Levy of tax on sale of lottery tickets

The Supreme Court has put an end to a long-standing dispute over the levy and collection of service tax on the lottery distributors in its verdict in the case of Union of India v. Future Gaming Solutions Pvt Ltd. holding that service tax is not applicable on the advertising, marketing and promotional activities undertaken by lottery distributors for the purpose of increasing their sale of tickets of lottery organised by the State government.

This article shall aim to examine the evolution of lottery in India, the legislative attempts to levy service tax, and the Supreme Court’s final reasoning.

The roots of lotteries can be traced back to ancient practices of gambling, which started as a mode of entertainment. The British Government introduced the Public Gambling Act, 1867 in India to regulate such activities by prohibiting gambling in public houses. Post-independence, lotteries were introduced by the government to raise funds for purposes like infrastructure development and public welfare schemes.

From a legislative competency perspective, gambling and lottery became subjects of the State legislature under Entry 34 and 62 of List II of the Seventh Schedule to the Constitution of India. Kerala pioneered State-run lotteries in 1967 to generate revenue for social welfare and employment, which other States later adopted. To ensure uniformity, the government of India enacted the Lotteries (Regulation) Act, 1998. Lottery distributors purchase online and paper lotteries from the State government for sale to customers and must pay a fixed amount to the State, irrespective of sales. The marketing, advertising and promotional costs are borne by the lottery distributors.

The crux of the issue was whether service tax could be levied on advertising, marketing and promotional activities undertaken by lottery distributors engaged in the sale of online and paper lotteries under agreements with the State of Sikkim. Between 2003 and 2016, service tax authorities repeatedly attempted to impose such a tax

2003: “Business Auxiliary Services” [Section 65 (19)] was introduced, intending to impose service tax on promotional and marketing activity undertaken towards goods or services. Notices issued to lottery distributors were challenged before the High Court of Sikkim, which held that lottery is an actionable claim, not goods. The Revenue’s appeal was also dismissed by the Supreme Court.

2008: Explanation to Section 65 (19) (ii) of the Finance Act, 1994 was introduced to bring lotteries within the scope of service tax. Subsequently, Section 65 (105) (zzzzn) was inserted, subjecting activities relating to promotion and marketing games of chance, including lottery, Bingo or Lotto to service tax. The High Court of Sikkim struck down the said attempt, stating that the cost of advertising and promoting is borne by the lottery distributors and the levy of tax on lottery is the exclusive legislative domain of the State legislature. The apex court affirmed the aforesaid decision.

2012 (Negative List-based regime): This paradigm shift excluded service tax on betting, gambling and lottery. Despite this, the Department contended that service tax was applicable. The same was challenged before the High Court of Sikkim, wherein it was held that lottery, being an actionable claim, is excluded from service tax. An appeal filed by the revenue was also dismissed.

2015: Definition of “lottery distributor or selling agent” was inserted with effect from May 14, 2015. Additionally, explanation 2 to Section 65B (44) was inserted, which clarified that service excludes transactions in money or actionable claims, thereby excluding activities relating to lottery promotion, marketing or sale. The High Court, even at this juncture, held that the distributors are engaged in buying and selling of the lottery tickets and not providing any service. The revenue challenged the same before the Supreme Court.

2016: Explanation 2 (ii) (a) to Section 65B (44) of the Finance Act was amended to exclude activities undertaken by distributors on behalf of the State from “transaction in money or actionable claim.” Once again, the High Court held that the Parliament lacked competence to tax the activity and the amendments were held ultra vires. The Revenue once again appealed before the apex court, while the lottery distributors approached the Supreme Court challenging the order passed by the High Court on the aspect of the absence of a mechanism to compute alleged services.

Meanwhile, the Supreme Court passed the order in the case of K. Arumugam v. Union of India, which was part of the Civil Appeal No. 2782 of 2012 (supra) wherein it was held that the lottery tickets being actionable claims expressly get excluded from the scope of Section 65 (19) (i) of the Finance Act i.e., the business auxiliary services.

During the hearing, the Revenue contended as per the Lotteries Act, the State organizing the lottery must be the ultimate seller and the State-organized lottery required the State to retain core control to protect public trust. The State of Sikkim has a monopoly over lotteries and, the lottery tickets were sold on “all sold” basis, which was subsequently amended to an “actual sold” basis as per the agreement. Further, in the case of online lotteries, the State directly sold tickets to customers through a computer terminal, with distributors only facilitating online sales. The above facts establish the existence of a principal-agent relationship between the State and the distributor.

The lottery distributors argued that the relationship between the State and the distributor is that of a buyer and seller, operating on a principal-to-principal basis. Under the agreement, the distributors are required to pay a minimum guaranteed amount irrespective of their sales, and the State does not indemnify the distributors towards any loss. The distributors bear the cost of promotion, marketing and advertising themselves, without reimbursement from the State. Further, the margin earned by the distributors on the sale of lottery tickets does not qualify as consideration in terms of Section 67 of the Finance Act and levying service tax on the sale of lottery tickets amounts to infringement of the State’s exclusive legislative power on betting and gambling.

The Supreme Court examined the concept of an agency under the Indian Contract Act, 1872 and observed that in paper lotteries, agreements refer to lottery distributors as "sole purchaser/ distributor/ promoter." The distributors must pay a minimum guaranteed amount to the State irrespective of tickets sold, bear the risk of unsold tickets—which are returned to the State to prevent misuse and ascertain sales—and also bear their own advertising and marketing costs without reimbursement, while appointing their own stockists and distributors at their “own risk and responsibility."

In online lotteries, though the agreements use “marketing agent”, the Court held that the substance of the relationship remains the same as in paper lotteries, with similar provisions for minimum guaranteed revenue and a bank guarantee. It further held that betting and gambling are subject to the State under Entries 34 and 62 of List 2, and the Central Government is not competent to levy tax. Relying on K Arumugam, the Court reaffirmed that the relationship between the State and lottery distributors is not of principal–agent.

The Supreme Court held that lottery distributors operate independently as a principal by purchasing tickets from the State for resale and bearing their own risks and costs for promotion, marketing and advertising, and that the Parliamentary amendments to impose service tax were “innocuous and cosmetic in nature” and did not change the substance of the relationship.

This decision gives great relief to the lottery industry and has a huge financial implication. Not only that, but the present decision will put an end to future litigations on the same issues, as the Service tax regime has also come to an end.

The present decision settled the long-pending dispute for the industry and recurring attempts made to impose service tax on the advertising, marketing and promotional activities undertaken by the lottery distributors to boost their lottery sales.

About the authors: Shradha Rajgiri is a Principal Associate and Sampath KM is an Associate with Shivadass & Shivadass (Law Chambers).

Rishab J, Associate Partner, provided his inputs.

Disclaimer: The opinions expressed in this article are those of the author(s). The opinions presented do not necessarily reflect the views of Bar & Bench.

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