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explained | What is windfall tax and why are countries imposing it on the energy sector right now?

Big energy companies posted huge profits in the first half of this year, leading to record windfall profits that governments tried to rein in

Big energy companies posted huge profits in the first half of this year, leading to record windfall profits that governments tried to rein in

the story So Far: Finance Minister Nirmala Sitharaman on Monday, September 2 defended the windfall tax Center imposed on domestic crude oil producersStating that this was not an ad-hoc move but was done after full consultation with the industry.

The central government on July 1 introduced a windfall tax of ₹23,250 per tonne on domestic crude oil production, which has since been revised four times every fortnight till now. The latest revision was done on August 31, when it was raised from ₹13,000 to ₹13,300 per tonne. Ms Seethraman explained the introduction of the windfall tax as a way to rein in the “unprecedented gains” made by some oil refineries, which have exported fuel to take advantage of skyrocketing global prices while impacting domestic supply. chose to do

Apart from India, several countries including the United Kingdom, Italy and Germany have already imposed windfall tax on super normal profits of energy companies or are considering doing so.

What is windfall tax?

Windfall taxes are designed to tax profits derived from an external, sometimes unprecedented event – ​​for example, energy price-rise as a result of the Russia-Ukraine conflict.

These are profits which cannot be attributed to any investment strategy or expansion of business actively undertaken by the firm. United States Congressional Research Service (CRS) defines windfall As “unearned, windfall gains in income without any extra effort or expense”.

Governments typically levy such profits retroactively as a lump-sum tax over and above normal rates of tax, which is called a windfall tax. One area where such taxes are regularly discussed is the oil market, where fluctuating prices lead to unstable or uncertain profits for the industry.

From the redistribution of windfall profits to governments around the world, when producers benefit at the expense of consumers, to funding social welfare schemes, and from the redistribution of windfall profits, as a supplemental revenue stream for the government, There are different arguments for imposing taxes.

For example, in 1980, then-President of the United States Jimmy Carter Introduced a crude windfall tax on the country’s oil industry. This was because between 1979 and 1981 the US government began issuing controls on oil prices, anticipating that the deregulation would bring huge profits to oil companies. This meant that the prices would rise to the level of the world market by then limited by the government; The US government’s Joint Committee on Taxation estimated that decontrol would increase profits for the oil industry by more than $400 billion.

Therefore, in order to recover more of the revenue going to the oil industry as a result of decontrol, the government imposed windfall tax, the CRS paper note.

Why are countries imposing unexpected taxes now?

Oil, gas and coal prices have seen a sharp increase since the end of last year and the first two quarters of the current year, although less recently. An August paper by the International Monetary Fund (IMF) said, “The economic recovery from COVID-19 has resulted from a combination of several factors, including the mismatch between energy demand and supply, triggered by the Russian war in Ukraine.” and has been extended.” , The recovery from the pandemic and supply issues as a result of the Russia-Ukraine conflict drove energy demand, raising global prices.

Rising prices meant huge and record profits for energy companies, resulting in huge gas and electricity bills for households in economies large and small. Since gains stem partly from external changes, many analysts call them windfall gains.

In early August, UN Secretary-General Antonio Guterres said, Strongly criticized “bizarre greed” Big oil and gas companies vying for record profits from the global energy crisis on the backs of the world’s poorest. He said it was “unethical” that the largest energy companies made a combined profit of nearly $100 billion in the first quarter of the year.

Big oil companies’ second-quarter profits outperformed previous one—Exxon Mobil posted its biggest quarterly profit in history in Q2 2022 at $17.9 billion, BP posted its second-quarter profit of $8.45 billion (over 14 years). highest), and Saudi Aramco’s quarterly profit nearly doubled from $25.5 billion last year to $48.39 this time.

The UN chief urged all governments to tax these exorbitant profits “and use the money to support the most vulnerable in this difficult time.”

The call for the imposition of unpredictable taxes also found support in organizations such as the IMF, which issued an advisory note on how such a tax should be levied. The head of the Organization for Economic Co-operation and Development (OECD), Mathias Kormann, also recommended in March that, given the windfall gains, European governments should focus on energy company profits to help fund aid programs for those most affected by inflation. Unexpected taxes.

Former UK Chancellor Rishi Sunak in May announced an unexpected 25% tax on oil and gas producers in the British North Sea, which was approved by lawmakers in July. The government said the tax, called the Energy Profit Levy (EPL), would raise 5 billion pounds ($5.95 billion) a year to help Britons struggling with rising energy bills.

In July, India announced an unexpected tax on domestic crude oil producers who believed they were taking advantage of higher oil prices. This Additional excise duty also imposed On diesel, petrol and air turbine fuel (ATF) exports.

India’s case was different from that of Europe, as it was still importing subsidized Russian oil. sources told The Hindu Business Line that the windfall tax was primarily targeted at Reliance Industries Ltd and Russian oil major Rosneft-backed Naira Energy, which the government believed was killing off exports of large quantities of the fuel made from Russian oil at the expense of the domestic market. Was doing.

Read also:Reliance, Naira face windfall tax on exports as well as local supplies

Analysts also saw the unexpected tax as a way for the Center to narrow the country’s widening trade deficit.

In Germany, except the finance minister in the ruling coalition, most parties were keen on the idea of ​​imposing an unexpected tax on the “excessive” profits of energy companies. Chancellor Olaf Scholz announced over the weekend that the country had decided to impose an unexpected tax or “coincidence tax” on power companies partly to protect its citizens from rising inflation in a 65 billion euro ($64.7 billion) package. to be financed.

The IMF noted that Italy has already imposed a one-time 25% tax on energy companies, while Spain has announced a temporary windfall tax for extraordinary profits earned by power utility companies in 2022 and 2023. Romania also introduced an 80% windfall tax on additional revenue earned by electricity producers.

What are the problems in levying such taxes?

Analysts say companies are confident of investing in any sector if there is certainty and stability in the tax regime. Since unforeseen taxes are levied retrospectively and are often affected by unforeseen events, they can create uncertainty in the market about future taxes.

Stuart Adam, a senior economist at the Institute for Fiscal Studies in London, told Deutsche Welle (DW) that he is not keen on such taxes. “It’s better to say in advance how much you’re going to be taxed under different circumstances and then do so rather than suddenly creating a one-time surprise in the tax system.”

German economist Andreas Peichl said Reuters That such taxes are populist and politically appropriate in the short run.

The IMF advice note also noted that taxes in response to price increases can suffer from design problems—given their quick and political nature. It states that “introducing a temporary windfall tax reduces future investments because potential investors will internalize the potential for potential taxes when making investment decisions”.

There is another argument about what a real windfall profit actually is and how it can be determined whether the level of profit is normal or excessive. a CRS reportFor example, argue that if a rapid rise in prices leads to high profits, then in one sense it can be called real unexpected because they are unpredictable, but on the other hand, companies can argue that it is that profit. Which he has earned as a reward for the industry. Taking risks to provide petroleum products to the end user.

Another issue is who should be taxed—large companies responsible only for high-value sales or the bulk of smaller companies—raising the question of whether producers with revenue or profits below a certain threshold are exempt. Should be known

In addition, the windfall tax imposed by Italy has already faced a bottleneck; Reuters reported that several Italian electricity, oil and gas companies had not paid their 40% installment of untaxed taxes by the scheduled June date, leaving the government with a revenue shortfall of approximately $9 billion.

Notably, when a uniform tax on domestic oil companies was introduced by the US in the 1980s, the revenue generated for the government was far less than it had anticipated, while the tax also reduced domestic oil production. reduced and increased imports.

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