NFT’S And Indian Law

6th June, 2022 - 11:54 am Categories: Technology 0 Comments

What are Non-Fungible Tokens (NFT)

NFT (Non-Fungible Token) are a digital assets that can be bought and sold online, usually with cryptocuurency. Understood as cryptographic assets, NFTs are usually a part of blockchains with a unique identification code and metadata that can be distinguished from one another. This is different from fungible tokens like cryptocurrencies which are identical to each other and and hence capable to be used for commercial transactions.

NFTs may also represent tangible assets, allowing for the trade of physical goods on a digital market. NFTs can represent a wide variety of objects, including artwork, GIFs, trade cards, and even virtual real estate. And despite the fact that the fundamental property of digital creations is an unending supply, NFT grants ownership of a specific digital production.

The recent development of NFT is the most significant advancement in the digital world as it enables the owner to demonstrate ownership. It is comparable to an authentication certificate. The main concept behind this is to limit the endless supply of digital creation, hence increasing its value. While several copies of that artwork may exist on the internet, the NFT owner owns the original artwork, and an outrageous amount of money is paid for these digital “bragging rights”.

For instance, if someone could right-click and save the photo to their computer, only the owner would be able to prove ownership, while everyone else would be able to authenticate the true owner using blockchain technology. NFTs are issued by a source, and every transaction and transfer of ownership is recorded in the blockchain. As there is no way to edit past data, anyone could track the whole history of an NFT.

Features Of NFT

Unique – It is not susceptible to forgery or other manipulation.

Exchange– On specialized websites, non-financial assets (NFAs) are traded using cryptocurrencies such as Bitcoin.

Indivisible – It cannot be subdivided into fractions or decimals. It cannot be subdivided into fractions or decimals.

Transferrable – NFT can be transferred from one individual to another over the blockchain. That is, it is available for purchase and sale. Each transaction would be recorded on the blockchain, allowing individuals to trace and retrace them.

Guarantee ownership of the asset – An NFT can only have a single owner at any given moment; by purchasing an NFT, a person can acquire sole ownership of a certain digital asset. It’s similar to purchasing an autographed version of the jpeg, except that anyone may view the work, save it to their computer, and reshare it online. However, individual ownership may be verified using blockchain technology.

NFT And Role Of Blockchain

Blockchains are essentially public ledgers that are maintained by thousands or even millions of computers around the world collaborating to record every single transaction involving cryptocurrencies and the public maintenance of such data. The blockchain will publicly record the transfer or purchase of NFTs for everyone to observe, and the owner of an NFT will have his own records available for verification by anybody.

The notion that NFTs are a sort of cryptocurrency is widespread. NFTs are digital assets that can be acquired with bitcoin. The only similarity between cryptocurrencies and NFTs is their shared blockchain-based digital record. With NFTs, each token has a unique value and cannot be swapped for a token with the same value. The value and openness of bitcoin are more transparent, and one Bitcoin can be exchanged for another.

NFT And Cryptocurrency – Current Legal Position In India

India has yet to pass a law regulating the NFT. The task of creating strong NFT laws is currently underway. According to research by NASSCOM, the Indian government and public sector have promoted and supported blockchain-based enterprises in which more than half of the world’s population is engaged. It may change with the enactment of the Banning of Cryptocurrency & Regulation of Official Digital Currency Bill, 2019. Section 3 of the bill forbids mining, generating, holding, selling, trading in, issuing, transferring, disposing of, and utilizing cryptocurrencies. The draft Bill defines “Cryptocurrency as any information, code, number, or token, created by cryptographic means or otherwise, that has a digital representation of value and is useful in business transactions, or operates as a store of value or unit of account”. Since NFTs give a digital representation of an underlying value, they may be classified as “cryptocurrencies”.

In the case of Internet and Mobile Association of India v. RBI, the Supreme Court of India ruled that the RBI circular dated April 6, 2018, prohibits national/organized/cooperative banks and NBFCs from operating with virtual currency also that the challenged circular was irrational and therefore in violation of Article 19(1)(g) of the Constitution of India as it directed all regulated companies to refrain from trading in cryptocurrencies.

In May of 2018, the Reserve Bank of India (RBI) released another circular instructing all banks to do due diligence for transactions involving virtual currencies, in accordance with existing anti-money laundering, foreign exchange, and countering the funding of terrorism legislation. The government and other regulatory bodies have yet to provide more clarification on the scope and extent of the legality of cryptocurrencies and crypto-assets.

Can NFTs Be Considered Securities?

NFTs are derivatives according to the Securities Contract (Regulation) Act of 1956, (SCRA). The uncertainty surrounding the legality of NFTs in India is compounded by the idea that trading in NFTs is prohibited under the Securities Contract (Regulation) Act of 1956 (“SCRA”).

In India, there is no separate legal structure for NFTs. This has led to a divide among experts over the classification of NFTs. Some consider NFTs to contract, while others consider them to be derivatives.

The definition of “derivative” in Section 2(ac) of the SCRA includes contracts whose value is derived from the prices or index prices of underlying securities. If NFTs are determined to be derivatives, they cannot be traded on virtual platforms since Section 18A of the SCRA states that derivative contracts are only legal if they are exchanged on a recognized stock exchange. In such a case, the mechanism where NFTs are exchanged must apply to the Central Government for recognition as a Stock Exchange.

NFT is a digital copy or token of the original work that it represents. However, possession of an NFT does not grant ownership of the underlying work that it represents.

In an instance of Copyright Act, 1957 in NFT: The difference between purchasing original artwork and an NFT is that the original work’s copyright does not instantly transfer to the purchaser of an NFT.

While it is conceivable for a holder of copyrights to transfer ownership rights to the buyer of an NFT at the moment of sale, this is not always the case. The rules of the Copyright Act of 1957 demand that the contract for sale has explicit, written terms for the assignment of rights. Once the rights are transferred in accordance with the rules of the Copyright Act, the holder of an NFT would be considered the owner of the copyrighted work. Consequently, the controlling sales contract governs the rights and scope of the parties to an NFT sale.

The majority of transactions involving NFTs are conducted via smart contracts, which can specify the conditions of a license, pay automatic royalties in the event of resale transactions, limit the use of copyrights, and track subsequent purchases of an NFT. A smart contract falls within the jurisdiction of the Contract Act of 1872 and the Information Technology Act of 2000.

In an Instance of Indian Contract Act, 1872 in NFT: An offer, acceptance, and consideration are the elements of a legal contract under the Contract Act. Although a smart contract contains the offer and acceptance components of a legitimate contract, the consideration component may be problematic. Most of the time, NFT transactions would be paid for with cryptocurrency in a smart contract. But, as was said above, the legality of cryptocurrencies in India is still unclear. This makes it hard to know if a smart contract and the transaction it is based on are valid.

In an Instance of Taxation in NFT: The prevalent belief is that the taxation of NFTs in India will rely on the nature or classification of the underlying asset. A non-financial transfer would be subject to a goods and services tax (GST), and the definition of goods under the Central Goods and Services Tax Act, 2017 covers movable property other than money and securities, while the definition of services includes anything other than goods. Based on what the NFT represents, it is quite likely that the GST would be applied.

In instances of transnational – NFT transactions: The Finance Act of 2020 has provisions addressing the equalization levy (EL), which levies a 2 percent tax on foreign firms with operations in India. If a marketplace is deemed an e-commerce operator under the Finance Act, the 2% EL may apply to either the gross value of the NFT or the gas cost levied by these marketplaces or both. Furthermore, cross-border NFT transactions will be subject to the Foreign Exchange Management Act of 1999, (FEMA). The FEMA’s treatment of an NFT would again be determined by the type of the underlying value and assets. However, the issue is not as straightforward as it may appear, as it is nearly impossible to pinpoint the location of an NFT. This may cause NFT holders and exchanges to circumvent FEMA restrictions entirely.

Legal Position of NFT in The United States

NFTs in the United States are similar to India, NFTs in the US are unregulated and their legal status is unclear. On 12 April 2021, a petition was submitted to the Securities and Exchange Commission (“SEC”) for the regulator to adopt a framework for the regulation of NFTs. Besides this, there is no official document about NFTs. But SEC officials say that trading in NFTs can be like breaking the law because NFTs often look like “investment contracts.”

Case:

SEC v. W. J. Howey Co. – This case is known as the ‘Howeytest’ case as laid down by the Supreme Court of the United States that the ‘Investment contract’ is included in the concept of ‘security’ under US law, among other things. An investment contract, according to the United States Supreme Court, exists when money is invested in a shared venture when returns are expected via the efforts of others. The most disputed feature here is ‘efforts of others,’ which are nothing more than the efforts of third parties to realize the financial potential of an asset. Whether the earnings are the product of the labor of others varies from case to instance. To illustrate, NFT formed from a GIF or a painting is not a safeguard because the GIF/painting is in its final phase and its worth is therefore not contingent on the ‘efforts of others.’ In contrast, if a real estate developer financed a particular project through the issuance of NFTs (representing a floor or unit), these NFTs would be securities under the Howey test since purchasers expect a return based on the developer’s efforts.

United States of America V. Larry Dean Harmon – The defendant is accused of conspiring to launder money through the operation of a bitcoin tumbler known as ‘Helix’ (used for exchange). The service offered by this tumbler was touted as a means of concealing transactions from authorities. Furthermore, purchasers of NFTs have pseudonyms and their profiles contain no identifying information.

How Can We Better Integrate NFT Into The Legal Framework?

NFTs are built on blockchains, which make it possible for parties to transact to maintain anonymity and privacy. Although it may be able to track down these persons by contacting the marketplace or cryptocurrency wallet and identifying their IP address. This would provide many opportunities for such parties to evade the law or conceal themselves from the regulatory authorities.

There are many issues regarding NFTs, particularly for a nation still grappling with the cryptocurrency dilemma. Nonetheless, what began as a trend is now gaining ground across the nation. The vast number of conventional and digital artists in India, as well as the benefits they can derive from NFTs, is cited as one of the primary reasons for their rapid adoption.

While uncertainty continues to surround NFTs and virtual assets, the Indian government has suggested a new regulation law for cryptocurrencies. Investors and analysts expect that this regulation will also contribute to clarifying the situation in India regarding NFTs.

Current rules can only provide short-term remedies to problems, whereas new regulations can provide long-term solutions to this new technological aspect. Whereas the future of NFTs in India is undetermined, they will likely continue to exist.

Conclusion

NFTs are the most recent type of crypto asset. As previously mentioned, in certain circumstances NFTs can function as securities that can be traded on decentralized peer-to-peer exchanges. India must also learn from nations with a well-balanced legal and regulatory environments, such as Singapore, Canada, Japan, and Switzerland. The legalization of cryptocurrencies is necessary for the efficient trading of NFTs in India. NFT trading is risky until there is a definitive ruling about the legality of cryptocurrencies in India. Second, the government must definitively determine whether NFT constitutes a derivative or not.

Author: Bipul Kumar- a student of Chanakya National Law University Patna, currently doing internship at Khurana & Khurana, Advocates and IP Attorney,  in case of any queries please contact/write back to us via email chhavi@khuranaandkhurana.com.