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Tax – the bugbear for India’s online gaming industry

The industry’s growth is being weighed down by taxation and legal uncertainty.

By Adarsh Somani and Sahil Kothari

India’s online gaming industry is poised to take off like never before. Considered to be one of the future pillars of the economy, the landscape of the online gaming industry has transformed during the pandemic, with a massive surge in players (annual user growth rate is compounding at 40%), revenues, and investments (in the following two years, it is expected to attract US$ 100 million in foreign direct investment). The growth in users from 250 million at the end of FY 2018 to 400 million by mid-FY 2020 has taken the market size of the online fantasy sports market to INR 24.3 billion.

A large consumer base, increasing accessibility to the internet, and development of expertise have all contributed to this surge. This has manifested in Indian online gaming startups being part of a unicorn club, which is expected to grow to USD 5.5 billion by 2025. Prime Minister Modi has recognized the vast potential of the Indian gaming industry too, applauding the contributions of Indian innovators and application developers.

However, the online gaming sector has been functioning under the weight of legal ambiguities and disputes right from its inception.

Legal Ambiguities

In the Indian context, each state has formulated its own laws governing online fantasy games.

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During the initial stages, the industry was marked with controversy over whether success in such games is dominated by one’s skill or luck, the latter being illegal in the majority of the states in India. The courts in certain states such as Tamil Nadu, Kerala, and Karnataka have ruled that online fantasy games involve substantial skill, which is nothing but business activity, and thus protected under Article 19 of the Constitution. This judicial intervention has finally put the issue to rest, by drawing a distinguishing line between the two.

Notwithstanding the above, certain states such as Assam, Sikkim, Nagaland, Odisha, Telangana, and Andhra Pradesh have continued to exercise their right to ban such online fantasy games.

Tax Impediments

Taxation has become another bane for the industry. Currently, a chance to win in betting, gambling, or horse racing is subjected to a GST rate of 28%. This tax is levied, not on the margins but on the total transaction value. The dispute which arises for consideration is whether the online gaming industry too will be subject to the same 28% rate of tax. If so, this will prove to be a major impediment to the industry’s projected growth.

Typically, participation in online gaming involves payment of an entry amount. The gaming company retains only a fraction of such an entry amount towards its platform fees. The balance amount is allocated towards a common prize pool from where prize money is distributed to the winners.

The gaming industry has made repeated representations to the government to clarify that GST should be levied only on the income or revenue of a gaming company and not on the gross entry amount. Additionally, the government has also been requested to tax games of skill differently from games of chance.

It should be noted that the collection towards a prize pool could well be characterised as an actionable claim or alternatively as monies collected and held under the trust of the participants. Actionable claims are a claim to any debt and are excluded from the purview of GST. Gaming companies usually make arrangements to keep the prize money pool untouched and in separate banking accounts too. It would, thus, be farfetched to bring the entire collection under the levy of GST especially when the law on the treatment of actionable claims is amply clear.

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While all this is being debated, in parallel, a Group of Ministers has been constituted to recommend the GST rate and applicability of GST only on the net margin that accrues to gaming firms. While clarity on this issue is awaited, current news reports indicate that a proposal to tax a 28% GST rate on gross entry amount is on the cards.

GST authorities, meanwhile, have issued notices to various industry players, proposing to recover incremental GST owing to the valuation dispute. This, no doubt, has dampened the sentiment in the industry. In fact, the low margins made by the industry are lower than the taxes potentially expected by the government in this retro churning of tax position!

On a slightly positive note, however, the Punjab and Haryana High Court provided much-needed relief recently, by directing GST authorities not to take any coercive action till a clarification is available from the government.

Industry Impact

The proposal to increase the tax rate from 18% to 28% would have a catastrophic impact on the online gaming industry. This will result in a direct impact on customers who will be forced to bear the burden of the additional tax cost.

Further, bringing online gaming under the GST slab of 28% will not only reduce the growth rate but also make returns on investment unviable. This will eventually stifle both innovation and investments in this sector. One should also not rule out the possibility of a few online gaming start-ups shifting base outside the Indian jurisdiction.

Interestingly, fees from online gaming the world over are taxed in the range of 15%-18%. Any rate upward from the global median could adversely impact the growth of the online gaming industry – implying not just an effective loss of revenues for the government but also a loss of substantial jobs which this industry has been instrumental in creating.

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Expectations from the government

There is no doubt that the government must draw a clear distinction between gaming and betting, which are completely different concepts. This distinction needs to be made for all statutory and commercial treatments as well.

Further, online gaming services should certainly be classified distinctly subject to a GST rate of 18% at most. A clarification in this regard is the need of the hour. An express clarification on the valuation aspect would also help to steer clear of any potential disputes with tax authorities.

A centralised regulatory body or framework to overlook the online gaming industry would help to ensure uniformity in application of law across the states. Currently, the gaming industry is examining the applicable rule of law in each state and taking policy decisions accordingly. The constitution of such a centralised body would ensure uniformity in application of law across the country. Such a self-regulatory body would also help to inspire further innovation and ensure a level-playing field for all platforms.

Addressing legal ambiguities which continue to persist in this industry along with a fair and reasonable rate of GST is the need of the hour. Greater clarity for industry, no doubt will pave the way for higher investor confidence and most importantly – improving India’s reputation for ‘Doing Business in India’.

*

Adarsh Somani is a Partner and Sahil Kothari is a Principal Associate at Economic Laws Practice. Views expressed are personal and do not necessarily reflect the views of MediaNama.

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