The tax differential?

The Deloitte/Ladbrokes report published today re-awakens the old argument that being a layer on an exchange is the same as being a bookmaker. Sometimes, this argument is used to say that it is therefore unfair that exchange layers are not taxed and levied as if they were bookmakers. Today, it is to maintain that the tax and levy take is somehow diminished because returns that should be captured are not. Either way, it is argued that £100 lost to a “bookie” makes £10 in levy and £15 in tax; but every £100 lost on Betfair generates 50p and 75p.

That is, of course, true in a one-bet world; but only if the punter loses that bet. The punter who wins his bet takes £100 off a traditional bookmaker who then pays no levy (or tax) at all. In fact, the next punter who loses £100 to the bookie only allows the operator to make up for his earlier loss: the traditional bookie's profit is still zero, so he still pays no levy or tax. In a two-bet world, the bookie could still have contributed nothing.

In fact, if you continue all day with one punter winning £100 and another losing £100, then Ladbrokes can take an infinite number of bets and pay no levy or tax because it would make no profit. In the same scenario, Betfair would pay 50p every time in levy and 75p every time in tax (given that one punter wins, pays Betfair its commission of £5, and Betfair pays 10% of that in levy and 15% of it in tax; so you might prefer to say an average of £3 in commission (which is charged on a sliding scale from 2-5%) and therefore 30p and 45p, but the argument is the same)).

Of course, in reality traditional bookmakers do not allow punters to win and lose exactly £100, unless they (the bookmakers) are very bad at what they do (which they aren't). When a punter loses £100, another one wins around £85, leaving profit on which levy and tax are paid. Bookmakers do not pay levy and tax on the £100 lost, but on the difference between what money is lost and what money is won – or, profit. And their higher profit margin does not necessarily make them more money. (If it did, in any industry, then why would anyone offer a lower price? Why is Walmart - a business which set out to cut margin - one of the world's most successful companies? How can Ryanair make more money than British Airways?)

Most bookmakers build a risk margin into their pricing to account for ‘bad’ results, and in general the risk premium is about 1.5%-2% per possible outcome. An 8-runner horserace has a 12%-15% over-round just to account for the risk; a football match, somewhere between 4 and 6%. Betfair takes the need for a risk margin out, because it uses its technology to enable it only to accept a bet if it can find a person or group of people who have the opposite view. So its margin for racing (with multiple outcomes) is no different than its margin for a tennis match (with two): only the operator’s margin remains in the price – consistent across all products - which is what makes Betfair’s prices consistently better: it doesn't add the traditional bookmaker's additional protective margin to account for risk.

Most people do not realise that this is what drives Betfair’s pricing, but think Betfair’s prices are better because they are “person-to-person”. Actually, Betfair is ‘many-to-many’ (rarely do any two bets match perfectly), but in any case, this has no effect on pricing. Betfair is merely matching supply and demand like any other bookmaker, and differs only by doing so perfectly, rather than approximately.

The traditional bookmaker's argument, which returns in the Deloitte report, is that Betfair’s prices are set by people who are really bookies acting without permits, laying prices just as a bookie does and therefore conducting the same business on Betfair with none of the associated costs. The ‘unlevel playing field’ argument says these people can offer better prices because they don’t pay levy and tax that they would have paid, giving them lower costs and somehow reducing the tax (and levy) take. It raises a simple question: if Betfair prices are better because they're generated by bookies without costs, then why are the odds offered by bookmakers offshore, who pay neither 10% levy nor 15% GPT and therefore don't have these costs either, not in turn significantly better than those onshore? You would expect them to be the same prices as Betfair's prices, not as traditional onshore bookies' prices. but in fact, the reverse is true. The answer is that it isn't the tax and levy cost that is determining the additional margin: it is the risk.

No-one is denying that there are former bookies who now play on Betfair. That would be absurd. But there are also former airline pilots who travel in passenger jets. They’re still in the air, perhaps even on the same routes; but they aren’t in control of the plane, they don’t need a licence to fly, and they aren't taxed as if they were pilots. Bookies who become punters take their chances like other punters - without contact with customers, and with no means of attracting business. On the whole, it is true that punters lose and operators win. But winning punters aren’t bookies just because they get it right,and there are plenty of examples of winning customers with bookmakers who look terribly professional but are still punters nonetheless.

So is it true, as stated in the Deloitte report, that 'therefore the levels of tax and levy are smaller compared to traditional bookmakers'? Or, to put it another way, does Betfair really enable non-payment of levy and tax because its layers should be paying levy too, on the grounds that they are bookmakers, and if they paid levy and tax as individuals, the levy and tax take would go up?

No, it isn't, for the simple reason that, contrary to conventional wisdom, the words ‘bookmaker’ and ‘layer’ are not inter-changeable. On Betfair, a layer is simply a punter (and no punter, professional or otherwise, pays levy or tax) who takes a view that the price over-states a horse’s chance of winning (just as a backer thinks it understates it).

In non-horseracing contexts, this is clear. A seller of shares thinks a company is over-valued, and a buyer that a company is under-valued. Neither the buyer nor the seller is a stockbroker. Equally, punters bet at Ladbrokes that Tiger Woods will not win the next Major. They do not suddenly become bookies as a result, any more than Ladbrokes suddenly becomes a temporary punter. But the exact same bet placed on Betfair requires you to lay Tiger Woods. It is a basic fact that it is not through expressing a negative view that you become a bookmaker, even if it does make you a layer So, what does make you a bookmaker?

The answer, in legal and regulatory terms, is that you provide a means to bet; accept stakes; hold money on behalf of clients; guarantee to pay out; can offer incentives to bet; ensure that the vulnerable are not taken advantage of, and that underage people do not bet; and you keep crime out. All of these things, Betfair does; not one can be done by any clients (of Betfair or any other bookmaker). Customers (Betfair and elsewhere) simply express their view on an outcome; present the total sum of money that they might lose; and, if they win, collect. Bookmaking has nothing to do with being the first to make a price (a bookie is perfectly entitled legally to change his price); nor about which side of the outcome you take. It is about being in a position of trust vis-a-vis the customer. For this, you require a licence which allows you to do things like tout for business.

For almost ten years now, the traditional bookmakers have pushed the argument that ‘Betfair layers are bookmakers’, as the Deloitte report published today implies. In reality, backing and laying are entirely interchangeable, and it’s just a question of how good you are at maths. Laying on Betfair is betting an outcome will not happen: layers enjoy no advantage over backers; and most Betfair customers make both back and lay bets. Betfair data, examined at great length by the Treasury, shows that a punter predominantly backing is as likely (or unlikely) to be profitable as a punter predominantly laying.

Customers who bet with traditional bookmakers are not taxed and levied; the licensed bookmaker is. That licensed bookmaker pays tax and levy on the differential between what it takes in from losses and what it pays out in winnings. Exactly the same is true on Betfair. No amount of repeating an argument which doesn't stand up to scrutiny is going to change that, so can we finally, a decade later, move on?