Non-fungible tokens: To Deal or Not To Deal

In the present day and age, digital investments and digital assets have become the new trend, as it has enabled one to sit comfortably at home and grow their investment pool by purchasing assets online through various platforms and exchanges undertaking business in such a sphere.

Bitcoin, Ethereum, Dodge Coin, to name a few, are examples of digital assets or otherwise popularly known as Cryptocurrencies. The latest addition to this brigade is the trending digital asset known as NFT (Non-fungible Token).

Amitabh Bachchan, a veteran Bollywood actor, recently introduced his NFTs on an NFT auction platform called Beyondlife.club. The actor’s produced NFTs, put on sale, include verses narrated by the actor himself from the book “Madhushala”, originally authored by his celebrated father, Late Sri Harivansh Rai Bachchan, and posters autographed by the actor, however, the launch for the same is eagerly awaited.

With the rising attraction towards this trend, two pertinent questions arise – what are NFTs and how do they work?

In order to understand what NFTs are, it is crucial to understand the difference between the terms – “fungible” and “non-fungible”. Meriam Webster defines fungible as something “capable of mutual substitution”; something that can be easily interchanged with something identical. On the contrary, ‘non- fungible’ is a term used for things that are unique in their existence and cannot be replaced, recreated or reproduced.

A digital token, on the other hand, is a certificate or receipt recording the transaction between the buyer and the seller of a digital asset. While many think that a non-fungible token is a digital asset, it is rather a certificate of authenticity and ownership awarded to the purchaser after the purchase of a non-fungible asset. An NFT guarantees buyer ownership, at any given time. There are various types of NFTs, including domain names, collectibles, trading cards, sports, digital art, music, virtual worlds and tweets amongst other things.

Cryptocurrency, Fan Tokens, NFTs- these are all a type of crypto assets that use blockchain technology as their powerhouse. In fact, NFTs can only be traded using cryptocurrency. Blockchain technology is based on a ‘distributed ledger technology’ where the proof of ownership certificate is stored in the form of code and such information that is stored on the blockchain, is accessible to the public domain. Each transaction on the blockchain is protected by smart contracts, which is an agreement written in code and is executed automatically to govern the transferability of ownership of the NFT from the buyer to the seller upon a successful transaction having taken place, which are further verified and stored on the blockchain ledger.

Legality of NFTs

The Reserve Bank of India (“RBI”), through its notification dated 6 April 2018, banned all dealings in virtual currencies for all entities regulated by RBI stating that services such as ‘registering, settling, maintaining accounts, giving loans, trading, clearing and any other services using virtual currencies shall with immediate effect stand prohibited.

In March 2020, the Supreme Court in Internet and Mobile Association of India v Reserve Bank of India, Writ Petition (Civil) NO. 528 of 2018, declared the above-mentioned notification by the RBI as unenforceable. While the Supreme Court quashed the notification, the question pertaining to the legality of virtual currencies wasn’t addressed by the Court.

In 2019, the Government of India introduced the ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’ (“Bill”) with the intention of prohibiting the complete usage of cryptocurrency. Under the Bill, the definition of cryptocurrency comprises of ‘any information or code or number or token’, carrying and representing a digital value, generated through ‘cryptographic’ means. By the understanding of the definition, NFTs can be included under the vast interpretation of the definition.

Furthermore, the Bill specifically places a ban on mining, generating, holding, sale, dealings, transfer, disposal and any other processes relating to cryptocurrency within the territory of India. Potentially, under this Bill, NFTs could stand banned as well. However, the Bill not having gained parliamentary assent has not yet gained the status of law.

Recently, the Government of India introduced the Cryptocurrency and Regulation of Official Digital Currency Bill 2021 (“Cryptocurrency Bill”). The Crypto Currency Bill aims to prohibit ‘private cryptocurrencies’, however, as the CryptoCurrency Bill is not available to the public, the extent of the ban cannot be clarified. The finance minister, Shrimati Nirmala Sitharaman informed that the CryptoCurrency Bill awaits clearance from the Union Cabinet.

Presently, it is imperative to note that in India, the concept of NFTs is still fairly new and hence lack the requisite regulations to effectively regulate NFT transactions in particular. However, there is a chance that India might regulate other digital assets including NFTs under the CryptoCurrency Bill upon gaining clearance from the Union Cabinet and further gaining assent from the Parliament.

Legal Issues Arising from NFTs

The sale and investment in NFTs are more frequent and people are showing genuine interest in digital assets The non-regulation or the limited regulation of NFTs poses a few issues as people continue to trade in it. This article discusses two such issues: (a) the issue of copyright ownership: whether copyright ownership is transferred along with other ownership rights and (b) how are NFTs taxed in India?

Who owns the copyright ownership of an NFT?

One of the most common issues arising with the purchase of NFTs is the issue of copyright ownership. Once the NFT is purchased, the ownership of the NFT is transferred to the person purchasing the NFT. However, the bigger question and a question that seeks clarification is whether the transferability of ownership of NFT also guarantees the copyright ownership of the NFT.

Simply put, the answer is No. As mentioned above, the term “non-fungible” means something that cannot be reproduced and recreated and is unique in its existence. The non- fungibility characteristic of the asset creates limited rights for the NFT purchaser, as it does not permit the NFT to be reproduced or recreated. Therefore, this means that the NFT purchaser only has right to sell the NFT.

Further, under section 14 of the Copyright Act 1957, the creator of the NFT has the right to reproduce, store and issue copies of the produced work. Therefore, as the original creation is maintained by the creator of the NFT, it is possible that the purchaser is buying a copy of the original work as NFT. As these are rights that are dispensed to the creator, the copyright of the NFT is not transferred to the purchaser. All that is assigned and transferred to the purchaser through the sale of the NFT is the ownership rights of the NFT but not the right under the copyright law of India.

Taxation of NFT

Another legal issue that arises due to the uncertainty around the legality of NFTs is how an NFT is to be taxed in the country. Neither the Income Tax Act, 1961 nor the Goods and Services Act, 2017 (GST) of India mentions anything about the taxation of NFT or any other crypto asset.

For the purposes of taxation, NFTs being crypto assets could be considered as intangible assets as they are only present in the digital form and cannot exist physically.

The Central Goods and Services Tax applies to the supply of any services or goods. NFT Platforms such as OpenSea, BeyondLife, Blockparty, Mynt and many others would possibly have to pay a GST for the supplying of NFTs as a service or a good. GST would apply both on transactions taking place within India and outside India. The absence of intermediaries on these platforms limits their liability to pay GST only on the sales of NFT.

Further, under Section 194-O, titled “Payments of certain sums by the e-commerce operator to e-commerce participant”, the Income Tax Act, 1961 provides for income tax to be deducted at the rate of 1% (one per cent) of the gross amount of sale. This income tax shall be applicable on e-commerce platforms either once the sale price for the service or the good is deducted from the purchaser’s account or at the time of payment, whichever takes place earlier.

The Income Tax Act further provides under Section 194 Q for tax collection at source. The clause states that for the purchase of goods that aggregate to an amount exceeding INR 50,00,000/- (Indian Rupees Fifty Lakhs only) take at source shall be deducted at the rate of 0.1 per cent. However, there is no delineation between the taxation on the sale of NFTs for Indian residents and non-residents. The FEMA Regulations under the RBI do not provide clarity on how the NFT sale or any crypto-asset sale will be taxed if the purchaser is a non-resident of India.

Equalization Levy

It is anticipated that once the NFTs are regulated in India, it shall be subject to double taxation. The Finance Act, 2020 introduced an equalization levy under Section 165A on “the amount of consideration received or receivable by an e-commerce operator from e-commerce supply or service made or provided”. The equalization levy to be charged on such e-commerce services is at the rate of 2% (two per cent) applicable on the gross value of the income from the platform and on the sale of NFT.

Future of NFTs in India

It is understood from the above, that due to the absence of regulations for NFTs, uncertainty lies around in the area. However, this uncertainty is shared by many other countries. While there are no specific legislation governing the regulation of NFTs, many countries are considering the regulation of NFTs under their respective digital asset laws.

In Germany, crypto assets are governed under the German Banking Act (KWG) and are defined as “a digital representation of value that is not issued or guaranteed by a central bank or a public authority and does not possess a legal status of currency or money but is accepted by natural or legal persons as a means of exchange or payment or which can be used for investment purpose and which can be transferred, stored and traded electronically”. NFTs not having specific legislation to govern it, are potentially going to be regulated under the above-mentioned act.

The NFT culture has been more prevalent and comparatively old in Japan than in other countries. In Japan, when dealing with fungible tokens, there are certain licensing requirements that are to be satisfied but NFTs do not attract any licensing as they are not regulated. Further, NFTs in the form of cards are very common in Japan given the gaming culture and market in the country.

Interestingly in 2021, China’s Central bank declared cryptocurrency as illegal in the People’s Republic of China. The blanket ban was placed on trading, dealing, purchasing, selling and all other processes that may allow the application of cryptocurrency. Contradictory to this, there are no regulations in China prohibiting or banning NFTs. However, given NFTs can only be purchased with cryptocurrency, the legality and presence of NFT in China remain ambiguous.

Russia has recently finalized its law on crypto assets. The law divides crypto assets into digital currencies, digital utility rights and digital financial assets. While the regulations don’t make an explicit mention of NFTs, it is clarified that NFTs shall be regulated if the nature of the NFT falls under either of the three categories.

It can be concluded from the above-provided information that the governance of cryptocurrency has been differently regulated in different countries, however, NFTs have not specifically been regulated and/ or legalized. In most countries, NFTs have been considered to be categorized as crypto assets and therefore are regulated by the same legislation as that governing cryptocurrency or digital assets.

NFTs remain unregulated in most countries, however, NFTs have become quite popular in the world. In India actors and cricketers such as Salman Khan, Sunny Leone and Rishabh Pant have also introduced their NFTs on various NFT auction platforms. Many more artists all over the world are introducing their memorabilia as NFTs.

NFTs allow artists to showcase and sell their work digitally. The biggest advantage in this is that they get to retain the copyright for the work created. Secondly, it eradicates middlemen and intermediaries. Further, NFT trade is governed by smart contracts and transactions are recorded on blockchain technology allowing the prevention of fraud, theft and breach.

With legislation in place to regulate NFTs, it shall eliminate people’s hesitance towards trading in crypto assets, allowing for a digital marketplace and digital investments in the future.

Frequently asked questions

1. What are NFTs?

NFTs are a sub-set of crypto assets. It is a certificate of authenticity and ownership awarded to the purchaser after the purchase of a non-fungible asset. An NFT guarantees one ownership at any given time.

2. What are the various types of NFTs?

Anything can be transformed into an NFT. Some examples of NFTs are: domain names, collectibles, trading cards, sports, digital art, music, virtual worlds, tweets, cartoons etc.

3. What currency is used to purchase NFTs?

NFTs can only be purchased with cryptocurrency. There are no other payment options available.

4. Can I reproduce an NFT?

If you have purchased an NFT, the rights that are transferred to you are ownership rights. However, no copyright rights are transferred. The copyright remains with the creator of the NFT. In case, one wants to recreate or reproduce an NFT, license shall have to be sought from the creator to do so.

5. How are NFTs regulated in India?

At present, there are no legislations in India to regulate NFTs. However, the CryptoCurrency Bill has been introduced by the Government of India which aims to ban all private cryptocurrencies. The Crypto Currency Bill awaits clearance from the Union Cabinet, as informed by the Finance Minister of India.