Windfall Tax: An Overview

Shubhangi Jain

13 Jan, 2023

The government levies a windfall tax on business entities due to abnormal gains from financial windfalls. The main objective of such a tax is reallocating abnormal profits favourably in one sector for social causes. Taxes on winnings from game shows and horse racing lottery tax, gambling or betting are examples of the same.  The present article discusses the overview of a windfall tax.  

What is a Windfall Tax?

A windfall tax refers to the tax levied against certain industries by the government when economic conditions permit those industries to experience significantly above-average profits. Such taxes are primarily levied on companies in the targeted industry having benefited the most from the economic windfall, most often commodity-based businesses. 

How does Windfall Tax Work?

The windfall tax is designed to tax the contributors of a new or external event (like the Ukraine-Russia conflict). Therefore, such tax isn’t on the basis of a regular, actively thought and company’s strategized policy or production process.

It’s usually a one-off tax imposed retrospectively over and above the normal tax rate. Such tax is regularly discussed for goods whose prices are highly volatile, like crude oil. 

These taxes are also related to individual and non-corporate entities suddenly observing a surge in their income levels by receiving a large corpus of wealth from gifts, inheritance, the game of chance, gambling or lottery winnings.

In many cases, inheritance and gifts from friends or relatives are exempted from the recipient’s tax. However, central or regional taxes may be levied on the giver of such inheritance.

Income from winnings from lottery and gambling is charged to tax either in the hands of the recipient or the giver of such income. 

These winnings must be reported in the ITRs (Income Tax Return) to be filed with the federal tax authorities. An individual awarded a huge monetary settlement after winning a legal dispute is expected to pay central income tax on the amount received. Comparatively, monetary settlements such as damages for personal physical ailments or sickness received are not considered taxable by the Tax authorities.

What are the Benefits of Windfall Tax?

The benefits of windfall tax are enlisted below –

• One of the most crucial benefits of this tax is its ability to boost the government’s revenue by helping it substantially provide public services to the citizens of the country, like building civil infrastructure, health facilities, sanitation, and building the nation’s military strength.
• The additional funds raised through windfall tax can service the debts by the countries to various global financial institutions and may bolster the national economy. However, it may also act as a disincentive to companies.
• If companies become aware that windfall gains are being taxed, they may not look out for such profits with innovative business plans^[1]. A part of these receipts has to be parked in a personal contingency fund in bank fixed deposits.
• The beneficiary of windfall gains can repay interest-bearing consumer or car loans, in which case the asset depreciates to lower than the loan outstanding. The other part of windfall gains can be used to repay housing loans to bring down interest costs and EMIs.
• The other alternative can be investing in the windfall proceeds in gold deposits wherein one part of the corpus can be given to a reputable charitable organization catering to the cause of education or health, or child welfare. The donations made to charitable causes can be used to claim deductions from 50% to 100% of the income liable to tax.

Drawbacks

Even after having numerous benefits, the windfall tax has certain drawbacks such as – 

• The economic impact of such taxation might lead to its immediate rejection because it is an arbitrary taxation system which would increase the risks of investing resulting, the investors demanding a higher return on their investments or choosing to stop investing altogether.
• Due to these taxes, there can be a reduction in the dividend payout to investors investing in oil-producing companies. These companies are not owned by cash-rich investors but by pension funds and insurance companies.
• Finally, it would reduce the funds available for investment in sources of fuel, consequently spiking energy costs.

When was Windfall Tax Introduced in India? 

The Indian Government imposed a special additional excise duty on the export of diesel and petrol on 1st July 2022 in order to stem the lack of energy products in the domestic market. There was an addition of ₹6/litre to petrol and ATF (aviation turbine fuel), ₹13/litre was levied on diesel along with the imposition of further export restrictions prior to this, oil companies (like Reliance and Nayara Energy Ltd.) had been opting for selling oil in foreign countries – they were making significant profits as well as depriving the domestic markets of cheap oil.

After July 1, these refiners were incentivised to sell their products to domestic oil marketing companies (such as HPCL and BPCL), bulk sales or retail. OMCs are thereby being relieved, enabling oil purchase at a lower rate without the excise duty from Reliance and others.

However, after some time, there was a reduction in these duties – wherein there was a removal of the export tax on petrol and ATF, the same being cut down to half on diesel, thereby helping in the restoration of confidence of investors in oil refiners such as Vedanta Ltd and raising their stock price. 

Yet again, in October, there was an imposition of a special additional excise duty of ₹3.5/litre on ATF, and the duty on diesel was increased to ₹10.5/litre. This reaction came in response to the temporarily increased international oil prices owing to the OPEC announcement of restricting the production of crude oil.

The quantum of this tax is currently reviewed every fortnight. 

What is the Reason for Levying Windfall Tax Now?

Since late last year, the prices of petrol, crude oil, gas and coal have experienced a significant increase which has been exacerbated by COVID-19 (inclusive of the pump-priming done during the pandemic leading to general inflation) and the Ukraine-Russia conflict (and the subsequent sanctions on Russia). The energy companies made windfall gains at the cost of customers who had to pay much higher prices for their energy consumption. Therefore, the UN Secretary-General requested countries to impose this tax on such companies, which profited massively from the rise in fossil fuel prices. Therefore, apart from India numerous other countries, like the UK, Germany etc., are contemplating towards the imposition of this tax.                                                                      

What is Impact of the Windfall Tax?

 Such a tax shall have the following impact – 

• The global increase in the prices of crude oil can greatly benefit the domestic producers.
• The unwillingness of the oil marketing businesses to sell the product at a loss due to prices not being increased despite higher crude and a weakening rupee, leading to a lack of fuel at retail stores.
• Oil marketing organisations have suffered losses of Rs 20–25 / ltr on diesel and Rs 10-15/ ltr on gasoline due to these two issues.
• The Indian rupee, which on July 1 hit a new low of 79 to the dollar, will benefit from the indirect import and export limitations through duty adjustments intended to lessen the burden on the current account deficit (CAD).
• The government shall receive Rs 7,000 crore yearly from the tax on petroleum, which follows record earnings alone, on roughly 30 million tonnes of domestically produced crude oil.

Conclusion 

The windfall tax was implemented when the companies were quoting absurdly high rates for gasoline during the Russia-Ukraine crisis. The primary goal of this tax is to lower the price of products and services for the end user’s benefit. Implementing global procedures to handle corporate greed and redistribute revenue between the rich and the poor is important.

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