Finance Minister has defended the windfall tax imposed by the Centre on domestic crude oil producers, saying that it was not an ad hoc move but was done after full consultation with the industry.

What is a 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.
• These are profits that cannot be attributed to something the firm actively did, like an investment strategy or an expansion of business.
• The US Congressional Research Service (CRS) defines a windfall as an “unearned, unanticipated gain in income through no additional effort or expense”.
• One area where such taxes have routinely been discussed is oil markets, where price fluctuation leads to volatile or erratic profits for the industry.

When did India introduce this?

• In July this year, India announced a windfall tax on domestic crude oil producers who it believed were reaping the benefits of the high oil prices.
• It also imposed an additional excise levy on diesel, petrol and air turbine fuel (ATF) exports.
• Also, India’s case was different from other countries, as it was still importing discounted Russian oil.

How is it levied?

• Governments typically levy this as a one-off tax retrospectively over and above the normal rates of tax.
• The Central government has introduced a windfall profit tax of ₹23,250 per tonne on domestic crude oil production, which was subsequently revised fortnightly four times so far.
• The latest revision was on August 31, when it was hiked to ₹13,300 per tonne from ₹13,000.

Why govt. introduced windfall tax?

• There have been varying rationales for governments worldwide to introduce windfall taxes like:

1. Redistribution of unexpected gains when high prices benefit producers at the expense of consumers,
2. Funding social welfare schemes, and
3. Supplementary revenue stream for the government

Why are countries levying windfall taxes now?

• Prices of oil, gas, and coal have seen sharp increases since last year and in the first two quarters of the current year, although they have reduced recently.
• Pandemic recovery and supply issues resulting from the Russia-Ukraine conflict shored up energy demands, which in turn have driven up global prices.
• The rising prices meant huge and record profits for energy companies while resulting in hefty gas and electricity bills for households in major and smaller economies.
• Since the gains stemmed partly from external change, multiple analysts have called them windfall profits.

Issues with imposing such taxes

• Companies are confident in investing in a sector if there is certainty and stability in a tax regime.
• Since windfall taxes are imposed retrospectively and are often influenced by unexpected events, they can brew uncertainty in the market about future taxes.
• IMF says that taxes in response to price surges may suffer from design problems—given their expedient and political nature.
• It added that introducing a temporary windfall profit tax reduces future investment because prospective investors will internalise the likelihood of potential taxes when making investment decisions.
• There is another argument about what exactly constitutes true windfall profits; how can it be determined and what level of profit is normal or excessive.
• Another issue is who should be taxed — only the big companies responsible for the bulk of high-priced sales or smaller companies as well— raising the question of whether producers with revenues or profits below a certain threshold should be exempt.

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