A Complete Guide to Handling a Tax Notice for Crypto Transactions in India

The excitement of crypto trading in India is now meeting the reality of tax compliance. Have you received a message from the Income Tax Department about your crypto investments? You’re not alone. With the government tightening its grip on the digital asset space, many investors are receiving notices for undisclosed or incorrectly reported crypto gains. Understanding why you received a Tax Notice for Crypto Transactions is the first step toward a stress-free resolution. This comprehensive guide will break down everything you need to know—from why these notices are sent to a step-by-step process for responding correctly. We will cover the tax implications of crypto transactions in India to ensure you are fully prepared and compliant. Whether you’re a salaried professional dabbling in crypto or a small business owner exploring new assets, this guide is for you.

First Things First: Understanding India’s Crypto Tax Regulations

Before you can effectively respond to a tax notice, it’s crucial to understand the legal framework that governs crypto assets in India. The government has laid out specific rules for Virtual Digital Assets (VDAs), a category that includes all cryptocurrencies and non-fungible tokens (NFTs). A solid grasp of these regulations is the foundation for accurate tax filing for crypto investors in India and for demystifying any communication you receive from the tax authorities. This section provides a foundational overview of the understanding crypto tax regulations India and the income tax on cryptocurrency earnings India.

The Legal Status and Taxation of Virtual Digital Assets (VDAs)

In India, while cryptocurrencies are not recognized as legal tender (meaning you cannot use them like the Indian Rupee for general transactions), they are not illegal. Instead, the Income Tax Act classifies them as Virtual Digital Assets (VDAs). This classification makes them a taxable asset class, and any income or gain generated from their transfer is subject to specific tax rules. The government introduced dedicated sections in the Income Tax Act to govern the taxation of VDAs, primarily Section 115BBH and Section 194S, to ensure all transactions are brought under the tax net.

Key Tax Rules Under Section 115BBH

Section 115BBH of the Income Tax Act lays down the core principles for taxing gains from VDAs. It’s essential to remember these rules as they are non-negotiable and form the basis of the tax department’s calculations.

Flat 30% Tax: All profits or gains from the transfer of any VDA are taxed at a flat rate of 30%, plus the applicable cess and surcharge. This high tax rate applies regardless of your income tax slab or how long you held the crypto asset.
No Deductions Allowed: The law is very strict about deductions. The only deduction you can claim against your sale proceeds is the cost of acquiring that specific crypto asset. No other expenses, such as exchange trading fees, network transaction fees, internet charges, electricity costs, or device depreciation, are allowed to be deducted from your gains.
No Set-Off for Losses: This is one of the most critical and often misunderstood rules.
- Losses incurred from VDA transactions cannot be set off against any other income, such as your salary, business profits, or capital gains from stocks or property.
- Furthermore, a loss from one VDA transaction cannot be set off against a gain from another VDA transaction. For example, if you made a profit of ₹20,000 on Bitcoin but a loss of ₹10,000 on Ethereum, you must pay tax on the full ₹20,000 profit. The loss from Ethereum cannot be used to reduce your taxable crypto income.

The Role of TDS Under Section 194S

To create a clear audit trail of crypto transactions, the government introduced Section 194S, which mandates a 1% Tax Deducted at Source (TDS) on the transfer of VDAs. This applies when the total transaction value exceeds certain thresholds within a financial year: ₹50,000 for specified persons (like individuals who are required to have their accounts audited) and ₹10,000 for all other individuals.

This TDS is deducted by the buyer or the crypto exchange facilitating the trade and is deposited with the government on your behalf. This transaction is then reflected in your Form 26AS and Annual Information Statement (AIS). This TDS trail is a powerful tool for the Income Tax Department, allowing them to track transactions and easily identify individuals who have not reported their crypto income correctly.

Why You Received a Tax Notice for Crypto Transactions

Receiving an official communication from the Income Tax Department can be intimidating. For a general overview, our Responding to Income Tax Notices: A Step-by-Step Guide provides essential information. However, these notices are often automated and triggered by specific data mismatches. Understanding the common reasons behind a Tax Notice for Crypto Transactions can help you pinpoint the issue and prepare an accurate response. A crypto transactions tax notice India is usually a result of the tax department’s advanced data analytics capabilities comparing the information you filed with the data they have collected from various sources.

Mismatch in Your AIS/TDS Data and ITR

This is the most common reason for receiving a notice. Every time TDS is deducted on your crypto sale under Section 194S, the crypto exchange reports this transaction to the tax department. This information, including the transaction value, is automatically populated in your Annual Information Statement (AIS). The department’s system then cross-references this AIS data with the income you declared in your Income Tax Return (ITR). If you failed to report the corresponding income or if the amounts do not match, an automated notice is generated flagging the discrepancy.

Complete Non-Disclosure of Crypto Income

Many investors, especially those with small gains, operate under the misconception that they don’t need to report their crypto income. Some believe that profits that are reinvested back into other cryptocurrencies are not taxable until withdrawn into a bank account. This is incorrect. Every single profitable transaction, whether it’s a crypto-to-INR sale or a crypto-to-crypto swap, is a taxable event and must be reported in your ITR, regardless of the amount. Complete failure to disclose any crypto income while your AIS shows transaction data is a major red flag for the tax department.

High-Value Transactions Reported by Banks/Exchanges

Under the Statement of Financial Transactions (SFT), banks and other financial institutions are legally obligated to report high-value transactions to the tax authorities. This includes large cash deposits, high-value bank drafts, and significant fund transfers. If you have deposited large sums of money into a crypto exchange’s bank account or received substantial withdrawals from an exchange, your bank will report it. If the tax department sees these high-value transactions but doesn’t find a corresponding declaration of income in your ITR, it can trigger scrutiny and lead to a notice seeking clarification on the source of these funds.

Incorrectly Claiming Losses or Deductions

As explained earlier, the tax rules for VDAs are very rigid. A common mistake that leads to a notice is the incorrect treatment of losses and expenses. Investors who try to set off their crypto losses against their salary or business income will immediately face a notice for filing a defective return. Similarly, claiming deductions for expenses like trading fees, internet bills, or wallet charges is explicitly disallowed. The tax system is designed to automatically detect these incorrect claims and will prompt you to correct your ITR.

A Step-by-Step Guide to Responding to the Notice

Receiving a tax notice is not a reason to panic. It is a formal request for information or clarification. By following a structured approach, you can respond effectively and resolve the issue. This crypto transaction tax guide India provides a clear roadmap for handling the notice and ensuring your tax filing for crypto investors in India is in order.

Step 1: Don’t Panic – Verify the Notice’s Authenticity

The first and most important step is to confirm that the notice you received is genuine. All official communications from the Income Tax Department must have a computer-generated Document Identification Number (DIN). You should carefully check for this DIN on the notice. To verify its authenticity, visit the official Income Tax e-filing portal, navigate to the “Authenticate Notice/Order Issued by ITD” service, and enter the DIN. If the portal confirms the DIN, the notice is legitimate. If not, it could be a fraudulent communication.

Official Portal: Income Tax Department e-filing portal

Step 2: Read Carefully and Understand the Discrepancy

Once you’ve verified the notice, read it thoroughly. Pay close attention to the section of the Income Tax Act under which it has been issued, as this indicates the nature of the query. Common notices include:

Section 139(9): A notice for a ‘defective return’, usually issued for incomplete information or incorrect claims (like setting off crypto losses). You are required to correct the defect within a specified time.
Section 143(1): An intimation letter that points out mismatches between the income you declared and the data available with the department (e.g., from your AIS). For a detailed explanation, see our post on Section 143(1): Understanding Income Tax Intimations and Notices. It may result in a tax demand or a refund.
Section 142(1): A notice of inquiry issued before an assessment, asking you to furnish specific documents and information related to your financial transactions.

Understanding the specific query raised by the department is crucial for drafting an appropriate response.

Step 3: Collate All Your Crypto Transaction Documents

To support your response, you must gather all relevant documentation. Being organized is key to providing a comprehensive and convincing reply. Create a file with the following documents:

Comprehensive transaction reports from all Indian and international crypto exchanges you have used during the financial year.
Bank statements that clearly show all deposits made to exchanges and withdrawals received from them.
A detailed computation of your VDA gains for the financial year. This should be a clear worksheet showing the date of purchase, cost of acquisition, date of sale, sale price, and the net profit for every single transaction.
A copy of the Income Tax Return (ITR) that you originally filed for the relevant assessment year.

Step 4: Prepare a Clear and Factual Response

Your response should be professional, factual, and directly address the points raised in the notice. Draft a point-by-point reply. If the notice is about a data mismatch, provide your detailed computation sheet and explain how you arrived at your declared income. If you genuinely made an error, it is best to acknowledge it honestly. State your willingness to rectify the mistake by paying any due tax along with applicable interest, and mention that you will file a revised or updated return as required. Attach all the documents you collated in Step 3 as evidence to substantiate your claims.

Step 5: Submit Your Response via the E-Filing Portal

Responses to tax notices must be submitted electronically through the same income tax portal where you file your returns. Log in to your account and navigate to the ‘e-Proceedings’ tab. Here, you will find the notice listed. You can upload your written response and all supporting documents as PDF attachments. Submitting online ensures there is a digital record of your compliance and the date of your submission.

Step 6: When to Seek Professional Help

While you can handle simple notices on your own, certain situations warrant expert assistance. You should consider consulting a tax professional if:

Your crypto transaction volume is very high and complex.
The notice is issued under a more serious section, such as Section 148 (for income that has escaped assessment).
You are unsure about the tax computation or how to interpret the notice.
The tax amount in question is substantial.

Navigating tax notices can be complex. TaxRobo’s team of tax experts can help you draft a perfect response and ensure full compliance. Contact us today.

Conclusion: Stay Compliant, Stay Worry-Free

The Indian tax landscape for cryptocurrencies is evolving, and the authorities are using technology to ensure compliance. The key takeaways are clear: all crypto income is taxable at a flat 30%, meticulous record-keeping is non-negotiable, and accurate reporting is mandatory. Receiving a Tax Notice for Crypto Transactions can feel daunting, but it is a manageable issue if you approach it with a systematic and honest strategy. Proactive compliance is always the best policy. By maintaining detailed records of every transaction and ensuring correct tax filing for crypto investors in India, you can avoid scrutiny and continue your investment journey with confidence.

Don’t let tax notices disrupt your investment journey. Whether you need help filing your crypto taxes accurately or responding to a notice, TaxRobo is here to help. Explore our ITR filing services today.

Frequently Asked Questions (FAQ)

Q1. What is the penalty for not reporting crypto income in India?

Failure to report or inaccurately reporting your crypto income can lead to significant financial penalties. The penalties can range from 50% of the tax evaded for under-reporting of income to 200% of the tax evaded for misreporting of income. This is in addition to the principal tax amount you owe and the interest charged under sections 234A, 234B, and 234C of the Income Tax Act.

Q2. How does the Income Tax Department track my crypto transactions?

The Income Tax Department has a multi-pronged approach to tracking crypto transactions:

TDS Data (Section 194S): Crypto exchanges are required to deduct 1% TDS on transactions and report this data, along with your PAN, to the department.
Annual Information Statement (AIS): Your AIS is a comprehensive statement that consolidates all your financial information, including details of crypto transactions reported by exchanges.
Bank Reporting (SFT): Banks report high-value cash deposits and other specified transactions, which can be correlated with crypto investments.

Q3. I forgot to report my crypto gains in my ITR. What should I do?

If you’ve realized your mistake before receiving a notice, you can take corrective action. If the due date for filing the ITR has not passed, you can file a Revised ITR. If the due date is already over, you have the option to file an Updated ITR (ITR-U). You can learn more by reading our guide titled ITR U – What is ITR-U Form and How to File ITR-U. You can file an ITR-U for up to two years from the end of the relevant assessment year. However, filing an ITR-U involves paying an additional tax of 25% or 50% on the aggregate of the tax and interest due. This is a far better option than waiting for a notice and facing higher penalties.

Q4. Do I have to pay tax on crypto-to-crypto trades or only when I sell for INR?

Yes, you have to pay tax on crypto-to-crypto trades. The law states that tax is applicable on the “transfer” of a VDA. A transfer includes not just selling crypto for INR (fiat currency), but also swapping one cryptocurrency for another (e.g., trading Bitcoin for Ethereum) or using crypto to purchase goods or services. In a crypto-to-crypto swap, you must calculate the fair market value of the asset in INR at the time of the trade to determine your sale consideration and compute the resulting capital gain.

Tax Notice for Crypto Transactions: What You MUST Know!