What is windfall tax?
A windfall is an unearned, unanticipated gain in income through no additional effort or expense. A tax imposed on such an unexpected rise in profits is called a windfall tax. They are usually imposed when there is a sudden increase in profits in a particular sector. They are also imposed if there is an acute need for a temporary spurt in public spending at the same time.
How windfall taxes work?
Windfall profits taxes are designed to tax the benefactors of a new or external event (such as the Ukraine-Russia conflict). Therefore, the tax is not based on a regular, actively thought and strategized policy or production process of the company – it is usually a one-off tax imposed retrospectively over and above the normal tax rate. Windfall taxes are regularly discussed in the context of goods whose prices are highly volatile, such as crude oil.
When did India introduce a windfall tax?
On 1st July 2022, the Government of India had imposed a special additional excise duty on the export of petrol and diesel in order to stem the lack of the energy products in the domestic market. While ₹6/litre was added to petrol and ATF (aviation turbine fuel), ₹13/litre was imposed on diesel. Further export restrictions were also imposed. Before then, oil companies (such as Reliance and Nayara Energy Ltd.) had been preferring to sell the oil in foreign countries – they were making significant profits as well as depriving the domestic markets of cheap oil.
Post July 1, these refiners were incentivised to sell their produce to domestic oil marketing companies (such as HPCL and BPCL), bulk sales or retail. OMCs thereby received a relief as they could buy oil at the lower rate without the excise duty from Reliance and others.
After some time, these duties were reduced – the export tax on petrol and ATF was removed and the one on diesel was more than halved. This helped restore confidence of investors in oil refiners such as Vedanta Ltd and raise their stock price.
However, again in October, a special additional excise duty of ₹3.5/litre was imposed on ATF while the one on diesel was increased to ₹10.5/litre. This reaction came as a response to the temporarily increased international oil prices due to the OPEC announcement of restricting production of crude oil.
The quantum of the windfall tax is currently reviewed every fortnight.
Why are countries levying windfall taxes now?
Petrol, crude oil, gas and coal prices have seen major increases since late last year and the increase has been exacerbated by COVID-19 (including the pump-priming done during the pandemic leading to a general inflation) and the Ukraine-Russia conflict (and the subsequent sanctions on Russia). As a result, energy companies have made windfall gains at the cost of customers who have had to pay much higher prices for their energy consumption. Therefore, the UN Secretary General urged countries to impose windfall taxes on such companies that have profited massively from rise in fossil fuel prices. Therefore, not just India, but many other countries such as the UK, Germany etc. are contemplating imposition of windfall taxes.
What are the issues with imposing windfall taxes?
- Creates uncertainty – Investments increase when the regulatory environment is stable and inspires business confidence. However, if the taxes keep getting imposed and withdrawn, then producers are unsure of their investments.
- Lack of definition – It is hard to give an objective rationale on how much to tax, on what extent of excess income to impose the tax upon, which sectors to tax etc. Hence, it may create discontent among companies, especially smaller companies who could not charge as high an amount during supply shortages, who think that the tax is unfair. Moreover, not all companies may understand the windfall tax definition and may think that it is a tax that is here to stay or it is going to be imposed from time to time for any small increase in the firm’s individual profits.
Windfall taxes do negatively impact the production levels and revenues of oil companies. However, they also bring stabilisation in the overall market indices such as Nifty or Sensex if the money collected from the additional tax is used judiciously and the reduced exports allows greater availability of the key raw materials (like crude and refined oil) for the domestic economy. Therefore, overall, it may have a positive impact on India’s overall economic stability.