Regulation and taxes put online gaming on a sticky wicket

While curbs and regulation of the burgeoning online gaming industry are necessary, has the government gone too far? Freny Patel reports. A deep dive into amendments to India’s 2021 information technology rules and recently proposed changes to the tax regime for online gaming throws up significant challenges and ambiguities. There is a call for greater clarity in the wake of an exponential growth in the number of online gaming users in India, brought about by the covid-19 pandemic and subsequent government-imposed lockdowns.

The compound annual growth rate of revenue from India’s gaming market in FY2021-2022 increased by 27%, from USD2 billion to USD£2.6 billion. It is projected to touch USD8.6 billion by FY2026-2027, according to gaming and interactive media venture fund, Lumikai. Against China’s 8% growth rate and the US at 10%, India’s gaming revenue grew 38% between 2017 and 2020.

Gaming under IT rules

The Ministry of Electronics and Information Technology (MeitY) has been identified as the nodal agency to oversee the growing online gaming industry.

Earlier this year, it proposed amendments to the Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Rules, with provisions against betting and wagering. It proposed a self-regulatory mechanism aimed at regulating online gaming content. Effectively, online gaming has been brought under IT rules that were initially issued for social media intermediaries and streaming platforms.

The gaming industry has welcomed the proposed guidelines on self-regulation, and the proposed light-touch regulatory framework. Prashant Phillips, a Delhi-based partner at Lakshmikumaran & Sridharan, says prominent participation from self-regulatory bodies may make business easier, provide much-needed clarity and help in the growth of the sunrise gaming industry in India. Roland Landers, chief executive of the All India Gaming Federation, also welcomed the amendments.

He says a uniform central regulation for online skill gaming has been a long-awaited industry demand. According to Ashima Obhan, a New Delhi-based senior partner at Obhan & Associates, the draft amendment rules bring certainty, which is especially important for investor confidence and potential investment.

The online gaming industry presently faces the perils of inconsistency because existing laws about online gambling fall under state governments.

For example:

• Nagaland, Meghalaya and Sikkim states provide a licensing mechanism for online games.
• Other states like Andhra Pradesh, Odisha and Telangana prohibit online games of chance and skill involving money.
• The southern states of Karnataka, Kerala and Tamil Nadu have passed laws prohibiting online games of skill and chance, but these have been challenged in various high courts and held to be unconstitutional.

Since online gaming is governed by different laws, there is a lack of clarity in regulations, explains Bagmisikha Puhan, a New Delhi-based associate partner of TMT Law Practice. Online gaming falls under IT laws because the games are played on the internet. However, due to advertisements and endorsements, online gaming is also governed by consumer protection laws, says Puhan.

“Since many of these games involve users playing with money in the hope of winning, gaming falls under the Public Gaming Act to ensure that one is not violating state border laws,” she says. There is no consistency when it comes to state-specific legislation. While the draft national rules are a first step towards regulating the industry, they do leave a lot of questions.

Some structural issues may hinder the growth and development of startups in the field, says Obhan. She cites a lack of a prescribed timeframe for self-regulatory bodies to approve online games, which may bring lengthy approval processes that are not feasible for startups with little funding. One of the biggest gaps in the draft rules is that “game” has not been defined, leaving it ambiguous as to what “online gaming” would be, says Obhan.

“The way the definition of online gaming is drafted, apps that offer discounts, rewards or cashback on transactions made through it could be brought under its purview,” she says. “This may even have tax implications,” leaving the industry vulnerable since it is unclear what organisations would have to adhere to the draft rules. Asish Philip Abraham, a Delhi-based partner at Lakshmikumaran & Sridharan, agrees there is “an interesting regulatory lacuna” posed by the definition and the option for the gaming operators to use intermediary protection. Phillips, at Lakshmikumaran & Sridharan, identifies ambiguities in the draft rules that include the interplay with state legislation, requirements to adopt responsible gaming, protecting users from addiction, and the deployment of random number generators. “Some of these obligations may also impact applications that offer discounts or promotional products in exchange for users playing contests for winning such rewards, apart from gaming platforms,” he says.

However, a greater ambiguity is the power that MeitY has to designate any internet game as an “online game”. The draft rules permit such action, should something “create a risk of harm to the sovereignty and integrity of India, security of the state, friendly relations with foreign states, public order, or on account of causing addiction or other harm among children,” says Shuchi Dutta, a Delhi-based associate at Obhan & Associates. Dutta says this power may be detrimental to several organisations operating in the internet gaming space, as there is no set or defined criterion for the MeitY to consider.

The draft IT rules call for online gaming intermediaries to have regulatory compliance officers and meet the Reserve Bank of India’s “know your customer” norms. Considering that they will “incur substantial expenditure at the stage of establishment, and significant costs for ongoing compliance thereafter, it is very possible that smaller players in the industry will face several difficulties while trying to expand or even break into the sector,” says Obhan. Appointing a nodal officer for around-the-clock co-ordination with law enforcement agencies, and fact-checking content on the platform to ensure that none of it has been identified as “fake” by the Press Information Bureau’s fact-checking unit may not be feasible for smaller companies, he says.

Self-regulation v regulator

Self-regulation is a vital part of today’s global economy.

Diverse industries have used self-regulatory processes to address a range of issues, says Phillips. “While regulators may be better suited in highly sensitive sectors such as banking, insurance or healthcare, self-regulatory bodies in emerging sectors such as online gaming and content platforms may be better suited to balance industry considerations with governmental objectives,” says Phillips. Their role to create regulations, monitor and enforce them may also be better received and addressed by the industry while also being subject to oversight by the government, he adds.

Obhan feels otherwise, and says that instead of a self-regulatory body, a regulator might be preferable, as it would not have any vested interest in the functioning of the online gaming industry. She highlights the possibility of conflicts of interest when a governing body has members from a significant online group and may force smaller innovators to disclose their confidential information and intellectual property. While these bodies would comprise industry members and not third parties, and would bring ground-level expertise to the industry, “this development is also concerning since it could lead to self-regulatory bodies being governed and dominated by members from larger online gaming intermediaries, thereby detrimental to startups looking to enter the space,” says Obhan.

The draft rules provide some criteria for the MeitY to consider before registering a self-regulatory body. This includes the presence of certain people on the board of directors or governing bodies, which, says Dutta, “interestingly does not include any lawyers or people from the legal profession”. While Puhan agrees with the need for a self-regulatory body, she says the onus on whether a game of skill should be left to the one uploading the game, its publisher, instead of defined boundaries.

Games of skill should not be framed under the legislation, but be left open to the courts to determine at a later stage, she says. “This has [already] been determined by the courts so there is no need to reinvent the wheel.”

Since courts have stated that rummy and fantasy games are legal and games of skill, there is a lot of ad revenue and endorsement for these games, Puhan points out. “That is not the case for other casual games of skill because they have probably not been tested in a court of law, or there is no framework that states that such games qualify as games of skill,” she says. This is a major challenge for the gaming industry.

Taxation conundrum

There is also a danger that the online gaming industry might be killed by tax.

The government proposes to overhaul the tax regime on winnings, and the Goods and Services Tax Council is deliberating whether to increase GST for online skill-based games from 18% to 28%. Effective from 1 April 2023, gaming platforms will be responsible for withholding tax following the introduction of section 194BA of the Income Tax Act, announced by Finance Minister Nirmala Sitharaman in the Union Budget 2023-24. Gaming companies will have to deduct tax at the rate of 30% from the net winnings of players, as opposed to the current INR10,000 (USD120) threshold for tax deducted at source (TDS).

The application of INR10,000 TDS was an open question for many years, according to Meyyappan Nagappan, a Mumbai-based partner at tax practice Trilegal, who appreciates the clarity in the gaming tax provisions. “Companies were not sure how TDS should be applied, whether it would be per withdrawal or on an aggregate basis, and were taking different positions based on what they were advised,” says Nagappan. The issue today, however, is the withholding tax levied at 30%.

Nagappan says this is “extremely high”, especially in the wake of recent court rulings that recognise gamers are professionals and they have a fundamental right to carry on gaming as a professional trade. Originally, gaming income fell under the other income bracket that targets casual and non-recurring income. But the world has changed since these provisions were first implemented many years ago. “Taxing winnings at a 30% withholding tax is not in line with the government’s aspirations for India to become a global gaming hub,” says Nagappan.

Not only is the rate of taxation a conundrum for games of skill but equally confusing is whether taxes have to be imposed on the platform fee, or on gross gaming revenue. Another question is whether online gambling will fall under offline gambling or the new section that talks about online games. This section could include both games of skill and games of chance, says Nagappan.

He says the discrepancy here is that while there is a INR10,000 threshold for offline gambling, there is no such threshold for online gaming. “We don’t know what the government will prescribe under the new section … rules in terms of how winnings are to be calculated with respect to online games.”

Gaming GST

Although there is no final decision on increasing the GST rate for gaming, the Directorate General of GST Intelligence slapped Gameskraft with an astronomical INR210 billion tax notice last year, alleging that the gaming platform had indulged in betting and gambling, and was liable to pay a GST of 28% on received collections. During Gameskraft’s appeal, the Karnataka High Court pointed out that experts should decide the nature of the game and not a GST officer, who would not have the expertise. “If the tax on the winnings is at 30% plus another 28% GST, there is very little left, thereby disincentivising the industry,” says Nagappan.

Courts know best?

A Gameskraft spokesperson reportedly termed the GST Council’s notice a departure from well-established law.

Games of skill are constitutionally protected by the Supreme Court of India and various high courts, he said. Fearing a ripple effect on other gaming platforms of the tax notice issued to Gameskraft, the industry has strongly contested that online games are games of skills and should not be treated as gambling or betting, where GST is levied at 28% instead of 18%. It will be imperative for the government to address the challenges to the draft IT rules and the proposed amendments to the tax law bring if India’s online gaming industry is to continue on its growth path, or otherwise fall prey to payments going to offshore gaming platforms.

Government authorities acknowledging these challenges are working with the MeitY to see how they can best deal with the situation.

The high level of taxation could easily push people to the grey market as it is very easy to come up with a mirror website, says Nagappan. “It’s not in anybody’s interest for transactions to move off-platform or offshore,” he adds.

If India is to unlock the full potential of the online gaming industry, the right level of regulatory support and a positive tax environment are the need of the hour to ensure that the sector continues to thrive and contribute to the India’s digital growth story.