By Adarsh Somani and Sahil Kothari
India’s online gaming industry is poised to take off like never before. Considered one of the future pillars of the economy, the landscape of the online gaming industry has transformed during the pandemic, with a massive increase in the number of players (annual user growth rate reaches 40% ), income and investment (in the after two years it should attract $100 million in foreign direct investment). Growing the number of users from 250 million at the end of fiscal 2018 to 400 million by mid-year 2020 took the market size of the online fantasy sports market to INR 24.3 billion.
A large consumer base, increasing accessibility to the Internet and the development of expertise have all contributed to this push. This was manifested in the fact that Indian online gaming startups are part of a unicorn club, which is expected to grow for $5.5 billion by 2025. Prime Minister Modi also recognized the vast potential of India’s gaming industry, applauding the contributions of Indian innovators and app developers.
However, the online gaming industry has been operating under the weight of legal ambiguities and litigation since its inception.
In the Indian context, each state has formulated its own laws governing online fantasy games.
During the early stages, the industry was marked by controversy over whether success in such games is dominated by skill or luck, the latter of which is illegal in the majority of states in India. . Courts in some states such as Tamil Nadu, Kerala and Karnataka have ruled that online fantasy games involve substantial skill, which is nothing more than a commercial activity, and therefore protected under the article 19 of the Constitution. This judicial intervention finally settled the question by drawing a line of demarcation between the two.
Notwithstanding the above, some states such as Assam, Sikkim, Nagaland, Odisha, Telangana and Andhra Pradesh have continued to exercise their right to ban such online fantasy games.
Taxation has become another plague for the industry. Currently, a chance of winning in betting, gambling or horse racing is subject to a GST rate of 28%. This tax is levied not on the margins but on the total value of the transaction. The dispute that arises is whether the online gambling industry will also be subject to the same 28% tax rate. If so, this will prove to be a major impediment to the projected growth of the industry.
As a general rule, participation in online games involves the payment of an entry fee. The gaming company retains only a fraction of such an entry amount for its platform fee. The balance amount is allocated to a common pool from which prize money is distributed to winners.
The gaming industry has made repeated representations to the government to clarify that GST should only be levied on a gaming company’s income or earnings and not on the gross amount of entry. Additionally, the government has also been asked to tax games of skill differently than games of chance.
It should be noted that collection towards a prize pool could well be characterized as an actionable claim or alternatively as sums collected and held in trust by participants. Actionable claims are a claim against any debt and are excluded from the scope of the GST. Gaming companies usually make arrangements to keep the prize pool intact and in separate bank accounts as well. It would therefore be far-fetched to subject the entire collection to the levy of GST, especially when the law on the handling of actionable claims is amply clear.
While all of this is being debated, in parallel, a group of ministers has been formed to recommend the rate of GST and the applicability of GST only on the net margin that accrues to gaming companies. While clarification on this issue is awaited, current news reports indicate that a proposal to tax a 28% GST rate on gross entry is on the cards.
The GST authorities, meanwhile, have issued notices to various industry players, offering to recover the additional GST due to the dispute over the assessment. This, no doubt, dampened sentiment in the industry. In fact, the low margins achieved by the industry are lower than the taxes potentially expected by the government in this retro churning of the fiscal position!
On a mildly positive note, however, the Punjab and Haryana High Court recently provided much-needed relief, ordering the GST authorities not to take any enforcement action until a clarification is available from the government.
Impact on industry
The proposal to increase the tax rate from 18% to 28% would have a catastrophic impact on the online gambling industry. This will result in a direct impact on customers who will be forced to bear the brunt of the additional tax cost.
Moreover, bringing online gaming under the slab of the 28% GST will not only reduce the growth rate, but also render the returns on investment unsustainable. This will ultimately stifle both innovation and investment in this sector. The possibility of a few online gambling start-ups moving outside of Indian jurisdiction should also not be ruled out.
Interestingly, online gambling fees worldwide are taxed between 15% and 18%. Any rate above the global median could have a negative impact on the growth of the online gaming industry, implying not only an effective loss of revenue for the government, but also a loss of substantial jobs that this industry has contributed to create.
There is no doubt that the government must make a clear distinction between gambling and betting, which are completely different concepts. This distinction must also be made for all legal and commercial processing.
In addition, online gambling services should certainly be separately classified and subject to a GST rate of no more than 18%. A clarification in this regard is the need of the hour. An express clarification on the valuation aspect would also avoid possible disputes with the tax authorities.
A centralized regulatory body or framework to oversee the online gambling industry would help ensure uniformity in enforcement across all states. Currently, the gambling industry is examining the applicable rule of law in each state and making policy decisions accordingly. The establishment of such a centralized body would ensure uniformity in the application of the law across the country. Such a self-regulatory body would also help inspire new innovation and ensure a level playing field for all platforms.
Resolving the legal ambiguities that persist in this industry as well as a fair and reasonable GST rate is the need of the hour. Greater clarity for the industry will undoubtedly pave the way for greater investor confidence and, more importantly, improving India’s reputation for ‘doing business in India’.
Adarsh Somani is a partner and Sahil Kothari is a senior partner at the economic law firm. The opinions expressed are personal and do not necessarily reflect the opinions of MediaNama.
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