NFTs are tokens that represent ownership of rights in underlying digital content, which is recorded on a blockchain. While cryptocurrencies are being given the side-eye by regulators across the globe, NFTs have been (comparatively) welcomed, particularly by the entertainment industry and creative artists. There is an element of exclusivity to NFTs, given that they are, by definition, non-identical and valued based on uniqueness. The ‘charm’ of having a unique association with the underlying work of an artist, brand, etc., has led certain NFTs to be treated akin to collectibles, garnering wide demand from enthusiasts. This is true for India as well. According to a recent study, India has the third most NFT companies headquartered worldwide.
While it appears that NFTs are here to stay, the legal status of NFTs is still unclear. In this article, we examine the current regulatory landscape governing NFTs in India and evaluate how they may be treated.
Current Status
At present there are no laws in India that expressly regulate or prohibit the selling or buying of NFTs. If you have been following the travails of cryptocurrency in India, ‘no news’ is definitely ‘good news’! In 2020, the Supreme Court of India (“SC”) had to step in to set aside a (shadow) ban imposed by the financial regulator on financial institutions from facilitating use of ‘virtual currencies'. Cryptocurrencies have been at the receiving end of regulatory disapprobation, with the financial sector regulator warning that financial entities should be mindful while facilitating virtual currency transactions and undertake all due diligence obligations, like KYC, anti-money laundering checks, etc.
In contrast, Indian regulators have not indicated an averse (or affirmative) stance towards NFTs. The only ‘statutory’ reference to NFTs has been made under the definition of “virtual digital asset” under the (Indian) taxation statute. Earlier this year, the central government amended the Income Tax Act, 1961, to tax income generated from “Virtual Digital Assets” (“VDAs”) at the rate of 30% and included NFT or tokens of similar nature under the definition of VDAs. Separately, the Advertising Standards Council of India issued “Guidelines for advertising of VDA” for advertising ‘virtual digital assets’.
Where do NFTs fit in?
Are NFT’s virtual goods? If we follow the Indian tax authorities view, NFTs are VDAs. That is to say, NFTs are ‘goods’ under Indian sale of goods laws, being digital assets that can be bought and sold via NFT marketplaces. Under SOGA, ‘goods’ include every kind of moveable property. Indian courts have clarified that the law does not distinguish between tangible and intangible goods; Indian courts have ruled that the test for classification as a good is subject to it having utility and being capable of being traded, transferred, transmitted, stored, delivered, or possessed . If NFTs are classified as goods, certain implied conditions and warranties under SOGA may apply to sale of NFTs, like fitness for purpose, merchantability, etc. In effect, buyers would be protected in case of a sale of NFTs that promises more than it delivers!
How do you really OWN an NFT? There appears to be some global consensus on IP rights related to NFTs, at least. Since NFTs are derived from an underlying artwork (e.g., the Mona Lisa or a scene of an iconic movie), the IP Rights related to the underlying artwork continue to vest with the artist / author of the artwork, and the NFT owner's rights are limited to those assigned by the artist / owner (such as, right to reproduce for non-commercial use, representation rights, publication rights, etc.). Under the Copyright Act, 1957 (“Copyright Act”) a copyright can be obtained over original literary, musical, dramatic and artistic works. The copyright holder also has the right to reproduce or distribute copies of it. Since an NFT is a digital token minted on an underlying asset, it can be argued that the author, and not the NFT creator, has a copyright over the work upon which the NFT is minted. It has been argued that the sale of NFTs can be likened to that of a non-exclusive software license. The purchase of software entitles the buyer to use it in the manner permitted by its creator. Similarly, the usage of NFTs is defined by the terms set out under 'smart contract' executed at the time of the issuance of an NFT and is unlikely to involve transfer of IP Rights to the underlying artwork, unless specified.
Does Indian contract law allow smart contracts? Smart contracts are programs stored on a blockchain that run when predetermined conditions are met. While these are usually automated, some parts may require human input and control. In case of NFTs, the record of ownership is registered on the blockchain. It is facilitated via a smart contract deployed on the blockchain between the buyer and seller of the NFT. It contains the 'unique ID' associated with the NFT minted and the terms governing the use of such NFT. The concept of smart contracts is still developing, and its validity is yet to be examined under the existing Indian contract law. It is an (extremely!) evolved form of clickwrap agreements, which have been held to be enforceable by Indian Courts. So long as the smart contract fulfils the ingredients of a valid contract under Indian law (i.e., lawful consideration and object, free consent of the parties and not considered 'void'), it would be enforceable under Indian law.
Are NFT buyers consumers? If you buy goods for non-commercial use (even virtual goods or services), you get certain protections under the Indian Consumer Protection Act, 2019 (“CPA”). These include making a claim for product liability for defective products, and unfair trade practices (including false representation as to the standard or goods, their usefulness, or wrongly implying sponsorship or affiliation). Under CPA the publication of misleading advertisements constitutes an unfair trade practice and is punishable with fines and/or penalties.The Consumer Protection (E-Commerce) Rules, 2020 issued under the CPA specifically govern the trade of goods and services, including digital products by e-commerce entities (i.e., electronic facility or platform for electronic commerce).
Can you advertise NFTs? Yes, but be careful of overpromising and underdelivering; misleading advertisements have consequences under Indian laws. The Indian advertising industry’s self-regulatory body, ASCI has also issued “Guidelines for advertising of VDA and Linked Services” (“Guidelines”). The Guidelines require advertisements relating to VDA to (inter alia) have risk disclaimers, not use words “currency”, “securities”, “custodian” and “depositories”, not depict minors below 18 years and contradict the regulatory and legal position on VDAs. Recently notified Guidelines for Prevention of Misleading Advertisements and Endorsements for Misleading Advertisements, 2022 further tightens the regulatory regime, making celebrity endorsers and influencers equally liable for misleading advertisements.
Finally, are NFTs Securities or an Investment? No, and issuers should not claim that they are! Indian Securities Law limits the scope of securities to shares, scrips stocks, bonds, debentures, debenture stock or other marketable securities linked to a company. Since NFTs derive their value from the underlying artwork, they may not qualify to be a security, i.e., representing a unit of investment in a company. In the same vein, NFTs may not be derivatives either, because they are not contracts which derive its pricing from underlying securities. As such, the marketing of NFTs as an investment, security or a commodity should be avoided, and its treatment should be clarified in by the NFT platform/ seller through website terms and conditions.
What to expect in the future
As is the case globally, there is no consensus on the legality of NFTs under Indian laws. Most jurisdictions (like India) are following a ‘wait and watch’ approach, and in the interim treating NFTs as VDAs or collectibles for the purposes of taxation. While NFTs are not treated with the same degree of negative connotation as cryptocurrencies by the Indian government, laws to regulate NFTs may arrive on the government’s radar if there are widespread abuses, such as the hacking of the Bored Ape Yacht Club NFTs which resulted in a loss of USD 2.2 Million for its owner. Parties engaged in buying, selling, or facilitating NFTs should be mindful and consider the risks in this light.
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