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FIG Paper (No. 39 – Series 3): Recent Learnings from the Indian Virtual Digital Assets Regulatory Space

While ministerial discussions on cryptocurrency regulation had been taking place at the G-20 level, we are expecting the Department of Economic Affairs (“DEA”) may come out with a consultation paper for regulating virtual digital assets (“VDA”) as soon as October this year.

In this FIG paper, we take stock of our recent learnings from interactions with domestic and offshore VDA players, making representations before the Financial Intelligence Unit, India (“FIU-IND”), and the Ministry of Electronics and Information Technology (“MeitY”), for registering and unblocking their platforms.

Registration of VDA Players with the FIU-IND

  • By a March 7, 2023 notification, issued by the Ministry of Finance, Government of India (“MoF”), the following activities were brought under the ambit of the Prevention of Money Laundering Act, 2002 (“PMLA”):
    • exchange between virtual digital assets and fiat currencies;
    • exchange between one or more forms of virtual digital assets;
    • transfer of virtual digital assets;
    • safekeeping or administration of virtual digital assets or instruments enabling control over virtual digital assets; and
    • participation in and provision of financial services related to an issuer’s offer and sale of a virtual digital asset.

    As a consequence, persons carrying on such activities for or on behalf of another natural or legal person in the course of business, i.e., virtual digital asset service providers (“VDASP”), are required to register as reporting entities with FIU-IND.

    • The definition of VDA[1] and the services offered by a VDASP are broad enough to bring a range of entities within the scope of VDASPs that need to register with the FIU-IND, including crypto exchanges, wallet providers, custodians, payment (fiat-crypto conversion) processors and cryptocurrency issuers.
    • The December 28, 2023, MoF Press Release, issuing show cause notices to 9 (nine) offshore VDA exchanges to register with the FIU-IND, also recognised that VDASPs operating in India (both onshore and offshore) are to be mandatorily registered with FIU-IND by stating that ‘the obligation is activity-based and not contingent on physical presence in India.’
    • Basis recent experience and the publicly available list of registered local crypto exchanges, we note that the FIU-IND has initiated action against crypto exchanges as the first step, due to most volumes being traded through such exchanges, and such exchanges facilitating crypto to fiat conversion and vice versa.
    • Basis recent interactions with the FIU-IND, the message from the regulator is that even though the FIU-IND has not yet issued show cause notices to other types of VDASPs, the risk of enforcement cannot be ruled out and all VDASPs should proactively seek registration to operate in India.

    Process of FIU-IND Registration

    The registration process with the FIU-IND is typically completed in 2-3 months and has the following stages:

    • Appointment of a Principal Officer (“PO”) (the MLRO equivalent who is in charge of reporting and anti-money laundering compliances) and a Designated Director (“DD”). The FIU-IND prefers the PO to be an Indian resident even for offshore VDASPs, for the purpose of official communication and coordination;
    • Self-Enrolment on FinGate Portal;
    • In-person/ Virtual meeting with the FIU-IND; and
    • Post-onboarding submission of documentation on FinGate portal, as called upon by the FIU-IND.

    Our recent experience has been that the FIU-IND executives screen applications meticulously, but are open to providing feedback on registration applications, and provide reasons for return/ rejection of applications. They are also flexible with offshore VDASPs on scheduling of meetings and the kind of official documentation that may be furnished for compliance. Our previous publication on FIU-IND registration for offshore players is available here.

    Key Compliances of a registered VDASP

    Upon registration with the FIU-IND, a VDASP would be subject to compliances under the PMLA.

    • Compliances: Objective compliances (appointment of PO/DD, KYC of customers and distributors, internal audit, transaction monitoring) and subjective compliances, including reporting suspicious transactions to the FIU-IND, based on specified thresholds. All reporting must be undertaken by the PO and uploaded on the FinGate portal.
    • Penalty:Non-compliance will lead to the VDASP, its DD/ PO or any other employee being penalised up to INR 1 lakh for each non-compliance. Each unreported transaction/ law enforcement request may be treated as an independent non-compliance. Till date, the only enforcement action by the FIU-IND, discussed in the section below, has been for non-registration and we are yet to see registered VDASPs being penalised for non-compliance with PMLA obligations.

      Enforcement Trends

      • In December 2023, FIU-IND sent notices to 9 offshore crypto exchanges for non-compliance with the PMLA. FIU-IND also wrote to MeitY, which works in coordination with FIU-IND, to issue blocking orders to restrict access to the entity’s website or mobile application on the Google Playstore and Apple Appstore in India.
        • Basis publicly available information, FIU-IND has also imposed monetary penalties for non-compliance with applicable Indian AML/ CFT laws (orders against KuCoin and Binance). The quantum of penalties has been decided basis factors such as period of non-compliance, number of transactions that went unreported, readiness to register with FIU-IND, and responsiveness to law enforcement requests.

        Tax-related Considerations

        • In July 2022, the introduction of the definition of VDA and specific tax provisions under the Income Tax Act, 1961, has made it mandatory for VDASPs to comply with a 30% flat tax rate to be paid in income tax for the transfer of any VDA[2], along with 1% tax deducted at source (at the time of credit of such transfer).[3]
          • Additionally, as a result of being registered as a reporting entity, the Indian tax authorities i.e., the income tax and the goods & service tax (“GST”) authorities may require VDASPs to register with them. Upon such registration, VDASPs may also be subject to compliances from a tax perspective.
          • Enforcement Actions: In August 2024, the Ahmedabad zonal unit of the Directorate General of GST Intelligence (“DGGI”) issued a show-cause notice to Binance, demanding GST payment dues of INR 722 crore (~USD 86 million) for the period starting fiscal year 2017-18.
          • Abolition of Equalization Levy: The Finance Minister, during the Union Budget 2024, announced the abolition of 2% equalisation levy on digital companies, online education-providing firms and software-as-a-service (SaaS) providers without a permanent physical presence in India, with effect from August 1, 2024. This is a positive step toward creating a level-playing field for tech-based companies, and a major relief in compliance costs.

          A Regulatory Framework as the Way Forward

          While VDASPs note the immense market potential for VDA adoption in India, most players are in a wait-and-watch mode on account of the lack of regulatory framework and legal clarity on whether VDA-related products will be permitted in India.

          Currently, the industry is awaiting a consultation paper on VDA regulations from a government panel led by the Secretary of the DEA next month. The aim of the discussion paper is to seek comments from relevant stakeholders on the remit of regulations for VDAs in India.

          In light of the WazirX security breach and the lack of remediation measures specific to VDAs, the need for a regulatory framework has become imminent.

          The team will continue to monitor further developments in this space, specifically to understand the implications of the DEA consultation paper once published.

          [1] Section 2(47A) of the Income Tax Act, 1961.

          [2] Section 115-BBH of the Income Tax Act, 1961.

          [3] Section 194-S of the Income Tax Act, 1961.