Globally, the gaming market was valued at $249.55 billion in 2022 and is anticipated to grow more than 2.67 times by 2030 . India's gaming market size is estimated to be around $2.6 billion in FY22 with over 500 million gamers, and is predicted to reach $8.6 billion by FY27.
Funding of $2.8 billion (~3% of total startup funding in India) has been raised by Indian gaming companies, from domestic and global investors over the last half decade. Being merely 3% in India, there is immense potential for it to grow further, in the guise of numerous contributing factors such as affordable smartphones, availability of data packs at throw-away prices, increase in the number of gamers, etc. The gaming sector has already yielded over six strategic exits of $775 million, three unicorns, and a public listing, oversubscribed 175x with a listing gain of 80% , since 2021.
Considering the growing traction, the Indian tax and regulatory framework has also evolved for online gaming companies in the last few years:
- FDI (Foreign Direct Investment) is prohibited in entities involved in lottery, gambling, betting including casinos. FDI is also banned in foreign technology collaboration for such sectors, including franchise, trademark, brand name, and management contract licensing. While lottery, gambling and betting are not defined per se, basis judicial precedents an inference may be made that “games of chance” would qualify under the prohibited sector and “games of skill” would be permissible to receive FDI. The Apex Court has adopted the ‘dominant factor test’, or ‘predominance test’ which requires assessment and determination of whether chance or skill “is the dominating factor in determining the result of the game”, while upholding rummy, horse racing and fantasy sports game, as a game of skill and not chance. A careful evaluation of business models is required to determine permissibility under FDI.
- Overseas Direct Investment (ODI), for outward remittances from India, foreign exchange regulations prohibit payments (i) out of lottery winnings, (ii) for purchase of lottery tickets, banned/prescribed magazines, football pools, sweepstakes, etc., and (iii) of income from racing/riding, etc., or any other hobby. These restrictions are wider than those provided for FDI and hence may seek to include Game of Skill, specifically use of ancillary phrase ‘any other hobby’. Therefore, technically, Indian residents looking to remit such amounts under LRS would come under the prohibition and may need approval of the RBI.
- Tax considerations: Tax due diligence and structuring acquisition plays a vital role in closing the deal structure. Tax developments that need careful flagging of risks and curating indemnities in this space, whether Indian or foreign (with Indian players), are provided below.
- GST: Pursuant to recommendations of GST council regarding taxability of online gaming, casinos, and horse racing, various amendments (including GST rate and valuation rules). Most aspects require careful consideration, including retrospective or prospective applicability of the revised taxation regime. Many online real money gaming companies have been issued GST notices demanding payments for a prior period, while GST at the rate of 18% was levied on platform fees for facilitating games of skill for such period. In view of hefty demands, it would be critical to review the potential liabilities and risk element involved in such transactions. While investors may want to push for water-tight indemnities against such demands, companies are advised to consider potential liabilities appropriately and their preparedness around anticipated/ received notices. Other areas requiring elucidation encompass GST applicability on wallet-to-wallet transfers and transitional wallet balances.
- Withholding tax obligations and equalisation levy: Withholding tax (TDS) provisions have undergone an overhaul to provide clear guidance and rules for tax deduction at source required to made on winnings, with TDS rate now standing at 30% on the ‘Net Winnings’ and deeming computation has been provided for undertaking TDS for year-end balances in user account. The Equalisation levy (EL) also applies on “overseas e-commerce operators” receiving consideration for e-commerce supply or services made/provided/facilitated by the e-commerce operator to specified persons (including Indian residents). EL is applicable at the rate of 2%, with a corresponding exemption from the application of income taxes for overseas operators. Online Gaming Intermediary not having a Permanent establishment in India to which the income relates to, is considered as e-commerce operator liable to EL.
- Requirement of establishing presence for offshore OGI under Information Technology (IT) laws: Recent amendments to the IT laws , mandates physical contact address in India and appointment of a Chief Compliance Officer who should be a key managerial personnel or senior employee for an offshore OGI who enable access to real money games. This creates potential exposures for constituting business connection and permanent establishment, thereby leading to taxation on net income basis at 40%, plus surcharge and cess and affixing TDS obligations on them, amongst other tax concerns.
Concluding remarks for the Industry at large
Taxation models adopted by many countries including Australia , Czech Republic , Malaysia and Singapore are mainly predicated on imposing GST on gross gaming revenue (GGR). In contrast, nations like Portugal , Poland etc., levy taxes on contest entry amounts and have subsidized tax rates ranging between 3% to 15%. In light of these global practices, the Indian government's decision to impose a tax on contest entry amounts at higher rates leads to increased GST burden. Currently, one of the crucial considerations for gaming platforms is to maintain the equilibrium while strategizing to absorb the entire GST liability or pass on a portion / entirety of additional tax burden to gaming players.
Offshore OGIs with an Indian user base, would need to be mindful of the potential exposures from an Indian tax and regulatory perspective, on the GST, EL, PE and TDS front, giving rise to the need for undertaking due diligence on potential risks and careful structuring to comply with regulatory laws. Rigorous implications may arise for non-compliant offshore OGIs, including debarring them from operating in the Indian market completely.
Onshore OGIs would need to re-look at their tax strategies and in-house compliance costs in light of recent developments. The growth rates may also need to be re-visited since the recent GST and TDS changes may impact startups at "multiple levels", including their user base, revenues, and investor sentiment. The clarity provided on the TDS front is a welcome move, albeit a few open issues need to be addressed expeditiously by the regulators.
Investors looking to invest in Indian OGIs, require careful diligence and structuring to ensure past and current tax risks are appropriately captured in transaction documents and the structure complies with regulatory laws.
The growth of this industry has contributed to employment opportunities not only in this industry but across the board, especially in IT and related services, attracting millennials and creating opportunities in non-conventional sectors. The online gaming industry has evident strategic importance with a growing Indian user base and rising investor interest in deals. It is, therefore, imperative that India establishes a robust, uniform, and unambiguous tax and regulatory landscape to fuel the impending growth of the sector.
- Research report by Fortune business insights titled Gaming Market, 2023-2030
- Play Games 24x7 Pvt. Ltd. v Reserve Bank of India & Anr. (WP No. 3047/2022)
- State of Andhra Pradesh v. K Satyanarayana & Ors AIR 1968 SC 825 and K.R Lakshmanan v. State of Tamil Nadu AIR 1996 SC 1153
- Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Rules, 2021