Non-fungible tokens (NFTs) are digital assets that can be used to establish ownership and value of an underlying digital asset, such as an original image, video, or sound. They are issued on these assets using blockchain technology and smart contracts. They are currently a highly speculative market in which to invest, subject to rapid declines or rises and cybersecurity threats, making them extremely volatile assets to acquire and maintain.

NFTs are primarily used to verify ownership, as it is difficult to locate and identify the original owner of work on virtual platforms, which facilitates the replication of work and the resulting decline in value. Therefore, NFTs are an attempt to enforce decentralization, ownership tracking, and value storage. It provides “digital bragging rights” through verifiable proof of ownership.

However, the legality of these digital assets remains a major concern. Apprehensions have been expressed regarding the legal status and authenticity of these tokens, especially in India and as a result, NFT followers in India have expressed concerns about its long-term viability due to the lack of explicit laws, restricting or preventing Indians from trading NFTs. .

Legal Implications of NFTS

Both NFTs and cryptocurrencies use the same “blockchain” technology, and NFTs are usually acquired using cryptocurrency. Keeping this in mind, analyzing the legality of cryptocurrencies becomes important in understanding the legal implications of NFTs.

General law

Although cryptocurrency has been around and present in India for ten years, the main debate around its legality started in June 2018, when the Reserve Bank of India (RBI) issued a circular advising banks not to trade in cryptocurrencies. However, the Supreme Court overturned this order in Internet and Mobile Association of India v Reserve Bank of India declare that the right to trade is a fundamental right under the Constitution.

Securities Law

Whether the trading of NFTs is prohibited under the Securities Contracts Regulation Act 1956 (“SCRA”) is uncertain as there is no formal or legal structure of legislation for NFTs and , therefore, no categorization of NFTs under the SCRA. NFT trading would be illegal in India if considered a derivative.

Under section 2(ac) of the SCRA, the term “derivative” is defined as “a contract the value of which is derived from the prices of the underlying securities”. If NFTs are considered derivatives, they cannot be traded on virtual platforms in accordance with Section 18a of the SCRA, but if an NFT is merely a reference to an existing asset and used as proof of its authenticity, classify it as a derivative would be incorrect.

copyright law

Currently, when NFT is purchased, the owner does not obtain the copyright in the underlying artwork. According to Section 19 of the Copyright Act 1957, to transfer copyright and be considered an owner, a written contract of sale stating the express assignment of copyright must be present.

Under Section 14 of the Copyright Act, only the owner of a work has the right “to reproduce and distribute copies thereof”. Therefore, unless the buyer and seller expressly restrict the resale or copying of the NFT, such action may not qualify for protection.

Therefore, the buyer can only establish ownership of the object if the owner expressly assigns his rights to him. However, the buyer’s digital item will be protected under the Copyright Act against unlawful copying or dissemination.

Tax regulations

In most cases, the type of underlying asset should dictate the tax treatment of NFTs. Example: For income tax and goods and services tax purposes, a digital art NFT could be considered property or intangible property and the appropriate taxes should be declared and remitted on it .

All virtual digital assets, including NFTs, are subject to a 30% tax levied by the government. Such high fees can deter novices and traders looking to make a quick buck, which can force investors out of the industry, reducing the value of those assets.

Additionally, as NFT transactions are cross-border and digital in nature, new tax issues arise every day. For example, sales of NFTs by overseas sellers to Indian buyers through an offshore NFT marketplace may be subject to a 2% equalization fee based on the gross value of the NFT and the marketplace revenue from Indian customers.

FEMA Regulations

The classification of the underlying asset transferred through the NFT, whether physical or digital, would decide their treatment under the law and regulations on foreign exchange management, which regulate cross-border transactions.

Although unclear, NFTs can be categorized as “intangible assets” and governed by the software and intellectual property portion of the FEMA regulations. Therefore, determining their location becomes important as they are supported by “global ledgers”, which means that information is recorded, shared and synchronized between data stores.

Collective investment schemes

If the main purpose of the NFT is to grant the ability to hold, buy and sell the asset, it is likely to be classified as a utility or exchange token. Issuance of NFTs qualifying as UCITS units may require registration and acquisition of a collective investment scheme license with SEBI.

And after?

Although there is no single legal framework in India for NFTs; they are generally governed by contract law. The majority of buyers and enthusiasts are looking for quick returns from NFTs and their late interest has waned. Several Nobel laureates have claimed that cryptocurrencies have no intrinsic value, and have even compared NFTs to pyramid schemes or Ponzi schemes.

As a result, the sale and purchase of symbolic artwork raises questions about its legality as well as other legal issues such as rights of NFT holders, liability of creator and holder, enforceability of various other cross-laws and the exhaustion of rights of copyright holders after the first sale.

The principle of c aveat emptor rightly applies to NFT trading and users should be aware of the risks before performing digital transactions in NFT.

(The author is a partner of King Stubb and Kasiva, a law firm)

Published on

July 17, 2022