Navigating the Intricacies of GST on Online Gaming

Background

In May 2021, the GST Council had constituted a Group of Ministers (hereinafter “GoM”) to recommend the base and rate at which GST should be levied on casinos, online gaming, and racecourses.¹

The GoM had earlier suggested that all activities under consideration should be taxed at 28% as casinos, online gaming, and horse betting all come under the category of betting or gambling.² The proposal was vetoed by the State of Goa. The GST Council asked the GoM to submit a fresh proposal in this regard after reconsideration. The same is still awaited.³

By way of this article, the author seeks to discuss the definition of “online gaming” and “gambling” under the relevant legal provisions, whether online gaming can be categorised as gambling under such provisions, and the larger social, economic, and legal implications of such categorisation by the GoM.

Contours of online gaming — Casual versus real money

The regulatory regime for online gaming is still at a nascent stage and therefore there are not many reliable sources to provide a concrete definition of online gaming. Guidance in this regard may be taken from the recently proposed Online Gaming (Regulation) Bill, 2022.⁴ The Bill seeks to establish an effective regime to regulate the online gaming industry to prevent fraud and misuse. Section 2(e) of the Bill⁵ states:

“Online gaming” means games played on any electronics device including personal computers, mobile phones, tablets, and other devices;

The Bill has been under criticism for its regressive nature and oversimplification of the online gaming industry on multiple levels, but relevant to this article is a lack of distinction between casual gaming and real money gaming.⁶

Casual gaming is where participants do not put money on the line, and therefore have no risk/prospect of losing/gaining money. Since money does not change hands, there are no tax implications in casual gaming.

Real money gaming on the other hand is where participants pay an entry fee to enter a competition, which is pooled together by a platform, and prizes are given to the winners from this pool, after deducting a certain percentage which becomes the profit of the platform for providing its service. It is this kind of online gaming which the GoM proposal aims to regulate via taxation. However, as explained in the next section of this article, it would be unwise of the GoM to characterise all real money games as gambling.

What constitutes gambling? The skill versus chance jurisprudence

The GoM’s earlier recommendation suggests that online gaming should be taxed in the same category as casinos and horse racing i.e. betting and gambling activities. The discussion on what amounts to “gambling” in India is more nuanced and is informed by almost six decades of settled legal jurisprudence.

Gambling in India is regulated by the Public Gambling Act, 1867.⁷ The Act does not define what constitutes “gambling”, but Section 12⁸ does define the activities that are outside of the application of the Act i.e. the activities that do not constitute gambling. It states —

“Nothing in the foregoing provisions of this Act contained shall be held to apply to any game of mere skill wherever played.”⁹

The Supreme Court, through the following judicial pronouncements, has defined the test to determine what constitutes “mere skill” as provided in the above provision.

The preponderance/dominant factor test

The roots of the preponderance test (also known as “the dominant factor test”) can be traced back to State of Bombay v. R.M.D. Chamarbaugwala¹⁰ (hereinafter “Chamarbaugwala”). The judgment authored by Sudhi Ranjan Das, C.J., while deliberating over the Bombay Lotteries and Prize Competitions Control and Tax (Amendment) Act, 1952, made a reference to the amended Section 2(1)(d)¹¹ of the Act that dealt with the definition of “prize competition”.¹² It was noted that all three clauses of Section 2(1)(d) were of a gambling nature, given that success in all of them depended on luck or chance and did not depend to a substantial degree upon the exercise of skill.¹³ The Court noted the changing contours of what amounted to gambling through the ages and laid down the current positions on the issue as:

17. … a competition in order to avoid the stigma of gambling must depend to a substantial degree upon the exercise of skill. Therefore, a competition success wherein does not depend to a substantial degree upon the exercise of skill is now recognised to be of a gambling nature.¹⁴

The Chamarbaugwala¹⁵ jurisprudence was further developed in State of A.P. v. K. Satyanarayana¹⁶ (hereinafter “Satyanarayana”). In this case, the Bench was seized with the responsibility of determining whether a certain establishment comes within the definition of a “common gambling house” under Section 3¹⁷ of the Public Gambling Act, 1867. The judgment, authored by M. Hidayatullah, J., as he then was, did not deeply delve into the difference between “game of skill” and “game of chance”. However, it did lay down that the game of rummy was a game of skill and therefore did not come under the ambit of gambling. It stated —

12. … The “three card” game which goes under different names such as “flush”, “brag”, etc. is a game of pure chance. Rummy, on the other hand, requires a certain amount of skill because the fall of the cards has to be memorised and the building up of rummy requires considerable skill in holding and discarding cards. We cannot, therefore, say that the game of rummy is a game of entire chance.¹⁸

Satyanarayana case¹⁹ was followed by the decision in M.J. Sivani v. State of Karnataka²⁰ (hereinafter “M.J. Sivani”). The judgment, authored by K. Ramaswamy, J., while delineating the categories of “game of skill” and “game of chance” stated that “No game can be a game of skill alone. Even a skilled player in a game of mere skill may be lucky or unlucky so even in a game of mere skill chance must play its part.””²¹ While technically accurate, this approach does not help in skill versus chance jurisprudence from a practical perspective. Because by that definition, every sport under the sun could be called a game of chance. Surely no one can argue with the fact that football and basketball are games of skill, in that the skill of the team dominates the outcome, compared to how lucky they were on any given day. However, under the categorisation created by M.J. Sivani case²², football would lie in the category of “games of mixed chance and skill”, the other two categories being “games of pure skill” and “games of pure chance”. In the author’s opinion, the two original categories under the preponderance test served their purpose much better than the three category system created by this case. However, M.J. Sivani case²³ did lay down that in the end, all that matters is whether the game in question has a preponderance of skill over chance or vice versa, and the same is to be determined on the facts of every case.²⁴

M.J. Sivani case²⁵ was followed by K.R. Lakshmanan v. State of T.N.²⁶ (hereinafter “Lakshmanan”), where the Bench was seized with the question whether betting on a horse race is a game of skill or a game of chance. Affirming the decisions in Chamarbaugwala case²⁷ and Satyanarayana case²⁸, and looking into the deep history and art of horse racing through various American judgments, the Bench concluded that horse racing is preponderantly a game of skill. The judgment, authored by Kuldip Singh, J., noted—

30. We have no hesitation in reaching the conclusion that horse racing is a sport which primarily depends on the special ability acquired by training. It is the speed and stamina of the horse, acquired by training, which matters. Jockeys are experts in the art of riding. Between two equally fast horses, a better-trained jockey can touch the winning post.²⁹

It is abundantly clear from the six decades of jurisprudence above that whether a particular activity amounts to gambling or not under the Public Gambling Act, 1867³⁰ depends on whether the game has a preponderance of skill or chance. It is also clear that the same cannot be determined by general rules and regulations and has to be determined in the facts and circumstances of each case.

It is also interesting, and in line with the above jurisprudence, that recently various laws that have sought to classify online gaming under the umbrella of gambling and hence prohibit them have been struck down by the judiciary. In February 2022, the Karnataka High Court struck down provisions of the Karnataka Police (Amendment) Act, 2021³¹ insofar as they prohibited betting on online games, including games of skill.³² The State preferred an appeal which is ongoing in the Supreme Court.³³ In August 2021, the Madras High Court struck down Part II of the Tamil Nadu Gaming and Police Laws (Amendment) Act, 2021³⁴ which banned betting or wagering in cyberspace, including games of skill if played for a wager, bet or other stakes.³⁵

In light of the above discussion, the proposal of the GoM to club all online gaming activities with casinos and horse races seems all the more baffling. Both horse racing³⁶ and rummy³⁷ (an online game) have already been categorised as games of skill by the Supreme Court. Laws prohibiting online gaming under the garb of gambling are being struck down by various High Courts of the country.

It is therefore the argument of the author that it would be unwise of the GoM to put down any general rules regarding the taxation of the online gaming sector. In fact, what the GoM needs to do is to draft comprehensive definitions for the delineation of games of skill and games of chance, and even lay detailed guidelines for the same if necessary. Whether a game is a game of skill or a game of chance should be determined based on the facts and circumstances of each case. As explained in the next section, in the absence of a thorough analysis and separate categorisation of games of skill for the purpose of taxation, the Government would only be opening itself up to excessive litigation.

Classifying games of skill as gambling amounts to arbitrariness under Article 14

It is well understood that taxation laws enjoy wide latitude compared to other laws. Unless a taxation law is manifestly arbitrary, the courts will leave it to the wisdom of the legislature to determine what to tax, in what manner and at what rate.³⁸ The excessiveness of a tax or the mere fact that a tax reduces a person’s income from his trade, profession or business cannot be the basis of a challenge in court.³⁹ A tax can even operate retrospectively without being struck down in certain cases.⁴⁰

However, where objects, persons, or transactions essentially dissimilar are treated by the imposition of a tax which is uniformly applied, it can result in discrimination for refusal to make a rational classification.⁴¹ And the current case of online gaming fits exactly into this category.

For a legislative classification to be valid under Article 14⁴², the twin conditions of intelligible differentia and rational nexus need to be fulfilled i.e. the classification must be founded on an intelligible differentia which distinguishes persons or things that are grouped together from others left out of the group,⁴³ and the differentia must have a rational relation to the object sought to be achieved by the statute in question.⁴⁴

The corollary being that things that are grouped together must have a commonality between them, and such commonality must have a rational relation to the object sought to be achieved by the statute in question.

As far as the GoM’s first proposal is concerned, online gaming and gambling were grouped together based on the commonality that they are both gambling,⁴⁵ an illogical presumption rebutted by the author’s arguments above. The object of grouping them together was taxation. However, excessive taxation of gambling and other activities like smoking and drinking is to discourage the public from such activities. These taxes are used as an instrument of social control⁴⁶ and they are levied for public health purposes to discourage consumption of harmful products by making them unaffordable.⁴⁷ In the context of gambling and betting laws in India, the Supreme Court in Chamarbaugwala case⁴⁸ delved into the history of gambling and extensively discussed how and why it is considered a vice in Indian society⁴⁹ and abroad⁵⁰ and therefore, needs to be curbed, lest the public welfare and social order be compromised.⁵¹

On the other hand, many online games being games of skill like football or basketball, and not creating the devastating societal harm that gambling does, have no reason to be classified as such and taxed at the same rate as sin goods and services.

In light of the above arguments, it is the case of the author that if the GoM were to proceed with this classification in their next proposal, the same would be open to challenge in court, cause excessive litigation and will be liable to be struck down.

Concluding remarks

It is important to note that the excessive taxation of the online gaming industry is not only in the best legal interest of the Government, but also not ideal from an economic perspective. By excessive taxation, the Government will stunt the growth of the industry in its nascent stage. Set to treble in value and reach $3.9 billion by 2025, India is expected to become one of the world’s leading markets in the gaming industry.⁵² The rise of cryptocurrencies, Web3 technology and virtual reality will contribute greatly to the ease and enjoyment experience of online gaming, further accelerating its growth. Over the long run, the Government would only benefit from reasonably taxing the online gaming sector because it will lead to the development of revenue, new technology and employment.