Following the announcement of a new tax regime for virtual digital assets (VDAs) in India, there was a shift of INR 32,000 Cr ($3,852 Mn) of crypto volume from domestic centralised VDA exchanges to foreign ones during February-October 2022, according to a report by think-tank Esya Centre.

Of this, cumulative volume of INR 25,300 Cr was offshored during April-September period of financial year 2022-23 (FY23).

The think-tank analysed the impact of the three announcements about centralised VDA industry in India made by Finance Minister Nirmala Sitharaman on February 1, 2022 while presenting the Union Budget 2022-23 – 30% tax on gains from VDA transactions, 1% TDS on VDA transactions above INR 10,000, and the provision disallowing the offsetting of losses.

As per the report, the new taxation policy has led to offshoring of domestic business and liquidity to foreign VDA exchanges. This is likely to have a big negative impact on tax revenues and will lead to decrease in transaction traceability, it said.

The total trade volume contributed by Indians on foreign centralised VDA exchanges was to the tune of INR 80,000 Cr between July and October 2022.

Implementation of 1% TDS had the most distortionary impact out of the three tax measures as Indian VDA exchanges lost up to 81% of their trading volumes in three-and-a-half months between July 1 and October 15, as per the study.

Moreover, many Indian VDA users seem to be switching from domestic centralised VDA exchanges to foreign counterparts, it said, adding that approximately 17 Lakh users made this switch during February-October 2022 period.

“India’s tax treatment of VDAs is regressive in comparison to other countries with high VDA adoption rates, such as the US, the UK, South Africa, Vietnam, Philippines and Brazil,” the report said.

The think-tank recommended a few measures to stem the offshoring of domestic business and liquidity to foreign exchanges, including bringing TDS on VDAs at par with securities transaction tax.

“Second, the government should reconcile tax rates vis-a-vis revenue maximisation by ascertaining the optimal taxation point(s) using economic analysis tools such as the Laffer Curve,” it said.

Moreover, India should adopt a progressive tax structure with differentiated rates for short-term and long-term gains, in line with international best-practices, it added.

During the Budget, the finance minister introduced a 30% tax on income from VDAs, including cryptos and non-fungible tokens (NFTs). The rule became effective on April 1, 2022. As per the rules, loss from one asset can not be set off against gain from other assets.

Within a few days of the announcements coming into effect, cryptocurrency exchanges such as WazirX, CoinDCX, BitBns, Zebpay, and Koinbazar started witnessing a downward trend in trading volumes.

Later, crypto exchanges saw more decline in trading volume after the 1% TDS rule came into effect on July 1, 2022.

Last month, industry body IndiaTech.org also wrote to the Finance Ministry that 1% TDS on VDA transactions has led to several Indian investors and crypto startups moving to foreign exchanges to avoid paying taxes.

“Since the primary intention was track and trace we recommend that the rate of TDS be deducted from 1% to 0.01% through an amendment to Section 194S,” the industry said.

On the other hand, Web3 industry body Bharat Web3 Association, which counts Coinbase, CoinDCX, CoinSwtich Kuber, and Polygon as members, also submitted a draft of concerns to the Finance Ministry recently and highlighted the high tax on crypto currencies.