The Online Gaming and Taxation Puzzle

From the stories of Mahabharata to the current day, the Indian social system has frowned upon the concept of gambling and treated activities related to gambling as taboo, illegal or restricted. The recent growth in technology and internet usage has given exponential growth to the online gaming sector which has been challenged, especially by tax authorities.  

The online gaming companies often encounter unique challenges under GST and transfer pricing, as well as changes in law, which tend to alter the dynamics of the sector. Some of these challenges and changes in law include:

1. Proposed GST rate of 28% for online money gaming on bet value: The industry had taken a stand that for games considered as ‘Games of skill’, the tax rate should be 18% on their revenue, in opposition to the Government’s view that GST is payable 28% on the bet value. Toeliminate this issue, the Government has proposed to levy GST at the rate of 28% on all online money gaming, irrespective of whether the same amounts to ‘Games of skill’ or ‘Games of chance’. 

2. GST registration and compliances: The Government has proposed to make online money gaming companies located outside India to obtain GST registration in India under the Simplified Registration Scheme and comply with GST provisions. Online gaming companies that do not have any physical presence in India would be mandated to obtain registration, maintain records of transactions with Indian customers, and file timely reports before the tax authorities.

3. Valuation for levy of GST: The proposedvaluation on the supply of online money gaming would be done at the entry-level, i.e. based on the amount paid or payable to or deposited with the online gaming company, by or on behalf of the player (excluding the amounts entered into games/ bets out of the winnings of previous games/ bets) and not on the total value of each bet placed. Levy of GST on the entire value of the first amount deposited by a player would require change in technology framework for generation of necessary reports which should be capable of providing the value on which GST is liable to be paid. 

4. Intangibles and intellectual property: Determining the value of intellectual property, such as game software, trademarks, and copyrights, can be complex. Ensuring arm’s length compensation for the use of these intangibles across different tax jurisdictions is a significant challenge.

5. Data and user contributions: Online gaming platforms gather large amounts of user data and may involve user-generated content. Allocating the value of data and user-generated content appropriately among different entities within the company can be difficult. This also coincides with the Digital Personal Data Protection Bill, 2023 approved by the Indian parliament recently.

6. Revenue allocation: Determining how to allocate revenue among different aspects of the gaming business, such as game development, marketing and support services, can be contentious, especially when these functions are spread across multiple jurisdictions.

7. Risk and R&D: Assigning risk and determining the allocation of research and development (R&D) expenses for game development and improvements can be intricate. Different jurisdictions may offer different tax incentives for R&D activities.

8. Royalties and licensing: If the gaming company licenses its games or technology to subsidiaries or related entities in different jurisdictions, setting appropriate royalty rates and ensuring compliance with local regulations can be challenging.

9. Emerging regulatory challenges: Transfer pricing regulations and guidelines are continuously evolving, and tax authorities are becoming more focused on the digital economy. Keeping up with changing regulations and addressing new challenges can be demanding.

10. Differing tax jurisdictions: Online gaming companies often operate in multiple countries, each with its own tax laws and regulations. Coordinating transfer pricing strategies that comply with the various jurisdictions' requirements is complex.

11. TDS on winnings from online games: In Finance Act, 2023, section 115BBJ was introduced, which prescribes tax on winnings from online games. Also, section 194BA was introduced, which covers withholding provisions for winnings from online games. This has resulted in tax being withheld on the net winnings at a rate of 30%. The withholding tax obligation would be on the Online Gaming Intermediaries. Unlike section 194B, there is no de-minis threshold for withholding. The mechanism to compute net winnings is prescribed in Rule 133 of the Income-tax Rules, 1962.

12. Documentation: 

1. TP documentation: Preparing comprehensive transfer pricing documentation that justifies the company's transfer pricing policies and methodologies requires a deep understanding of the gaming industry and the ability to communicate this to tax authorities.

12. GST documentation: Entities operating online gaming platforms from outside India should understand the reporting and documentation requirements of the GST law and ensure that the requisite documentation is maintained.

12. Intercompany agreements: Documenting and justifying the terms of intercompany agreements for services, intellectual property, and other transactions is crucial to demonstrate that the transfer pricing is conducted at arm's length.

12. Lack of comparables: Finding comparable transactions or companies within the gaming industry for benchmarking purposes can be challenging due to the unique nature of the industry and the limited availability of public data.

Addressing these challenges requires a combination of expertise in tax, transfer pricing and GST regulations, a solid understanding of the gaming industry, and careful consideration of the company's business model and operations.

The article has been written by Lalit Attal, Partner, Tax and Regulatory Services, and Karthik Mani, Associate Partner, Indirect Tax, BDO India