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.
"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.
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.
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.