NFTs and The Legal Conundrum

Author: Hunar Student, Rajiv Gandhi National University of Law, Punjab


NFTs are non-fungible tokens or digital assets that represent an object or commodity like art, music, videos, etc. NFTs are “non-fungible” i.e., each NFT is unique and cannot be traded for another. They are uniquely coded digital assets operating via blockchain technologies that are bought and sold online. Blockchain technologies are essentially public ledgers that facilitate the process of recording and updating transactions that take place in the online market.[1] One of the major goals of trading NFTs is to allow creators and artists to share their work in the international market without going through legal restrictions while also ensuring the claims of the original owner remain intact. NFTs are traded using cryptocurrency, a digital currency that is uniquely encoded and can be used to purchase goods in the global online market.[2]

Currently, there is no legal framework that regulates the trade of NFTs in India due to which, the contractual relationship between entities is determined by The Indian Contract Act, 1872. However, the anticipated bill, The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 that was introduced during the winter session of the Parliament, may provide a clear stance of the Indian government. Due to the lack of statutory regulation, there is an alarming dearth of legal recourse available with the original owner which may prove to be one of the biggest problems surrounding the trade of these tokens.

The Scope of NFTs

It is imperative that it must be specified what is the nature of the underlying rights being sold via the NFT. This primarily includes examining the rights of ownership that are being traded, the right to use intellectual property rights, and other contractual rights.[3] Due to the lack of a regulatory framework, there is a huge amount of uncertainty surrounding the classification of NFTs. It is believed that the sale and purchase is not permitted under the Securities (Contract) Regulation Act, 1956 by virtue of Section 18A.[4] SCRA defines a “derivative” as a contract that derives its value from the prices or index of prices of underlying securities.[5] As a derivative under Section 18A of the Securities Contract (Regulation) Act, 1956, NFTs can only be traded on authorized exchanges like stocks. Also, the lack of a legal framework for the derivative value of a non-financial asset makes the trade on NFTs more ambiguous and adds a layer of precariousness to its position.


Intellectual Property Rights

On purchasing an NFT, the buyer only receives the ownership rights of a single copy of the NFT on sale by the original owner. The ownership rights that are granted are only for personal use, collection of artworks, or for sale in the secondary market.[6] There exists no right in the hands of the purchaser to reproduce, or claims over the original work unless specified in the terms of the sale, and in order to reproduce or exploit the IP rights, the buyer would need the express permission of the original owner. Due to the decentralized and rigid nature of blockchains, the enforcement of IP rights against the purchaser becomes a laborious task. There exists a high probability of identity concealment by people by masquerading as original owners. The lack of any legal recourse available to the original owner is one of the most serious problems surrounding NFTs.


Cross-Border Transactions

Currently, there is no legal restriction imposed on Indian citizens to trade NFTs in the global online market. However, the legality of the trade may change dramatically depending upon how the government seeks to define the underlying asset as physical or digital. The treatment of NFTs under the Foreign Exchange Management Act, 1999 depends heavily on how the government defines the nature of these commodities. FEMA is the regulatory framework that oversees cross-border transactions. The trade of NFTs will be considered as cross-border transactions under FEMA which will raise questions as the classification of NFTs as intangible assets not only makes it difficult to ascertain their location but also make transactions restrictive due to the ambiguity surrounding cryptocurrency. Thus, Indian residents will be forced to make transactions using fiat currencies which is not only restrictive but also a very tedious approach. Also, the silence of the central bank i.e., The Reserve Bank of India related to the legality and treatment of crypto assets in the Indian market increases uncertainty. Furthermore, most of the buyers and sellers of NFTs are located outside India, which makes it difficult to ascertain their location and may altogether allow the entities to evade the law.


Taxation

Just like cryptocurrencies, NFTs are also considered to be taxable assets or property. However, the taxability of the same primarily depends on two issues i.e., how the government defines the underlying asset carried by an NFT and how one interacts with it.

Under the Goods and Services Tax framework, any property or good that is movable creates the liability to pay tax. However, in the case of NFTs, the underlying asset that is being traded must be a capital asset in order to attract taxation under the GST framework. Thus, the lack of definition of the asset as a security of a capital asset creates an air of ambiguity when it comes to levying tax on the trade of NFTs. Furthermore, the location of the platform where the trade takes place will also affect the implementation of GST as it will only be applied to sellers trading at an Indian platform and not Indian residents trading at an International or non-domestic platform. Therefore, this creates a complex regime of taxation which makes tax monitoring a tedious and laborious process and also increases the probability of tax evasion.

The cross-border and digital nature of transactions involving NFTs may also lead to the existence of additional tax issues for the participating entities.[7]


Conclusion

There is an urgent need for legislation for the trade of cryptocurrencies and NFTs. While the air of ambiguity and numerous amounts of questions remain unanswered, it can be concluded that NFTs are a creative and popular method of trade and commerce especially in today’s era of digitalization. Furthermore, the regulatory challenges and the legal conundrum are bound to increase in the coming future with the rise in popularity of these assets. Therefore, it becomes even more imperative for the government to recognize these assets via justified regulations instead of the imposition of a total and concrete ban. As the number of Indian buyers and sellers of NFTs increases over the years, it is only imperative that the legal regime addressing the myriad issues including anti-money laundering regulations, tax implications, financial regulations, intellectual property issues, etc. shall also emerge.[8] India can learn by example from the various regulatory steps taken by countries like the US, UK, China, etc., pertaining to the trade of NFTs and cryptocurrencies.


[1] IBM, https://www.ibm.com/in-en/topics/what-is-blockchain, (last visited Jan. 14, 2022).

[2] BUSINESS INSIDER, https://www.businessinsider.in/stock-market/news/cryptocurrency-is-an-electronic-private-type-of-money-heres-how-it-works-and-how-you-can-invest-in-it/articleshow/80238624.cms (last visited Jan. 14, 2022)

[3] OSBORN CLARKE, https://www.osborneclarke.com/insights/what-are-legal-issues-around-nfts, (last visited Jan. 14, 2022)

[4] Securities (Contract) Regulation Act, 1956, § 18A, No. 42, Acts of the Parliament, 1956 (India)

[5] NLUJ LAW REVIEW, http://www.nlujlawreview.in/non-fungible-tokens-examining-its-legal-validity-in-india/, (last visited Jan. 14, 2022)

[6] RNA, Technology And IP Attorneys, Demand to Clarify Legality of NFTs in India Grows, MONDAQ (Jan. 14, 2022, 9:14 PM), https://www.mondaq.com/india/fin-tech/1128836/demand-to-clarify-legality-of-nfts-in-india-grows

[7] Priyam Raj Kumar, The Future of Non-Fungible Tokens in India, IJPIEL (Jan. 15, 2022, 7:30 PM), https://ijpiel.com/index.php/2021/08/24/the-future-of-non-fungible-tokens-in-india/

[8] Id.

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