International In-house Counsel Journal Vol. 7, No. 28, Summer 2014, 1 Lawyering in the Online Gambling Sector Part 2 - non-legal aspects of the in-house work MARTIN LYCKA Legal Counsel, Betfair Limited, UK Being an in-house lawyer does not only require top class knowledge of a requisite number of different areas of law but also an in-depth understanding of the products sold by the business as well as non-legal elements that may affect its performance, in particular taxation. This is even more the case in the online gambling sector where competition is tough, regulation is very strict and taxation can seriously impact the future success of the business and its more innovative products. This article will deal with some non-legal aspects of the work of in-house lawyers in the online gambling industry, focussing on the taxation of gambling products and the necessity of cooperating effectively with in-house and external tax advisers, to be able to advise on and deliver external messages about non-legal aspects of the business. It will also deal with the regulatory, tax and other issues associated with the operation of betting exchanges, one of the most innovative products offered across the global online gambling industry. It will highlight some of the challenges an in-house lawyer may face if his objective is to get the innovative products, which some people may find complex, or even controversial, albeit for no good reason, regulated in a new jurisdiction. This article will argue that national governments and regulators are best advised to introduce a taxation regime that will permit all potentially interested operators to enter newly regulated online gambling markets with a view to generating healthy competition. This should ultimately lead to a sizeable reduction in the size of the previously existing unregulated market and enhance levels of consumer protection. I will also argue that innovative products like betting exchanges should not be omitted in practice from regulation, either by way of prohibitive taxation or prohibitive regulatory restrictions, because of the risk that consumers will find ways to bypass such regulation and continue using their favourite gambling products anyway. Taxation of online gambling products Some (in-house) lawyers would tell you that they’ve chosen to do law because maths was no friend of theirs during the secondary school days. Or that the internal tax team will be there if help is required or something goes awry. Be that as it may, tax issues usually form part of every (in-house) lawyer’s practice and at least some understanding is required. To have good background in tax is even more important in the online gambling sector where the product and tax regulation are inseparably intertwined. Unworkable tax regulation may mean that the business cannot be commercially viable in that jurisdiction. In general, the taxation of online sports betting can provide an important source of revenue for national governments if it is properly designed. When calculating the total tax burden all operating costs must be taken into account, including all associated business taxes, licence fees, administrative and compliance costs, as well as the actual tax rate. A prohibitively high betting tax, or an improperly structured one, drives online gambling International In-house Counsel Journal ISSN 1754-0607 print/ISSN 1754-0607 online 2 Martin Lycka operators out of the market, resulting in lower revenue for the government and fewer choices for consumers. Prices in the betting markets are based on the operator’s expectation of the outcome of an event. This fact needs to be combined with the assumption that customers naturally strive to achieve the highest possible pay out rates which forces the operators to offer competitive rates. If it turns out that the operators cannot balance their books to face the two above factors they can react in two different ways: either by reducing their profit margins or by increasing in their prices. Several economic studies have shown that in a turnover tax system where the company faces a constantly high tax burden (assuming the turnover of the operator remains constant or very similar over a long period of time), the reduction of margins leads to irrecoverable losses, which may ultimately force the operator out of the market.1 In combination with a workable effective rate, the choice of an efficiently structured tax can have benefits for consumers, operators, and governments. One structure, a gross gaming revenue (“GGR”) tax, is levied directly on the operator’s revenues, which reflects its actual position on the market. Moreover, the GGR tax creates a level playing field between operators, permitting the freedom to provide consumers with greater choice and value without concern for the margin of specific offerings. The GGR tax, as opposed to a turnover tax, i.e. a tax on the total volume of bets collected by the operator, is the best option for the online sports betting sector because it has the highest potential to provide better value, entertainment, and choice for the consumer. The margins of online gambling operators genuinely oscillate between 90 and 96 percent (depending on the types of products that are offered). By consequence if a country that is in the process of regulating its online gambling market decided to apply any form of a turnover tax, the operators would struggle to make the two ends meet because the very low margins they generate would have to cover the turnover based tax as well as all other costs associated with entering a market and maintaining market positions. Even a very low turnover tax combined with the other costs would take a very high proportion of revenue away from the operators and would make them reconsider their presence in such a market as will be shown below in the example of France. Economic studies conducted in the online gambling sector have also shown that increases in price as an attempt to balance the operator’s book in a turnover system is by no means ideal either.2 This is because if the operators opt for this false strategy the turnover tax system compels them to reduce the turnover (to pay less tax), whilst increasing the price to artificially high levels which are not acceptable to customers (to at least retain the same level of bottom line). This may result not just in lower tax income for the government but also force customers to look for “cheaper” alternatives, most likely in the black, i.e. unregulated, market. In one of their studies PWC summarised the unsuitability of the application of a turnover based tax for taxation of online gambling products as follows:”a tax levied on stakes should be avoided as it discourages competition and customer demand (taxes are typically passed to the user), while encouraging use of non- regulated channels, leading finally to a smaller taxation base”.3 1 See for example, Australian Productivity Commission, Report on Gambling, 2010: http://www.pc.gov.au/projects/inquiry/gambling-2009, or Schmidt, U., Maschke, M., Das Wettmonopol in Deutschland, Status Quo und Reformansaetze, Kiel Policy Brief, No. 18, 2010. 2 See for example, Australian Productivity Commission, Report on Gambling, 2010: http://www.pc.gov.au/projects/inquiry/gambling-2009, or Schmidt, U., Maschke, M., Das Wettmonopol in Deutschland, Status Quo und Reformansaetze, Kiel Policy Brief, No. 18, 2010. 3 PWC, Report, Romanian Market Assessment and Tax Scenarios, June 2011. Non-legal aspects of the in-house work 3 Unlike the turnover taxation system, a betting duty based on the operator’s gross gaming revenue is conducive to price competition between the operators (which is always good for the ultimate beneficiary, i.e. the customers).4 Assuming a workable tax rate, taxation based on gross gaming revenue doesn’t compel operators to reduce their turnover (because the turnover figure is irrelevant for the purposes of this tax) or their profit margins (because excluding other costs the tax rate would have to be relatively very high to reduce operators’ profit to naught). In addition, the gross gaming revenue regime is much more flexible because it is capable of effectively supporting diverse business models, including online cash poker and betting exchanges. Neither of these two products could effectively work if they were to be taxed on the basis of the operator’s turnover. The principal reason for that is turnover is not equivalent to the money effectively held by the operators of these types of games, let alone the revenue/profit they make. This means that to achieve a workable taxation regime, it is not enough to introduce a gross gaming revenue tax full stop. It is equally important to make sure that the definition of “gross gaming revenue” is wide and flexible enough to cover all online gambling products available in the market. PWC opined in one of their recent studies on an EU gambling market that a broad enough definition of “gross gaming revenue” removes potential volatility between accounting periods and simplifies the audit and compliance process, especially for poker.5 In other words online gambling operators will be keen on entering a particular market only if they can be sure that they will have an option of offering the widest possible portfolio of their products. This is not to say that they must choose to do so every time or that they may be forced not to offer some of their products for regulatory or other reasons. However any change to the existing portfolio or look of products usually gives rise to additional costs, which especially in the case of smaller economic markets, may count against operators’ entry. Another important general consideration is the rate of the betting duty.