1% tax could trigger severe market reactions, hammer prices and threaten cryptocurrency ecosystem, economists warn.

Indian crypto traders have been waiting for over three months for the commencement of a highly controversial component of India's next cryptocurrency tax policy - the 1% tax on TDS (tax deducted at source). The tax will be imposed whenever an Indian buys or sells cryptocurrency.

The tax went into effect on Friday, July 1, setting the stage for a test - an anticipated negative impact on crypto adoption and the market. Determining the impact of the tax will be a wait-and-watch game at a time when investors around the world are facing a slowdown.

What is the tax?

India’s new crypto tax law has two major provisions, the 1% TDS liability and a 30% capital gains tax on all transactions. The latter provision came into force on April 1.

TDS is a tax that the exchanges are responsible for paying on behalf of the sellers using their platform. The exchange will be charged 1% of the transaction's value. The seller will be able to reduce his or her total tax liability by 30% by using this credit.

If a transaction occurs, the government must be notified within 30 days from the end of the month in which it occurred. The sum deducted must be paid to the government within that time period as well.

Certain types of taxpayers may be exempt from paying tax on transactions up to INR 50,000 ($640) in a year.

The following section details other procedural specifications.

In the latest update

In the announcement released on June 30, the government said that there is no need to pay 30% tax and 1% TDS on some NFTs and digital assets.

The exemption applies to digital gift cards or vouchers that can be used for the purchase of goods and services, or those that can be used to get discounts on goods and services.

Points that are not redeemed for money, such as mileage points, reward points or loyalty cards, have also been excluded from the definition of virtual currency. The same applies to subscriptions to websites or platforms or applications.

Land records are one of the few tangible assets that cannot be represented by a non-fungible token (NFT).

The 1% TDS has been the subject of debate

The announcement of the crypto tax rules on Feb. 1, 2022, caused an uproar in the Indian crypto community. The biggest issue they had was with the 1% TDS.

The 1% TDS is too high, they say, and could kill trading volumes, increase the already high level of brain drain, and make tax collection and understanding extremely cumbersome.

Representatives of the crypto industry met and pleaded with government representatives to remove or change this specific provision.

Sumit Gupta, co-founder and CEO at CoinDCX, a "crypto investment app" that was once India's most well-known and largest exchange but is now, said this tax would do more harm than good. He said developers and entrepreneurs might flee to friendlier jurisdictions, and that the 30% taxation rate coupled with 1% TDS is "unfair."

Nirmala Sitharaman, India's finance minister, argued that the government is taxing crypto because people are profiting from it and that the goal is to "check the source and trail" without legitimizing it.

"Regulations are good for the crypto industry and a definite positive step. However, 30% taxation and 1% TDS is unfair. We humbly urge the government to reconsider the % of TDS and tax. Onerous taxation and TDS is proving to be a major hindrance to the growth of this industry. The objective of tracking transactions and transparency can very easily be achieved in other ways too," tweeted Gupta.

The predicted outcome

CEO of one of India's biggest exchanges, WazirX, Nischal Shetty told CoinDesk that "we have entered a period of pain" after the proposal became law on April 1.

"The 1% TDS could kill liquidity, which would ultimately lead to a drop in profitability for everyone. It's a lose-lose situation," Shetty said.

When the 30% tax was imposed on trading volumes in April, they fell sharply, by more than 70% in some cases.

Hours before the new tax went into effect, exchanges announced that they would be shutting down their systems because of TDS implementation, showing how retailers and the industry will have to streamline tax collection processes which they say are difficult.

The days leading up to July 1 have seen "1% TDS" trending on Twitter. Crypto exchanges and influencers have been hosting educational

Opposition to government/central bank

A video of a former finance minister, Ritesh Pandey, who had previously called for the end of the 1% tax on transactions, went viral as 1% TDS started to trend.

Pandey said, "In our country, where so many unicorns are emerging, the government's regulation is strangling all crypto transactions."

"The people in the 18-25 years of age are heavily invested in this (crypto and other VDAs), and the TDS is effectively ending their ambitions and innovation. I call on the government to remove the 1% TDS from all crypto transactions," said a young MP, referring to virtual digital assets.

The Governor of India's Central Bank, Shaktikanta Das, recently said that cryptocurrencies were a clear danger and that anything which derives value based on make-believe without any underlying is just speculation.