India: Taxability Of Online Games: Landmark Precedent For The Sector

1. BACKGROUND

Over the last few years, the online gaming sector has been growing by leaps and bounds. The sector has seen a spurt, not only in the number of companies launching games, but also in consumer or rather, in this case, player interest. Various reports have pegged the annual growth of this sector at 28-30 percent. Such growth has also drawn the attention of the Government, which not only is bringing in laws to regulate the sector but is also looking to maximize its revenue by taxing the sector.

While under the Income Tax Act, 1961 a lot of the open issues are being clarified either through amending the existing law or by bringing in new provisions. However, under the indirect tax regime, the issue regarding the levy of GST on online games has been hotly contested. In this context, the Goods and Services Tax (“GST”) Department has shown its clear intent to impose tax on all kinds of online games, on the face value of Contest Fee (known as Entry Fee) charged by the operators and impose tax at the rate of 28% on such fee. The said approach treats all kinds of online games at par with betting or gambling. However, gaming operators, who are engaged in skill-based games, have been heavily contesting the said claims made by the Revenue Department and discharging their liability at the rate of 18%, on the actual revenue earned by such operators (known as Platform Fee / Convenience Fee / Rake Fee). Any adverse action on this front could have led to closure of small businesses while also making it unprofitable for the large-scale businesses in the long term.

In a much-awaited judgment by the Karnataka High Court¹ , a huge relief has been provided to the sector by holding that games of skill cannot be taxed at par with the games of chance, as they are not akin to betting or gambling. Consequently, the proposal to demand tax on the face value of contests, at the rate of 28% has been set aside, while upholding the position adopted by the sector at large.

The Karnataka High Court was hearing a batch of petitions filed by Gameskraft Technologies Private Limited (“Gameskraft”) inter alia challenging the show cause notice issued by the Revenue Department, wherein they proposed to charge tax on the entire “buy-in” amount of more than INR 70,000 crores. In the said batch of petitions, impleadment applications were filed by leading gaming associations, who were supporting the case of Gameskraft. As per reports, the total proposed demand under the show cause notice was INR 21,000 crores (including interest and penalty).

We have provided below a brief synopsis of the matter along with our comments and the way forward.

2. LEGAL POSITION AND SYNOPSIS OF GAMESKRAFT'S CASE

Under GST Laws, the valuation mechanism and the rate of tax as applicable on games of skill and games of chance are strikingly different. While supplies, including supply of actionable claims and services relating to betting and gambling attract 28% tax rate, other nature of online games which qualify the criteria of being a game of skill attract 18% tax rate. Further, on account of provisions of Rule 31A of the Central Goods and Services Tax Rules, 2017, games of chance are taxed on the face value of the contest. On the other hand, in the absence of any specific provision pertaining to valuation of games of skill, GST liability is discharged on the actual revenue which is earned in the form of Platform Fee / Convenience Fee / Rake Fee charged from the users of their platform.

It is also important to note that placing of stakes for a chance to win in a contest has been held to qualify as ‘actionable claim'² . Under GST Laws, ‘actionable claim' is covered within the scope of ‘goods' and is specifically, outside the ambit of GST. However, ‘actionable claim' in relation to lottery, betting and gambling are taxable under the GST.³

In view of the above, the position adopted by the Revenue Department is entirely premised on the fact that the underlying games offered by gaming operators qualifies as betting / gambling. In most cases, the said position is a re-adjudication of the nature of game, given the fact that most of these games have already been tested by several courts in the past and such games have been categorically held as games of skill.

Allegations under the Show Cause Notice issued to Gameskraft:

• Gameskraft is involved in betting / gambling and therefore engaged in supply of actionable claims which are goods.
• Gameskraft has misclassified their supply as services under SAC 998439 instead of actionable claims.
• Gameskraft has earned revenue of more than INR 70,000 crores (which is the entire ‘buy-in' amount collected from the users) and not discharged appropriate tax liability on such revenue.
• Gameskraft offers discounts / bonuses to induce the players to indulge in more game plays.
• Games of skill played with monetary stakes partake the character of betting.

Arguments by Gameskraft and Impleading Parties:

• ‘Rummy' has the highest traction over the platform of Gameskraft, which constitutes 96% of the total games played over the platform. This game has been consistently held to be a ‘game of skill' by several courts in the country, including the Supreme Court.
• Revenue Department has made a malicious attempt to inflate the revenue figure of Gameskraft, by portraying the entire ‘buy-in' amount as their revenue. In this regard, the Revenue Department has failed to consider the Terms and Conditions of the platform which clearly indicate that the monies deposited by the users are held in ‘trust' by Gameskraft.
• Offering discounts / incentives to market its business and platform does not change the nature of games played, which are games of skill.
• ‘Rummy' has been held to be a game of skill by several courts including the Karnataka High Court in the case of All India Gaming Federation⁴ .
• Revenue Department has been unable to provide any material or legal basis to justify that the games offered by Gameskraft qualify as ‘betting or gambling'.
• Revenue Department has wrongly noted that Gameskraft is engaged in supplying actionable claims, as it is only a facilitator for online games offered on their platform. In any case, ‘actionable claims' only in relation to games of chance are taxable under the GST laws and will not be taxable in the present facts.

Relevant findings by Karnataka High Court:

• ‘Actionable claim' other than lottery, betting and gambling are neither supply of goods nor supply of services. Consequently, for imposition of tax on online games qualifying as games of skill, it needs to be seen whether they can be classified as lottery, betting or gambling.
• Any game / competition that relies substantially upon exercise of skill cannot be classified as ‘gambling'⁵ . Rummy is a game where exercise of substantial skill is the activity of the player and such skill controls the outcome of the game and not chance. When the outcome of a game is dependent substantially or preponderantly on skill, staking on such game does not amount to betting or gambling.
• Rummy is a game of skill, even if played for stakes.⁶ Playing for stakes or not cannot be a criterion to determine whether a game qualifies as a game of skill.⁷
• Rummy is not a game where the outcome is being predicted or forecasted, but is a game being played where success and the outcome of the game is substantially and preponderantly dependent on the exercise of skill of the player.
• The phrase ‘betting and gambling' featuring in Entry 34, List II of the Constitution does not include games of skill⁸ . A statute that applies to both ‘betting' or ‘gambling' as well as game of skill, will be severed to only apply to activities which amount to ‘betting' or ‘gambling'.
• Given that ‘gambling', ‘game of chance', ‘game of skill' has developed meanings in judicial parlance, the principle of nomen-juris requires that these words are interpreted in their legal sense instead of general parlance. In a game of rummy, certain amount of skill is required the fall of cards has to be memorized and the building up of rummy requires considerable skill in holding and discarding cards. Therefore, a game of rummy is a game of skill.⁹
• The terms ‘betting' and ‘gambling' under Entry 6 of Schedule III of the Central Goods and Services Tax Act, 2017 (“CGST Act”) must be given the same interpretation given to them by the courts in the context of Entry 34 of List II of Seventh Schedule of the Constitution. Consequently, it falls out that games of skill are not covered within the scope of Entry 6 of Schedule II of the CGST Act.
• Revenue Department has cherry picked stray sentences from several judgments to build-up a nonexistent case out of nothing, which is impermissible in law.
• In terms of Section 7(2) read with Schedule III of the CGST Act, actionable claims in relation to games of skill are outside the purview of GST.

INDUSLAW VIEW

The judgment by Karnataka High Court in the case of Gameskraft has for the first time cleared the air around levy of GST on online game qualifying as games of skill. The said judicial precedent is likely to provide a much-needed breather to the sector as several gaming operators were in receipt of similar notices by the Revenue Department.

It must be noted that the judgment in the case of Gameskraft has predominantly focused on the game of ‘rummy' wherein relief has been granted by the Karnataka High Court, on the basis of several judicial precedents supporting the claim of Gameskraft that rummy qualifies as a game of skill. In our experience, we have seen that, traditionally, the approach taken by the Revenue Department during investigation/ audit/ adjudication, is to follow a judgment as a precedent if the facts of a case are similar to the case-laws relied upon. Consequently, for other games, a deeper analysis will have to be done to review whether a particular game format is covered by a judicial precedent holding such game format to be a game of skill and to consequently rely on the judgment by Karnataka High Court in Gameskraft case. In case of any notice or proceedings initiated by the Revenue Department, depending on the facts and the said analysis, one may look at challenging the notice before the jurisdictional High Court pointing out the said facts.

We must highlight the recent amendments under the Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Amendment Rules, 2023 (“IT Rules 2023”) that has introduced a certification process for online games, through Self-Regulatory Bodies (“SRBs”). In the said IT Rules 2023, the SRBs acting under the aegis of Ministry of Electronics and Information Technology (“MeiTY”) will certify the games qualifying as games of skill basis the objective criteria to be set out by such SRBs in consultation with MeiTY. Once a particular gaming product is certified by such SRBs to qualify as a game of skill, the Revenue Department can be expected to rely on the view taken by the SRBs for the purposes of taxation. One may hope that with the positive outlook shown by the Government towards the prosperity of online games, the same will not be hindered on account of adverse positions by the Revenue Department.

It may be relevant to highlight that the issue pertaining to rate of tax and value on which such tax should be imposed, for online gaming, is also pending before the GST Council. Despite the judgment by Karnataka High Court, the battle is not completely won by the sector. Even at this stage, GST Council may propose any tweaks in the provisions relating to rate or value, for the purpose of taxing online skill-based gaming operators at par with betting or gambling. The said proposals will need to be brought into effect through suitable amendments under the GST Laws. At that stage, a new line of challenge may become available to the stakeholders. Be that as it may, one may hope that the judgment by Karnataka High Court gives guidance to the GST Council to continue with the current levy insofar as the games of skill are concerned and not dilute the distinction between games of skill and games of chance from the aspect of taxability.

Footnotes

1. Gameskraft Technologies Private Limited v. DGGSTI, TS-181-HC(KAR)-2023-GST

2. Skill Lotto Solutions Pvt. Ltd. v. Union of India, 2020 (43) GSTL 289 (SC)

3. Section 7 read with Entry 6 of Schedule III of the CGST Act, 2017

4 All India Gaming Federation v. State of Karnataka, 2022 SCC Online Kar 435 (DB)

5. State of Bombay v. RMD Chamarbaugwala, AIR 1957 SC 699

6. State of Andhra Pradesh v. K. Satyanarayana, AIR 1968 SC 825

7. Head Digital Works Private Limited v. State of Kerala, (2021) SCC Online Ker 3592

8. RMD Chamarbaugwala v. Union of India, AIR 1957 SC 628

9. K. Satyanarayana, Ibid.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.