Tax Investigation of Bitcoin Transactions:

The virtual currencies market has seen a steady growth in the last few years. Most of the
investors of virtual currencies are High Net worth Individuals who are suspected to have
invested their unaccounted income in Bitcoins/Virtual currencies. As the sector remains
unregulated, it is highly possible that unaccounted investment and income generated out of
it is used for evasion of taxes.
Virtual Currency is a digital currency in which encryption techniques are used to regulate the
generation of units of currency and verify the transfer of funds, operating independently of a
central bank. It can be digitally traded as a medium of exchange. The best known crypto
currency is Bitcoin. Other popular crypto currencies are Litecoin, Ethereum, Dash, Zcash,
Monero etc.
The investment in Bitcoins has gained momentum due to the anonymity provided by
the same. The public key of the Bitcoin holder is open and the corresponding ledger is
accessible to everyone. However the identity of the owner of the public key holding Bitcoins
remains anonymous. Due to this, the unaccounted income earned by the high net worth
individuals is being routed through the investments in Bitcoins and other virtual currencies.
The unaccounted investment in Bitcoins is possible by following ways:
A. Purchasing of Bitcoins: Here the unaccounted income earned through
various other activities is invested by individuals in the Bitcoins directly. The
cash deposited in various bank accounts is then transferred to the registered
exchanges and Bitcoins are purchased. When these Bitcoins are sold, the
proceeds are received through the banking channels. This has become a very
convenient way of money laundering due to the anonymity provided by the
same.
B. Investment in foreign exchanges: The unaccounted income earned in India
is transferred out of the India through illegal channels and the same amount is
utilized for purchasing of the Bitcoins from the exchanges and websites
registered out of the India. Investment in Bitcoins out of India through
unauthorized transfer of money outside the borders involve violation of FEMA
and possible violation of Black Money (Undisclosed Foreign Income and Assets)
and Imposition of Tax Act, 2015 having an asset (including financial interest in
any entity) located outside India, held by the assessee in his name or in respect
of which he is a beneficial owner, and he has no explanation about the source
of investment in such asset or the explanation given by him is in the opinion of
the Assessing Officer unsatisfactory.
These Bitcoins purchased out of India by transfer of money through illegal
channels are then transferred to the public key of the real beneficiary owner.
As the identity of the pubic key holder remains anonymous and asset is present
in the virtual world, it is highly possible that these transactions have evaded
taxation in India.
C. Investment in the mining of the Bitcoins: Bitcoin mining has become a
profitable industry. Bitcoins can be mined by making individual investment and
mining of the Bitcoins. Investment in Bitcoin mining can also be made by
investing in Bitcoin mining companies. These companies then distribute the
rewards to the investors in proportion of their investments. The rewards
received have not been offered for taxation as mining companies are
registered out of India.

D. Cash purchase of Bitcoins in India: LocalBitCoins is a P2P exchange platform.

Buyers and sellers agree on trade terms and LocalBitCoins is used as Escrow.
LocalBitCoins is available in nearly every country. LocalBitCoins does not
impose any pricing limits on its users. Users are free to decide their own prices
and limits. The payment methods available to buyers are through banking
channels as well as cash deals. LocalBitCoins does not require any ID
verification or any personal information besides an email id which is required
to sign up. Platforms like these are used by individuals to buy and sell Bitcoins
in cash.

Demonetization and aftermath….

a. The Anonymity provided by the Bitcoin transactions has enabled the

Consequent to the demonetization of legal currencies of Rs. 500 and
Rs. 1000, initially there was rush towards making cash investments in
gold by using the demonetized currencies. However, after the second
week of the November 2016, the investment in the Bitcoins gained
momentum. This is evident clearly from the fact that, the price of the
Bitcoin reached to about $ 966.6 in December 2016 from $ 707 of the
second week of the November, 2016.

b. Coin Dance, a platform that aggregates public data on bitcoin,

showed that Localbitcoins, a bitcoin trading platform, saw Rs 1.1 crore
exchanged for bitcoin in India in the week beginning on 12 November
2016, and Rs 1.6 crore in the week after that. In the week beginning
on 26 November 2016, Localbitcoins saw exchanges worth Rs 2.8
crore more trade by far, when measured by rupee value, than the site
had ever recorded in a single week before. This fact becomes
important in the light of cash transactions enabled by LOcalBitCoins.
According to data compiled by Coin Dance, trading volumes at peer-
to-peer bitcoin exchange LocalBitcoins has spiked aggressively in
India since November 9, while leading Indian bitcoin
 exchanges Zebpay, Unocoin and Coinsecure are witnessing a surge of
new users coming onto their platform to exchange rupees for
bitcoins.
१. According to Zebpay Co-Founder Saurabh Agarwal, Zebpay's trade
volumes have increased by 25 percent from October to November
2016, they have had 50,000 new users sign up to their exchange in the
month of November 2016 alone, well above the usual 20,000 new-user
increases they have experienced in previous months.
Coinsecure experienced a 300 percent increase in user sign-ups in
November 2016, while Unocoin had their user base increase threefold
in the wake of India's currency reform. Sandeep Goenka, COO and co-
founder ZebPay, has given the media statements claiming that it has
crossed a turnover of Rs.500 Cr in December 2016.

Surge in the prices of Bitcoins:

Bitcoin prices has reached at $10,000 today. The following chart shows surge in the prices of
the Bitcoins:
Sr.no Month & Year Price in $/Bitcoin
1. April 2012 4.9
2. April 2013 139.2
4. October 2013 198.2
5. November 2013 1112.4
6 April 2014 448.3
7. April 2015 236.1
8. April 2016 446.1
9. 14 November 2016 707.4
9. December 2016 966.6
10 April 2017 1435.2
11 July 2017 2856
12 August 2017 4718.2
13 1 Sept.2017 4904.90
14 11 Sept 2017 4200.60
15 October 2017 4367
16 2 Nov 2017 6711
17 04 Dec 2017 10900.

This surge in the prices of the Bitcoins has resulted in yielding huge capital gains in the
hands of the investors in Bitcoins. According to media reports, Unocoin, Bangalore
based Bitcoin exchange platform has 3.7 Lakh unique customer logins and the
 platform sees 2,000 transactions on a daily basis, seeing equal numbers of bitcoins
sold and bought every day. It has been claimed that average value of each transaction
on unocoin is Rs.30,000/- and out of 3.7 Lac unique customer logins, 1 Lac are active
and performing transactions. It is pertinent to note that this data pertains to the year
2016, when Bitcoin rate was $1000 per Bitcoin. As per a 2016 Trak.in report, India
boasts more than 50,000 Bitcoin wallets. Of these, 700-800 Bitcoins are operated
daily. Bengaluru-based Bitcoin startup Unocoin raised $1.5 Mn in a Pre Series-A
round from Blume Ventures, Mumbai Angels and ah! Ventures in September 2016.
Zebpay raised Series A funding of $1 Mn from angel investors in January 2016.
Another Bitcoin trading platform Coinsecure secured $1.2 Mn as part of its Series A
investment round from an undisclosed investor in April of 2016.
Regulatory oversight:
The Bitcoins transactions remain unregulated till date. RBI in its Press release dated
24.12.2013 had stated that there have been several media reports of the usage of VCs,
including Bitcoins, for illicit and illegal activities in several jurisdictions. The absence of
information of counterparties in such peer-to-peer anonymous/ pseudonymous systems
could subject the users to unintentional breaches of anti-money laundering and combating
the financing of terrorism (AML/CFT) laws.
This regulatory arbitrage has helped individuals to invest unaccounted income in Bitcoins and
Virtual currencies. The unprecedented high profits earned through these activities have also
not been offered for taxation by taking the leverage of regulatory arbitrage.
Multilevel Marketing Schemes:
MLM companies offer investments by the individuals in the companies. These
companies are collecting investments from various individuals in Bitcoins and virtual
currencies. By following the the same modus operandi of Multilevel Marketing
companies, they are giving periodic rewards to the investors. The investment generated
by these MLM companies is then invested in the mining of the Bitcoins and Virtual
Currencies. The returns generated by both, individuals and MLM companies are not
being offered to tax.
Questionnaire:
1. Details of the sources of income.
2. Details of the Income tax returns filed
3. Details of the movable and immovable properties
4. Details of movable and immovable properties in the name of family members.
5. Whether you are dealing in Bitcoins/ other cryptocurrencies?
6. What are other cryptocurrencies you are dealing in
7. Since when you are dealing in cryptocurrencies.
8. What was your source of income for the initial investment.
9. In which Bitcoin/cryptocurrency exchanges you have accounts. In India as well as
abroad. Submit the details.
10. Furnish the details of all the wallets you are using along with their Unique
ID/number.
11. Are you using physical hardware wallet for storing your Bitcoins and other
cryptocurrencies? Give the balance as on date along with the public ID/wallet
number on the Blockchain account.
12. Submit the details of all of the public keys/wallets owned by you and your family
members on Blockchain.
13. Submit the details of all of the Unique client ID’s/wallets owned by you and your
family members on Bitcoin/Cryptocurrency exchanges in India as well as abroad.
14. Please state whether you are buying/selling Bitcoins and other Cryptocurrencies
from webstes like Poloniex.com, Coinbase.com,Bittrex.com or any other websites
registered out of India.
15. What was the mode of payment for making Bitcoin/cryptocurrency purchase from
websites registered out of India.
16. What was the mode of payment for receiving money out of Bitcoin/cryptocurrency
sales from websites registered out of India.
17. Submit the details of total purchase and sales of Bitcoins and other
cryptocurrencies from websites registered out of India.
18. Please state whether you are buying/selling Bitcoins and other Cryptocurrencies
from LocalBitcoins.com. If yes, what was the mode of the payment
made/received? Submit the details.
19. Please state whether you are buying/selling Bitcoins and other Cryptocurrencies
in cash by making peer to peer transfer? If yes submit the details of payments
made/received. Also provide details of the buyer and seller along with his public
ID on Blockchain/wallet number.
20. Please state whether you are buying/selling Bitcoins and other Cryptocurrencies
in cash from any platform? Submit the details of transfer along with the details of
the platform.
Whether you have invested in mining of Bitcoins or any other Cryptocurrency? If
yes, submit the following details.
A. Whether you yourself is involved in mining by investing in own physical set up
B. Whether you are have invested in cloud mining, hash mining
C. Details of the total investment in mining, Financial Year wise
D. Details of reward fees earned by mining of Bitcoins and other cryptocurrencies,
Financial Year wise
E. Details of the mining companies you have invested into along with the details
of reward fees earned financial year wise.
F. Furnish the detailed ledger of profits earned from mining of Bitcoins and other
crypto currencies.
21. Details of investment/sales of Bitcoins and other Cryptocurrencies in India and
abroad during 8.11.2016 to 31.12.2016.
22. Have you received any Bitcoins/cryptocurrency in lieu of any sales made/services
rendered within India. Please furnish the details of such transactions along with
 the details of the person making such payments and his wallet/blockchain public
ID details.
23. Have you received any Bitcoins/cryptocurrency in lieu of any sales made/services
rendered/exports made outside India. Please furnish the details of such
transactions along with the details of the person making such payments and his
wallet/blockchain public ID details.
24. Please state whether you have offered income from Sale of Bitcoins or any other
Cryptocurrency, either in India or in Chilli in any of the previous financial years.
25. Please furnish the details of your transactions in Cryptocurrency fincial year-wise,
furnish the details in following format.
Sr. Currency Initial Amount Amount Total Total
No invested Amount invested withdrawn profits balance
invested date- datewise earned as on
wise year- date in
wise INR

Brief about Cryptocurrency:

Crypto currency is a digital currency in which encryption techniques are used to regulate the
generation of units of currency and verify the transfer of funds, operating independently of
a central bank. It can be digitally traded as a medium of exchange. The best known crypto
currency is Bitcoin. Other popular crypto currencies are Litecoin, Ethereum, Dash, Zcash,
Monero etc.
Bitcoins are created through Block chain mining. The creator of Bitcoins, Satoshi
Nakamoto has declared that there will be total 21 Million Bitcoins. The value of Bitcoins
comes from the economic principle of demand and supply. Thus, as Bitcoins are going to be
limited, the artificial scarcity created is ensuring its value. As on date, 12.5 Bitcoins are being
created every 10 minutes by the process of mining. For every 2,10,000 authenticated blocks
(about once every 4 years) the number of Bitcoins mined will be halved. This halving in the
rate of Bitcoins mined per Block will go on for every four years until 2140 A.D.

Technology:
Crypto currency is based on the science of cryptography and Blockchain technology. In order
to understand how cryptocurrency works, we need to understand a few basic concepts.
Specifically:
Public Ledgers: All confirmed transactions from the start of a cryptocurrency’s creation are
stored in a public ledger. The ides of the coin owners are encrypted, and the system uses
other cryptographic techniques to ensure the legitimacy of record keeping. The ledger
ensures that corresponding “digital wallets” can calculate an accurate spendable balance.
Also, new transactions can be checked to ensure that each transaction uses only coins
currently owned by the spender. Bitcoin calls this public ledger a “transaction block chain“.
Transactions: A transfer of funds between two digital wallets is called a transaction. That
transaction gets submitted to a public ledger and awaits confirmation. When a transaction is
made, wallets use an encrypted electronic signature (an encrypted piece of data called a
cryptographic signature) to provide a mathematical proof that the transaction is coming
from the owner of the wallet. The confirmation process takes a bit of time average ten
minutes for bitcoin while “miners” mine to confirm transactions and add them to the public
ledger.

Mining: In simple terms, mining is the process of confirming transactions and adding them
to a public ledger.
In order to add a transaction to the ledger, the “miner” must solve an
increasingly-complex computational problem, sort of like a complex mathematical puzzle.
Mining is open source, so anyone can confirm the transaction. The first “miner” to solve the
puzzle adds a “block” of transactions to the ledger. The way in which transactions, blocks,
and the public blockchain ledger work together ensures that no one individual can easily
add or change a block at will. Once a block is added to the ledger, all correlating transactions
are permanent and a small transaction fee is added to the miner’s wallet along with newly
created coins. This process of mining is ensured with reward (The amount of new bitcoin
released with each mined block is called the block reward) and fees associated with
confirming the transactions. Thus, miners receive two rewards. One, mining creates new
Bitcoins for every Block mined. The other reward comes from transaction validation fees.
For adding one block to the block chain, miner is rewarded 12.5 newly created Bitcoins. The
block reward is halved every 2,10,000 blocks or roughly every 4 years. The difficulty of
mining adjusts itself with the aim of keeping the rate of block discovery constant. Thus, if
more computational power is employed in mining, then the difficulty will adjust upwards
making mining harder over time. The mining process is what gives value to the coins and is
known as a proof-of-work system.
HOW IT WORKS??
A Bitcoin is created by mining a Block (Block is a collection of data containing the
transactions). First Bitcoin is created by mining the first Block (which is called as Genesis
Block) in 2009 by Satoshi Nakamoto. Bitcoin is an open source network having public ledger.
This public ledger is visible to everyone on the network and can be checked, verified by
anyone on the network. A person holding the Bitcoin account has two keys: a Public key and
a Private Key. A person’s public key shows public ledger of transactions made by him. This
public key is unique key for everyone and visible to everyone on the network. Private key is
the personal key of digital wallet holder and it has to be kept safe and confidential.
Let’s take an example..
In Bitcoin network, when A wants to send Bitcoins to B, this transaction is given separate
digital ID. This Digital ID of each unit is encrypted to avoid hacking or duplication or any
fraud. To transact the Bitcoins, A needs to announce on the network that a particular
amount from his account should be deducted and added to B’s account. Any transaction
that is announced on the network is recorded by the special software in computers called as
“nodes”. The persons working on network are called as “miners”. These miners have to
verify and approve the transaction between A and B. They verify the previous transactions
of the sender from his public key for verification of the available balance in his account.
Miner also verifies digital signature of the sender to confirm the genuineness of the
transaction. This transaction is added to the Block.
A Block contains a number of transactions as shown below.

Block is added to the Blockchain by miners after solving complex mathematical problem.
The high randomness in the math problem makes it unlikely that two people will solve it at
the same time. Typically, it takes around 10 minutes for a Block to get added to the
Blockchain.

EACH BLOCK WITH TRANSACTIONS MUST BE RELATED TO PREVIOUS BLOCK IN TIME FRAME. OTHERWISE CHAIN
WILL NOT HOLD.

Block 1 Block 2 Block 3 Block 4

TIME
Thus, after Block is added to the Blockchain, transaction between A and B for transfer of
Bitcoins gets completed.