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INTRODUCTION
In the Online Gaming Industry, understanding the complexities of
financial transactions is not merely a matter of financial prudence
but has become an essential component of compliance, risk
management, and strategic decision-making. Building upon our
article “The Flow of Payments in Online Gaming Business Volume
I: Tracing Its Revenue Sources, International Purchases,
Cryptocurrency, and Money Laundering,” where we scrutinized
the ebbs and flows of digital assets, identifying the complicacies
in-game transactions and how money-laundering activities take place
in the virtual economies. This critical examination provided
invaluable insights into the financial underpinnings of the
industry.
Now, in Volume II of our series of articles, we will discuss and
analyze the Legal and Tax Implication in this dynamic sector. In
today’s world, the legislative frameworks and fiscal
regulations globally are continually adapting to the modernization
and advancements brought up by the digital age, hence it is very
crucial for industry stakeholders to stay up-to-date on the
evolving domain to remain relevant in this competitive
ecosystem.
THE LEGAL IMPLICATIONS
“Every aspect of online gaming, from user data
protection to taxation, is a chessboard of legal moves where the
players are both players and pawns.”
The legal landscape surrounding these transactions varies by
country. The regulatory landscape for online gaming in India is
still underdeveloped, leaving many questions unanswered. While some
forms of gaming, such as fantasy sports, have been recognized and
regulated to a certain extent, the status of others remains
uncertain. The absence of comprehensive legislation specific to
online gaming has led to a patchwork of state laws, judicial
rulings, and regulatory guidelines.
In contrast, some nations like the United States of America and
the European Union have developed a basic framework governing the
transactions associated with the online gaming business, though
these frameworks are evolving continuously.
1. Privacy and Data Protection:
India’s most significant legislation concerning data
protection is the Digital Personal Data Protection Act, of 2023
(DPDP). The DPDP mandates that gaming companies must obtain
explicit consent from users for collecting and processing their
data. This is especially significant for online gaming platforms,
which typically require extensive data for user registration,
payments, and in-game analytics. The act also requires Data
Localization i.e. the storage of critical personal data within the
borders of India. This provision ensures that players’
sensitive information remains under Indian jurisdiction, increasing
data security. The act proposes the establishment of a Data
Protection Authority of India (DPAI), responsible for regulating
and overseeing data protection. Gaming companies would be held
accountable for how they handle user data under the DPAI’s
watchful eye.
The Information Technology Act, of 2000 (IT Act) also
incorporates various aspects of online activities, including data
protection and cybersecurity. While it does not specifically
address online gaming, it is pertinent to this sector. Section 43A
of the IT Act places the responsibility on organizations to protect
sensitive personal data. Section 72A of the act deals with privacy
violations and criminalizes the disclosure of personal information
without the consent of the person concerned. Information Technology
(Reasonable Security Practices and Procedures and Sensitive
Personal Data or Information) Rules, 2011 prescribe standards for
securing sensitive personal information, such as financial data.
Online gaming platforms are subject to this provision, ensuring
that they maintain robust security measures to safeguard user
information. It is relevant to online gaming operators and their
obligations regarding user data.
In the USA, the Children’s Online Privacy Protection Act
(COPPA) is a federal law that imposes strict requirements on
websites and online services that target children under 13. Online
gaming platforms offering games aimed at this age group must comply
with COPPA, which includes obtaining parental consent before
collecting personal information from children. Also, there exist
state-level regulations such as the California Consumer Privacy Act
(CCPA), which grants California residents the right to know what
personal information is being collected about them, the right to
opt out of data sales, and the right to have their data
deleted.
In the EU there stands the General Data Protection Regulation
(GDPR) of 2018. GDPR imposes strict rules on the processing of
personal data, which includes player information collected by
online gaming platforms. Companies must ensure that data is
processed lawfully, transparently, and for specified purposes. GDPR
grants players various rights, including the right to access their
data, request its deletion, or rectify inaccurate information.
Online gaming operators must provide mechanisms to fulfill these
requests. Also for High-risk data processing activities, such as
those involving children, may require Data Protection Impact
Assessments (DPIAs) to assess and mitigate risks.
2. Gambling Laws and Regulations:
The Public Gambling Act of 1867, is a colonial-era legislation
that serves as the foundation for gambling laws in India, though
there exists no relevant provision for online gaming and gambling
in it as of now. In contrast, Sikkim has taken the initiative of
legalizing online sports betting within the state, with the
promulgation of the Sikkim Online Gaming (Regulation) Act 2008.
Under this Act, a license for placing bets on sports games such as
football, cricket, lawn tennis, chess, golf, and horse racing can
be issued.
Under the Lotteries (Regulation) Act 1998, it is the state
governments have the power to organize, conduct, and promote
lotteries, subject to the conditions prescribed. Horse racing and
betting on horse racing were earlier permitted only at licensed
premises. But with the issuance of licenses by various state
governments to take online betting on horse racing can now be
offered in the Royal Calcutta Turf Club, Royal Western India Turf
Club, Madras Race Club, Bangalore Turf Club, and Hyderabad Race
Club.
In casinos in Goa and Sikkim, again the entire gamut of payment
mechanisms is available, subject to proper KYC verifications.
However, for lotteries, banking, and online payment systems are not
available. Tickets, whether paper or digital, are bought through
payment of cash and a vendor’s shop.
In the USA we find a mature and developed legal framework for
regulating Online Gambling activities and the financial
transactions associated with them. The Wire Act which was
originally enacted to target organized crime, prohibits the use of
wire communications for betting and wagering activities across
state lines, and for years, it was interpreted as a blanket ban on
online gambling. However, a 2011 reinterpretation clarified that it
primarily applied to sports betting. The Unlawful Internet Gambling
Enforcement Act (UIGEA) (2006) is a federal law that regulates
online gambling payment processing. It prohibits financial
institutions from knowingly processing transactions related to
illegal online gambling, which are outlined under state law. The
repeal of the Professional and Amateur Sports Protection Act
(PASPA) in 2018 allowed states to legalize sports betting. This led
to a wave of state-level legalization and regulatory frameworks for
online and in-person sports betting.
In the United Kingdom & Malta, we see Gambling is not
restricted but is regulated. While the Gambling Commission was
established under the Gambling Act of 2005 in the UK, the Malta
Gaming Authority (MGA) was established under the Gaming Act of
2018, and are responsible for licensing and regulating all forms of
gambling, including online betting. The commissions’ main
objectives are to, ensure that gambling is conducted fairly and
openly, protect children and vulnerable individuals from the harms
of gambling, prevent gambling from becoming a source of crime or
disorder, and safeguard consumers and their funds.
3. Consumer Protection Laws:
The Consumer Protection Act of 2019 (CPA), which replaces the
earlier Consumer Protection Act of 1986 is the primary legislation
governing consumer rights and protection in India. It, and is a
comprehensive legal framework designed to address modern
challenges, including those related to online services, such as
online gaming. Section 2(7) of the CPA, defines a consumer as any
person who buys any goods or avails any services, including those
available online, for consideration. Gamers who pay for online
gaming services, virtual items, or in-game purchases are,
therefore, included in this definition and are entitled to consumer
rights and protections.
The Act recognizes several legal rights of consumers, such as
the right to be protected against unfair or restrictive trade
practices, this includes protection against deceptive advertising,
fraudulent in-game purchases, and other unfair or deceptive
practices employed by gaming companies, and also provides redressal
mechanisms for consumers. Section 14 of the CPA outlines the
procedure for filing complaints, making it a legal avenue for
gamers to seek remedies for grievances, such as issues with in-game
purchases, inadequate customer support, or unfair bans.
In the USA, the Federal Trade Commission (FTC) is the primary
federal agency responsible for enforcing consumer protection laws.
The FTC investigates deceptive or unfair practices related to
in-game purchases, such as false advertising or unfair billing
practices. Whereas in Europe, the EU’s Consumer
Rights Directive and the Unfair Commercial Practices
Directive are particularly relevant. These laws
require that consumers are provided with clear and accurate
information about the products or services they purchase, including
in-game items.
4. Intellectual Property Rights:
Gaming businesses rely heavily on intellectual property rights,
including copyrights, trademarks, and patents, to protect their
games, characters, and brands. The unauthorized use or distribution
of copyrighted materials within games can lead to legal challenges
and claims of copyright infringement. The Indian Copyright Act of
1957, is central to IPR in online gaming. It shields original
literary, artistic, and musical works and computer software.
Section 2 (o) deals with Computer Programs as Online games are
often implemented as computer programs, making them eligible for
copyright protection under this section. Section 14 of this act
deals with exclusive rights, game creators have the exclusive right
to reproduce, adapt, and distribute their games. Unauthorized
copying or distribution can lead to copyright infringement. Section
51 of the act penalizes Infringement and Online gaming companies
must be cautious about using third-party materials without proper
licenses or permissions.
Gameplay mechanics that offer inventive solutions to problems
can be patented under the Patents Act of 1970, protecting these
innovations from replication. Section 2 (l) of the act defines
Patent as any new and useful process, machine, manufacture, or
composition of matter, or any new and useful improvement thereof,
that can be patented. Section 48 of the act deals with the Rights
of the Patentee as Patent holders have the exclusive right to
prevent others from making, using, selling, and importing the
patented invention.
Trade-Related Aspects of Intellectual Property Rights (TRIPS) is
an agreement under the World Trade Organization (WTO) that sets
down minimum standards for many forms of intellectual property
regulation. It is relevant to online gaming companies as it
includes the protection of gaming content.
The European Union has introduced the Copyright Directive and
the Database Directive to harmonize copyright laws across its
member states. These directives grant creators significant control
over their works and their digital distribution. Articles 3 and 4
of the Copyright Directive (2019/790) relate to text and data
mining exceptions and fair remuneration for authors and performers,
affecting the use of in-game text and music, and Database Directive
(96/9/EC) governs the protection of databases, and it can be
relevant for online games that rely on extensive databases for
gameplay.
In the United States, the primary law governing intellectual
property is the Copyright Act of 1976. Section 102(a) of the act
covers original works of authorship that are fixed in a tangible
medium of expression. Online games, their code, music, and artistic
elements are typically protected by copyright.
5. Cross-Border Transactions and Currency Exchange:
Global gaming companies often deal with cross-border
transactions and multiple currencies. The legal implications
involve currency exchange rates, taxation, and compliance with
international financial regulations. The application of treaties
such as the United Nations Convention on the Recognition and
Enforcement of Foreign Arbitral Awards (New York Convention) can be
crucial in resolving cross-border payment disputes.
Foreign Exchange Management Act, 1999 (FEMA) is the key
legislation governing foreign exchange and cross-border
transactions in India. Under FEMA, online gaming companies must
adhere to specific guidelines for foreign exchange transactions.
Section 4 of the act empowers the Reserve Bank of India (RBI) to
regulate all aspects of foreign exchange, including transactions
involving online gaming platforms. The RBI issues periodic
guidelines that online gaming companies must adhere to. Section 6
is pivotal, as it empowers the RBI to manage capital account
transactions, which encompass various aspects of online gaming,
such as payments, receipts, and foreign investments. The Foreign
Exchange Management (Deposit) Regulations, 2016 specify the terms
and conditions governing foreign currency accounts held in India.
Online gaming platforms that receive international payments may
need to establish these accounts in compliance with FEMA.
The Prevention of Money Laundering Act (PMLA), 2002 requires
gaming operators to implement robust Anti-Money Laundering (AML)
and Know Your Customer (KYC) measures. These measures include
verifying the identities of players engaged in high-value
transactions, ensuring transparency in currency exchange, and
preventing money laundering activities within the online gaming
sector. The Payment and Settlement Systems Act of 2007, empowers
the Reserve Bank of India (RBI) to oversee payment systems, which
may encompass payment gateways used by online gaming platforms. Any
company facilitating cross-border transactions in India must adhere
to the regulations set forth by the RBI.
Payment Services Directive (PSD2) in the European Union
introduced regulatory requirements for payment services within the
EU. It aims to enhance security in online payments and promote
innovation while ensuring consumer protection. Regulation (EU)
2018/1807 on a Framework for the Free Flow of Non-Personal Data in
the European Union, encourages the use of block chain technology
while ensuring the free flow of data within the EU.
The Unlawful Internet Gambling Enforcement Act (UIGEA) in the
USA, does not explicitly regulate cross-border transactions but
indirectly affects them. It prohibits financial institutions from
processing payments related to unlawful online gambling activities.
The Bank Secrecy Act (BSA) in the USA requires financial
institutions to report transactions exceeding $10,000 and
suspicious activities. It impacts online gaming platforms handling
significant transactions.
Financial Action Task Force (FATF) recommendations provide
global standards for combating money laundering and the financing
of terrorism. These recommendations impact cross-border
transactions by ensuring due diligence measures are taken by
financial institutions.
6. Payment, Refund, and Cancellation Policies:
Gaming companies must comply with the Payment Card Industry Data
Security Standard (PCI DSS) to safeguard consumers’ financial
information. Some states have consumer protection laws that mandate
specific refund policies for digital purchases and companies may
establish their own refund and cancellation policies, which must be
clearly communicated to players. While the EU’s Consumer Rights
Directive provides consumers with the right to request a refund for
digital purchases within 14 days of purchase, this right may be
waived if the consumer has expressly agreed to begin the delivery
of digital content before the withdrawal period ends. Game
developers may have their own refund policies that comply with EU
law.
In the USA, Federal Trade Commission (FTC) Guidelines provide
for online businesses concerning refund and cancellation policies.
These guidelines aim to ensure transparency and fairness for
consumers. Online gaming operators must align their policies with
these guidelines to protect player interests.
In India, the Consumer Protection Act of 2019 safeguards the
interests of consumers, which also extends to online gamers. It
obligates online gaming companies to provide clear and fair refund
policies and mechanisms.
TAX IMPLICATIONS
“Death and taxes may be inevitable, but
taxation without justification is not.” — Merton
Miller
As the online gaming industry is growing, so are the
complexities of the tax implications for businesses in this sector.
This is due to the fact that online gaming businesses typically
operate across multiple jurisdictions, and the tax rules for these
businesses can vary widely from country to country.
One of the key challenges for online gaming businesses is
determining where they are taxable. This can be a complex issue, as
it depends on a number of factors, including the location of the
business’s servers, the place of residence of its customers,
and the type of gaming activities it offers. In addition, online
gaming businesses need to be aware of the different types of taxes
that may apply to their business. These taxes can include income
tax, corporate tax, value-added tax (VAT), and gambling tax.
1. Income Tax (Direct Tax):
Online gaming businesses in India are subject to income tax on
their profits. The applicable income tax rate will depend on the
type of business entity and its turnover. For example, individual
proprietors and Hindu Undivided Families (HUFs) are taxed at
graduated rates, while companies are taxed at a flat rate of 25%.
Income Tax Act, 1961 is the fundamental law that governs the Income
tax laws in India. Under section 2(24)(ix) of the act the term
“income” is defined, which includes any winnings from
lotteries, crossword puzzles, card games, and other games of any
sort or gambling or betting of any form or nature whatsoever. These
winnings are subject to income tax. Section 194B of the act
specifies that any person responsible for paying any person any
income by way of winnings from any lottery crossword puzzle or card
game and other games of any sort is obligated to deduct tax at
source (TDS). TDS is applicable to certain payments made to online
gaming businesses, such as payments for advertising and marketing
services.
The United States imposes federal income tax on various forms of
income, including winnings from gambling and gaming. Section 61 of
the Internal Revenue Code (IRC) defines gross income, encompassing
all income from whatever source derived, including winnings from
games of chance. Section 165(d) of the IRC addresses gambling
losses and permits players to deduct gambling losses up to the
extent of their gambling winnings. Section 6041 of the IRC places
the responsibility on gaming operators to report winnings of $600
or more to the Internal Revenue Service (IRS). Online gaming
operators use IRS Form W-2G to report gambling winnings to the IRS.
Players receiving certain types of income, such as prizes or
gambling winnings, may receive this form and must report it on
their federal tax return. In addition to federal taxation, states
like Nevada and New Jersey, with prominent gaming industries, have
specific income tax laws regarding gambling winnings.
Each EU member state has its own income tax laws that govern how
income, including winnings from gambling or online gaming, is
taxed. In France there is a provision of Déclaration des
Revenus, which specifies that individuals who receive taxable
gambling income are required to report it on their annual income
tax return, specifying the source and amount of the winnings.
France applies progressive tax rates to gambling income, which
means that the tax rate increases with the amount of winnings.
In the UK, online gaming players often enjoy a relatively
favorable tax environment. Section 333 of the Income Tax (Earnings
and Pensions) Act 2003 specifies that winnings from betting,
gaming, and lotteries are not subject to income tax.
2. Corporate Tax & TDS:
Section 115BAA of the Income Tax Act of 1961 outlines the
special corporate tax rate applicable to domestic companies,
including those in the business of online gaming. As per this
section, domestic companies can opt for a reduced corporate tax
rate, subject to certain conditions. However, by virtue of Section
40(a)(ib) certain expenses related to online gaming companies are
disallowed in case the online gaming companies fail to deduct and
remit the tax on the winnings paid out. Section 194B of the act
mandates the deduction of TDS on winnings from lotteries, crossword
puzzles, card games, and other games of any sort. Online gaming
companies are required to deduct TDS when making payments to
players and remit the same to the government. Section 194BB
requires TDS @30% on income more than INR. 10,000 by way of
winnings from horse races.
In the USA, Section 11 of the IRC specifies the imposition of
the federal corporate income tax on a corporation’s taxable
income, and Section 61(a) of the code defines gross income as
“all income from whatever source derived,” which includes
income generated by online gaming companies. Online gaming
companies must calculate their taxable income according to the
provisions outlined in this section. In addition to this: Online
gaming companies operating in Nevada are subject to gaming taxes,
which are imposed on the gross gaming revenue as per the Nevada
State Gaming Tax Act. Also in New Jersey, online gaming operators
must comply with the state’s gaming regulations and pay taxes
based on their gross gaming revenue by virtue of the New Jersey
Casino Control Act.
In the UK online gaming companies are subject to corporate
income tax as per the Corporation Tax Act 2010. While players may
not be directly taxed on their winnings, gaming operators are
subject to the Betting and Gaming Duty (BGD) which is imposed on
gaming operators as a duty on their gross gambling profits. The
Finance Act 2001 introduced this duty.
3. Value Added Tax (VAT):
Value Added Tax (VAT) is a consumption tax applied to goods and
services at each stage of production or distribution, including
those related to gaming, VAT is levied in a manner designed to
ensure a level playing field for businesses and to prevent tax
evasion.
While VAT laws in India are governed by the central government,
VAT rates may vary by state. Certain online gaming services may be
classified as taxable services under the service tax regime.
However, it’s important to note that the Goods and Services Tax
(GST) has replaced the service tax in India since July 1, 2017. An
Indian resident company that operates an online game of skill will
be subject to GST at the rate of 18% and at the rate of 28% in case
of online game of chance.
In the USA, Sales tax applies on the sales of digital goods,
including in-game purchases, and varies from state to state as
there is no federal law. There is a landmark case of South Dakota
v. Wayfair, Inc. (2018) in which it was held that states can impose
sales tax on out-of-state sellers, including online gaming
companies, even if they lack a physical presence in the state. This
decision effectively expanded the reach of sales tax
regulations.
In EU states and most parts of the world, VAT is applicable to
Digital Services. One of the drawbacks of the EU VAT system is that
the VAT rates vary across all of its member states. To simplify VAT
compliance for businesses operating across EU member states, the EU
introduced the Mini-One-Stop-Shop (MOSS) scheme. This scheme allows
businesses to declare and pay VAT in a single EU member state,
typically the one where they are established. The tax authorities
in that member state then distribute the VAT revenue to the
respective countries where the services are consumed. MOSS greatly
streamlines VAT reporting for businesses offering digital services,
including in-game purchases, to consumers in multiple EU
countries.
TAX COMPONENTS:
Following are the essential tax components that are
pre-requisite to determining the tax liability:
1. Determining Real-World Value:
For determining the tax liability for virtual items, we need to
check whether they hold any intrinsic real-world value or not.
Virtual items that are merely cosmetic or aesthetic upgrades are
typically not considered to have real-world value as they do not
confer any tangible advantage in gameplay. Virtual items that may
include items like virtual currency, rare in-game assets, or items
obtained through randomized loot boxes, have a direct impact on
gameplay and can be traded, sold, or converted into real-world
currency are more likely to be subjected to taxation, due to their
potential for monetization outside the gaming ecosystem.
- State-Level Variations: Each state has its own
tax authority. Hence the tax treatment of virtual items differs
significantly from one state to another. While some states have
taken steps to clarify the tax obligations for digital goods,
others have not addressed this issue directly. - Exemption Certificates: In some cases, players
may be exempt from sales tax, such as when they purchase virtual
items for educational or medical purposes. Businesses must ensure
they have a system in place to process exemption certificates
accurately.
2. Tax Residency:
The first step is to determine the tax residency of the gaming
company. This will determine which country’s tax laws apply to
the company’s in-game ad revenue. If the gaming company is
resident in a country with a territorial tax system, it will only
be taxed on income generated from within that country. However, if
the gaming company is resident in a country with a worldwide tax
system, it will be taxed on all of its income, regardless of where
it is generated.
3. Sourcing Rules:
Once the tax residency of the gaming company has been
determined, it is necessary to determine where the in-game ad
revenue is sourced. This will determine which country has the right
to tax the revenue. The sourcing rules for in-game ad revenue vary
from country to country. However, in general, the revenue will be
sourced in the country where the players who view the ads are
located. This means that a gaming company resident in a country
with a territorial tax system may still be taxed on its in-game ad
revenue if the players who view the ads are located in a country
with a worldwide tax system.
4. Transfer Pricing:
If a gaming company has a presence in multiple countries, it is
important to consider the transfer pricing implications of in-game
ads. Transfer pricing is the process of setting prices for
transactions between related parties. Gaming companies need to
ensure that the prices they charge for in-game ads are arm’s
length, which means that the prices should be similar to the prices
that would be charged if the transactions were between unrelated
parties.
If the gaming company does not charge arm’s length prices
for in-game ads, the tax authorities in one country may adjust the
company’s profits to reflect the arm’s length prices. This
could result in the company paying more tax in that country.
5. Withholding Taxes:
Another important global tax consideration for in-game ads is
withholding taxes. Withholding taxes are taxes that are withheld
from payments made to non-resident taxpayers. If a gaming company
is resident in one country and it makes payments to non-resident
taxpayers for in-game ads, it may be required to withhold tax from
those payments. The amount of withholding tax that is required to
be withheld will depend on the tax treaty between the two
countries.
CONCLUSION
Online gaming is a dynamic world, where technology meets passion
and the virtual worlds become playgrounds. The flow of payments in
a gaming business is complicated and is a multidimensional issue
that requires careful consideration of international and national
laws and treaties. Further, the evolving role of cryptocurrency has
emerged as a crucial factor in determining gaming
participation.
The integration of cryptocurrency as a virtual currency has
opened doors to a new era of autonomy and ownership for gamers.
This digital revolution has not only enhanced security and
transaction speed but has also given players control over their
in-game assets. Further International transactions played a pivotal
role in the global gaming industry by connecting players from
diverse corners of the world. However, these transactions are not
without their complexities. Issues like currency fluctuation,
regulatory compliance, and tax implications necessitate a delicate
balance between innovation and regulation.
Moreover, the gaming industry faces increasing scrutiny from
regulators concerned about potential money laundering and fraud.
Consequently, gaming companies are challenged to implement
stringent AML and KYC measures to ensure compliance with global
regulations and to maintain the integrity of the gaming
ecosystem.
Global treaties like the United Nations Convention against
Corruption (UNCAC) and the United Nations Convention against
Transnational Organized Crime (UNTOC) provide a framework for
combatting illegal gambling and money laundering. However, the
enforcement of these treaties varies widely.
The flow of payments in the gaming industry is a complex web of
legal and tax considerations, and it requires a comprehensive
understanding of the policies’ global landscape. Gaming
companies must thoroughly analyze the diverse legal frameworks and
tax codes of different jurisdictions to remain compliant. Staying
informed about evolving regulations, engaging legal experts, and
implementing robust compliance measures are essential steps to
ensure a successful and legally sound gaming business.
Whether you’re a player, developer, or regulator, embracing
these changes while staying grounded in the core principles of
fairness, inclusivity, and responsible gaming will be the key to
unlocking the boundless potential of this captivating world.
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.
