Kee, Pei-Teing --- "Should gambling gains be taxed as income?" [1995] MurdochUeJlLaw 22; (1995) 2(2) Murdoch University Electronic Journal of Law

SHOULD GAMBLING GAINS BE TAXED AS INCOME?

Author:	Pei-Teing Kee School of Law, Murdoch University
Issue:	Volume 2, Number 2 (July 1995)

INTRODUCTION

Should gambling gains be taxed as income? It is sometimes argued that gambling gains are not taxed because governments are not inclined to see gambling loss deductible. On what basis would such losses be deductible? Is there another basis for holding gambling gains to be taxable which does not involve gambling losses being deductible? If gambling gains are to be taxed, should the cost of the winning gamble itself (e.g. the cost of the lottery ticket) be deductible?

i.  Should gambling gains be taxable?

A number of arguments can be advanced against the taxation of gambling gains.  One argument is that any gains made from a pastime should not be taxed. For most people, gambling is merely a pastime and not intended to be an income generating activity. However, there are people who rely on their gambling activities as their primary source of income or conduct a gambling business rather than engage in gambling as a hobby. In Graham v Green [1925] 2 KB 37, the punter's sole means of livelihood was derived from backing horses from his residence at starting price. In Case K25 78 ATC 243, the punter attended most Sydney races, leased offices with phones installed for betting, employed staff and used a computer to analyse racing results and recommend future bets. Furthermore, people who gamble are not only concerned with having fun but also want to win.

A second argument is that gambling gains should not be taxed because gambling involves pure chance, a high risk of losing and any gains made are unexpected receipts. There is some truth in this argument. However, some gamblers make systematic attempts to reduce the odds of losing by obtaining valuable information from horse trainers, using computers to analyse results and recommend future bets and avoiding bets on trifectas, quinellas or other riskier bets that are highly dependent on chance: Trautwein v FCT [1936] HCA 46; (1936) 56 CLR 196; Case K25 78 ATC 243; Evans v FCT 89 ATC 4540. The other problem with this argument is that any form of business would involve some element of luck and the risk of failure due to changes in market preferences or economic conditions and other similar factors. Many small business fail after a year from commencement. Similarly, not all of the receipts obtained by a business are expected receipts. Examples of these include a lucrative contract obtained in unusual circumstances or a generous donation.

A third argument is that gambling gains may indirectly bear another kind of tax and, therefore, should not be taxed in the hands of the gambler. An important source of State revenue are State taxes in relation to prizes and gambling[1]. Public lotteries arranged by "State governments already contain an element of taxation in the form of surpluses channelled to ... finance ... public purposes"[2]. "[R]acing and poker machine operations attract a variety of taxes"[3]. The Burswood Resort Casino contributes 15% of its gross revenue from gambling in taxes[4]. In the racing arena, 2.25% of gross takings from ticket betting via machines are paid in taxes[5]. Bookmakers are also taxed at 2.25% of gross takings on the racecourse (includes betting on the phone)[6]. The TAB is taxed at 6% on its turnover[7]. However, these taxes are not imposed directly on the prizes or winnings so gambling gains effectively remain untaxed. Only the organisations conducting the gambling activities are taxed but not the individual gamblers themselves.

An argument that arises from the fact that State taxes in relation to prizes and gambling generate State revenue is that the taxing of gambling gains would result in a loss of State revenue if the tax deters or discourages people from gambling. However, it is difficult to estimate what sort of an impact such a tax would have on gambling practices. If people gamble to support an addiction similar to a smoking addiction or alcoholism, then they will continue to gamble regardless of any taxes imposed on gambling gains. Furthermore, it is possible that revenue from taxing gambling gains would equate with or exceed any loss in revenue from the discouraging effect of the tax.

Probably the two most convincing arguments against taxing gambling gains are, firstly, the difficulties of administration and compliance and, secondly, the corresponding result that gambling losses become deductible[8]. Where control and enforcement is beyond the power of any efficient tax administration, especially with respect to minor or casual gambling winnings[9], the taxing of gambling gains would create unfairness to the honest taxpayer[10]. The government would not want to see gambling losses deductible because most gamblers make losses rather than gains[11]. Furthermore, honest taxpayers would find it difficult to prove their losing investments[12]. However, that fact that all gambling receipts (for both amateur and professional gamblers) are taxable in the United States[13], illustrates that it is feasible and not administratively unworkable to tax gambling gains. In the United States, "losses are deductible only to the extent of gains"[14]. The issue of whether there is an alternative basis in Australia for taxing gambling gains that does not involve gambling losses being deductible will be addressed in part iii.

The primary argument for taxing gambling gains is to achieve equity or fairness. People should be taxed according to their ability to pay. Those in similar economic circumstances should pay equal amounts in taxes while those in different economic circumstances should pay different amounts relative to their different positions. If certain gains, such as gambling gains, are omitted from the tax base then people with similar taxpaying capacities will not be taxed equally[15]. An increase in spending power should be taxed regardless of its source - whether it was obtained by "hard work, criminality, inheritance or good luck" is irrelevant[16]. Similarly, whether a taxpayer needs the money, or how s/he intends to use it, should not matter.

Another argument for taxing gambling gains is to promote efficiency. Efficiency refers to neutrality. Taxes should not affect a taxpayer's market choices by making certain types of investment or spending more attractive simply because of the after-tax consequences[17]. A regime that taxes some gains but not others, such as gambling gains, will encourage taxpayers to prefer untaxed gains and the system is no longer neutral or efficient[18]. It diverts resources away from what the market determines would be the most productive form of use towards a less productive use with a more favourable after-tax outcome.

The arguments in favour of taxing gambling gains are more convincing than the arguments against taxing gambling gains, for which there are many counterarguments. It is, therefore, submitted that gambling gains should be taxable.

ii.  On what basis would gambling losses be deductible?

Firstly, gambling losses would be deductible where the gambler's activities constitute a business. If a taxpayer is found to be in a business of gambling, the proceeds of that business will be assessable income under s. 25(1) of the Income Tax Assessment Act (ITAA) (1936) (Cth)[19]. Accordingly, the taxpayer, is entitled to claim as deductions, expenses and losses necessarily incurred in running that business under s 51(1) of the ITAA[20].

The courts have been rather reluctant to find a business of betting. In Brajkovich v FCT 89 ATC 5227 at 5234, the Full Federal Court stated that 'the gambler who seeks to demonstrate that he is ... a businessman has more to show by way of system and profit motive than those who engage in more conventionally "commercial" activities'. The Commissioner of Taxation has also stated in an income tax ruling[21] that although it is possible for a mere punter to be carrying on a business of betting, it will be rare for a taxpayer with no connection with racing other than betting to be carrying on a business of betting.

The principle criteria for determining whether there is a business of gambling were laid down in Brajkovich at 5233:

- 'whether the betting is conducted in a systematic, organised and "businesslike" way'; - 'its scale: i.e. the size of the wins and losses' -'whether the betting is related to, or part of, other activities of a businesslike character, e.g. breeding horses'; - 'whether the bettor appears to engage in his activity principally for profit or principally for pleasure'; - 'whether the form of betting chosen is likely to reward skill and judgment or depends purely on chance'; - 'whether the gambling activity ... is of a kind which is ordinarily thought of as a hobby or pastime'.

Evidence of a systematic operation includes using a computer as a data base for form guides or to calculate odds; formulating a plan to obtain the best odds; taking steps to lessen the element of chance, maintaining a fund of capital with which to bet; and maintaining adequate daily and weekly records of the taxpayer's position[22].

The Commissioner of Taxation recommends that the factors considered in Brajkovich, Evans and Babka v FCT 89 ATC 4963 be taken into account in determining whether a business of gambling exists[23]. Where the courts find that there is a business of gambling because of a profit motive, a systematic operation or other similar factors, any gambling losses would become deductible under s 51(1) of the ITAA.

iii.  Is there another basis for holding gambling gains to be taxable which does not involve gambling losses being deductible?

Under the current situation, the courts or Boards of Review have found a business of gambling to exist only in cases where gambling gains have been made[24]. Attempts by taxpayers to claim gambling losses as deductions by asserting a business of betting have failed[25]. However, by holding gambling gains taxable were there is found to be a business means that, in future, the taxpayer may claim any gambling losses as deductions (unless it is found that the business no longer exists!).

Where a right to a chance to win a prize in a lottery is received in lieu of income[26], it is not clear whether missing out on the prize could be claimed as a deductible loss. Income tax may be imposed on winnings from such arrangements without involving the deductibility of losses.

Another instance of holding gambling gains taxable without making gambling losses deductible is the winnings from certain investment-related arrangements drawn or decided on or after 24 December 1991[27]. Three criteria must be satisfied before an arrangement qualifies as an investment-related lottery:  (1) The prize must arise as a matter of chance;  (2) The chance to win must be provided partly (if not wholly) because the taxpayer holds an investment with an investment body like a bank or building society;  (3) The chance to win the prize or the prize itself must not otherwise be taxable[28].

There is also the indirect taxation of gambling gains under Part IIIA of the ITAA, which does not allow deductions for gambling losses. Under ss 160ZB(2) and 160ZB(3), a capital gain does not accrue and a capital loss does not incur as a result of a taxpayer's participation in a form of gambling. However, s 160ZB(2) does not apply to an amount of consideration received from the disposal of an asset originally obtained from gambling which may, therefore, give rise to a capital gain. Section 160ZB(3) is silent on the issue of whether a capital loss can be incurred on the disposal of an asset obtained from gambling[29]. This may suggest that capital losses cannot result from the sale of assets acquired from gambling[30].

However, on the grounds of consistency, academic opinion suggests that a capital loss will also arise, given that s 160ZB(2) specifies that a capital gain will result from the sale of an asset obtained from gambling[31]. If a capital loss does arise on the disposal of an asset acquired from gambling and the taxpayer makes a net capital loss under s 160ZC, the net capital loss cannot be deducted against other income but can be offset against capital gains or carried forward against future capital gains instead[32].

In order to make gambling gains taxable in general without allowing gambling losses as deductions, new legislation must be enacted. There is no reason why the legislation cannot specify that gambling losses are not deductible. An example of where certain items are made non-deductible although the corresponding income is taxable is the taxation of income from illegal activities. Income from illegal transactions are subject to tax: Partridge v Mallandaine (1886) 2 TC 179. The same test applies to amounts derived from legal as well as illegal transactions when determining whether they are assessable income or not[33]. However, s 51(4) of the ITAA does not allow deductions for fines and penalties incurred in the process of obtaining income from illegal activities.

Gambling as an activity may be taxed by introducing a consumption tax. Gambling losses would not be deductible under this scheme. However, this would not amount to making gambling gains taxable since anyone who engages in gambling would bear the tax, regardless of whether a gain or a loss is made.

iv.  If gambling gains are to be taxed, should the cost of the winning gamble itself (e.g. the cost of the lottery ticket) be deductible?

Where the courts find a gambling business exists, then any losses or expenses (such as the cost of a winning gamble itself) necessarily incurred in running the business, are deductible under s 51(1) of the ITAA. In order to achieve equity or fairness, any general tax on gambling gains should allow the cost of all winning gambles to be deductible. If a tax is imposed on an increase in spending power[34] or the ability to pay, it should tax the net gain (or real gain) and not the gross gain. This is why s 51(1) allows as deductions, all losses or outgoings incurred in gaining or producing income or are necessarily incurred in running a business to gain or produce such income.

The real issue is not whether the cost of the winning gamble should be deductible but defining the cost of the winning gamble. A taxpayer may argue that a streak of losses in a series of bets were made which led to placing a winning bet and the cost of the winning gamble should include the cost of the series of losing bets. It would be absurd to allow such a wide definition for "the cost of the winning gamble" and any attempt to draw a line between what does and what does not fall within the definition would be arbitrary. Any proposal to make the cost of the winning gamble deductible should define that cost narrowly. Only the cost of the immediate winning bet placed should be deductible.

LIST OF WORKS CONSULTED

Books/Loose-leaf services

CCH Tax Editors, Australian Federal Tax Reporter Vols. 1 & 7, CCH Australia Ltd, Sydney, 1993.

CCH Tax Editors, Australian Income Tax Guide Vols. 1-3. CCH Australia Ltd, Sydney, 1991.

CCH Tax Editors, Australian Income Tax Rulings Vols. 1 & 3. CCH Australia Ltd, Sydney, 1993.

CCH Tax Editors, 1995 Master Tax Guide CCH Australia Ltd, Sydney, 1995.

Cooper, G. S., Deutsch, R. L. & Krever, R. E. Cooper, Krever and Vann's Income Taxation: Commentary and Materials (2nd ed). Law Book Company, Sydney, 1995.

Downing, R. I., Armdt, H. W., Boxer, A. H. & Matthews, R. L. Taxation in Australia: Agenda for Reform Melbourne University Press, Melbourne, 1964.

Grbich, Y., Bradbrook, A. J. & Pose, K. Revenue Law: Cases and Materials Butterworths Pty Ltd, Sydney, 1990.

Greenbaum, A. Australian Income Taxation: A Concise Casebook Law Book Company, Sydney, 1994.

Gzell, I. V. et al. Australian Tax Practice: Capital Gains Tax Vol. 1, Butterworths Pty Ltd, Sydney, 1990.

Kemp, R. K., Steep, A. R. & Fernandez, R. G. Barrett & Green's Principles of Income Taxation (4th ed). Butterworths Pty Ltd, Sydney, 1991.

Lehmann, G. & Coleman, C. Taxation Law in Australia Butterworths Pty Ltd, Sydney, 1989.

McLeod, N., Passant, J. & O'Keeffe, B. Essential Tax Legislation (4th ed). Law Book Company, Sydney, 1995.

O'Grady, G. W. & O'Rourke, K. J. Ryan's Manual of the Law of Income Tax in Australia (7th ed). Law Book Company, Sydney, 1989.

Parsons, R. W. Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting Law Book Company, Sydney, 1985.

Ross, S. & Burgess, P. Income Tax: A Critical Analysis Law Book Company, Sydney, 1991.

Waincymer, J. Australian Income Tax: Principles and Policy Butterworths Pty Ltd, Sydney, 1991.

Woellner, R. H., Vella, T. J., Burns, L. & Chippindale, R. S. Australian Taxation Law (3rd ed). CCH Australia Ltd, Sydney, 1990.

Woellner, R. H., Vella, T. J. & Burns, L. Australian Taxation Law (4th ed). CCH Australia Ltd, Sydney, 1993.

Articles

Ferrers, T. "Two Melbourne Cup Specials" Chartered Accountant Vol. 60, No. 10, November 1989, pp. 36-37. Gherghetta, R. "Taxing the Punter: What's the Betting?" Taxation in Australia Vol. 28, No. 3, September 1993, pp. 141-147.

O'Keefe, A. B. "The Meaning of "Carrying on Business" Under Section 51(1) and Other Sections of the Income Tax Assessment Act" State Convention Paper, Taxation Institute of Australia: Victoria Division 1983, pp. 12-32.

Richards, R. "Gambling: When Does It Become A Business?" Australian Accountant Vol. 59, No. 8, September 1989, p. 92.

Richards, R. "A Lucky Punter" Australian Accountant Vol. 59, No. 9, November 1989, pp. 76-77.

Richards, R. "The 1991 Federal Budget" Australian Accountant Vol. 61, No. 9, October 1991, pp. 26-30.

Searle, P. K. "The Onus of Proof in Asset Betterment Cases: A Review of Ma v Federal Commissioner of Taxation and Case Z32"  Australian Tax Review Vol. 21, No. 4, December 1992, pp. 250-258.

Other Sources

Public Relations Officer, Burswood Resort Casino, Great Eastern Highway, Victoria Park WA 6100, Ph: 362 7777, Date: 26 April 1995.

Racing Division, Office of Racing & Gaming, Hyatt Centre, 3 Plain St, East Perth WA 6004, Ph: 425 1888, Date: 26 April 1995.

Cases

Babka v FCT 89 ATC 4963

Brajkovich v FCT 89 ATC 5227

Case 59 11 CTBR (OS).

Case E38 (1954) 5 TBRD

Case H13 (1956) 8 TBRD

Case H94 (1957) 8 TBRD.

Case K25 78 78 ATC 243

Case T61 (1968) 18 TBRD

Evans v FCT 89 ATC 4540

Graham v Green [1925] 2 KB 37

Jones v FCT (1932) 2 ATD 16

Partridge v Mallandaine (1886) 2 TC 179

Prince v FCT (1959) 12 ATD 45

Trautwein v FCT [1936] HCA 46; (1935-1936) 56 CLR 196

Statutes

Income Tax Assessment Act (1936) (Cth):

Sections 25(1), 51(1), 160L, 160Z, 160ZB(2), 160ZB(3), 160ZC, 160ZO.

NOTES

[1] R W Parsons, Income Taxation in Australia: Principles of Income, Deductibility and Tax Accounting, Law Book Company, Sydney, 1985, p67.

[2] R I Downing, H W Armdt, A H Boxer, R L Matthews, Taxation in Australia: Agenda for Reform, Melbourne University Press, Melbourne, 1964, p63.

[3] Parsons, p67.

[4] Public Relations Officer, Burswood Resort Casino, Great Eastern Highway, Victoria Park WA 6100, Ph: 362 7777, Date: 26 April 1995. 

[5] Racing Division, Office of Racing & Gaming, Hyatt Centre, 3 Plain St, East Perth WA 6004, Ph: 425 1888, Date: 26 April 1995.

[6] Ibid.

[7] Ibid.

[8] Parsons, p20.

[9] R I Downing et al, p63.

[10] Parsons, p21; Y Grbich, A J Bradbrook, K Pose, Revenue Law: Cases and Materials, Butterworths Pty Ltd, Sydney, 1990, p84.

[11] G S Cooper, RL Deutsch, R E Krever, Cooper, Krever & Vann's Income Taxation: Commentary and Materials (2nd ed), Law Book Company, Sydney, 1995, p3-10.

[12] Parsons, p21.

[13] S Ross & P Burgess, Income Tax: A Critical Analysis, Law Book Company, Sydney, 1991, p46; R Gherghetta, "Taxing the Punter: What's the Betting?", Taxation in Australia, vol. 28, no. 3, September 1993, p. 146.

[14] Ross & Burgess, p46. 

[15] Cooper et al, p1-26.

[16] Ross & Burgess, p31.

[17] Ross & Burgess, p18.

[18] Cooper et al, p3-10.

[19] Gherghetta, p141.

[20] Ibid.

[21] IT 2655: Income Tax: Betting and Gambling - Whether Taxpayer Carrying on Business of Betting or Gambling, 17 October 1991.

[22] Evans v FCT 89 ATC 4540 at 4557.

[23] IT 2655.

[24] Trautwein v FCT [1936] HCA 46; (1935-1936) 56 CLR 196; Prince v FCT (1959) 12 ATD 45;  Case K25 78 ATC 243; Case E38 (1954) 5 TBRD; Case H13 (1956) 8 TBRD; Case H94 (1957) 8 TBRD.

[25] Brajkovich v FCT 89 ATC 5227; Jones v FCT (1932) 2 ATD 16; Case T61 (1968) 18 TBRD; Case 59 11 CTBR (OS).

[26] Described as prescribed lottery arrangements. Winnings were to be taxed as income tax under proposed legislation, according to the 1991 Federal Budget papers: R Richards, "The 1991 Federal Budget", Australian Accountant, vol. 61, No. 9, October 1991, p2

[27] CCH Tax Editors, Australian Income Tax Guide, Vol. 1, CCH Australia Ltd, Sydney, 1991, pp532, 533. 28Ibid.

[29] Gherghetta, p145.

[30] Grbich et al, p174.

[31] Gherghetta, p145; CCH Tax Editors, 1995 Australian Master Tax Guide, CCH Australia Ltd, Sydney, January 1995, pp319, 320; CCH Tax Editors, Australian Federal Tax Reporter, Vol. 7, CCH Australia Ltd, Sydney, 1993, para. 78-830; IT 2584 cited in I V Gzell et al, Australian Tax Practice: Capital Gains Tax, Vol. 1, Butterworths Pty Ltd, Sydney, 1990, p3874.

[32] Sections 160ZC, 160 ZO of the ITAA; J Waincymer, Australian Income Tax: Principles and Policy, Butterworths Pty Ltd, Sydney, 1991, p. 81. 

[33] TR93/25 in CCH Tax Editors, Australian Income Tax Rulings, Vol. 3, CCH Australia Ltd, Sydney, 1993, p15,704.

[34] Ross & Burgess, p31.