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McDermott's New Tax Bill is Wrought With Problems...By Hartley Henderson

It wasn't that long ago that many British gambling firms left the country to start an online business because they felt they couldn't compete with other Internet offshore gambling companies that were operating in tax havens.

Britain imposed a 10% tax on all bet (later reduced to 9%)and also made the companies pay normal income taxes on top of that. This was acceptable for land based gambling since it was the only option for British citizens who wanted to bet at a brick and mortar casino or sportsbook. But on the internet, where there are no borders, there was no reason for the customers or companies to pay the tax when bettors could make a wager at an online book in Antigua or Costa Rica and not have any tax assessed on their winnings.

Consequently, the British companies looked for their own tax havens and found them in the Isle of Man, Gibraltar and Alderney which were close to the UK market but offered tax shelters. Some UK companies also looked to Malta, Antigua and Costa Rica.

The UK government recanted when it was clear that most companies were going to pull their internet operations out of Britain and lifted the replaced tax on bets with a 15% tax on gross profits. While that amount was still hefty, most gambling companies felt it was reasonable and moved their online sports betting operations back to the mainland. At the same time the majority left their online poker and casino operations offshore in tax havens since the margins on poker and casinos are lower.

Last week Jim McDermott announced the details of his online gambling tax bill that was announced in March.

The legislation, which is a companion bill to Barney Frank's Internet Gambling Regulation and Enforcement Act, proposes taxes on deposits for "licensed" online gambling companies totaling 8% (6% would go to the state and 2% to the federal government). The tribes would also benefit and states can opt out if they wish. The 8% total tax is in addition to the normal taxes companies would be expected to pay on their income at year end. Of course winning gamblers are expected to pay taxes on winnings. Obviously the tax is strictly for poker and casinos since sports betting is excluded from both bills but there are suggestions that if online sports betting is ever legalized in the U.S. the percentage of tax demanded from sports betting would be much higher.

Gambling pundits and many in the government are applauding this bill and are excited at how much revenue it can generate for state and federal coffers.

A recent study by H2 Gambling Capital concluded that iGambling would create up to 32,000 jobs and $57 billion in tax revenue over 5 years in the U.S. or 28,000+ jobs and $30 billion if sports betting is excluded. But there are several questions that arise regarding the bill's fairness and viability that must be addressed.

The first question is why there is a different onus placed on internet bets versus land based ones. No land based casino is expected to pay a tax on deposits made at the casino and infact I can't find any cases in the U.S. where a business is expected to pay a tax on anything other than its net income.

The process for taxation is fairly clear in all democratic countries: At year end a business prepares financial statements (usually under the watch of a CPA) and if the company has profits it pays a percentage of that to the government as a cost of doing business. If they show losses they can claim those for a refund against prior year profits. The tax rates are different from country to country (and some countries do offer tax havens) but the tax is always based on income.

It appears McDermott is trying to circumvent that custom and is essentially telling companies like Harrah's that they will pay through the nose for the "privilege" of offering online gambling to U.S. citizens. For some reason land based gaming isn't viewed as privileged.

While Harrah's and Caesar's etc. may not say anything at first believing they need to shut up until they are allowed to offer online gambling, at some point they will expect an equal playing field between their land based operation and the online operation. In the meantime it?'s almost a sure thing that the any companies given a license to offer online gambling won't absorb the deposit tax themselves and will likely pass it on to the customer. This will be accomplished by either charging a surplus fee on deposits, by lowering payouts at the online casinos, or increasing the rake at poker games. Either way the American bettors will lose out, or the offshore gambling establishments will still look more enticing to most American bettors.

A second question relates to the 50% tax on unlicensed offshore deposits. If an offshore company agrees to this usurious tax, do they then become licensed and legal per the U.S. government?

If so why wouldn't they be afforded the opportunity to set up shop in the U.S. and pay the lower tax on deposits? Also,if the companies aren't going to be recognized as legal then why in the world would they cooperate with the U.S. government at all? For that matter, what possible reason is there to even include offshore companies in the bill? I asked Martin Owens, a lawyer specializing in Internet and interactive gambling, for his opinion on the proposed 50% tax on offshore companies and he basically laughed it off.

"The idea of taxing unlicensed Internet gambling businesses at 50% could only have come from a crack pipe.  If somebody is not licensed within the USA, under that scheme, then by definition , you're talking about a business located offshore. The offshore operations are offshore precisely because that enables them to duck US taxes and US regulations. Why not tax them at 100%, 500%, 10,000%? It's all fantasy, because they can't be reached in the first place."

There is, however, one issue that could still become a concern to the U.S. government if the bill is ever passed and the government tries to tax offshore companies at a much higher rate than those operating in the U.S. In 2007, the U.S. announced it would be rewriting its WTO commitments after losing its final appeal at the appellate court. To date that hasn't been done. Infact it appears the U.S. still hasn't come to an agreement with all affected countries.

There is a strong belief by many in the industry that the current USTR has decided not to pursue the option of rewriting the commitments and just plan to ignore the WTO ruling altogether. The U.S. came to agreements with many countries that asked for compensation but actually providing that compensation could be quite costly in a time the U.S. really can't afford it. As long as the USTR doesn't rewrite the WTO commitments they don't have to do pay out anything and it seems clear the WTO is in no position to force them to anyways. The $21 million worth of compensation the WTO awarded Antigua as a result of bringing forward the challenge in the first place shows how little influence and power the organization has over the U.S. The WTO also did little in demanding compliance for other countries that lost against the U.S. on other trade issues such as Canada and the softwood lumber dispute.

The one entity that the U.S. won't be able to ignore if it raises its voice is the EU. The U.S. relies on the EU heavily in trade and really can't afford to upset them too much.

EU Trade Commissioner Peter Mandelsson came to an agreement with the USTR which gave the U.S. the EU's blessing to rewrite its commitments in exchange for concessions in shipping and storage but former EU Trade Commissioner Catherine Ashton and current Commissioner Karel De Gucht don't seem to have much respect for that agreement.

Along with the Remote Gambling Association it appears the EU is prepared to rip up that agreement if the U.S. flinches at all. And it's also fair to say that if the U.S. starts up an internal internet gambling market that charges 8% tax on deposits while at the same time expecting companies like Party Poker, William Hill or 888 Gaming to pay 50% tax on deposits that it will be seen as purely protectionist and a gross violation of the agreement.

The U.S. may try to avoid this concern by offering UK companies the opportunity to apply for a license in the U.S. but unless it's a totally open playing field it's unlikely the EU or other countries will accept that offer. While the WTO itself may have no influence on the USTR, large trading partners very well may.

A third question that comes to mind relates to the deposits itself. One of the main reasons stated by Barney Frank for the bills he introduced (and don't forget McDermott's is a companion bill) was concern that the UIGEA was an unfair burden on banks and credit card companies.

He believed that forcing the banks to try and police the internet was unreasonable, particularly in a time of downturn. The concern was valid and the banks stated they had no way of differentiating "legal" online gambling transactions from "illegal" ones.

This was widely accepted but a few of months ago banks announced that the task wasn't all that difficult at all and credit card companies started turning down deposits for Pokerstars and other sites which didn't re-code 7995 online gambling transactions as something else. Nevertheless, banks still contend that bank wires or checks to companies that aren't clearly labeled "gambling", "sportsbook", "poker", etc. are almost impossible to spot or stop.

So the question that has to be asked is how the government is going to identify offshore gambling companies to charge the 50% tax when they can't do so currently. More significantly, how does this bill do anything to help the banks overcome the task placed on them which they deemed as extremely costly and a virtual impossibility?

Credit cards are becoming a far less used method for deposits at offshore gambling businesses and payment processors are becoming far more aloof at finding legal ways around the UIGEA requirements. Also, as technology advances there will be methods to deposit and withdraw to offshore establishments that don't use the banking system at all. The tax is a moot point if the banks or internet police don't know who to tax.

Another nuance in the plan is that it's predicated on Barney Frank's bill passing which is a long shot at best. I asked Martin Owens to comment on McDermott's bill in general and his response was fairly terse.

"The McDermott bill (I presume you're referring to HR 4976, introduced 25 March of this year) is all about taxing "licensees" under 31 USC 5382. But guess what -  There is no such thing as 31 USC 5382. That's part of the Frank Bill, which has yet to pass.

So what you're asking is: if somebody comes around with a loaf of bread, so that we can make ham sandwiches, provided somebody else shows up with a ham, what kind of mustard goes best with all those ham sandwiches? That's assuming of course that we will also get a table, a plate, and a sharp knife to cut the ham, from someplace."

The point is fair. When Barney Frank started the campaign against online gambling it was for reasons that the public could identify with - namely that the government shouldn't be trying to stop people from partaking in an activity that isn't harming anyone but themselves. His agenda was to counter the likes of John Kyl, Robert Goodlatte and others in government who are pandering to the religious groups and trying to tell Americans how they should live their lives. It seemed to work and without question the Libertarian mindset has taken set with many Americans who are tired of being told by government how to think and act.

Somehow Frank's campaign has been hijacked by others with a different agenda and now there are numerous caveats to his bill. First there were the tax proponents like McDermott who want to assure the bill revolves around collecting taxes on bets. Then there were the anti-sports pundits like Robert Wexler who wants to make sure that any bills exclude sports betting and it appears now there are others who are willing to support the bill only if the Native Groups can make money off it.

They may all be valid agendas but it has taken away from the main focus of the bills in the first place which is "let Americans partake in an activity that harms no one but themselves without fear of arrest and regulate it so that they can do so without fear of being cheated or taken advantage of." When you put in condition after condition, a bill becomes so watered down it loses its focus.

Regardless, Owens is convinced this is all fantasy and any changes to gambling laws in the U.S. will be as a result of states passing their own laws and taking it to court if necessary. He believes there is no political capital for Frank to pursue this to the end:

"The cold, hard fact of the matter is: Internet gambling is just not that important in the national scheme of things.  Congress has other things on its plate, like completely insupportable deficits, and how to stop people who are deeply [messed] up in the head from getting their hands on atomic weapons. The default position is - there is a slight benefit for conservatives in opposing the expansion of gambling.  There is no corresponding political advantage for those who propose expanding gambling, including on the Internet.  And I simply don't see the likes of Barney Frank spending serious political capital for the sake of Internet gambling."

Let's hope Owens is right and when online gambling is legalized in the U.S. that it is done so in a fair and open manner. Americans are taxed enough as it is.

Hartley Henderson

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