20 January 2022
Non-fungible tokens (“NFTs”) are one-of-a-kind digital tokens that serve as proof of asset ownership and cannot be duplicated. NFTs use blockchain technology, which creates a digital record of all the NFT transactions over an extensive network of computers and cannot be exchanged with other items, unlike cryptocurrency. While NFTs can represent tangible assets such as property or artwork, the bulk of NFTs are used to describe digital collectables such as digital artwork, music, images, and videos. are cryptographic assets on a blockchain with unique identification codes and metadata that distinguish them from each other. Unlike cryptocurrencies, they cannot be traded or exchanged at equivalency. This differs from fungible tokens like cryptocurrencies, which are identical to each other and, therefore, can be used as a medium for commercial transactions.
NFTs are also known as nifties, representing real world objects like art, music, game items, and videos. NFTs are sold in digital card form. They are held on Etherum blockchain, primarily. An NFT has a unique owner at one time. While anyone can view a NFT, the buyer has the status of the official owner. They can be sold or transferred to another user via Blockchain technology. Due to this, the ownership can always be tracked.
NFTs are created or ‘minted’ from objects that may represent tangible or non-tangible assets.These include:
To buy NFTs, a user needs to open a digital wallet that allows them to store cryptocurrency and NFT. In most cases, NFTs can only be bought for cryptocurrencies. The following steps shall be undertaken to buy NFTs:
What Are The Risks?
Like cryptocurrencies, NFTs are largely unregulated. Anybody can create and sell an NFT and there is no guarantee of its value. Losses can stack up if the hype dies down.
In a market where many participants use pseudonyms, fraud and scams are also a risk.
Laws in India
Presently there is no law or legal framework that governs NFT in India. Their classification thus remains a tricky issue with the possibilities of how it can be defined. Under Indian law, NFTs are not yet categorised or recognised as “securities”, and no governmental organisation or authority regulates or recognises the trading platforms on which NFTs are traded. Some opine that NFTs fall under the ambit of mere contracts, whereas others consider NFTs to be a derivative based on their characteristics. The following shows how it can be dealt with under the existing legal framework.
Many people believe that possessing an NFT is the same as owning the copyright to work; however, this is not the case. Owning an NFT involves holding a specific digital copy of the work, and it is a digital certificate filed on a blockchain that authenticates just the digital version. The property itself, artistic creation, is not transferred. This means that the underlying copyright typically stays with the work's creator.
While it is possible for a copyright holder to transfer ownership rights to the purchaser of the NFT at the time of sale, the provisions of the Copyright Act 1957, require the contract for sale to provide for such assignment of rights explicitly, in writing.
Once the rights are assigned in compliance with the provisions of the Copyright Act 1957, an NFT holder would be treated as the owner of the copyrighted work. Accordingly, the rights of the parties to an NFT sale, and the extent of such rights, are determined by the governing sales contract.
Most NFT-related transactions take place through smart contracts, which may stipulate the terms of a licence, provide automatic royalties in case of resale transactions, set limits to the use of copyrights, and track subsequent purchases of an NFT. A smart contract is governed by the Indian Contract Act, 1872 and the Information Technology Act, 2000.
Cross Border Legal Implications
NFT’s have not yet been governed by any specific act in India but there are a few specific Foreign Exchange Management Act of 1999 (“FEMA”) laws that do prevent crypto-trading. Even if allowed, the laws for crypto-trading or NFT’s would depend solely on how the assets in question have been treated in relation to ownership.
Chapter VIII of the Finance Act, 2016 contains the provisions relating to Equalisation Levy(“EL”). Section 165A of the Income Tax Act, 1961 charges an equalization levy of 2% on the consideration received by an 'e-commerce operator' from 'e-commerce supply or services' made or provided or facilitated by it. If a marketplace is classified as an e-commerce operator under the Finance Act, the EL of 2% may be applied to either the gross value of the NFT or the gas fee imposed by these marketplaces or both. In addition, cross-border NFT transactions will be subject to the FEMA.
Section 9 of the Central Goods and Services Tax Act, 2017 (CGST Act) states that GST is levied on goods, services, or both. The Act's definition of 'goods' covers all types of moveable property, while the definition of 'services' encompasses everything that isn't a movable property. This opens the door to the possibility of imposing GST on NFTs. On the other hand, the definition of 'supply' requires that the transaction take place in the course or promotion of business. NFT developers will likely have to charge GST at the point of sale.
If an NFT represents an asset that is classified as a security under Indian securities regulations, it might be subject to such laws. NFTs are effectively derivatives under the Securities Contract (Regulation) Act of 1956 (SCRA), according to certain legal authorities. Derivates are defined as "a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument, contract for differences, or any other form of security; a contract whose value is derived from the prices, or index of prices, of underlying securities", according to the SCRA.
As a result, if a particular NFT relates simply to an existing asset and is offered as a guarantee of the asset’s authenticity, classifying it as a security (derivative) would be incorrect. Rather, it should be guided by contract rules in general. Fractional NFTs (which provide a partial ownership interest in the NFT), on the other hand, which have arisen as a result of exorbitantly priced NFTs that most market players cannot purchase, may be classified as a security. Furthermore, if promises of a return on investment are made, NFTs will appear to be a speculative investment rather than a digital collection, and hence could be classified as a security in India.
Trading NFTs is risky unless and until a definitive decision on the legality of cryptocurrencies in India is reached. A proposal for a Central Bank Digital Currency (CBDC) backed by the country’s banking regulator could be included in the Cryptocurrency Regulation bill set to be introduced soon.
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