Are NFTs a boon or a bane? A legal perspective

NFTs are digital assets that represent the ownership of collectibles such as artwork, a GIF, an image, a video, audio or even a tweet that can be bought or sold. It is backed by blockchain technology and can be traded using one of the more popular cryptocurrencies like Ethereum which holds its unique value and cannot be changed over time.

The market cap of NFT expanded nearly tenfold between 2018 and 2020 from the date of its introduction in the year 2017. Since then, this has exploded in popularity, and the sales of NFTs have surged up to $25 billion by 2021. This clearly indicates the interest of buyers all across the globe to invest in these digital assets and shows a potential future market for NFTs.

As per Statista, comparing results from several Google Surveys held across the world in September 2021 reveals that non-fungible tokens were especially popular in Southeast Asia and Latin America. Although the source admits the methodology used is not flawless, the position of certain countries in this ranking is noticeable. Globally, investors are trading in high volumes in NFTs.

However, not all is good in the NFT land. There has been a lot of criticism in general about cryptocurrencies from major economies in the world and it has changed the dynamics of the NFT universe. India, for example levied a heavy tax cap in its last Union Budget to curb cryptocurrency transactions in India. Daily trading volumes on Indian crypto exchanges, which collectively cater to about 15 million people, have tumbled by between 88% and 96% since peaking last year, according to data from Coingecko.

Legal Implication involved in NFTs trading in India

Cryptocurrency buzz has tremendously grown during the last 5 years and NFTs are one of such assets backed by cryptocurrency. However, the lack of clarity on the legal status and trading regulation creates a major concern. The government is still contemplating laws in order to regulate cryptocurrency. In June 2018, the Reserve Bank of India (RBI) issued a circular advising banks not to deal in cryptocurrencies. However, if we talk about the current status, NFTs are neither legal in India nor its trading and this creates an apprehension in the mind of Indian investors. 

Evolution of NFTs

Status of NFTs as per the Securities Contract Regulation Act, 1956 (SCRA): No proper categorisation of NFTs is provided under the Securities Contract Regulation Act, 1956 (SCRA). Few consider it as a contract and others as a derivative and if we consider it as a derivative, then trading of NFTs will be prohibited as per the SCRA. As per Section 2(ac) of the SCRA, the term ‘derivative’ is “a contract whose value is derived from the prices of the underlying securities”. As per Section 18a of SCRA derivatives cannot be traded on virtual platforms, derivative is considered legal if they are exchanged on a recognised stock exchange. In such a case, the platforms where NFTs are exchanged must apply to the Central Government for recognition as a stock exchange. 

As per FEMA Regulations: The assets that are transferred via NFT, whether physical or digital, will be subject to the regulations that are involved in cross-border transactions of the Foreign Exchange Management Act, 1999 (FEMA). The stance is not clear whether NFTs can be categorised as ‘intangible assets' and governed under the software and intellectual property parts of the FEMA regulations. The main issue arises from the location of an NFT because it is supported via global records means information is shared across global platforms hence degerming NFT's location is an important aspect. 

As per the Income Tax Regulations: The 2022-2023 Budget has clearly mentioned all virtual digital assets, including NFTs, are subject to 30% tax plus cess and surcharges on transactions dealing with virtual currencies. Further, as per Section 165A of the Finance Act, 2020 purchase of NFTs by Indian buyers falls under the purview of cross-border transactions if the seller belongs to another country subject to a 2% equalization fee based on the NFT's gross value and the marketplace's income from Indian customers. These regulations restrict the Indian buyer and discourage such buyers to participate in NFTs transactions. 

Conclusion

To conclude, there is no specific provision provided under the Indian Laws pertaining to the NFTs and currently, it is governed by the general principle of contract. While NFTs hold a great future from a technology perspective, the average Indian consumer is concerned and unable to invest because of a lack of legal structure and clarity. The legalisation of cryptocurrencies is essential for trading in NFTs along with clarity on the status of NFTs. For now, the NFT revolution seems exciting and promising but legal regulation can make it more impactful for the purpose of trading in the Indian market. Hence, Indian investors must be cautious while investing in NFTs because of the risk with it due to the lack of legal clarity under the Indian Laws.

The author of this article is Bhavya Sharma, a Fellow Company Secretary, a Lawyer and the founder of Bhavya Sharma & Associates (BSA), a Professional Business Consultancy.

(Disclaimer: The views expressed above are the author's own and do not reflect those of DNA.)

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