Specific Legal Risks associated with P2P Transactions in India (2/2)

---

INTRODUCTION

In our previous post we discussed the ‘shadowy’ nature of P2P transactions, particularly in the context of centralized exchanges (CEXs) in India. To recap, we highlighted that these transactions – despite their name – do not function without mediation. The Reserve Bank of India’s (RBI) 2018 circular, which effectively prohibited banks and other financial institutions from dealing with crypto businesses, pushed exchanges towards the ‘P2P’ route. By blocking the fiat-to-crypto gateway it compelled them to ostensibly separate these two layers through escrow mechanisms.

If you’ve come straight to this post, we suggest reading the first part in which we’ve explained this in more detail.

We should highlight that fiat-crypto escrows are not unique to CEXs. Most decentralized exchanges (DEXs) use them too. It’s just that with the latter they tend – at least in most cases – to be entirely algorithmic. CEXs are more human-dependent because of their design.

And sure, when one is dealing with a legally uncertain domain such as this, human craftiness can prove more useful than algorithms.

This does not however mean that what crypto exchanges did post 2018 was illegal. As the Supreme Court clarified in 2020, owning and trading crypto was never illegal in India.

The main reason for covering P2P transactions in this series is to foreground the legal risks they continue to carry. Our hope is that this will guide retail customers in the present and inform meaningful regulation in the future.

RISK 1: FEMA

We are going to outline three main kinds of legal risks associated with P2P transactions. First, retail customers must be aware of potential violations under foreign exchange norms. As per the Foreign Exchange Management Act (FEMA) 1999, individuals and businesses must comply with certain stipulations while dealing with foreign exchange, currency and security. These include a wide array of activities – ranging from dealing and holding to transacting, realising and repatriating foreign exchange – outlined in Chapter II of the legislation.

If you or your business relies on – or is thinking of relying on – routine P2P exchanges involving crypto, then you should ask your lawyer to do the following:

1. Is the consideration being paid or received for any cryppto asset to a person resident outside India?
2. What is the nature of the crypto transaction executed by you? Are such transactions regulated under FEMA Act or any rules or regulations issued by RBI under FEMA?

The objective of FEMA is to facilitate external trade and payments and to maintain foreign exchange market in India. ‘Foreign currency’ has been defined in FEMA, but it is not clear whether crypto can be included in the definition. There is no specific guidance on this from RBI or even in form of any judicial precedent.

RISK 2: PMLA

The second risk is probably the riskiest one.

You will no doubt remember our spiel on escrows in the last part, which showed why the fiat and crypto layers of a transaction had to be separated in the context of a shadow ban.

Under the Prevention of Money Laundering Act (PMLA) 2002 it is illegal to engage in activities that funnel ‘proceeds of crime’ through the financial system. Transactions that are used to facilitate such activities can result in criminal charges for the parties involved.

What are ‘proceeds of crime’, you wonder?

Here’s the legal definition:

“proceeds of crime” means any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offence or the value of any such property or where such property is taken or held outside the country, then the property equivalent in value held within the country or abroad [sec 2(u), emphasis added]

‘Scheduled offences’ refers to a long list of specific crimes which have been listed at the end of the legislation. It includes everything from murder and narcotics to explosive substances and wildlife protection. These are also known as ‘predicate offences‘ since the offence of money laundering is predicated on them.

Whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property shall be guilty of offence of money-laundering. (sec 3, emphasis added)

So let’s say there was an original crime the proceeds from which eventually end up with a counterparty with whom you enter into a P2P transaction. Could you be charged with the offence of money-laundering?

Yup. Refer sec. 23 and 24 of the act for more legal juice.

In essence, if you happen to find yourself in the unfortunate situation of being charged with the offence of money-laundering – you and your lawyer will have to show that you had no knowledge that you were dealing with tainted money.

“Heck, it was a P2P transaction”, you might even say to the police, “I had no knowledge who I was dealing with at all!”

“Why not?”, they would most likely retort.

“I was just buying and selling crypto, that’s not illegal right?”

“Yes it is, if you’re buying or selling using tainted money.”

“But I didn’t know that it was tainted!”

“How do we know that you didn’t know it was tainted?”

At this point you will most likely call your lawyer for backup.

RISK 3: KYC

Remember the Zebpay quote from the first part about counterparty risks of P2P txs? This is in a way what it was referring to.

In the hypothetical conversation above, it is important to recognise that the police’s reasoning is not unsound. They are asking you to be aware of your counterparty, i.e. it is a KYC request (therefore in such investigations, the CEX involved is also roped in).

Now, the crucial question is this – did you or did you not have a legal obligation to know if your P2P counterparty was genuine?

The general answer to this question, as is the case so often in law, is that ‘it depends’.

If there are specific rules about the object you are trading which carry the obligation of knowing your counterparty, then you must. If not, then you need not.

Take, for instance, real estate – which has certain conveyancing and registration requirements which must be fulfilled. Or motor vehicles – if you’re the owner of a car showroom you cannot get away by selling SUVs to minors. Same thing with guns. You get the drift.

And now you may ask…is crypto part of this list?

Yes, after July 2022.

DEATH AND TAXES

If you’ve been following India’s cryptolaw journey, you will know that the first regulatory measure came in the form of taxes on ‘virtual digital assets’ (VDAs). This definition happens to be quite broad and includes both cryptocurrencies and NFTs.

The Finance Act of 2022 introduced a general provision in the Income Tax Act 1961 (namely sec. 194s) which places an obligation on the buyer of VDAs to deduct tax. In other words, if you’re an Indian resident and you’ve bought and sold crypto or NFTs after July last year, you most likely have tax liabilities pertaining to them. And if you do, it follows that you should’ve known who your counterparty is. [GST obligations pertaining to such transactions are a bit unclear, since the characterisation of VDAs remains grey.]

The long and short of it is that PMLA and KYC charges often work together. They are easy to attract and difficult to dispel – especially when – while engaging in P2P transactions you unwittingly encounter a malicious counterparty.

---

As always in this space, stay cautious and DYOR.

And when in doubt, please consult your lawyer.