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Let’s talk about Windfall Tax

Heard about the term “windfall”? It basically means some unexpected gain. Received a big fat check from your NRI uncle out of the blue? Yeah, that is a windfall gain.

Then, what would windfall tax mean? Roughly speaking, it would be a tax on that “unexpected gain”. It is a one-off tax imposed on companies that have benefited from something that they weren’t responsible for.

So, why are we talking about Windfall Taxes all of a sudden? Well, as it turns out, there is one sector that has been making “windfall” profits amidst the Russia-Ukraine conflict and that sector is…drumroll… the oil and energy sector. And if companies are making windfall profits, they gotta pay taxes on that too right?

Windfall Taxes

What is Happening?

Economically, the world isn’t doing great. The Russia-Ukraine conflict affected the global economy in a way that no one could have imagined. Global supply chain disruption has inflated the price of oil and consequently, the price of other necessities has shot up too. As the common man continues to suffer under the woes of inflation, companies that refine and sell oil have come out as big beneficiaries owing to sky high price of oil. 

However, it doesn’t seem fair that while most people are struggling with a sharp rise in prices of oil and other necessities, few get to reap “supernormal” profits. To give some context, England based oil and gas company BP saw its profits getting doubled in the first three months of the year while Shell’s profits nearly tripled.
And owing to the huge profits they have been making, taxman’s attention turned to them.

On 26th May, the UK government announced that it would impose a 25% windfall tax on oil and gas companies. And guess what…this is not the first time that the energy sector has had to have to deal with windfall Tax. Back in the 1980s, the US had levied a windfall tax on oil companies when oil price controls were being removed and oil companies were booking superb profits. The UK had levied a “special tax” on North sea oil companies whose profits were multiplying owing to increased oil prices.

Coming back to contemporary times, Along with the UK, countries like Hungary and Italy have also jumped on the bandwagon of levying Windfall Tax on their energy sectors among others.

So, what is the purpose of the Windfall Tax? Is it just to punish companies that are managing to make more profits than others? Now that doesn’t seem fair…

Why Windfall Tax?

Continuing our trail of thought….why windfall tax? Well, in the current context many are making cases for levying it

More resources in the hands of the Government

Inflation has affected the common people the most. With the price of essential goods rising at a much faster rate than paychecks, it is only obvious that governments would have to spend more on welfare schemes to cushion the common people from the impact of inflation.
Increased revenue from windfall taxes would help the government ramp up its spending on public welfare programmes and that in turn may help households who have been hit the hardest by the rising bills. 

 It seems fair

Though this might be more of a philosophical argument, but it makes sense. If someone has managed to make a huge profit purely out of luck, it is only fair that they are asked to share some of their spoils, especially when others are suffering under the same scenario. Moreover, many of these oil companies, receive heavy subsidies from their respective governments. So again when the tables turn, it isn’t unfair to expect the companies to share some of their profits. 

 Better than long term taxes

Windfall taxes are one-off taxes and history has shown that these taxes aren’t kept in force for a long time. So companies may find windfall taxes more favourable as opposed to an increase in corporate tax rates. 

Arguments Windfall Tax

Well, not everyone seems to be onboard with Windfall tax and it shouldn’t come as a surprise that oil and energy companies will oppose it. So let’s hear their side of the story as well

It’s just unfair

The same argument of fairness that can be used to justify windfall tax can also be used to oppose it. Many argue that there is no benchmark to determine what can be called “supernormal” profits. Especially for certain businesses which have fluctuating income, some years can go great while some years can be pretty bad.
Take 2020 for example, owing to covid most of these oil and gas companies had to go through a pretty bad phase, but they did have to bear the brunt of them. So now that they are booking some profits, why share that?

Discourage investments

A very popular yet controversial argument. Many believe that windfall tax may discourage companies from investing in their growth and technology. So, if we take oil companies, for example, they may shy away from investing in technologies which can increase their profit. This is because they may feel that if their profits increase, the government may find another reason to levy windfall tax, thereby again gnawing at their profits. Companies scaling back their expansion efforts may have a detrimental effect on the economy as expansion would lead to cyclic impacts like the creation of jobs, better technology and so on.

Investors likely to suffer

If taxes eat away a significant part of profits, it would definitely mean that investors’ pie share would also become smaller. Not only would investors which may include the general public will get less dividend income, but the government would also witness reduced dividend income from state-owned oil companies. 

India and Windfall tax

Well, guess what…in India too, there have been some whispers around levying Winfall Tax on oil and gas companies. Companies like Reliance or even state-owned ONGC have been booking record profits, naturally inviting the attention of the taxman.

Like the entire globe, India is also witnessing inflation and in order to tackle that, the Indian Government has announced inflation-fighting fiscal measures worth almost INR 2 lakh crore. So, given India’s increasing expenditure burden, additional resources via windfall tax does sound like a tempting option. While some experts and policymakers believe that this is a good step to take, others may feel that it is unfair and may also have the potential to destabilise our current tax system.

Although the murmurs are getting louder, there has been no official confirmation or declaration from the Indian Government. So which team are you on?

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Got Questions? Ask Away!

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    Hope this helps!

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