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Context

• The Finance Ministry has lowered Windfall Profit Tax levied on domestically-produced crude oil as well as on the export of diesel and ATF, in line with softening international oil prices.

Overview

• 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.

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 economic conditions come from a sudden windfall gain to a certain business or industry, typically as a result of a geopolitical disruption, natural disaster, or war that causes unusual spikes in demand or supply interruptions. A good example is a confrontation between Russia and Ukraine.
• A tax imposed on such an unexpected rise in profits is called a windfall tax.They are usually imposed when there is a sudden increase in profits in a particular sector. They are also imposed if there is an acute need for a temporary spurt in public spending at the same time.

When did India introduce a windfall tax?

• In July 2022, the government of India enacted windfall taxes amid domestic crude producers making exceptional gains due to the global impact of the Russia-Ukraine war. Domestic players gained tremendous profit by selling crude to refiners at internationally bench-marked pricing.
• Also, due to the confrontation between Russia and Ukraine the central excise charge was reduced, and there were additional expenditures on food and fertilizer. These factors led to an increase in government spending. In order to close the shortfall, the government levied a windfall tax on the oil industry.
• While ₹6/litre was added to petrol and ATF (aviation turbine fuel), ₹13/litre was imposed on diesel.

Why are countries levying windfall taxes now?

• Petrol, crude oil, gas and coal prices have seen major increases since late last year and the increase has been exacerbated by COVID-19 and the Ukraine-Russia conflict (and the subsequent sanctions on Russia).
• As a result, energy companies have made windfall gains at the cost of customers who have had to pay much higher prices for their energy consumption.
• Therefore, the UN Secretary General urged countries to impose windfall taxes on such companies that have profited massively from rise in fossil fuel prices. Therefore, not just India, but many other countries such as the UK, Germany etc. are contemplating imposition of windfall taxes.

Reasons for Implementing Windfall Tax

• India’s record-high trade deficit and a depreciating rupee have raised the value of imports, which is the economic justification for implementing windfall taxes.
• Additionally, the government’s spending increased as a result of the recent reduction in Central Excise Duty and increased spending on fertilizers and food. In order to close this imbalance, it subsequently decided to impose a windfall tax on the oil industry, which increases the government’s revenue.

• • Call from International Organisation: Restitution of these in excessive profits was demanded by the IMF, World Bank, and UN Secretary-General.
  • Conflict between Russia-Ukraine: Oil prices are now fluctuating due to the fighting, and Russian oil is now less expensive.
  • Raise the trade surplus: These actions can reduce the trade deficit that the nation now experiences as a result of its high oil import costs.
  • Benefits distribution: The general public should receive a portion of the company’s revenues.
  • Protect people from inflation: The nation will protect its inhabitants from global inflation by enacting taxes.
  • Social welfare program funding: The profits can be put toward a social welfare program.
  • Increase the revenue: The government’s revenue will rise as a direct result of these taxes. 

Benefits of Windfall Tax

• 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.

Drawbacks of Windfall Tax

• The economic impact of such taxation might lead to its immediate rejection because it is an arbitrary taxation system that would increase the risks of investing resulting, the investors demanding a higher return on their investments or choosing to stop investing altogether.
• A reduction in the number of profits left over for corporate reinvestment. The government may decrease the amount of investment made by businesses by eliminating this easy source of funding.
• Windfall taxes make the tax system unpredictable. Businesses may have legitimate suspicions that the tax will be reimposed in the future. That might deter them from making capital expenditures (investments to increase their output and earnings) because they might be worried that the government might tax some of the potential returns away. As a result, economic growth may be slowed, and the government may face a loss of business from better-established multinational companies.
• Another issue is the idea that retrospective windfall taxes are unfair; in other words, businesses should be informed in advance of the tax laws so they may make decisions about how to behave rather than having their lawfully obtained earnings confiscated.
• Lack of definition – It is hard to give an objective rationale on how much to tax, on what extent of excess income to impose the tax upon, which sectors to tax etc. Hence, it may create discontent among companies, especially smaller companies who could not charge as high an amount during supply shortages, who think that the tax is unfair. Moreover, not all companies may understand the windfall tax definition and may think that it is a tax that is here to stay or it is going to be imposed from time to time for any small increase in the firm’s individual profits.
• 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.

Challenges of imposing the Windfall Tax:

• Cut back on investment: After-tax private sector investment may decrease as a result.
• Problems with exports: If this tax applies to the goods that India exports to other nations, they may be burdened (still it has not been implemented on other products apart crude oil)
• Crisis in inflation: In an era of inflation, it is challenging to retain the windfall tax. Businesses can experience losses and market collapse.

Conclusion

• Windfall taxes do negatively impact the production levels and revenues of oil companies. However, they also bring stabilization in the overall market indices such as Nifty or Sensex if the money collected from the additional tax is used judiciously and the reduced exports allows greater availability of the key raw materials (like crude and refined oil) for the domestic economy.
• Therefore, overall, it may have a positive impact on India’s overall economic stability.