Here’s why India’s anti-money laundering laws are keeping a close eye on crypto players

While we await regulations specific to virtual digital assets (VDA), there have been peripheral changes in the regulatory environment. Firstly, there was a new regime for imposing tax on income from the VDA; then came reporting requirements under the Companies Act; and now VDAs have been brought under the Prevention of Money Laundering Act (PMLA).

The PMLA allows the government to prescribe measures to prevent money laundering. It provides for strict measures, including confiscation of property. The Enforcement Directorate (ED) often takes action under the PMLA, including related to virtual asset service providers (VASPs).

The Ministry of Finance has issued notification no. 1072 (E) dated 7 March 2023, which prescribes various requirements, including the implementation of due diligence, maintenance of records, etc., on VASPs who are now registered as Persons who carry out a designated business or Profession and are therefore subject to a reporting unit (RE). VASPs typically include NFT platforms, cryptocurrency exchanges, crypto payment gateways, etc. Where VASPs carry out activities for or on behalf of another person, it shall be considered RE under the PMLA. The activities covered by the PMLA are: (i) exchange between VDAs and fiat currency; (ii) exchange between one or more forms of VDAs; (iii) transfer of VDAs; (iv) custody or administration of VDAs or instruments enabling the control of VDAs; and (v) participation in and provision of financial services related to an issuer’s offer and sale of a VDA.

REs are subject to a number of obligations under the PMLA, including performing due diligence and maintaining records. Such requirements arise both at the time of acceptance of a client (KYC) and when a client transacts beyond specified limits or performs international money transfer operations. The KYC records must be filed with a central KYC registry within 10 days of acceptance by a client.

Where transactions are carried out beyond prescribed limits or involve currency etc., or where the transactions pose a high risk of money laundering or financing of terrorism, stricter due diligence requirements are placed on RE before such transactions are carried out.

The record keeping requirements need RE to ensure that individual transactions can be reconstructed. Such records must be kept for a period of five years from the date of the transaction. The REs are also required to develop internal mechanisms so that high-risk transactions can be detected in advance. All suspicious transactions must be reported periodically. Penal consequences are prescribed for breach of compliance with the provisions of PMLA.

It is clear that the government wants visibility and line of sight for people involved in VDA transactions. VASPs are now treated as financial institutions and a mechanism is being sought to ensure the reporting of transactions that are suspicious and the elimination of unwanted actors.

Like VDAs, another set of people that have come under increasing scrutiny are charities. Non-profit/charitable institutions have been exposed to increased scrutiny in recent times. They have been under the taxman’s lens and on the radar of agencies entrusted with regulating allied laws.

Actions against recognized politicians and people associated with major political parties have also led to increased scrutiny of high-ranking officials.

Therefore, several amendments have been notified in the Prevention of Money Laundering (Maintenance of Records), 2005 (‘PMLMR Rules’). Some of the most important changes are:

(i) Obligations to “group companies”: The term “group” has been defined to have the same meaning under the Income Tax Act to include a parent company and all entities where, due to ownership/control, consolidated accounts are required to be maintained.

It is further provided that “groups” are required to implement group-wide guidelines for the purpose of fulfilling obligations under the PMLMR rules. These include verification of identity of reporting entities and maintenance of records among other procedures and compliance under Chapter IV of PMLA.

(ii) Non-profit organizations: The term “non-profit organization” (NPO) has been changed to mean an entity or organization established for religious or charitable purposes in accordance with Section 2 (15) of the Income Tax Act, which is registered as a trust or a company under the Societies Registration Act, 1860, or similar legislation or a company registered under section 8 of the Companies Act, 2013.

Accordingly, reporting entities will have to maintain records of transactions involving receipts from non-governmental organizations (including religious or charitable institutions) of more than ₹10 lakh or foreign currency equivalent.

Further, banks/financial institutions/intermediaries are required to register details of their NPO clients on the DARPAN portal of NITI Aayog and maintain such registration for five years from the end of business relationship with the client or account closure, whichever is later.

(iii) Reduction in the threshold for identifying the beneficial owner (BO): The threshold for identifying the BO in companies and trusts was 25 per cent and 10 per cent respectively. This has been reduced evenly to 10 per cent for both categories.

While this will affect all companies and trusts, an immediate impact will be on foreign portfolio investors (FPIs) who are likely to have to wait a little longer in the queue for grant of registration due to increased due diligence and KYC norms.

(iv) Inclusion of Politically Exposed Persons: “Politically Exposed Persons” (PEP) are now defined under the PMLMR Rules as individuals who have been entrusted with prominent public functions by a foreign country, including heads of state or government, senior politicians, senior government or judicial or military officers, top managers of state-owned companies and important political party officials.

This is to bring uniformity with the definition of PEP under the existing foreign exchange rules, which is in line with the recommendations of the Financial Action Task Force.

Measures to regulate both VDAs and charities are welcome. It would be appropriate for the government to now come up with comprehensive legislation to govern VDAs.

The author is the Managing Director of Dhruva Advisors LLP. The views are personal