Virtual Digital Assets (“VDAs”) come under the ambit of Prevention of Money Laundering Act, 2002 (PMLA)

Virtual Digital Assets (“VDA”) have been defined under the Income tax Act, 1961 as any information, code, number or token (not being Indian currency or foreign currency) generated through cryptographic means. VDA also includes Non-fungible tokens (“NFT”) which are assets that have been tokenised by block chain. NFTs can be traded and exchanged for money, cryptocurrencies or other NFTs. NFTs can represent digital or real world items like art work, real estate or properties etc.

With the rise of Virtual Digital Assets (“VDAs”) such as cryptocurrencies, non-fungible tokens etc., the global organisation Financial Action Task Force (“FATF”) released a report in the year 2021 to tackle trading in such assets, which might be the possible route of Money Laundering. With the same perspective, the Indian Government too found the need to employ mechanisms to mitigate and neutralise the risk of these VDAs. Consequently, the government imposed anti-money laundering provisions on VDAs including cryptocurrencies by bringing them under the purview of the Prevention of Money Laundering Act, 2002 (“PMLA”) in accordance with the official gazette Notification No. S.O. 1072(E) dated 07.03.2023. Under this notification, Virtual Digital Asset Providers including cryptocurrency exchanges, dealers, wallet providers fall under PMLA and hence are under the obligation to provide assistance to FIU-IND. Furthermore, FIU-IND has the power to monitor their transactions and report any suspicious activity to the Law Enforcement Agency.

Background

The Government of India had released a Press Release dated 06.02.2023 wherein the Ministry stated that the Directorate of Enforcement took cognizance of several cases relating to crypto currency frauds wherein a few crypto exchanges were found to be involved in money laundering.  In line with above findings, the Ministry of Finance has extended the compliance requirements, such as verification of identities, maintenance of records and enhanced due diligence as provided for in the PMLA to various service providers of virtual digital assets (which includes cryptocurrencies, non fungible tokens and other assets as may be notified by the Central Government as per the Income Tax Act, 1961).

         Press Release dated 06.02.2023 Posted on: 06.02.2023 6:38PM by PIB Delhi

Crypto Assets are borderless, require international collaboration to prevent regulatory arbitrage

Under PMLA, Rs. 936 crore related to crypto currency is attached/seized/freezed by ED as on 31.01.2023

Crypto Assets are by definition borderless and require international collaboration to prevent regulatory arbitrage. This was stated by the Union Minister of State for Finance, Shri Pankaj Chaudhary, in a written reply to a question in Lok Sabha today.

Therefore, the Minister stated, any legislation for regulation or for banning can be effective only with significant international collaboration on evaluation of the risks and benefits and evolution of common taxonomy and standards.

The Minister stated that the Directorate of Enforcement is investigating several cases related to crypto currency frauds wherein a few crypto exchanges have also been found involved in money laundering. Necessary action as per provisions of Prevention of Monyt Laundering Act, 2002 (PMLA) has been taken by the Directorate of Enforcement. As on 31.01.2023, proceeds of crime amounting to Rs. 936 crore have been attached/seized/freezed, 05 persons have been arrested and 06 prosecution complaints (PCs) including 01 supplementary PC have been filed before the Special Court, PMLA in these cases.

Further, the Minister stated, under Foreign Exchange Management Act, 1999 (FEMA) assets amounting to Rs. 289.28 crore have been seized under section 37A of FEMA and 01 Show Cause Notice to cryptocurrency exchange Zanmai Labs Pvt Ltd, known as WazirX and its directors under FEMA for transactions involving cryptocurrencies work Rs. 2,790 crore has also been issued.

Giving more information, the Minister stated that RBI has been cautioning users, holders and traders of Virtual Currencies (VCs) vide public notices on December 24, 2013, February 01, 2017 and December 05, 2017 that dealing in VCs is associated with potential economic, financial, operational, legal, customer protection and security related risks. RBI, vide its circular dated May 31, 2021 has also advised its regulated entities to continue to carry out customer due diligence processes for transactions in VCs, in line with regulations governing standards for Know Your Customer (KYC), Anti- Money Laundering (AML), Combating of Financing of Terrorism (CFT), obligations under Prevention of Money Laundering Act (PMLA), 2002, etc. in addition to ensuring compliance with relevant provisions under Foreign Exchange Management Act (FEMA) for overseas remittances.

Notification No. S.O. 1072(E), Dated 07.03.2023

The Ministry of Finance has notified an amendment in Prevention of Money-Laundering Act, 2002. The amendment aims to expand the scope of the Act to cover a wide range of cryptocurrency or virtual digital assets (VDA) transactions under the purview of PMLA, 2002. Now, activities by a person carrying on designated business or profession under section 2(1) (sa) of PMLA, shall include exchange between virtual digital assets (VDA) and fiat currencies, exchange between one or more forms of virtual digital assets, transfer of virtual digital assets etc. For this purpose, VDA shall have the same meaning assigned to it in clause (47A) of section 2 of the Income Tax Act, 1961

Text of Section 2(1)(sa) of PMLA, read with Notification No. S.O. 1072(E) dated 07.03.2023

S.O. 1072(E). - In exercise of the powers conferred by sub-clause (vi) of clause (sa) of sub-section (1) of section 2 of the Prevention of Money-laundering Act, 2002 (15 of 2003) (hereinafter referred to the as the Act), the Central Government hereby notifies that the following activities when carried out for or on behalf of another natural or legal person in the course of business as an activity for the purposes of said sub sub-clause, namely:-

(i)   exchange between virtual digital assets and fiat currencies;

(ii)  exchange between one or more forms of virtual digital assets;

(iii) transfer of virtual digital assets;

(iv)  safekeeping or administration of virtual digital assets or instruments enabling control over virtual digital assets; and

(v)   participation in and provision of financial services related to an issuer's offer and sale of a virtual digital asset.

Explanation:- For the purposes of this notification “virtual digital asset” shall have the same meaning assigned to it in clause (47A) of section 2 of the Income-tax Act, 1961 (43 of 1961).

 

Notification Coverage

The Ministry of Finance has notified an amendment in Prevention of Money-Laundering Act, 2002 by way of Notification No. S.O. 1072(E) dated 07.03.2023.  The Act has been amended to include cryptocurrency or virtual digital assets (“VDA”) transactions within its scope. This means that certain transactions are now subject to the provisions of the Act. The amendment shall be applicable to the following entities:

(a) exchange between virtual digital assets and fiat currencies;

(b) exchange between one or more forms of virtual digital assets;

(c) transfer of virtual digital assets;

(d) safekeeping or administration of virtual digital assets or instruments enabling control over virtual digital assets; and

(e) participation in and provision of financial services related to an issuer’s offer and sale of a virtual digital asset.

If an entity falls under the above mentioned categories they are considered to be Virtual Assets Service Providers (“VASPs”) and are required to follow various reporting requirements.

Reporting Requirements

(a)  Verifying Identity:

Under section 11A of the Act, every reporting entity shall verify the identity of its clients and the beneficial owner, by:

§  authentication under section 2(c) of the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016, if the reporting entity is a banking company;

§  offline verification under the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Act, 2016;

§  use of passport issued under section 4 of the Passports Act, 1967; and

§  use of any other officially valid document or modes of identification as may be notified by the Central Government on this behalf.

(b)  Records Maintenance: Under section 12 of the Act,

v  Every reporting entity shall:

§  maintain a record of all transactions as to enable it to reconstruct individual transactions (for 5 years from the date of the transaction);

§  furnish to the Director, information relating to such transactions, whether attempted or executed, the nature and value of which may be prescribed; and

§  maintain record of documents evidencing identity of its clients and beneficial owners as well as account files and business correspondence relating to its clients (for 5 years after the business relationship between a client and the reporting entity has ended).

v  Every information maintained, furnished or verified, shall be kept confidential.

It can be therefore concluded that, if a company engages in activities related to the buying and selling of VDAs, such as processing transactions, offering VDAs for sale, making purchase offers, or providing financial services related to them, it will be considered a reporting entity.

Mandatory Compliance under the Prevention of Money-Laundering (Maintenance of Records) Rules, 2005

Notification No. S.O. 1072(E) dated 07.03.2023 says entities dealing in VDA will now be considered ‘reporting entity’ under PMLA. Reporting Entities have to comply with PML Rules framed under PMLA. Cryptocurrencies and other VDA service providers have now come under the definition of ‘reporting entities’ which will mean that they must necessarily comply with similar rules requiring them to conduct KYC verification and follow reporting standards as are required by other regulated entities. Additionally, this would also mean that ED will now have greater powers to search and seize while investigating any VDA service provider for potential violations under the PMLA.

Reporting entities have to comply with the Prevention of Money Laundering (Maintenance of Records) Rules, 2005 ("PMLA Rules") framed under the PMLA. Crypto exchanges, intermediaries, and other VDA service providers are now notified as 'reporting entity' which would necessarily mean that they must comply with similar rules requiring them to conduct KYC verification and follow similar reporting standards as other regulated entities.

Additionally, this would also mean that ED will now have greater powers to search and seize while investigating any VDA service provider for potential violations under the PMLA. The consequences of violating the provisions of the PMLA could subject them to rigorous penal consequences including imprisonment of 3-7 years, in addition to the attachment of their properties. This Notification brought the VDA transactions at par with other 'reporting entities' in terms of the power of the ED to investigate instances of money laundering effected through transactions in VDAs.

Mandatory compliance obligations as reporting entities

As reporting entities, VDA-related businesses will now have to comply with certain obligations as listed in PMLA and PMLA Rules. These would broadly include:

 

(a) Crypto entities have to maintain records of transactions

The Centre’s move to bring the cryptocurrency sector under the ambit of PMLA is in line with the global trend of requiring digital-asset platforms to follow anti-money laundering standards similar to those followed by other regulated entities like banks or stock brokers.

 

A gazette notification issued said that “exchange between virtual digital assets and fiat currencies, exchange between one or more forms of virtual digital assets, transfer of virtual digital assets (VDA), safekeeping or administration of virtual digital assets or instruments enabling control over virtual digital assets, and participation in and provision of financial services related to an issuer’s offer and sale of a virtual digital asset” will be now be covered under the Prevention of Money Laundering Act, 2002.

 

The crypto exchanges and other VDA-related businesses must have an internal mechanism for maintaining records of all transactions including cash transactions of more than Rs. 10,00,000. They must also maintain records of all series of cash transactions integrally connected to each other, which have been individually valued below Rs. 10,00,000, where the monthly aggregate exceeds Rs. 10,00,000, among other records. VDA service provider will have to maintain records of :

(i)       all transactions in a manner that enables the statutory authorities to reconstruct individual transactions

(ii)     all clients and beneficial owners as well as account files and business correspondence relating to its clients.

(iii)   VDA service providers shall also maintain physical records of the identity of its clients after filing e-copy of such records with the Central KYC Records Registry.

Covered transactions related to cryptocurrency and Virtual Digital Assets (VDAs) under the PMLA

Under the PMLA, the transactions involving cryptocurrency and Virtual Digital Assets (VDAs) that are subject to regulation now include the following activities:

§   Converting virtual digital assets into fiat currencies and vice versa.

§   Exchanging one or more types of virtual digital assets.

§   Transferring virtual digital assets.

§   Safely storing or managing virtual digital assets.

§   Offering financial services connected to the issuer’s sale of virtual digital assets.

The entities are required to verify the identity of clients and beneficial owners, and maintain records of transactions for five years from the date of transaction and shall include details like nature, value, and date of transactions in order to facilitate the authorities to reconstruct individual transactions, if and when required. They must maintain records of identity, files and correspondences of clients for five years from the end of the business relationship or closure of account, whichever is later 

(b)   Appointment of principal officer and reporting to Financial Intelligence Unit -  India ( “FIU-IND”)

        Every VDA service provider (“VDASP”) being a reporting entity, will have to appoint a principal officer and designate a director to ensure overall compliance with PMLA and the PML Rules. VDSAPs must inform the name, designation, and address of the principal officer and designated director to the Financial Intelligence Unit India (FIU-IND).

 (c) Performing KYC of their clients and users on the platform

The intermediaries and exchanges dealing in VDAs in India will be required to conduct enhanced due diligence on their clients and users, as prescribed under the PMLA. It includes verification of the client's identity, additional steps to examine the financial position and ownership, including sources of the client's funds, nature of the relationship between the parties, and recording the reasons for conducting the transaction.

 

VDA service providers will have to carry out due diligence with every client and examine each transaction undertaken by the client. In case VDA service providers suspect any suspicious activity of money laundering or terror financing it shall review the due diligence measures including obtaining client information and the nature of business relationship. The client due diligence shall include policies, controls and procedures approved by the senior management of the reporting entity.

Further, VDA service provider will have to register with the Central Registry of Securitization Asset Reconstruction and Security Interest of India and file the electronic copy of the client's KYC records with the Central KYC Records Registry, within 10 (ten) days after the commencement of an account based relationship with a client.

(d)  Verify identity of clients

VDA service providers will identify their clients and also see whether they are acting on behalf of a beneficial owner. If client is acting on behalf of beneficial owner then the beneficial owner’s identity must also be verified. Identification of the client needs to be done at the time of commencement of an account based relationship and for an amount equal to or exceeding Rs. 50,000 or on any international transaction.

Penalty for non-compliance by a reporting entity under the PMLA

In case of non-compliance with the PMLA Rules, the newly designated reporting entities i.e., crypto exchanges and other VDA service providers can be subjected to monetary penalties.

In case of non-compliance by a reporting entity under the PMLA, the director of the FIU-IND may issue a show-cause notice to a reporting entity on account of failure to comply with the requirement of Chapter - IV of the PMLA. Upon adjudication, the director of FIU-IND may pass an order imposing a monetary penalty which shall not be less than Rs. 10,000 but may extend to Rs. 1,00,000 for each failure. The monetary penalty is in addition to any other action that may be taken under any other provisions of the PMLA.

Consequences of violating the provisions of the PMLA

The consequences of violating the provisions of the PMLA could subject them to rigorous penal consequences including imprisonment of 3-7 years, in addition to the attachment of their properties.

Foreign Portfolio Investors

The amendments will have implications on Foreign Portfolio Investors (“FPIs”) as well. FPIs are entities or individuals engaged in the practice of trading and transacting in cryptocurrency on behalf of their client who own the crypto being traded (“beneficial owners”).

The threshold for the definition of beneficial owners has also been reduced to any individual or group holding 10 per cent ownership in the client of a ‘reporting entity‘ will now be considered as beneficial owner  against the ownership threshold of 25 per cent applicable earlier.