One red paperclip, almond milk, cryptocurrencies, and taxation

Have you heard the story of one red paperclip? Fascinating in itself, it refers to the true life events of a person who exchanged a single red paperclip with a pen, the pen with a doorknob; and in a series of onward exchanges, ultimately received a house in exchange. What is important to note is that the value attributed in each successive exchange increased, perhaps because the legend behind the item grew.

And did you know that the Food and Drug Administration, USA (FDA) contemplated whether plant-based products should be allowed to be labelled as “milk” or not?

These seemingly unrelated topics could have a significant impact on taxation of digital/crypto currencies in the future.

Digital currencies or digital assets

Just because plant-based products are commonly referred to as milk, a question remains whether the nature of such products would automatically become that of milk. Similarly, should the nature of cryptocurrencies be decided based on how it is commonly referred by the public? Should they be treated as ‘currencies’ as understood in the financial world, or as digital products/services?

The European Union VAT Committee has focused its tax discussion by classifying cryptocurrencies either as a negotiable instrument, or as a digital product (i.e. an electronically supplied service).

Similarly, India has recently imposed a withholding tax by treating cryptocurrencies as digital assets instead of treating them as traditional currencies. Though the Reserve Bank of India has recently launched digital rupee, it should not be misunderstood as being equivalent to other cryptocurrencies. The Indian FM has stated that the country has no plans to recognise digital/crypto assets as currencies.

Cryptocurrencies are essentially stateless ‘currencies’ outside traditional commerce or governance. A consistent global approach is yet to emerge on the categorisation of cryptocurrencies.

Cryptocurrencies vs NFT

The taxation debate on cryptocurrencies could be better appreciated by comparing it with NFTs (non fungible tokens). Both, cryptocurrencies and NFTs, uses the same programming/encoding technology (i.e. blockchain) and are stored in digital wallets.

NFTs are digital tokens that represent ownership of digital assets such as an image, tweet or music/video. Just like a physical painting, even though multiple copies can be made of any digital asset, a NFT represent the ownership over the original digital asset.

For taxation purposes, a purchase/sale of NFT should normally be treated as a traditional supply of digital product for a consideration. As much as NFTs could be treated as digital assets, it could be argued that cryptocurrencies should follow the same tax treatment.

(Pankaj S. Jain is the managing director of AskPankaj Tax Advisors. For feedback and queries, you may write to info@AskPankaj.com. Views expressed are his own and do not reflect the newspaper’s policy.)