Free Play Held Not to Be “revenue” for Purposes of Tribal Revenue Sharing with a State: Case Analysis Of Pueblo of Isleta v.. Grisham

“Free play” is a marketing tool, broadly within the category of “comps,” used by casinos on the theory that patrons incentivized with complimentary play are more likely to visit the casino or gamble more while there. Free play means credits that are given by casinos to special or new customers, that cannot be converted to cash but can be played on slot machines as if they were cash.

Because states levy significant taxes on commercial (non-Indian) gaming and often require “revenue sharing” (as a percentage of slot machine win) in the context of tribal gaming, the question of how to treat free play for purposes of accounting for payment of taxes or revenue sharing has come up often. The decision in any given case turns on the language used by the state gambling taxation statute or the tribal-state gaming compact revenue sharing provision, but the terms are sometimes viewed as ambiguous because they often do not address free play directly.

The basic dynamic is the same in virtually every jurisdiction. States, which seek to maximize public revenue, wish to view free play as the same as any other money bet on machines, and view all “coin in” as revenue to the casino, no matter whether the patron brought the money to the casino or the casino “comped” the patron with free play. Casinos, on the other hand, whether commercial or tribal, tend to view free play as an expense, not revenue, and claim that it is unfair, and even irrational, to treat free play as part of the gross revenue to the casino.

Millions of dollars are ultimately at stake in determining proper accounting treatment of free play. Some states have dealt with the issue by statute. ¹ Under Nevada statutes and rules, free play has not historically been calculated as part of net revenue; it is counted as “$0 drop,” but it is not deductible as an expense either. ² Prize payouts, however, are deductible. ³ A few cases have reached the courts. ⁴ For a variety of reasons, disagreements about this issue have only rarely produced final decisions in public forums, ⁵ but a federal court recently reached the issue.

In Pueblo of Isleta v. Grisham, ⁶ a federal district court in New Mexico held that free play is not “revenue” for purposes of revenue sharing in tribal-state gaming compacts. The impact of this decision is to limit the amount of revenue the state takes from Indian gaming.

At issue was the state's contention that free play credits offered by tribes should be treated as “coin in” revenue when played and therefore, should be included in calculations to determine revenue sharing with the state. To the tribes, free play reflects a cost rather than net revenue. Thus, tribes argued that such payments should not be included in the calculation of net win, and instead would constitute an illegal tax in violation of the Indian Gaming Regulatory Act (IGRA).

In addressing the issue, the court first confronted an arbitration clause. The arbitration clause provided for arbitration of “payment disputes,” but excluded from arbitration questions of “validity or effectiveness” of the compact. The court held that, although the dispute certainly constituted a dispute about payments owed and thus was encompassed within the broad terms of the arbitration provision, the tribes' underlying claim was whether the revenue sharing provisions were valid if the state's claims were correct. This question of validity was specifically excluded from arbitration. The court thus found that the arbitration clause did not bar the court from reaching the substantive issue.

In reaching the substantive issue of how to account for free play for revenue sharing purposes, the court held that, under Generally Accepted Accounting Principles (GAAP), a gaming operation must exclude the face value of free play, and deduct the value of prizes won as a result of free play, from gross gaming revenue, also known as net win. The court found that GAAP was consistent with the “economic reality” of free play because “a casino doesn't make any money when a customer uses it.” Since the compact required the tribes to calculate net win according to GAAP, the court accepted the tribes' argument that free play should be excluded from net win. Given that the tribes had not agreed to the terms as articulated by the state, the court further held that a compact provision that purports to include revenues from free play would be akin to a tax. It would thus violate IGRA's prohibition of state taxation of Indian gaming revenues.

In reaching its decision, the court noted numerous policy statements by the U.S. Department of the Interior indicating that the state's position on free play was erroneous and illegal, but it declined to defer to those statements, relying instead on its own independent analysis of the issue.

Pueblo of Isleta v. Grisham reached a sensible result. In the Indian gaming context, sovereign states and tribes presumably have the authority to contract around the application of GAAP, but the regulatory structure of the industry is designed to make accounting transparent and casinos easily subject to audit. Adherence to GAAP is important as a regulatory principle. It helps prevent fraud. If parties wish to depart from GAAP, they should do so unambiguously. Likewise, in the commercial gambling taxation context, states should, as a policy matter, adhere to GAAP. Treating free play as revenue in that context is not necessarily irrational, but it imposes an additional tax on a casino. Thus, if a state wishes to treat free play as part of net revenue, it should state so clearly.