Windfall Tax

Finance Minister Nirmala Sitharaman defended the windfall tax imposed by the Centre on domestic crude oil producers. She said the introduction of the windfall tax as a way to rein in the phenomenal profits made by some oil refiners. These refiners chose to export fuel to reap the benefits of skyrocketing global prices while affecting domestic supplies.

Background –

• The Central government on July 1, introduced a windfall profit tax of ₹23,250 per tonne on domestic crude oil production.
• This was subsequently revised fortnightly four times so far.
• Analysts believe that the windfall tax in India was targeted mainly at Reliance Industries Ltd and Russian oil major Rosneft-backed Nayara Energy.
  • As per the government, these companies were making a killing on exporting large volumes of fuel made from discounted Russian oil at the cost of the domestic market.
    • Keeping the national interest in mind, India started to import cheap Russia oil after the Ukraine war.

What is ‘windfall tax’?

• Windfall taxes are designed to tax the profits a company derives from an external, sometimes unprecedented event— for instance, the energy price-rise as a result of the Russia-Ukraine conflict.
• The United States Congressional Research Service defines a windfall as an unearned, unanticipated gain in income through no additional effort or expense.
• These are profits that cannot be attributed to something the firm actively did, like an investment strategy or an expansion of business.
• Governments typically levy a one-off tax retrospectively over and above the normal rates of tax on such profits, called windfall tax.

Rationale behind imposing windfall taxes –

• Redistribution of unexpected gains when high prices benefit producers at the expense of consumers,
• To fund social welfare schemes,
• As a supplementary revenue stream for the government,
• As a way for the Centre to narrow the country’s widened trade deficit.

Why are countries levying windfall taxes now?

• Prices of oil, gas, and coal have seen sharp increases since late last year and in the first two quarters of the current year, although having reduced recently.
• The increase stems from a combination of factors, including a mismatch between energy demand and supply during the economic recovery from COVID-19, further amplified by the Russian war in Ukraine.
• The rising prices meant huge and record profits for energy companies while resulting in hefty gas and electricity bills for household bills in major and smaller economies.
  • Eg., the combined profits of Shell, Exxon Mobil, Total Energies, BP, Chevron Corp and Saudi Aramco went from $45.09 billion in Q2 2021 to $107.64billion in Q2 2022.
• Since the gains stemmed partly from external change, multiple analysts have called them windfall profits.

Multilateral institutions supporting windfall tax –

• The calls to introduce windfall taxes found support in organisations like the IMF, UN, and Organisation for Economic Co-operation and Development (OECD).
• Recently, the U.N. chief urged all governments to tax these excessive profits and use the funds to support the most vulnerable people through these difficult times.
  • He said it was immoral that the largest energy companies in the first quarter of the year made combined profits of close to $100 billion.

Issues with windfall tax –

• Brings uncertainty in the market —
  • • Since windfall taxes are imposed retrospectively and are often influenced by unexpected events, they can brew uncertainty in the market about future taxes.
    • This may affect the future investment in the related sectors.
• Populist in nature —
  • • Many analysts believe that such taxes are populist and politically opportune in the short term.
    • The IMF advice note also said that taxes in response to price surges may suffer from design problems—given their expedited (quick) and political nature.
• Profits earned in such instances are reward for the risk taken —
  • • Companies argue that it is the profit they earned as a reward for the industry’s risk-taking to provide the end user with the petroleum product.
• Who should be taxed is another issue —
  • • Another issue is who should be taxed — only the big companies responsible for the bulk of high-priced sales or smaller companies as well.
    • This raises the question of whether producers with revenues or profits below a certain threshold should be exempt.