India’s Crypto Traders Face AI-Driven Tax Audit Maze

India’s evolving tax framework for cryptocurrencies has introduced stringent compliance requirements for traders and investors, with the 2025 tax year emphasizing transparency and accurate reporting. The government has formalized the treatment of virtual digital assets (VDAs) under the Income Tax Act, imposing a flat 30% tax on gains from transfers, with no allowable deductions for trading expenses or loss set-off. This tax applies uniformly to all forms of crypto, NFTs, and tokens, with Indian and foreign currencies explicitly excluded from the VDA definition [2].

To enforce compliance, the government has implemented a 1% tax deducted at source (TDS) rule, which applies to crypto transactions exceeding INR 50,000 for business purposes and INR 10,000 for others. On Indian exchanges, TDS is typically handled automatically, but for foreign or peer-to-peer trades, investors are responsible for manually deducting and depositing TDS. Failure to comply with these requirements can trigger audit flags, especially in cases of unreported VDA income or TDS discrepancies [2].

Audit risks in India are no longer random but are data-driven, with the Income Tax Department employing advanced tools like Project Insight and the Non-Filer Monitoring System to cross-check transactions with filings. These systems leverage artificial intelligence and blockchain analytics to detect mismatches between taxpayer returns and third-party data. The government has also trained tax officers in digital forensics and blockchain analysis through partnerships with institutions like the National Forensic Science University [2].

One of the key triggers for audits is a mismatch in TDS data. When the TDS information reported by exchanges in Form 26AS or the Annual Information Statement does not align with the VDA income declared in an individual’s ITR, it raises red flags for non-compliance. Similarly, failing to report VDA income in Schedule VDA of the ITR increases the likelihood of audit notices. The Income Tax Department treats such omissions as deliberate or careless behavior, potentially leading to legal consequences [2].

With the adoption of the international Crypto-Asset Reporting Framework, India’s ability to track foreign crypto transactions is expanding. This global data-sharing initiative enables cross-border reporting, reducing the ability of investors to hide offshore holdings. As a result, investors using foreign exchanges must be especially vigilant in their tax reporting, as manual TDS responsibilities are now under greater scrutiny [2].

To mitigate audit risks, experts recommend maintaining detailed records of all crypto transactions, including dates, values in rupees, asset types, and fees. Filing the correct ITR form is also crucial—ITR-2 for investors and ITR-3 for active traders or those earning from staking and mining. Using audit-ready tools like crypto tax software can help automate tracking and ensure compliance with the updated return (ITR-U) process, which allows voluntary corrections for past errors [2].

The consequences of non-compliance are severe, with undisclosed crypto income attracting an effective tax rate of 78%, including surcharge and cess. Penalties for under-reporting and misreporting can range from 50% to 200% of the tax due, and in extreme cases, imprisonment under the Income Tax Act. The Prevention of Money Laundering Act further amplifies these risks, giving authorities the power to seize assets without prior judicial approval. Additionally, the Black Money Act applies to undisclosed foreign holdings, imposing strict penalties on investors using offshore platforms without proper disclosure [2].

Looking ahead, the government is broadening the legal definition of VDAs and strengthening enforcement mechanisms. Tax officers are being empowered with greater authority to access electronic data, including cloud storage and online accounts during investigations. These changes signal a shift toward a more transparent and enforceable regulatory environment for digital assets, with global integration reducing the scope for non-compliance [2].

Source: [1] Koinly Blog - Crypto Tax News, Strategies & Tips (https://koinly.io/blog/) [2] Crypto Audit Risks & Triggers in India: A Complete Guide (https://www.koinx.com/tax-guides/crypto-audit-risks-triggers-india)