Impact on Investments in the Gaming Industry Amidst the 28% GST Row

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Online gaming in India is experiencing rapid growth, driven by widespread access to smartphones. The user base is estimated at 570 million, with nearly 9 billion gaming app downloads in 2023, reflecting a 28% compound annual growth rate (CAGR) since 2020.

Between 2019 and 2023, the industry attracted significant domestic and foreign investment. Moreover, affordable data rates and the pandemic further boosted the development and honing of skills through mobile-based online gaming opportunities.

The Indian government recognising the potential of the industry allowed 100% FDI (Foreign Direct Investment) in the online gaming sector thereby making it an attractive proposition for fast-growing consumption and eyeballs to investors.

As per a report released by EY in 2023, India contributes 1.1% to global online gaming revenue. The technical expertise in the country enables the continuous development of online games, with Indian developers excelling in animation capabilities. This thriving ecosystem attracts significant investment from both domestic and foreign sources.

How Taxation and Regulatory Ambiguities Impacted Investments?

It is critical to recognise that even after the existing potential and capabilities of the industry and gamers, the ambiguities in the regulatory framework hamper the industry's sustained growth. The Ministry of Electronics and Information Technology (MeitY), the nodal ministry for regulating online gaming, attempted to streamline the regulatory framework by introducing new rules under the IT Act 2000.

However, this effort stalled mid-way, leaving two critical issues unaddressed. Firstly, it failed to define the parameters distinguishing games of skill from games of chance. Secondly, it created confusion by seeking to prohibit wagering on event outcomes, despite the primary purpose of the rules being to govern online real-money games.

In addition the imposition of GST on the online gaming platforms basis the face value of deposits, also had investors worried. Since the advent of the GST regime in 2017, real money online game providers have been paying 18% GST (applicable on the platform fee) and the same was accepted as a general practice by the GST department.

Despite that, in 2023, the GST department decided to impose a retrospective tax on online gaming companies, with demands from online gaming companies exceeding 1.5 lakh crores. All investments that were supposed to come in and that would have further led to the growth of this industry came to a zilch.

According to the latest EY-USISPF, the increasing GST costs have decreased revenues for online gaming companies (by 50%-100%) and halted FDI into the sector since October 2023.

Many companies in the industry faced a serious 'funding winter'. As per the report published by EY and USISPF in June 2024, in comparison to 2019 when investments worth $2.6 billion flourished in the industry from domestic and global investors came to a halt. The report says no capital has been raised in the sector since 1st October 2023.

Even existing investors have started considering an exit to look for other avenues to hedge their risks. Their concerns were further aggravated by the fact that post-October 2023, 28% GST was imposed on the value of the first deposit, which approximately led to a 400% increase in tax, thus affecting the business model and survival of the online gaming companies.

It led to a drop in the revenues of the regulated online gaming sector and the growth of players in the grey market. A double whammy for the sector! This necessitated the critical need for a comprehensive regulatory regime to address the sprouting of unregulated entities.

Additionally, the costs for the gaming companies further increased, as they were all engaged in expensive litigations against the GST demands in various courts in India. Thereby, further spiraling reduced investor confidence.

Outlook for the future

A silver lining is emerging that should provide some hope for investors in the online gaming sector. Firstly, the issue of retrospective tax imposition and the incidence of tax has reached the Hon'ble Supreme Court.

The Government of India has filed transfer petitions in various high courts to consolidate all matters related to challenges in the online gaming sector for the Supreme Court's adjudication. There is hope that the Supreme Court will finally resolve this issue and end the uncertainty.

Additionally, on June 22, 2024, the GST Council accepted the Fitment Committee's provision and decided to introduce Section 11A in the CGST Act. This section allows the Government, on the Council's recommendation, to exempt or reduce GST in cases where the tax was underpaid or unpaid due to common trade practices.

Although this provision is not specific to the gaming sector, its introduction gives the online gaming industry hope. It enables the possibility of voiding GST demands on the industry, as all online gaming platforms were paying an 18% tax on their platform fees based on established practice.

The years 2023 and early 2024 have been challenging for India's online gaming industry. However, with the easing of the GST stance on the sector and the Hon'ble Prime Minister's AVGC policy, the industry could be poised for renewed growth, aspiring to become a global leader. India already has a robust foundation with its flourishing IT industry.

Conclusion

To achieve global leadership, several factors are essential: developing secure software for responsible online gaming, building infrastructure for data storage, creating algorithms and artificial intelligence to process data, and expanding server capabilities.

Additionally, increasing data usage to facilitate online gaming, providing smart mobile phones and computers, funding the sports ecosystem through sponsorships, and developing India-specific content through gaming studios will be crucial. These studios could create content for the global market, enhancing India's soft power, similar to the Indian film industry. These ancillary industries are expected to grow alongside the Indian online gaming sector.

Thus, to achieve global leadership, investments from domestic and global sources are necessary to facilitate the growth of India's online gaming industry. By attracting both higher investments, the Indian online gaming industry can ensure a comprehensive and sustainable ecosystem. This will enable the industry to grow and compete on a global scale, fostering innovation, creating jobs, and contributing to the economy.

- By Aruna Sharma (Practitioner Development Economist and retd Secretary GoI) & Vidushpat Singhania (Managing Partner, Krida Legal)