Non-Fungible Tokens: Future in India

Introduction
Non-Fungible Tokens or NFTs are a combination of a special type of cryptocurrency that
represents digital art and has distinctive characteristics. They are unique tokens that are
governed and built through blockchain. Like other tokens, NFTs can also be transferred and
traded, although as they are a one-of-a-kind trading card, NFTs are not interchangeable. They
have similar functions to cryptocurrencies however, unlike cryptocurrency they are singular,
without any duplications, and have a unique signature that is embedded in its metadata. The
signature could be anything that describes the asset or points towards the asset. Some of the
famous and recent NFTs include digital art of cats which were sold for $170,000; the Gucci
Ghost which was sold for $3,600; Tweet of twitter’s CEO Jack Dorsey which was sold for $2.9
million.
Even though this technology is still in its infancy stage, recent years have shown fast growth
and the continuous growth in the demand for NFT is clear. Since the beginning of 2021, major
NFT marketplaces have witnessed their cumulative sales grow by 50 to 100 times. As creating
an NFT does not necessarily require knowledge of cryptocurrency, or crypto wallet and can be
available to anyone with an internet connection, it is much easier to access. It only takes
seconds to create a 'collection' and upload it on the NFT marketplace. Additionally, the
copyright of the original artwork remains with the creator itself, thereby the buyer does not
have the right to duplicate the work. No matter how many times an NFT is transferred, the
metadata of the blockchain always allows the owner to be traced, making the technology
deterrent against copyright infringement. So, to sum it up anyone can buy digital art but only
one person can own it. Another aspect of NFTs is that they can be programmed using smart
contracts, which would allow the artists to automatically get paid a programmed percentage of
royalty, every time a secondary sale of their work occurs.

Dealing with NFTs in India

As mentioned earlier, NFTs are nothing but digital tokens that can be sold and bought in the
marketplace like any other valuable. Popular and public blockchains such as Ethereum are used
for generating and dealing with NFTs. They can be either created directly by developers using
developing tools or by users through a third-party marketplace like Opensea and Nifty
Gateway. For non-developers, these marketplaces provide a user-friendly interface and an
effortless method to create and sell NFTs. Mostly, NFTs are dealt with crypto assets however,
considering the recent growth some platforms have also enabled purchases via debit and credit
cards. When the payment is received in a non-crypto format, a backend transaction is
performed on the blockchain to enable the transfer of the concerned NFT.
As of present, no legislation or law prohibits Indian residents from dealing with NFTs. Even
though RBI and the government have commented on having a regulatory body and framework
for handling cryptocurrencies and the digital economy, no separate legal policies are in talks
for NFTs. As there are no domestic marketplace for NFTS in India, they are operated and
governed by foreign establishments which raises some ambiguities under Foreign Exchange
Management Act, 1999 (FEMA), the act governing cross-border economic transactions in
India. Extrapolating existing provisions under FEMA, NFTs could be treated as intangible
assets however, determining the location of an NFT remains an open question. In Internet and
Mobile Association of India v. Reserve Bank of India, the Supreme Court of India clarified that
intangible asset like cryptocurrencies 'cannot be stored anywhere'. Based on this judgment, the
location of NFT should be determined based on where the owner resides. Further, the treatment
of NFT would also be depended upon the underlying asset that is been exchanged. For instance,
an NFT transferring a parcel of land would be treated differently from an NFT transferring a
work of art. Nevertheless, the ambiguities raised due to cross-border transactions allow Indian
entrepreneurs to establish an NFT marketplace for Indian residents and avoid the confusion
caused by FEMA.

Intersection of NFT and intellectual property rights

As of today, intellectual property claims of NFTs have not been tested in courts or legislations.
Although the default rule under any intellectual property law is to grant protection to the
creators of original ideas. Under the Copyright Act, 1957 the general rule is that when a
property is sold, the copyright in the work is retained with the original copyright holder. Even
though as per ‘first doctrine sale’ the buyer has the ability to resell the property, he cannot
make any additional copies. If the same principles are applied to NFT it would mean that as
long as the author of the work specifically transfers the ownership of copyright, they would
own the copyright of the underlying asset in the NFT.
The next important aspect to be considered with introduction of NFT is to recognize the
difference between ownership of NFT and ownership of underlying asset. For instance, if you
create a NFT in the form digital GIF of LeBron James dunk, you will have the ownership of
NFT, but the underlying asset belongs to the NBA. As ownership of NFT does not guarantee
ownership of any intellectual property associated with it, you would not be permitted to
reproduce or distribute the copies. NBA still retain the exclusive rights and unless they
expressly agree to transfer those rights, displaying or making derivatives of the original work
would amount to copyright infringement.

Taxation of NFTs in India

The tax treatment of an NFTs should logically depend upon the underlying asset, however, the
cross-border transactions are likely to create chaos and issues concerning taxation liabilities.
Expansion of equalization levy (EL) made via Finance Act, 2020 applies to e-commerce
operators at the rate of 2%. Thus, any e-commerce operator that receives consideration for the
supply of goods and services to an Indian resident, the person using an Indian IP address, or
even a non-resident under specified circumstances would be liable to pay EL. Accordingly, the
NFT marketplace may also be subject to such tax liabilities. Further the term 'e-commerce
supply or services' has been defined very broadly and Finance Act 2021 further provides that
EL would not apply just on the commission amount but on the entire consideration received
from the buyer.
Practically applying these EL provisions to NFT transactions create certain complications.
Firstly, as the definition of ‘e-commerce supply and service’ is so wide it takes into its spectrum
not only the marketplace of NFTs but also all electronic services including the blockchain that
is used to facilitate such transactions. Secondly, the NFT marketplace does not have the access
to the consideration received thereby it would lead to a situation where marketplaces are forced
to pay EL of 2% of the entire consideration as a tax even when they do not have access. Thirdly,
there is ambiguity in determining whether the gas fees (fees that are paid by users to validate
transactions on the blockchain) that are directly received by the blockchain miners would be
taxable under this regime or not. Fourthly, it may not always be feasible for the NFT
marketplace to keep track of the residence status or IP address of each seller or buyer. As the
location of the buyer is a pre-determinant for applying EL, it imposes implication problems.
Further Section 194-0 of the Income Tax Act, 1961 requires the e-commerce operator to
withhold tax, irrespective of the fact that payment is directly made to the seller or not. This
would create cashflows problems for NFT marketplaces as they would be liable to pay to
deduct tax on the consideration paid to the sellers, even when the amount does not flow through
them. Another key challenge would be determining if tax-collection-at-source (TCS) provision
under the GST regime would be applicable or not. Firstly, depending on the place of transaction
relevance of GST laws would have to be determined then based on underlying transactions
classification of supplies would take place. Thereafter the question of applicability of TCS
would come. As per Section 52 of the CGST Act, e-commerce operators who receive the
consideration on behalf of the seller or vendor are liable to deduct TCS on net taxable supplies.
In traditional e-commerce platforms, TCS should be applied however, applying the same
should not apply to NFT marketplaces as the consideration is directly exchanged between the
parties through an automated contract.

Money laundering through NFT

NFT can also become a viable source for people to avoid tax altogether. Just like initially
bitcoin and other cryptocurrencies were used for illicit activities, NFT has also made its way
into money laundering. For decades artworks and historical artifacts have been used to launder
money and avoid taxes, and with the introduction of NFT, the whole process became a lot
easier. The basic idea of laundering money is to disguise the true origins of a proceed into what
seems to be a legitimate source of income. NFT marketplaces can be accessed by anyone, and
the price of the digital art is determined by the buyers themselves. So, if a person Y has $1
million illegal money, they could use that to buy art from NFT platforms, then resell it and
bank the profits. As the money now received is by selling "precious digital art" it's completely
clean and legal. As NFT does not require any physical location and most of the NFT
marketplace operate with little or no KYC requirement it has become the best money
laundering method in the crypto world.

Conclusion
The recent hype and growth of NFT have allowed creators to sell their art without giving up
ownership rights and at the same time enables buyers to have some basic usage rights. No
matter how one interacts with NFT, i.e., either create and sell them in the marketplace or buy
and sell NFTs as an investor, it raises issues with intellectual property rights and existing tax
legislations. For a country like India, where there is no domestic marketplace for NFT and
regulations of blockchain and cryptocurrency are in limbo, dealing with NFTs becomes even
more complicated. While the booming NFTs are attracting artists and creators, the fact that
they are a highly risky asset should be kept in mind and the principle of caveat emperor shall
be followed. No doubt that NFTs brings with it abundance of opportunities but it also carries
challenges for IP rights. It is not clear as to what rights and remedies are available for creators
if their work is tokenized without permission, or how would the first sale doctrine would
operate in the world of NFTs and the implication of unauthorized tokenization of trademark
goods and services. Apart from ensuring that their IP rights are preserved and enforced, it is
also advisable for all persons dealing in NFTs through India to assess and comply with all tax
obligations that may be applicable. Failure to do so could be problematic for the buyer, seller
as well as marketplace.