Understanding Income Tax Provisions for Indian Online Gaming Companies

Indian online gaming companies must navigate various income tax provisions to ensure compliance with the country's tax laws. Below are key tax considerations:

1. Corporate Tax Rate
– Domestic Companies: The standard corporate tax rate for domestic companies is 25% if their turnover does not exceed INR 400 crore in the previous year. Otherwise, the rate is 30%.
– New Manufacturing Companies: New domestic companies incorporated on or after October 1, 2019, and commencing manufacturing before March 31, 2024, can opt for a concessional tax rate of 15%, subject to conditions.

2. Minimum Alternate Tax (MAT)
MAT is applicable at 15% of the book profits for companies that show profits in their financial statements but have zero or negligible taxable income. However, companies opting for the concessional tax regime under Section 115BAA or Section 115BAB are exempt from MAT.

3. Tax on Winning from Online Games
– Any income earned from winnings from lotteries, crossword puzzles, races including horse races, card games, and other games of any sort, or from gambling or betting of any form or nature, is taxable under Section 115BB at a flat rate of 30%.
– TDS under Section 194B: The payer must deduct tax at source at 30% if the winning amount exceeds INR 10,000.

4. Goods and Services Tax (GST)
Online gaming companies are subject to GST. The rate depends on the type of game:
– Skill-Based Games: Generally, 18% GST is levied on the platform fee or commission charged by the gaming company.
– Chance-Based Games: Such as betting or gambling, are subjected to 28% GST on the full bet amount.

5. Reporting Requirements
– Online gaming companies must comply with various reporting requirements, including the filing of income tax returns, TDS returns, and GST returns.
– In addition, significant beneficial ownership, foreign assets, and liabilities must be reported in certain cases.

6. Advance Tax
Companies must pay advance tax in four installments during the financial year if their tax liability exceeds INR 10,000. Failure to pay advance tax attracts interest under Sections 234B and 234C.

Online gaming companies must navigate these provisions carefully to ensure compliance and optimize their tax liabilities.

Table of Contents

1. Overview
2. Taxation
3. Income Tax provisions applicable to Online Gaming Companies (OGCs)

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1. Overview

The Indian gaming industry is thriving due to robust growth drivers conducive to the business environment. The growth trajectory of the industry, the advent of technology, huge geographical reach, and complexities involved in the business model require a specific examination of the applicability of direct tax laws for Indian Online Gaming Companies (OGCs). This chapter only deals with the applicability of direct tax laws with respect to OGCs and various persons who participate as gamers.

2. Taxation

2.1 Provisions of Section 4(1) of the Income-tax Act, 1961 (Act) deals with the charge of income which reads as

‘Where any Central Act enacts that income-tax shall be charged for any assessment year at any rate or rates, income-tax at that rate or those rates shall be charged for that year in accordance with, and [subject to the provisions (including provisions for the levy of additional income-tax) of, this Act] in respect of the total income of the previous year of every person’.

On plain reading of this section, one can understand that the total income of the person in respect to the previous year will be charged at the prescribed rate of income tax in the relevant assessment year.

2.2 The provisions of Section 5 of the Act deal with the scope of the total income of the resident and non-resident persons and Section 6 of the Act deals with provisions relating to the residential status of the persons. Thus, the scope of the total income of the persons depends on their residential status. Subject to certain exceptions the global income of a resident person is taxed in India and in respect of non-resident income which is received, accrued, deemed to accrue, or deemed to be received in India is generally taxed in India. Section 10 of the Act exempts certain income from taxation even though they are in the nature of income.

2.3 Therefore it is clear that what is taxed under the Act is only income and section 2(24) of the Act gives an inclusive definition of income and as per clause (ix) of the said section income also includes income from winning from lotteries which read as under:

‘any winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or from gambling or betting of any form or nature whatsoever.

Explanation.—for the purposes of this sub-clause

(i) “lottery” includes winnings from prizes awarded to any person by draw of lots or by chance or in any other manner whatsoever, under any scheme or arrangement by whatever name called”;

(ii) “card game and other game of any sort” includes any game show, an entertainment programme on television or electronic mode, in which people compete to win prizes or any other similar game.”

Thus, winning from games that are played through electronic modes is taxable as income as per the provisions of the Act.

2.4 Section 14 of the Act classifies the income which is taxable under five heads of income which are as under:

1. Salaries
2. Income from House Property
3. Profits and gains of business or profession
4. Capital Gains
5. Income from other sources

In light of this background, we need to understand the profits and gains of the OGCs and also how the winning by the participants in online gaming contests are taxed in India.

3. Income Tax provisions applicable to Online Gaming Companies (OGCs)

3.1 The OGCs derive income from various operational, financial, and investment activities conducted by them. After preparing the financial statement it is necessary to segregate the income into respective heads of income as per provisions of Chapter IV B to E of the Act.

3.2 While computing the income under the head business or profession, the OGC is eligible to claim various deductions in respect of eligible expenses. There may be issues with respect to revenue expenses whose benefit is spread across a few years. There will be issues as to eligibility for depreciation on intangibles, payment of expenses without TDS compliances, deductions for research and development and also matching concept as stipulated by section 37 of the Act. The Government by Finance Act, 2022 has introduced new provisions of TDS u/s 194R requiring deduction of TDS at 10% in respect of benefits and perquisite as referred to in section 28(iv) of the Act. Non-compliance will lead to disallowances u/s 40(a)(ia) of the Act along with the levy of interest and penalty as per the provisions of sections 201(1A) and 271C of the Act. Further, it may also lead to persecution U/s 276B of the Act. Therefore, utmost care and due diligence are required in compliance with the laws. As seen from the business model of the OGCs, they derive various sources of income that are mainly from business activities. A few examples of business revenue streams of the OGCs and their taxability are narrated hereunder.

3.3 The OCGs may also have income from the transfer of capital/investment assets. Such income is charged as long-term or short-term capital gains. The capital gain tax is an incidence of tax on the gains made by way of the transfer of capital assets.

3.3.1 Section 2(47) of the Act defines transfer as

“Transfer in relation to capital assets includes,

i. the sale, exchange or relinquishment of the asset; or

ii. the extinguishment of any rights therein; or

iii. the compulsory acquisition thereof under any law; or

iv. in a case where the asset is converted by the owner thereof into, or is treated by him, as stock-in-trade of a business carried on by him, such conversion or treatment; or

v. the maturity or redemption of zero coupon bonds; or

vi. any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882; or

vii. any transaction (whether by way of becoming a member of, or acquiring shares in a cooperative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of any immovable property”.

3.3.2 The definition of transfer is not exhaustive, it can include any other kinds of transfer also as per the ratio decided in the case of Sunil Siddharthbhai v. CIT (1985) 156 ITR 509/23 Taxman 14 (SC). A few important judicial landmark judgments in connection with transfer are tabulated hereunder.

3.3.3 It is important to note that a transaction may be within the ambit of the definition of transfer as per section 2(47) of the Act, but it will not be as per transfer for the purpose of section 45 because specific exclusions given in the provisions of sections 46, 46A and 47 of the Act.

3.3.4 Section 2(14) of the Act defines Capital Asset, which means

“a) property of any kind held by an assessee whether or connected with his business or profession,

b)

to

c)…”

As per the provisions of this section certain assets even though capital assets are not considered Capital Assets for the purpose of section 45 of the Act. Goodwill of the business is considered capital as per the ratio decided in the case of Haji Abdul Kader Sahib v. CIT (1961) 42 ITR 296 (Ker.). Rights under the contract are capital assets as per the ratio in the case of Rustom Spinners Ltd. v. ITO (1990) 32 ITD 30 (Ahd.-Trib.). Whether the controlling interest in a subsidiary or holding company by way of corporate structure is capital assets is an issue discussed and deliberated in the case of Vodafone International Holdings BV v. Union of India (2012) 341 ITR 1/17 taxmann.com 202/204 Taxman 408 (SC)

3.3.5 The question of the year of transfer and the nature of capital assets are subject to litigation. There will be no capital gain unless all the conditions precedent to the transfer of capital assets as per the contract are fulfilled.

3.3.6 As the sector is fast expanding there will be a situation of mergers and acquisitions which may result in a slump sale as defined in section 2(42C) of the Act. Consideration under slump sale is determined and guided by rule 11UAE of the Income-tax Rules, 1962. If it is long-term capital gain no indexation benefit is available. No deduction for amortized expenses U/s 35D relating to preliminary and preoperative expenses amortized and self-generated goodwill is available. There will be tax incidence on the sale of acquired goodwill and intangibles which is dealt with by provisions of section 55(2) of the Act.

3.4 The OGCs raise money at huge valuations by charging hefty security premiums. The security premium is a capital receipt within the ambit of section 2(24) of the Act. However one has to keep in mind provisions of section 56(2)(viib) which stipulates that

‘Where company not being a company in which are public are not substantially interested, receives in any previous years from any persons being resident any consideration for issue of shares that exceeds the face value of such shares the aggregate consideration received for such shares as exceeds the fair market value of the shares’.

This provision is subject to certain exceptions as provided in the proviso to the said section and also subject to Rule 11UA(2) of the Income-tax Rules, 1962 which prescribes the NAV Method, Discounted Cash flow Method.

3.5 Since the OGC deals with a large number of the public and also raises funds through investors, it is necessary to ensure above-the-board documentation so that the provisions of deemed income u/ss 69 to 69D read with section 115BBE of the Act are not attracted. The burden of proof is vested in the taxpayer as per the ratio decided in the case of Kale Khan Mohammad Hanif v. CIT (1963) 50 ITR 1 (SC). The tabulation of deemed income is as under:

The income referred to in above referred sections is taxed at a special rate referred to in section 115BBE of the Act at 60%, along with a surcharge of 25% and health and education cess of 4%. Thus, overall rate of tax on deemed income is 78%. Further, there will be a levy of penalty U/s 271AACC of 10% of the tax payable.

3.6 If the net result of the computation is profit then the tax is payable and if it is loss then subject to the provision of section 115JB of the Act there may not be any tax incidence. In case of losses, be it depreciation loss or be it business loss these are either adjusted in the current year or carried forward subject to provisions of sections 70 to 72A of the Act. Applicable Income Tax rates for various corporate entities for A.Y. 2024-25 under different scenarios are tabulated here under:

Further companies opting for sections 115BAA and 115BAB are exempt from MAT provisions u/s 115JB, whereas companies that have opted for 115BA are liable for MAT u/s 115JB at the rate of 15% and Health and Education Cess at 4% on the Income tax and surcharge.

Further foreign companies are taxed at 50% or 40% for different incomes along with applicable surcharge at 2% or 5% and 4% of Health and Education Cess.

3.7 The Government of India has recognized the importance of the young startup sector in terms of innovation, job creation, FDI inflow, and also the amount of revenue generated by the  Therefore, vide Finance Bill, 2016 certain provisions are introduced to give 100% deductions of profit as per provisions of section 80-IAC. The Finance Act of 2023 has amended the provision to extend benefits of 80-IAC to all eligible startups that have incorporated between the period 1-4-2016 to 1-4-2024. These deductions are available for a period of 3 consecutive assessment years out of 5 years only to startups subject to compliance with conditions stipulated under the Act. This provision is subject to MAT provision u/s 115JB of the Act.

3.8 The Non-Resident OGCs may be subject to DTA, Equalization Levy, PE issues, and issues of taxation of royalty, taxation of SASS etc. This chapter does not deal with cross-border taxation aspects.

3.8.1 EqualizationLevy was first introduced by the Finance Act of  It is charged on the amount paid to a Non-Resident not having PE in India in respect of specified services provided by them to a resident or to a non-resident having PE in India. The levy is charged at 6% of the consideration paid to a non-resident U/s 165(1) of the Act. A threshold limit up to Rs. 1,00,000 payment to non-residents during the previous year is provided on which no levy shall be charged. Services covered under this section are:

• Online advertisements.
• Any provisions for digital advertising space.
• Any other facility or services for online advertisement.
• Any other services as may be notified by the Government.
• Levyat 2% on digital services provided through e-commerce (This aspect is not covered in this chapter).

3.8.2 Some of the OGCs who either pay or derive income from services covered under provisions of section are required to comply with law relating to equalization levy. Payment of levy has to be made on or before 7th day of month immediately following the month in which transaction take place as per provisions of section 166(2) of the Act. Section 167(1) provides for filing of the return in Form No. 1 before 30/06 immediately following the financial year.

3.8.3 In case the levy is not paid the expenses related to such levy shall be disallowed u/s 40(a)(ib) and shall be allowed only in the year of payment of such levy.

3.8.4 Non-payment of levy or delayed payment of levy will also lead to a charge of interest and penalty as per sections 170 and 171 of the Act.

3.9 The OGCs are required to maintain books of account and get the books of account audited under the provisions of the Company’s Act 2013. The provisions related to maintaining of books of account and audit are provided in section 44AA and section 44AB of the Act. The OGCs (if individual, Partnership Firm, and LLP) are eligible to declare profit and pay tax as per the provisions of section 44AD of the Act subject condition that their turnover during the previous year does not exceed Rs. 2.00 Crores.

3.10 OGCs are required to file return of income as per the provisions of Chapter XIV more specifically provisions of section 139(1) of the Act. The returns of income filed may be selected for regular scrutiny assessment by the issue of notice U/s 142(1) r. w. s. 143(1) of the Act or by the issue of reassessment/income escaping assessment U/s 148 of the Act.

3.11 Regulatory authorities like GST Department, Income Tax Authorities, and Enforcement Directors are empowered to conducts search and seizure operations as per the provisions of the relevant law. Any non-compliance in one Law will lead to a huge impact on the assessment proceedings in other Law. The search and seizure operations under the Act will have far-reaching implications for the business as a whole.

3.12 As reported in The Indian Express e-Paper dated 24-2-2022 income tax authorities have conducted search and seizure operations on one OGC based in Mumbai. Post conclusion of the search operation Central Board of Direct Taxes has released a press statement

“The search revealed that the group has been introducing its unaccounted cash into books of account as unsecured loans, security premium, partner’s capital, agricultural income, share transactions, commission and trading income, etc., in the form of accommodation entries. This cash has been routed through several layers of dummy/shell companies controlled by the entry provider groups or through hawala channels. The amounts introduced in the books of account have been invested in real estate and securities market,”

said a statement issued by the Central Board of Direct Taxes (CBDT). The income tax department has unearthed several millions of worth of tax fraud by the OGCs. The following table gives a few examples of the issues uncovered during the search operations by the direct tax department on OGCs.

3.13 There may be several complex and unresolved aspects that may lead to adverse burdens on the OGCs, therefore it is advisable to follow the most conservative, learned, opinion and compliance-driven strategy to mitigate the risk of litigation.