THE POLICY LAB (TPL-08)
SEPTEMBER 03, 2022

By J B Mohapatra

ALONGSIDE phenomenal growth in reach and penetration of e-sports, fantasy sports and other online gaming platforms reciprocating to the demographic profile, recreational needs and plentiful opportunities for monetisation, issues of regulatory oversight, governance mechanism, developing responsible gaming tools and taxation matters have come to the fore. A private Member's Bill entitled "The On Line Gaming (Regulation) Bill 2022' with the stated objects to establish 'an effective regime to regulate online gaming industry to prevent fraud and misuse and for matters connected therewith and incidental thereto' has also been tabled in April 2022, whereby an Online Gaming Commission with wide rule making and licensing powers has been envisaged for (a) oversight the functioning of online gaming websites (b) make periodical or special reports to the central government on any matter pertaining to online gambling (c) suggest appropriate measures to control or curb illegal online gaming (d) grant, suspend or revoke licenses for online gaming websites and determine fee for licence applications and renewals of such websites and (e) any other matter referred to it by the central government. As it is, Gaming Control Boards (by whatever name called) have been established under legislation at federal and state level in USA, France, Denmark, Hungary, Norway, Portugal and many more jurisdictions, whose primary mandate is to make rules, enforce laws, impose sanctions for violations, initiate and conduct investigations, grant, suspend or revoke licences and design and establish processes and procedures for collection of taxes and fees. Once we have the definitional clarity on legality of online gaming in India, and the views of the states who have inherent constitutional mandate to legislate on any matters on betting and gambling are reasonably accommodated, the central gaming authority once established, would be expected to administer a unified law which addresses the concomitant issues including battling illegality and crime, and establishing responsible and transparent accounting practices and procedures for the sector.

Two principal issues arise in considering the existing legislative provisions in Income Tax Act (IT Act) to address the challenges of online gaming sector : (a) whether the 'skill vs chance' debate arising essentially under Public Gambling Act, 1867 and Prize Competition Act, 1955 is relevant for considering questions of taxability of winnings under the IT Act and (b) whether the existing withholding legislation and regime for online gaming are adequate and robust.

While games of skill vs games of chance itself is incorporated in the Public Gambling Act, 1867 ("an Act to provide for the punishment of public gambling and the keeping of common gaming houses") administered in certain parts of India and excludes from penal consequences any game of 'mere skill', differentiation is generally made on a case to case basis, as in State of Andhra Pradesh vs K.Satyanarayana (SC) 1968 AIR 825 holding that thirteen card game of rummy is not a game entirely based on chance or in the case of Dr K.R.Lakshamanan vs State of Tamilnadu (SC) 1996 AIR 1153 where it holds that wagering or betting on a race horse is a game of skill and not of chance. This differentiation rendered specifically in the context of invoking penal consequences for acts legislatively recognised as antithetical to public policy and order prima facie does not figure in the legislative formulation for imposing tax on winnings from games of any sort or the judicial precedents flowing therefrom, although there have been sporadic attempts to introduce such classification in many litigations. In CIT vs G.R.Karthikeyan - 2002-TIOL-2709-SC-IT in the context of winnings from a highway motor rally which was claimed to be outside the scope of taxation within the meaning of section 2(24) of the IT Act since purportedly rally was stated to be not a 'game' but a test of skill and endurance, went on to hold that section 2(24)(ix) of the IT Act referring to lotteries, cross word puzzles, races including horse races, card games, other games of any sort and gambling and betting of any form or nature whatsoever renders an inclusive definition of income, and by dint of the logic, winning from highways motor rally becomes taxable. While Karthikeyan's case related to a matter relevant for AY 1974-75, Finance Act, 1987 introduced section 115BB with effect from 1-4-1987 under chapter XII (determination of tax in certain special cases) making provision of a flat rate of taxation (currently 30%) in respect of winnings from lotteries etc, and inserted subsection (4) in section 58 to disallow any expenditure or allowance in computing income by way of winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or from gambling and betting of any form or nature whatsoever. Meanwhile, Finance Act 2001 with effect from 1-4-2002 introduced an Explanation to section 2(24)(ix) to say (a) lottery includes winnings from prizes awarded to any person by draw of lots or by chance or in any other manner whatsoever, under any scheme or arrangement by whatever name called (b) 'card game and other game of any sort' includes any game show, an entertainment programme on television or electronic mode, in which people compete to win prizes or any other similar game. Going by the phraseology and legislative set-up configured at present via provisions of section 115BB and section 2(24)(ix), it would be prudent to say that these provisions adequately address concerns of taxability of winnings from online gaming activities whether or not the winnings are derived from exercise of skill or held as chance-based.

In addition to the taxing provisions in section 115BB, tax withholding provisions in section 194B for specifically targeting income in the nature of winnings from lottery, games of any other sort, gambling etc ( these are to be regarded as income from other sources as per section 56(2)(ib), but taxed as special cases at special rates under section 115BB) sets out, as any other TDS provision, to ensure the twin goals of revenue maximisation and minimisation of cost of collection apart from containing the propensity for tax evasion. The provision reads as follows:

"Winnings from lottery or crossword puzzle.

194B.   The person responsible for paying to any person any income by way of winnings from any lottery or crossword puzzle or card game and other game of any sort in an amount exceeding ten thousand rupees shall, at the time of payment thereof, deduct income-tax thereon at the rates in force :

Provided   that in a case where the winnings are wholly in kind or partly in cash and partly in kind but the part in cash is not sufficient to meet the liability of deduction of tax in respect of whole of the winnings, the person responsible for paying shall, before releasing the winnings, ensure that tax has been paid in respect of the winnings."

While taxability of prize money received in kind or partly in cash and partly in kind has been answered in the provision itself, the TDS liability threshold of Rs 10,000 said to be triggered 'at the time of payment thereof' is rife with may possible interpretations, foremost being whether the threshold is subject to an annual determination of all winnings or whether the ceiling is with reference to winning at the conclusion of a specific round of competition. While large majority of TDS provisions applicable to various nature of payments abide by a single parameter for discharging the onus of timing for satisfying TDS liability- that is TDS is to be made at the time of credit to the account of the payee or at the time of payment thereof, whichever is earlier- (for example in section 194- interest on securities or section 194A- interest other than interest on securities or section 194C- payment to contractors, 194D- insurance commission, 194G- commission on sale of lottery tickets, 194H- brokerage or commission, 194I- payment of rent, 194J- fees for technical services, 1940- payment to e-commerce operator, 194Q- payment for purchase of goods, 194S- payment for virtual digital assets etc ), there are at least 3 provisions which set the timing trigger for discharging TDS liability right at the time of payment (194BB- winnings from horseraces, 194DA- payment in respect of life insurance policy and 194B- winnings from lottery, crossword puzzles, games of any other sort etc). That said, absence of any reference or clarity in the provision itself for determining winning from games of any other sort whether annually or per competition wise in section 194B opens up real possibilities for manipulative structuring of winning in a manner that would tend to defeat the very purpose of legislation which set out to specifically tax such winnings without allowing any expenditure or loss or set-off at the highest marginal rate.

So while the policy makers grapple to meaningfully address the challenges of online gaming, be they social casinos for rummy or poker or fantasy sports, including formulating data residency rules for data localisation, developing KYC standards for gaming companies, a central regulatory mechanism for licencing of online gaming and content, from the tax side, foremost of the issues would be setting up systems for responsible accounting practices, reliable record keeping, internal control procedures and putting these across in eventual legislation or administrative policy decisions. Including prize winnings beyond a threshold for statement of financial transaction (SFT) reporting obligation under section 285BA, mandatory KYC and PAN requirement for gaming participants, and re-working the provisions of section 194B for ensuring that no structured arrangement frustrates the TDS liability would be welcome first steps towards that end.