Based on the holding period, the profit you make are liable to short-term or long-term capital gains tax, experts tell Tinesh Bhasin.
While virtual currencies like Bitcoin are gaining popularity, there is still lack of clarity on how they should be taxed.
Many buyers of cryptocurrencies, therefore, don't pay tax on the gains they make on selling them.
Software developer Pawan Bharti recently sold Bitcoin worth Rs 55,000 after his investment doubled within three months.
In the last week of July, one Bitcoin was around Rs 1.74 lakh. Recently, it has gone over Rs 3.85 lakh, an appreciation of over 121 per cent.
The virtual currency, however, can be bought in smaller units. "Neither my friends or I am aware that we need to pay tax on these gains," says Bharti. He is planning to invest the money in fixed income instruments.
"What investors don't realise is that the Income Tax Act may not cover the taxation of virtual currencies specifically. But there are provisions that cover all kinds of income and gains," says Archit Gupta, CEO, ClearTax.
The definition of capital assets under Section 2(14) is broad enough to include any investment in cryptocurrencies.
The taxation of virtual currencies would depend on the purpose for which an individual buys it, say experts.
If a person has purchased a virtual currency to pay for goods, then there should be no tax. It's as good as cash in the wallet that one uses for transactions.
But rarely anyone uses virtual currencies for such payments. Most buy it to pocket the profit.
Any profit arising out of the sale of virtual currencies can be construed as capital gains, according to tax experts.
"Accordingly, the capital gains tax will be applicable depending upon the holding of such investments," says Suresh Surana, founder of RSM Astute Consulting Group.
If these are held as an investment for three years or more, the gains will be considered as long-term capital gains.
The investor will need to pay 20 per cent tax after considering indexation benefit.
If an individual sells it within a year, the gains will be treated as short-term capital gains. The profit will be clubbed with the income.
The investor will need to pay tax depending on his income tax slab.
If the transactions in bitcoins are substantial and frequent, it could be said that the individual is trading in bitcoins. The tax treatment would then change and the gains made would be considered as business income.
It means the tax is payable as per the applicable slab rates of the investor.
There is no clear definition of what constitutes "frequent" transactions. Tax experts say it would vary from case to case.
If it is business income, then the investor would also need to pay advance tax, failing which there would be a penalty.
What many don't realise is that the authorities can easily track the transactions in virtual currencies.
"All virtual currency exchanges onboard customer after complying with the KYC (Know Your Customer) requirements. There's also a banking trail to all transactions," says Saurabh Agrawal, co-founder and CEO of Bitcoin exchange Zebpay.
If you have not paid taxes on Bitcoin transactions, then the income tax authorities may send a notice asking you to explain the gains reflected in the bank account.
The assessing officer will then give you an opportunity to revise the returns and pay applicable tax.
In case you have losses, tax experts say don't set them off or carry them forward. Many expect Central Board of Direct Taxation to notify rules on taxation of virtual currencies soon.
Photograph: Benoit Tessier/Reuters.