Kalindhi Bhatia October 21 2022 NFTs in India – where do they fit in? BTG Advaya | Tech, Data, Telecoms & Media - India Kalindhi Bhatia Tech, Data, Telecoms & Media IntroductionCurrent statusQ&A on NFTsCommentIntroductionNon-fungible tokens (NFTs) are tokens that represent ownership of rights in underlying digital content that is recorded on a blockchain. While cryptocurrencies are regarded with doubt 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 allure of having a unique association with the underlying work of an artist or brand has led certain NFTs to be treated akin to collectibles, which has garnered wide demand from enthusiasts. This is true globally, as well as for India. According to a recent study, India is the third country to have most NFT companies headquartered worldwide.While it appears that NFTs are here to stay, the legal status of NFTs is still unclear. This article examines the current regulatory landscape governing NFTs in India and evaluates how they may be treated.Current statusAt present, there are no laws in India that expressly regulate or prohibit the selling or buying of NFTs. 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 in order to tax income generated from virtual digital assets (VDAs) at the rate of 30% and included NFTs or tokens of a similar nature under the definition of VDAs. Separately, the Advertising Standards Council of India issued guidelines for the advertising of VDAs.Q&A on NFTsAre NFTs virtual goods?Following the view of Indian tax authorities, NFTs are VDAs. That is to say, NFTs are considered goods under Indian sale of goods laws, as they are digital assets that can be bought and sold via NFT marketplaces. Under the Sale of Goods Act 1930 (SOGA), "goods" include every kind of moveable property. Indian courts have clarified that the law does not distinguish between tangible and intangible goods and 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 the sale of NFTs, such as fitness for purpose or merchantability. 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 intellectual property (IP) rights related to NFTs. Since NFTs are derived from an underlying artwork (eg, the Mona Lisa or a scene from an iconic movie), the IP rights related to the underlying artwork continue to vest with the artist or author of the artwork, and the NFT owner's rights are limited to those assigned by the artist or owner (eg, the right to reproduce for non-commercial use, representation rights and publication rights). Under the Copyright Act 1957, 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, not the NFT creator, holds 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 licence. 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 the "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 programmes 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 the 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 identification document associated with the NFT and the terms governing the use of the NFT. The concept of smart contracts is still developing, and its validity is yet to be examined under existing contract law. It is an evolved form of clickwrap agreements, which have been held to be enforceable by the courts. So long as the smart contract fulfils the ingredients of a valid contract under the law (ie, an agreement that is not considered void and in which there is lawful consideration and object, and free consent of the parties), it would be enforceable under the law.Are NFT buyers "consumers"?When buying goods for non-commercial use (even virtual goods or services), one receives 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 of goods or their usefulness, or wrongly implying sponsorship or affiliation). Under the CPA, the publication of misleading ads 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 (ie, electronic facility or platform for electronic commerce).Can you advertise NFTs? NFTs can be advertised, but proper care should be taken when overpromising and underdelivering; misleading advertisements have consequences under the law. The advertising industry's self-regulatory body (ASCI) has issued guidelines for advertising of VDA and linked services. These guidelines require advertisements relating to VDA to, among other things:include risk disclaimers;not use the words "currency", "securities", "custodian" and "depositories";not depict minors (people under 18); andnot contradict the regulatory and legal position on VDAs.The recently notified Guidelines for Prevention of Misleading Advertisements and Endorsements for Misleading Advertisements 2022 further tighten the regulatory regime, making celebrity endorsers and influencers equally liable for misleading advertisements.Are NFTs securities or an investment?NFTs are not securities. Indian Securities Law limits the scope of securities to:shares;scrips stocks;bonds;debentures;debenture stock; orother marketable securities linked to a company.Since NFTs derive their value from the underlying artwork, they may not qualify as a security, namely as representing a unit of investment in a company. In the same vein, NFTs may not be derivatives either, because they are not contracts that derive their pricing from underlying securities. As such, the marketing of NFTs as an investment, security or a commodity should be avoided, and their treatment should be clarified by the NFT platform or seller through the website's terms and conditions.CommentAs 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 see" approach and are, in the interim, treating NFTs as VDAs or collectibles for the purposes of taxation. While the Indian government does not treat NFTs with the same degree of negativity as cryptocurrencies, laws to regulate NFTs may be enacted if there are widespread abuses, such as the hacking of the Bored Ape Yacht Club NFTs, which resulted in a loss of $2.2 million for its owner. In this light, parties engaged in buying, selling or facilitating NFTs should be mindful and consider the risks.For further information on this topic please contact Kalindhi Bhatia at BTG Legal by telephone (+91 22 6177 2900) or email ([email protected]). The BTG Legal website can be accessed at www.btg-legal.com.