GST on Online Gaming and Virtual Digital Assets – Regulatory Overreach or Legitimate Taxation?

The entertainment and investment landscape of India has changed with the digital revolution, with online gaming and virtual digital assets (VDAs) becoming multi-billion-dollar industries. But these innovations have ignited tough regulatory arguments, especially regarding the treatment of Goods and Services Tax (GST). The Finance Act, 2022, introduced a high tax of 30 percent on VDA gains and 1 percent Tax Deducted at Source (TDS), and changes to GST regulations placed online gaming in the spotlight. [1]This leads to a basic issue: Is this the overreaching of regulations or a constitutional taxation authority? So, in the upcoming paragraphs, you will know more about GST on Online gaming and virtual digital

Legal Environment of Virtual Digital Assets

Definition and Scope

In 2022, the Finance Act, 2022, added to the Income Tax Act, 1961, defining VDAs as any information, code, or number or token produced by cryptographic means that represents digital value. [2]It includes cryptocurrencies, such as Bitcoin and Ethereum, non-fungible tokens (NFTs), and other digital assets. Most importantly, the Central Bank Digital Currency (CBDC) in India, which was introduced in 2022, has legal tender, as opposed to privately issued cryptocurrencies.

India is the seventh country in the world in terms of digital currency adoption, and 7.3% of the population utilizes these assets[3]. However, these assets are not considered legal tender, and this brings ambiguity in the regulation.

Taxation Framework

The Finance Act, 2022, created a punitive tax regime: 30% flat tax on profits and no deduction on expenses other than the cost of acquisition, a TDS on transactions above certain specified limits of 1 percent, and no loss set-off. This sin tax strategy would treat VDAs like lottery wins, which would be a warning to the government, and not an invitation.

GST on Online Gaming: The Skill vs. Chance Debate

Constitutional Framework

Entry 34, List II (State List) of the Seventh Schedule empowers states to legislate on “betting and gambling.” [4]The Supreme Court has always believed that the entry encompasses games of chance and not skill. The Court in the case of State of Bombay v. R.M.D. Chamarbaugwala (1957) held that even a scintilla of skill will take a game out of the realm of gambling.[5]

Judicial Precedents

The Supreme Court, in a decisive move in State of Andhra Pradesh v. K. Satyanarayana (1968) concluded that rummy was a game of skill and took a lot of skill to hold and dispose of cards. [6]This was reiterated in K.R. Lakshmanan v. State of Tamil Nadu (1996), where the Court noted that golf, chess, and even rummy are games of skill.[7]

In the case Junglee Games India Private Limited v. State of Tamil Nadu (2021), the Madras High Court applied the same principle to online rummy and poker, where the case did not consider the medium of play to change the nature of the game. [8]In the same manner, online gaming platforms were upheld by the Karnataka High Court in All India Gaming Federation v. State of Karnataka (2022).[9]

Controversy of Tamil Nadu

Notwithstanding the unmistakable judicial declarations, Tamil Nadu passed the Prohibition of Online Gambling and Regulation of Online Games Act, 2022, along with rummy and poker in its Schedule under the category of games of chance. [10]The Madras High Court partially invalidated this legislative effort to overrule judicial precedent in All India Gaming Federation v. State of Tamil Nadu (2023). [11]The Court believed that states have the power to regulate online gaming and ban gambling, but that they could not arbitrarily declare skill games to be chance games without evidence.

The claims by the State regarding the manipulation of the random number generators (RNG), the use of bots, and the knowledge of the dealers that all cards were rejected due to insufficient substantive evidence. The Court pointed out that the online games use the same skill factors as the offline ones, and strong security protocols, such as 128-bit SSL encryption, KYC verification, and iTech Labs certification, indicate that there is no usage of bots.[12]

Regulatory Overreach or Legitimate Concerns?

Arguments for Regulation

Public Health Concerns: The WHO has acknowledged gaming disorder as a mental illness. [13]States have valid concerns in safeguarding citizens against addiction, loss of money, and fraud.

Revenue Generation: As the online gaming industry in India is worth more than 10000 crores, taxation guarantees the government income as it controls the industry.

Consumer Protection: Minors and other vulnerable groups need to be safeguarded against predatory actions. The survey of 2 lakh teachers in the State showed alarming effects on attention, vision, and behavior, but this applied to underage players who are already banned by platforms.

International Precedent: Online gaming is highly regulated in many developed countries. In Liga Portuguesa de Futebol Professional (2009), the Court of Justice of the European Union affirmed the legislation of Portugal against the illegal operators.[14]

Arguments Against Overreach

Violation of the Constitution: The outright prohibition of skill games violates Article 19(1)(g) that safeguards the right to practice any profession or engage in an occupation. [15]In Internet and Mobile Association of India v. RBI (2020), the Supreme Court invalidated the banking ban on crypto entities by RBI by highlighting proportionality.[16]

Legislative Competence: Entry 34, State List Authorizes legislation about betting and gambling: the games of chance, but not skill. K.R. Lakshmanan explained that it is impossible to separate gambling and betting. States can regulate games of skill under Entry 26 (Trade and Commerce), but not prohibit them.[17]

Absence of Empirical Data: The Justice Chandru Committee Report of Tamil Nadu did not have objective data.[18] It interviewed school teachers regarding underage students, although sites blocked 18+ users. The claims of bots and the use of AI and software manipulation were not substantiated.

Distinction Without Difference: The State did not establish how online rummy/poker is essentially different from physical forms. RNG software is pseudo-randomly close to the shuffling of physical cards. Several protection measures, such as antifraud algorithms, card information encryption, and random table assignment, are used on platforms.

Ministry of Electronics and IT Framework

In 2023, the Government of India issued the “I.T.(Intermediary Guidelines and Digital Media Ethics Code) Amendment Rules” [19], which define Online Real Money Games and establish Online Gaming Self-Regulating Bodies (SRBs) to monitor these games. The SRBs will also make certain that online real money games do not present a threat to the Sovereignty of India, protect the user from harm and addiction by implementing age verification, and provide warnings on a more regular basis than currently occurs to consumers playing these games.

This is an approach that is less obvious than a ban, but focuses on regulation and not prohibition.

Analysis: Striking the Balance

The Legitimate Taxation Argument

There are provisions in the Constitution regarding taxing profits of online games and VDAs. Under Article 19(6), in the State List (Entry 26), reasonable restrictions can be placed on the fundamental rights. [20]Similarly, there is an authority to regulate trade so long as engaging in such activity is undertaken for a legitimate purpose. The principles of proportionality as enunciated by the Supreme Court in Modern Dental College and Research Centre v. State of Madhya Pradesh (2016) provide for five tests: a legitimate objective; a rational nexus; necessity; proportionality; and balance.[21]

Regulatory Excesses and Over-reach

This classification of skill games as gambling represents an overreach. There has been an established body of work, which includes the decision made by the High Court on Junglee Games, which supports the following points:

• Rummy and Poker are both examples of “skill” games (despite including “elements of chance”)
• The online version of Skill Games does not fundamentally differ from its offline form
• States may regulate – but are not allowed to prohibit – Skill Games
• Regulatory limitations should be supported by empirical data.

The imposition of a 30% tax with no allowance for deductions is overly punitive, treating the lawful conduct of business as a sin. This punitive behaviour will discourage legitimate businesses from operating (pushing to Offshore or Underground operation).

Policy Recommendations

Policy Makers:

1. Bifurcated Approach: Distinguish clearly between skill and chance games for regulatory purposes;
2. Taxation in Proportion: Decrease tax rate to encourage compliance, provide for an allowance for costs of doing business.
3. Self-Regulatory Framework: Support the mechanism processes of the SRB instead of blanket bans
4. Age Verification: Implement a strong KYC/Aadhaar-based verification check for users
5. Time/Money Limits: Do not prohibit, but instead regulate/limit through reasonable operational hour limits; deposit limits
6. Harmonization: Harmonize the GST regulations with the definitions of Income Tax for all interpretations.But this categorization of skill games as gambling is an overstep. The Junglee Games and later decisions by the High Court confirm the following:
   • Rummy and poker are skill games, although they have elements of chance.
   • Online versions don’t fundamentally differ from offline versions
   • Skill games can be regulated but not prohibited by states.
   • Regulatory restrictions should be supported by empirical evidence.

The tax rate of 30 percent without any deduction is way too punitive, as it considers lawful business operations as a sin. This will deter honest business, which may push operations into the offshore or underground.

For Industry:

1. Transparency: Public availability of verifiable evidence of RNG fairness, the lack of bots, and security.
2. Responsible Gaming: Introduce self-exclusion, addiction warnings, and user education.
3. Compliance: Willingly implement the SRB standards and collaborate with the regulators.

Conclusion

Controlling online gaming and Virtual Digital Assets represents a quintessential conflict between innovation and regulation, as well as between personal freedom and government interference. Although the State has no doubt, the right to tax and control the emerging sectors, this power should not exceed the necessary level and should be based on evidence and constitutional. The existing system, especially the wholesale application of the gambling tax to skill-based online games, is skewed towards excessive regulation instead of a sensible approach to governance.

The interventions of the judiciary, particularly the Madras High Court, confirm that there is a necessity to observe the existing differences in games of skill and chance. The impending Supreme Court ruling in the Gameskraft Technologies [22]case is likely to shed long-overdue light on this changing situation.

In the future, India needs a more subtle and consistent regulatory framework, one that draws a line between skill and chance, that provides rational and proportional taxation and encourages innovation, whilst protecting vulnerable users. In an economy that is rapidly becoming more digitalized, it is not to stifle technological advancement but to control it in specific and far-sighted ways.

Taxation must regulate innovation, not suffocate it.

Author: Ms. Ananya Singh, student at Symbiosis Law School, Noida 

Link to similar articles: https://jpassociates.co.in/indias-new-tobacco-cess-tax-framework/

References

Cases:

1. All India Gaming Fed’n v. State of Karnataka, 2022 S.C.C. OnLine Kar 435
2. All India Gaming Fed’n v. State of Tamil Nadu, 2023 S.C.C. OnLine Mad 6973
3. Directorate General of Goods & Servs. Tax Intel. v. Gameskraft Techs. Pvt. Ltd., S.L.P. (C) No. 19366-19369 of 2023 (order of the Supreme Court dated Jul. 18, 2024)
4. Internet & Mobile Ass’n of India v. Reserve Bank of India, (2020) 10 S.C.C. 274
5. Junglee Games India Pvt. Ltd. v. State of Tamil Nadu, 2021 S.C.C. OnLine Mad 2762
6. K.R. Lakshmanan v. State of Tamil Nadu, (1996) 2 S.C.C. 226
7. Liga Portuguesa de Futebol Profissional v. Departamento de Jogos da Santa Casa da Misericórdia de Lisboa, Case C-42/07, 2009 E.C.R. I-07633
8. Modern Dental Coll. &Rsch. Ctr. v. State of Madhya Pradesh, (2016) 7 S.C.C. 353
9. State of Andhra Pradesh v. K. Satyanarayana, A.I.R. 1968 S.C. 825
10. State of Bombay v. R.M.D. Chamarbaugwala A.I.R. 1957 S.C. 699

 Constitutional & Statutory Provisions:

1. India Const.
2. The Finance Act, 2022, No. 6 of 2022, India Code (2022)
3. The Income Tax Act, 1961, Act No. 43 of 1961, India Code (1961)
4. The Tamil Nadu Prohibition of Online Gambling and Regulation of Online Games Act, 2022, Act No. 9 of 2023 (India)

Administrative Rules & Reports:

1. Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Amendment Rules, 2023, Notifn. No. G.S.R. 275(E) (Apr. 6, 2023)
2. Rep. of the Comm. Headed by Just. K. Chandru (Retd.) to Advise on Enacting a Fresh Law on Online Games (2022)
3. U.N. Conf. on Trade & Dev. [UNCTAD], Development Prospects in a Fractured World: Global Disorder and Regional Responses, U.N. Doc. TDR/2022 (2022)
4. World Health Org. [WHO], International Classification of Diseases for Mortality and Morbidity Statistics (11th rev. 2019)

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[1] The Finance Act, 2022, No. 6 of 2022, India Code (2022).
[2] The Income Tax Act, 1961, § 2(47A), Act No. 43 of 1961, India Code (1961).
[3] U.N. Conf. on Trade & Dev. [UNCTAD], Development Prospects in a Fractured World: Global Disorder and Regional Responses, U.N. Doc. TDR/2022 (2022).
[4] India Const. sched. VII, list II, entry 34.
[5] State of Bombay v. R.M.D. Chamarbaugwala, A.I.R. 1957 S.C. 699.
[6] State of Andhra Pradesh v. K. Satyanarayana, A.I.R. 1968 S.C. 825.
[7] K.R. Lakshmanan v. State of Tamil Nadu, (1996) 2 S.C.C. 226.
[8] Junglee Games India Pvt. Ltd. v. State of Tamil Nadu, 2021 S.C.C. OnLine Mad 2762.
[9] All India Gaming Fed’n v. State of Karnataka, 2022 S.C.C. OnLine Kar 435.
[10] The Tamil Nadu Prohibition of Online Gambling and Regulation of Online Games Act, 2022, Act No. 9 of 2023 (India).
[11] All India Gaming Fed’n v. State of Tamil Nadu, 2023 S.C.C. OnLine Mad 6973.
[12] See id. at ¶ 101.
[13] World Health Org. [WHO], International Classification of Diseases for Mortality and Morbidity Statistics (11th rev. 2019).
[14] Case C-42/07, Liga Portuguesa de FutebolProfissional v. Departamento de Jogos da Santa Casa da Misericórdia de Lisboa, 2009 E.C.R. I-07633.
[15] India Const. art. 19, cl. 1(g).
[16] Internet & Mobile Ass’n of India v. Reserve Bank of India, (2020) 10 S.C.C. 274.
[17] India Const. sched. VII, list II, entry 26.
[18] Rep. of the Comm. Headed by Just. K. Chandru (Retd.) to Advise on Enacting a Fresh Law on Online Games (2022).
[19] Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Amendment Rules, 2023, Notifn. No. G.S.R. 275(E) (Apr. 6, 2023).
[20] India Const. art. 19, cl. 6.
[21] Modern Dental Coll. &Rsch. Ctr. v. State of Madhya Pradesh, (2016) 7 S.C.C. 353.
[22] Directorate General of Goods &Servs. Tax Intel. v. Gameskraft Techs. Pvt. Ltd., S.L.P. (C) No. 19366-19369 of 2023 (order of the Supreme Court dated Jul. 18, 2024).