Digital Assets & the Indian Anti-Money Laundering Regime

For decades, governments and financial organisations have been worrying about money laundering. Most crimes that involve money laundering are financial activities that are connected to illicit financial schemes, organized crime, narcotics, corporate fraud, governmental corruption, tax evasion, smuggling and terrorism financing. Real estate purchases, company investments, and the incorporation of ‘shell’ corporations are just a few of the ways used to conceal the true origins of money. Money laundering obscures the  illegal origin of the proceeds and acts as a vital tool in enabling those involved in criminal activities to profit enormously while limiting the risk of sanction. If left unchecked, it has the potential to quickly destabilise financial systems, hinder economic progress, and deteriorate the social fabric of nations.

With the explosive growth of the market for digital assets over the past few years, the use of these assets in illegal activities including money laundering, theft and fraud schemes, trafficking, and funding terrorist organisations is on the rise. The Financial Action Task Force has issued a warning that ‘gaps in the global regulatory system have created significant loopholes for criminals and terrorists to abuse,’ which runs the danger of resulting in the formation of a ‘virtual safe haven for the financial transactions of criminals and terrorists.’ Due to the decentralised and anonymous nature of cryptocurrencies, they have recently emerged as a novel method of money laundering.

Anti-Money Laundering Laws in India

In India, the Prevention of Money Laundering Act, 2002 (‘PMLA’) has been updated significantly to include the regulation of cryptocurrencies and digital assets. In the exercise of its powers under section 2(1)(sa)(vi) of the PMLA, the Central Government, via a notification dated March 07, 2023 (‘Notification’),  has brought activities involving or relating to virtual digital assets (‘VDA’), including cryptocurrencies and NFTs under the purview of the PMLA. Financial services provided in connection with the offer and sale of VDAs, including the exchange of fiat currency for VDAs, the exchange of one or more types of VDAs, the storage or management of VDAs and the provision of tools that allow control over VDAs, as well as the involvement in and delivery of such services, are all subject to the PMLA as a result of the Notification.

Other jurisdictions have recently known similar developments. In the United States, the Anti-Money Laundering Act of 2020 (‘AMLA’) introduced extensive reforms of anti-money laundering and counter-terrorism financing (‘CFT’) laws. The AMLA expands and modernises the Bank Secrecy Act and the US AML/CFT framework by codifying FinCEN’s guidance on digital currencies and clarifies that businesses that provide services related to ‘value that substitutes for currency’ (§6102(d)) fall under the BSA’s coverage of financial agencies and institutions (including currency exchanges and money transmitting businesses). In addition, AMLA expands the definition of ‘monetary instruments’ to include ‘value that substitutes for any monetary instrument.’ Similarly, in the UK, the Money Laundering and Terrorist Financing (Amendment) (No 2) Regulations 2022 (‘MLR 2022’) expands the existing information-sharing regime for wire transfers (contained in the retained EU Funds Transfer Regulation) to include cryptoasset transfers. The MLR 2022 amends the Financial Services and Markets Act 2000 to extend the Financial Conduct Authority’s (FCA) change in control regime to cryptoasset exchange providers and custodian wallet providers. These modifications will require proposed acquirers of a cryptoasset firm to notify the FCA prior to any acquisition or increase in control so that a ‘fit and proper’ assessment can be conducted.

In the crypto realm, it is quite simple for an individual to open a crypto wallet without having to reveal their identity or meet any KYC criteria, and then load funds therein in the form of cryptocurrency. The intriguing aspect is that there is no transfer restriction on transactions with cryptocurrency. Furthermore, cryptocurrencies do not require official permission, and can be delivered in a matter of minutes. In India, in light of the Notification, however, if an individual transfers cryptocurrency with monetary value without fully disclosing it to the government and the receiver does not declare it as income or payment, both parties may be held accountable under the PMLA.

The Indian government will be able to regulate and track cryptocurrency transactions now that it is subject to the PMLA. This implies that the PMLA can be used to investigate any cryptocurrency transaction suspected of being the ‘proceeds of crime.’ Under the scheme of the PMLA, whoever is involved in any manner or relates to the ‘proceeds of crime,’ whether through concealment, possession, or use of such proceeds, shall be guilty of money laundering. The PMLA has intentionally defined the term ‘money laundering’ in a broad and simplistic manner as ‘any process or activity connected with the proceeds of crime and disguising them as untainted property.’ Section 3 of the PMLA provides that whoever directly or indirectly attempts to indulge, knowingly assists, is knowingly a party or is currently involved in any process or activity connected with the proceeds of crime, including its concealment, possession,  acquisition or use, and claiming that it constitutes untainted property would be guilty of the offence of money-laundering.

Thus, any activity that involves VDAs and is suspected of being connected with money laundering will be subject to the same rigours as any other transaction involving fiat currencies. It is the obligation of exchanges to maintain transparency, identification, and compliance with the rules. Further, as reporting entities under the PMLA, banks, other financial institutions, cryptocurrency exchanges and intermediaries will have to verify customer and counterparty identities, keep records, and file reports in relation to any suspicious activity. These reforms confer upon the Enforcement Directorate the ability to investigate any suspected financial wrongdoing using cryptocurrency holdings. Under the new rules, bitcoin exchanges, custodians, and administrators must report suspicious activity to the Financial Intelligence Unit (‘FIU’). Participants in the cryptocurrency market must now make reasonable attempts to verify and maintain accounts for persons and transactions and report any suspicious conduct to the FIU. To comply with the spirit of the notification, crypto-exchanges in India may even have to log transactions made by investors that surpass a specific amount within a given fiscal year and notify them to the tax authorities. The government now has unrestricted access to all records kept by cryptocurrency exchanges as a result of this decision.

The Government also amended section 271C of the Income Tax Act, which sanctions failure to pay Tax Deducted at Source (TDS) on VDAs, a month before to the issuance of the Notification. The non-payment of TDS is now punishable by a fine of up to the amount owed or imprisonment for up to six months.

Conclusion

The Notification is a late but necessary move by the Ministry of Finance. Since the PMLA has been interpreted as applying to all transactions involving virtual digital assets, those engaging in or facilitating such transactions now need to verify the legitimacy of the assets involved and the conditions under which they have been stored. While the inclusion of cryptocurrencies under the purview of the PMLA is a positive development in the fight against money laundering using cryptocurrencies, and may end up building investor trust in the long term, the broad sweep of the Notification would impose the mandate on a vast range of noncustodial organisations, including software developers and node operators. This may result in preventing Indians from using blockchains and VDAs which do not provide validators in their networks to monitor their infrastructure.

The Notification, however, fails to address the corporate governance issues such as those that affected WazirX, which according to India’s Enforcement Directorate, ‘had created a web of agreements with Crowdfire Inc USA, Binance (Cayman Islands), Zettai Pte Ltd Singapore to obscure the ownership of the crypto exchange,’ and FTX, whose collapse in November 2022 sent the crypto market into turmoil.  The Notification may also lead to a decrease in engagement in the VDAs in the short term, as Indians would only be able to utilise VDAs in a highly controlled and monitored setting.

The Indian government will also confront obstacles when trying to put these rules into effect. Cryptocurrencies are decentralised and may be used anywhere in the world without the need for approval from a central bank. Therefore, it would be crucial for the Indian government to work with other nations to stop the laundering of illicit funds through cryptocurrency.

Saai Sudharsan is an Advocate at Madras High Court.

Sriram Venkatavaradan is an Advocate at Madras High Court.