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  • Parth Birla, Sakshi Tiwari

Taxing Unearned Income: An Insight into Windfall Taxes

[Parth and Sakshi are students at Hidayatullah National Law University Raipur and Dr Ram Manohar Lohiya National Law University Lucknow, respectively.]


The windfall taxes have again come to the news with the Central Government announcing to completely slash it from INR 4,100 to nil on the domestic petroleum crude oil exports. While previously the government reduced it from INR 6,400 per tonne to INR 4,100 per tonne. The adoption of windfall taxes was a general idea and has been prominent in the news globally due to the change in its trend. Countries worldwide like the UK, Italy and Germany have already levied a windfall tax or are in the process of imposing it. The taxes were first levied by governments worldwide to curb the supernormal profits earned by the public and private energy companies who chose to export fuel to reap the benefits of skyrocketing global prices while affecting domestic supplies.


The taxes were announced by the government on 30 June 2022 (came into force on 1 July 2022) and were under continuous revision every fortnight. The taxes were introduced with the view to restrict the sale of crude oil exports and prevent any further effect on domestic supplies. The rise in exports was a result of an imbalance between energy supply and demand during the COVID-19 pandemic, which was further exacerbated by the Russia-Ukraine war. With the prices equaling to pre-war times, the government issued a notification to reduce the taxes on the fuels. The article is an attempt to analyze the different aspects of windfall taxes in India and assess the need for such taxes at the global level while linking it to the prevailing economic conditions.


Windfall Gains and Taxes


A windfall gain is an income which accrues to an individual or an organization due to unexpected and sudden developments in the market due to market forces and other factors. The windfall gain concerning an individual can be a one-time event such as winning a lottery, a settlement award from a lawsuit, inheritance of a share in property etc. However, from the point of view of an organization or company, the ambit of windfall income is fairly vast. The changing geopolitical affairs and government regulations on trade policy affect the product market of the country or world and lead to organizations earning unexpected returns from the prevailing circumstances. Proceeds or profit from a large sale also fall in the realm of a windfall gain.


A windfall tax can be referred to as the tax levied on some unanticipated gain in income through no additional efforts or expenses. Essentially, the income on which the tax is charged must be earned due to unforeseeable circumstances. The rationale behind charging such taxes is to constrain the producers or manufacturers from benefiting from unanticipated income or windfall income. Companies frequently earn windfall profits in sectors like crude oil, where supply and demand are the primary factors influencing the price of the product turning it highly volatile in nature. In India, a prominent development took place recently in the energy sector as the government decided to charge taxes on the unforeseen income earned by the oil (energy) companies due to the geopolitical changes witnessed in the Russia-Ukraine region. Russia’s invasion of Ukraine did not just affect the livelihood and economic conditions of the citizens of the country but also the markets, economies and businesses worldwide. These taxes are usually retrospective and transitory in nature. For instance, in 2008, a barrel of West Texas Intermediate crude oil cost nearly $130 jumping from roughly $60 a year earlier. Oil and gas companies earned enormous profits, but they were short-lived because a barrel of oil was only trading at $40 per barrel just five months after the price peaked.


Legal Application


Since determining the unusual market behaviour which leads to unanticipated gains is a highly subjective concept, the legality of the windfall tax becomes crucial. Although there is no specific law in India that addresses this issue at the moment, it is safe to say that the government is well within its rights to enact such legislation and rules on taxation under Article 265 of the Constitution of India which mentions “no tax shall be levied or collected except by the authority of law.” According to this, the executive through a notification is empowered to make laws in accordance with the following legal provisions.

The government terms windfall taxes as special additional excise duty which is applied to high-value items. These duties are levied through the Central Excise Tariff Act 1985 and can be applied retrospectively. Section 3 of the abovementioned statute also provides emergency power to the Central Government to increase excise duty given that circumstances exist. The power to apply these additional duties, with the view to promoting the public interest, also emanates from the Fourth Schedule to the Central Excise Act 1944 and Section 147 of the Finance Act 2002. Thus, these additional profits of energy sector companies can be taxed through the above-mentioned provisions.


Windfall Taxes: A Two-Fold View


Analysis of the government’s policy reflects that the windfall taxes have proved to be a double-edged sword. The taxes, on the one hand, become an asset for the government, when it tries to convert such abnormal monetary benefits into investments for social causes and the welfare of the people. On the other hand, levying such taxes, even though retrospective in nature, act as a demotivating factor for producers and the industry as a whole. The increase in such windfall taxes takes away the opportunity to invest in better and more efficient production tools and techniques, and research and development.


While one of the most certain benefits of charging such taxes is the increment in government revenue, another major reason is its efficiency. An argument advanced in favour of a one-off windfall tax is that it is more efficient due to its retrospective nature and that it is based on an external event or change. Charging such a tax is more efficient than imposing a corporate or personal tax as it will find its implication in the future due to which the companies or producers may change or specifically negate their operations to lower their production to decline the taxes. Such behaviour further impacts the economic well-being of the nation while windfall taxes are free from such concerns. They are also more predictable as they are based on past income and events which makes it fair to impose and easy to comply with even for the companies.


However, true to its nature it is accompanied by certain drawbacks. Since these taxes are imposed on an ad-hoc basis, such imposition affects the investments done by the investors. Eventually, it could also lead to a change in the location of such industries in order to avoid such taxes which can be detrimental for the countries that are heavily dependent on such investments and revenues. It might deter the pace of investment even in the renewable energy sector as it discourages the companies to invest and further slows down the development towards increased energy security. Another disincentive can be the ambiguity around what will constitute normal gain and what shall go out of its ambit. The imposition of such taxes also gives way to a one-off subsidy. The oil companies which are asked to pay such windfall taxes may also demand a one-off subsidy as the prices which soar high due to external market factors may also collapse due to the same factors. Such possibilities can be difficult for the government to handle and hence adds up to the drawbacks.


Global Status


Windfall taxes are meant to redistribute gains for the benefit of society as a whole, and not to penalize a particular sector for making excessive profits. The main reason behind the imposition of windfall taxes was the increasing trade deficit of India and a weak rupee that had increased the value of India’s imports. The USA has been imposing such taxes since the 1980s through the Crude Oil Windfall Profit Tax Act 1980, and even Britain has continued the trend of levying such taxes since 1981. In the present scenario, the IMF has suggested that countries impose windfall taxes in the energy sector due to the soaring prices of fossil fuel all over the world. It argues that using tax measures aimed at taxing the “extra” income can be opted for without discouraging investment and will limit future price increases. The UN Secretary-General recommended nations levy windfall taxes on businesses that had profited immensely from the surge in the price of fossil fuels. As a result, nations including the UK, Germany, and others have considered imposing windfall taxes. The possibility of permanent imposition of windfall tax cannot be ruled out in the context of the current state of affairs of the global economy.


Conclusion


Coherent to its volatile nature the windfall tax domain presents varied benefits and losses to different stakeholders. The critical analysis of the data presented by the authorities suggests that crude oil prices internationally and the imposition of windfall taxes go hand in hand in India. For instance, as per the Petroleum Planning and Analysis Cell (PPAC), crude oil prices were as high as $116.01 per barrel in June 2022 and then came down to $78.10 per barrel in December. The trend witnesses an eventual replication with respect to windfall taxes as they were introduced and then slashed by the government. It is worthwhile to note that these taxes turned out to be a big source of income with the government earning at least INR 25,000 crore in the last financial cycle, which was not anticipated in the budget.


Thus, it can be construed that the windfall taxes with respect to India, even though they are necessary for the country’s economy, should not be arbitrary in nature and demand a better legislation framework. The present situation substantiates the need for more organized and specific laws for taxing these profits. Keeping in mind the current policy of the government regarding impromptu revisions in the tax rates, it can be said that it creates uncertainty in the markets and economy. However, the imposition of these taxes does serve the greater good of society to some extent while keeping oil companies in a disadvantageous position.

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