Taxing times for online gaming

The online gaming industry in India is going through one of its most turbulent times. Over four months after the implementation of a 28% Goods and Services Tax (GST) on the sector, operating costs of gaming companies have increased by as much as 4x to 6x, resulting in reduced or no profitability. Companies are trying to offset this increased cost by reducing their marketing budgets, laying off employees and adopting other cost-cutting measures at different levels to survive. Worse still, amid the new tax regime that increases GST payments of companies by as much as 1,000%, as per some estimates,several promising startups even have had to shut shop. “Already, several startups in the gaming sector have ceased operations following the 28% GST adjustment. If the government’s anticipated review post-March fails to yield favourable results, I anticipate dire consequences for numerous gaming companies, including major players,” says Aman Gupta, VP, finance, Witzeal Technologies, a new-age gaming tech company.

Amid the row, the government expects to collect up to Rs 140 billion ($1.7 billion) in GST next financial year by taxing the online gaming companies, revenue secretary Sanjay Malhotra was quoted as saying by Reuters last week. In the fiscal year that ends on March 31, the government will collect about Rs 75 billion from the tax, Malhotra said in the report, up from Rs16 billion the previous year. The tax generated Rs 35 billion in the October-December quarter,he added. “The industry has stabilised, but it is early to make conclusive remarks,” he was quoted as saying by the report.

Bloodbath on G-street

The mayhem began soon after the GST Council, consisting of the Union finance minister and representatives from all states and Union territories, announced its decision to impose a 28% GST on online gaming last year.

Quizzy, an online real-money gaming platform founded by Sachin Yadav and Amit Kumar in 2021, became the first casualty. The information gamifying platform, based on day-to-day news developments, had received funding from 100X VC, We Founder Circle and Anchorage Capital Partners, among others, totalling $305,000.

Around the same time in August last year, Fantok, a real-money gaming startup, also suspended operations. Founded by Ronak Ahuja, Prakhar Saxena and Ashok Vishwakarma in 2022, Gurugram-based Fantok is a social gaming platform for real-money binary prediction games hosted by social media creators on short videos. Within three months of its launch, Fantok had surpassed 15,000 downloads and amassed a community of over 130 creators.

Another online gaming startup that halted its real-money gaming operations after the GST death blow last year was One World Nation (OWN). Founded in February 2022, OWN had raised $2 million in its seed funding round from Better Capital,Polygon Studios, Cloud Capital and Indigg the same year.

Workforce reduction

Following the new GST regime, the vibrant gaming ecosystem took a tumble, with many startups having had to lay off people to stay afloat. In August last year, online gaming unicorn Mobile Premier League (MPL) laid off 350 employees— nearly50% of its workforce. “The new rules will increase our tax burden by as much as 350-400%. As a business, one can prepare for a 50% or even a 100% increase, but adjusting to a sudden increase of this magnitude means we need to make some very tough decisions,” the co-founders said in an email to the employees.

In August last year, web3 gaming startup Hike’s Rush Gaming Universe, a casual gaming platform,reduced its employee count by about 22% following the GST blow. The platform laid off approximately 55 employees, with 24 of them being non-full-time workers.

The blockchain gaming startup led by Bharti Enterprises scion Kavin Bharti Mittal had raised money from marquee investors like Jump Crypto, Tribe Capital and Republic Capital. The gaming platform claims to have 5.2 million monthly active users and distributed over $308 million to winners annually,as per reports. “Business is in best shape ever. This 400% increase in GST is a bazooka pointed at us. We’ll need to absorb some of it,” Kavin Bharti Mittal later said in a statement.

Soon thereafter, online poker platform Spartan Poker let go of 125 people, or 40% of its workforce, as it struggled to adjust to the new realities of 28% GST on deposits. Founded by Amin Rozani, Sameer Rattonsey, and Peter Abraham in 2014,Spartan Poker is a popular destination for online poker players.

Bearing the brunt

In the longer run, start-ups will bear the brunt of the increased taxation, as to compete in the market they will have to fund these discounts or cashbacks to customers from their pockets. “This could eventually make them unviable in the longer run,” says Manish Mishra, partner, JSA Advocates and Solicitors, a law firm in India providing strategic and innovative legal solutions to corporates, businesses and institutions.

“The increased tax will eventually have an impact either on the available prize pool, which may reduce, or the entry fee, which may go up. This would alter the risk-reward matrix for the consumer. This might eventually result in an erosion of the consumer base. However, the games which are addictive in nature and have a high consumer base may still reflect a lower level of elasticity to the tax burden,” adds Mishra.

According to Kishore Kumar, lead, GST and customs, Taxmann Allied Services, a leading provider of resource and information on tax and corporate laws, the tax hike could lead to increased game prices or additional charges for users. “The immediate effects include re-evaluating business models and potential downsizing, as companies grapple with maintaining their profitability. This change also discourages foreign investment in the sector,” he adds.

As long as gaming companies bear the brunt of the heightened GST rates, Gupta of Witzeal Technologies feels we may not witness significant shifts in consumer behaviour and spending. “However, given India’s sensitivity to pricing, once this burden is passed on to consumers, we can expect a notable decrease in user engagement and expenditure on gaming platforms. This could inadvertently bolster unorganised and unregistered gaming platforms. Ultimately, such developments could lead to substantial revenue losses for the government,” he adds.

Legitimate industry revenue would shrink by around 33x to 43x times the current levels within the first five years, as per a report titled, ‘GST on Online Gaming: Analysing the effect of the tax rate and value of supply on tax revenues’,released by Deloitte and the Federation of Indian Fantasy Sports in July last year. “This is expected to result in lower investments in R&D, decreased innovation, and reduced spending on marketing and IT services. Ancillary industries associated with the sector may also be affected,” it adds.

A landmark case

By the end of February or early March, the Supreme Court (SC) is likely to begin the final hearing of a landmark case, probably drawing to an end the prolonged tax overhang on the industry.

On January 8, the SC issued a notice to the Directorate General of GST Intelligence in response to petitions filed by the E-Gaming Federation and gaming startups Games24x7 and Head Digital Works challenging the government’s decision to retrospectively impose 28% GST on the full value of the bets placed,and not on the gross gaming revenue. The apex court directed the Centre and GST department to file their response in two weeks.

The GST department has also undertaken to file a transfer petition seeking transfer of all cases pertaining to the same issue of law from various high courts to the Supreme Court.

As per reports, an ongoing appeal on a notice issued to Bengaluru-based Gameskraft Technology over a GST demand of Rs21,000 crore from the tax authorities is also set to be included under the same ambit. Incidentally, Gamekraft’s superapp Gamezy, which allowed cricket fans to pick virtual teams, compete in virtual tournaments, and win prizes, also shut operations last year following the GST row.

Online gaming companies have been in a disagreement over the payment of 28% GST instead of 18% levied for the period up to October 1 last year. While the gaming companies feel the 28% GST is applicable only from October 1, the government is of the opinion that the October 1 revision only provided clarity to a law that was already in force. The retrospective tax demands add up to nearly Rs 1.5 trillion.

However, according to some latest reports, the gaming companies may get a breather on this issue as the Centre is likely to soften its stance on the retro GST demand notices. The government now sees merit in the argument that a company cannot pay unrealistic tax demands, the reports add.

The way forward

The GST Council may review implementation-related issues pertaining to the 28% GST by the first quarter of next financial year, as per reports. However, looking ahead, the industry eagerly anticipates long-term clarity and a progressive taxation regime. “This clarity is crucial for driving the next phase of growth, as it will not only provide a conducive environment for businesses but also revive investor confidence in the sector. A progressive taxation regime will further incentivise investment, leading to the creation of more job opportunities for our talented youth,” says Namratha Swamy, COO of MPL, a leading mobile esports platform that allows users to participate in free as well as paid competitions across over 60 games in multiple categories,including fantasy sports, sports games, puzzle, casual and boardgames.

“The online skill gaming has been on an explosive trajectory these last few years. With the right regulatory support, this sector has the potential to not only create a thriving ecosystem for gamers and game developers but also to showcase the prowess of Made in India games on the global stage,”adds Swamy.

According to Mishra of JSA Advocates and Solicitors, an ideal taxation structure for the sector could have been to have a moderate level of taxation, say at 18%. “If at all tax has to be levied at 28%, it should only be levied on the platform fee charged by the gaming companies and not on the prize pool or the pot value. This would ensure that the government will get a higher tax revenue but at the same time the sector is not crippled with the GST burden,” he adds.

It is important for the government to relook at the taxation models and align its taxation landscape with existing models across the globe, which largely work on the gross gaming revenue (GGR) model, says Kumar of Taxmann. “This will help provide a level-playing field for gaming platforms in India fostering innovation and employment generation,” he adds. The simplest method to calculate the taxable value could be the total amount placed in the game or the entry fee less any amount paid out as the prize money / winnings,feels Gupta of Witzeal Technologies. “Even some states in the US allow the deduction of certain expenses from the adjusted gaming revenue. This ensures that the levy of tax is on the amounts received less what is paid out,” he adds.

Chinese checkers

The GST row in India comes at a time when neighbouring China is trying to soften its stand after hitting the online gaming ecosystem with regulatory restrictions that sent stocks tumbling.

The National Press and Publication Administration (NPPA) announced approval of 105 games in December, describing the move as a show of support for “the prosperity and healthy development of the online game industry”.

A few days earlier, the same regulators announ-ced a wide range of proposed guidelines that would ban online games from giving players rewards if they log in every day, if they spend on a game for the first time or if they spend several times on a game consecutively. All are common incentive mechanisms in online games.