(Yet Another) Internet Sweepstakes Update

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Chris McLaughlin

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internet_sweepstakes_1The North Carolina General Assembly banned internet sweepstakes more than four years ago.  The North Carolina Supreme Court upheld that ban more than two years ago.  A few months later that court struck down excessive municipal privilege license taxes on these businesses.  Last year the General Assembly eliminated nearly all municipal privilege licenses, including those on sweepstakes operators, as of this July.

And yet the headlines are still filled with sweepstakes news.  “Greensboro Police Department to begin ‘full enforcement’ of sweepstakes law in March.”  “Sweepstakes, internet cafés put on notice” after Rockingham County sets March 31 as the deadline for sweepstakes operators to cease operations or face criminal prosecution.  What’s going on here?

The motivation for much of this recent news was a N.C. Court of Appeals decision in November 2014 upholding the conviction of two sweepstakes operators for violating the criminal law ban.

The defendants in State v. Chapman argued that their sweepstakes system fell outside the ban because it relied on a “pre-reveal” system.  A “pre-reveal” system is one that shows whether the customer’s sweepstakes entries have won any money before the customer has the opportunity to play an electronic game.

Prior to the ban, most sweepstakes systems offered customers the option of a pre-reveal but defaulted to game play to reveal whether entries were winners.  My field research suggests that very few customers chose this option, for the obvious reason that playing a computer game is more fun than hitting the “reveal” button over and over again. (My field research also produced a profit of $12.  But don’t tell the IRS.)

The criminal law ban passed in 2010 outlawed the use of electronic games or other “entertaining displays.” (See my criminal law expert colleague Jeff Welty’s analysis of what the ban covers and doesn’t cover here.)  After the ban was upheld in 2012, many sweepstakes operators quickly switched to “pre-reveal” systems (or at least claimed to do so) in an effort to skirt the new law.  A handful of prosecutions of these “pre-reveal” system operators achieved mixed results in trial courts across the state, leaving local governments and law enforcement confused as to the legality of sweepstakes businesses in their jurisdictions.

The Court of Appeals ruling in State v. Chapman  was the first appellate court opinion on the issue. In a unanimous decision, the three-judge panel concluded that the 2010 law does in fact ban “pre-reveal” systems.  In justifying its decision to look past the superficial aspects of a particular sweepstake system and focus on the substance of the sweepstakes activity, the court reached back to a one-hundred-year-old N.C. Supreme Court opinion for this entertaining quotation:

[N]o sooner is a lottery defined, and the definition applied to a given state of facts, than ingenuity is at work to evolve some scheme of evasion which is within the mischief, but not quite within the letter of the definition. But, in this way, it is not possible to escape the law’s condemnation, for it will strip the transaction of all its thin and false apparel and consider it in its very nakedness. It will look to the substance and not to the form of it, in order to disclose its real elements and the pernicious tendencies which the law is seeking to prevent. The Court will inquire, not into the name, but into the game, however skillfully disguised, in order to ascertain if it is prohibited[.] It is the one playing at the game who is influenced by the hope enticingly held out, which is often false or disappointing, that he will, perhaps and by good luck, get something for nothing, or a great deal for a very little outlay. This is the lure that draws the credulous and unsuspecting into the deceptive scheme, and it is what the law denounces as wrong and demoralizing.

The court concluded that the ban covered all sweepstakes run via computers that involve electronic games, regardless of whether the games are offered before or after prizes (or lack thereof) are revealed.  The defendants’ convictions were upheld.

The Chapman decision apparently emboldened law enforcement officials across the state, hence the rash of headlines touting more rigorous enforcement of the sweepstakes ban in some communities.

The decision has also prompted lots of calls and emails from local government tax and finance officials asking what it means for their privilege license taxes on sweepstakes operators.  Here are my answers to some of the more popular questions I’ve received.

Does the Court of Appeals ruling mean that all internet sweepstakes businesses in the state are now illegal?

No.  It may be that all of the sweepstakes businesses still operating today are using “pre-reveal” systems similar to the one in State v. Chapman and that all of those systems are in violation of the criminal prohibition against internet sweepstakes. Then again, other courts may reach different conclusions—see this civil case out of Alamance County in which a jury decided that a pre-reveal system did not violate the ban.

The bottom line is that we don’t know which of these sweepstakes, if any, will be charged, tried, and convicted of violating the ban. Unless and until that happens, the presumption of innocence works in favor of all of the sweepstakes businesses operating in the state.

What should I tell someone who wants to open a new sweepstakes business in my town/county?

Feel free to remind them of the ban on internet sweepstakes and that local law enforcement may attempt to enforce the ban on anyone operating a sweepstake business. But I don’t think it’s your job to tell potential sweepstakes operators that what they plan to do is illegal. That’s a job for law enforcement officials, not tax and finance officials.

Should I issue privilege licenses to new sweepstakes businesses?

Yes, assuming your city levies privilege license taxes on sweepstakes businesses. (Counties cannot tax sweepstakes.) A privilege license is simply proof that a business has paid the applicable privilege license tax.  If your city does not levy privilege license taxes on sweepstakes businesses, then there is no privilege license to issue.

If your city does tax sweepstakes, then you should levy the tax for the 2014-2015 tax year and issue a license after you remind them of the ban that may or may not affect their business.  Some cities prorate privilege license taxes for businesses that open in the middle of the tax year; if your tax ordinance calls for proration, then prorate the tax. If your tax ordinance is silent about proration, then charge the business the full amount of the tax for the full 2014-2015 tax year.

Remember that nearly all local privilege license taxes disappear as of July 1, 2015.  Your city should not levy privilege license taxes on any business, sweepstakes included, beginning with the 2015-2016 tax year.  (Note that a very few local privilege license taxes will remain, most important among them the beer and wine taxes I mention here.)

If a business is convicted of violating the ban on internet sweepstakes, does my city need to refund privilege license taxes paid by that business?

Possibly.  G.S. 14-307 bans all local privilege license taxes on the operations of illegal gambling machines. If a business is convicted of violating the ban on internet sweepstakes, then it seems reasonable to conclude that any privilege license taxes paid by that business were taxes levied on the operation of an illegal gambling machine and therefore barred by G.S. 14-307.  I think a convicted sweepstakes operator would have the right to ask for a refund of all local privilege license taxes paid to a city for all years the business was operating in that city.

If a sweepstakes business voluntarily shuts down in the middle of the 2014-2015 tax year due to the threat of criminal prosecution, does my city need to refund privilege license taxes paid by that business?

No, unless your tax ordinance calls for pro-rated refunds for all businesses that close mid-year. If your ordinance does not call for refunds, providing refunds might violate the state constitutional ban against “emoluments” (a fancy word for gifts) of public money to private parties.  (More this issue here.)

G.S. 14-307 would not apply because the business was not convicted of illegal gambling. The mere threat of prosecution would not trigger an obligation to provide a privilege license tax refund to a sweepstakes business that closed in response to that threat.

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2 Responses to (Yet Another) Internet Sweepstakes Update

  1. Alex Hamilton says:

    Should we be going after business personal property listings from them?

    • Yes, absolutely. If these businesses owned personal property as of Jan 1, 2015, then the business owes property taxes on that property for 2015 even if that business later shuts down. Unlike privilege license taxes, those property taxes would still be valid even if the business is later convicted of operating illegal gambling machines.

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