact foreign investment.
•  2] Sign more BIT’s in core sector: The committee recommends that India should sign more BITs in core or priority sectors to attract FDI.
• Generally, BITs are not signed for specific sectors.
•  It will require an overhauling of India’s extant treaty practice that focuses on safeguarding certain kinds of regulatory measures from ISDS claims rather than limiting BITs to specific sectors.
• 3] Fine-tune Model BIT: Model BIT gives precedence to the state’s regulatory interests over the rights of foreign investors.
• The Model BIT should be recalibrated keeping two factors in mind:
• a) tightening the language of the existing provisions to circumscribe the discretion of ISDS arbitral tribunals.
• b) striking a balance between the goals of investment protection and the state’s right to adopt bonafide regulatory measures for public welfare.
• 4] Improve the capacity of government officials: The committee recommends bolstering the capacity of government officials in the area of investment treaty arbitration.
•  While the government has taken some steps in this direction through a few training workshops, more needs to be done.
• What is needed is an institutionalised mechanism for capacity-building through the involvement of public and private universities.
• The government should also consider establishing chairs in universities to foster research and teaching activities in international investment law.

Need to improve poor governance

• A very large proportion of ISDS claims against India is due to poor governance.
• This includes changing laws retroactively which led to Vodafone and Cairn suing India.
• Annulling agreement in the wake of imagined scam which resulted in taking away S-band satellite spectrum from Devas.
• The judiciary’s fragility in getting its act together (sitting on the White Industries case for enforcement of its commercial award for years).

Suggestions

• The Committee could have emphasised on greater regulatory coherence, policy stability, and robust governance structures to avoid ISDS claims.
• The government should promptly assemble an expert team to review the Model BIT.

Consider the question “India is one of the most frequent respondent-state globally in terms of investor-state dispute settlement (ISDS) claims. In context of this, examine the reasons for such frequent disputes and suggest the way forward.” 

Conclusion

The committee’s report on India’s BITs have novel suggestions, but it is lacking in several aspects.

UPSC 2022 countdown has begun! Get your personal guidance plan now! (Click here)

Back2Basics: ISDS mechanism

• Investor-state dispute settlement (ISDS) is a mechanism in a free trade agreement (FTA) or investment treaty that provides foreign investors, with the right to access an international tribunal to resolve investment disputes.
•  ISDS promotes investor confidence and can protect against sovereign or political risk.
• If a country does not uphold its investment obligations, an investor can have their claim determined by an independent arbitral tribunal, usually comprising three arbitrators.