In today's Finshots we talk about windfall tax and the debate surrounding this controversial topic

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The Story

For the past few days, the Indian media has been abuzz with one phrase — windfall taxes. And when state-owned Oil and Natural Gas Corporation (ONGC) announced its highest ever net profits, the whispers became louder — will the Indian government impose a windfall tax on the company?

After all, countries like Hungary, Italy, and the UK have already imposed a windfall tax over the past couple of weeks.

But what is this windfall tax everyone’s going on about?

Okay, first let’s look at what’s happening right now. Globally, oil and gas prices are at an 8-year high. And it’s rising each day because there’s a mismatch in demand and supply precipitated by Russia’s war on Ukraine — at least partially.

And these vagaries have benefited a select few companies. Companies that refine and sell oil— like ONGC and Reliance. They’ve managed to capitalize on this price rise and they’re now in line to reap “supernormal” profits.

On the other hand, common folk continue to struggle. Inflation is at an almost decadal high in India, and there’s no respite anywhere. So the public perception is changing. They want some of the beneficiaries to share their spoils. They want oil and gas companies (and others like them) to pay a one-off tax on account of the supernormal profits they’ve generated this year.

A windfall tax so to speak.

And no, it’s not a novel idea. The idea actually dates back to World War 1 — when the UK introduced something called the Excess Profits Duty. At the time, the idea was to divert the tax income to aid the war effort. So the government slapped a 50% tax on profits that were above the “normal” level. And as the war dragged on, they upped the rate to 80% in 1917. It was only abolished in 1921 — a full two years after the war had ended.

Did businesses revolt? Not quite. They felt it was their patriotic duty. They paid up.

And so there’s an argument to be made that windfall taxes can aid the economy once again as we navigate through the pandemic. Maybe they can help governments tide the crisis. Lend a helping hand of sorts.

But companies will argue otherwise.

In fact policymakers in India flirted with the idea of windfall taxes way back in 2008. And needless to say, private players like Reliance opposed the initiative. They argued that it would be patently unfair to tax away proceeds (above and beyond the normal threshold) simply because oil prices went on a rally. The next tryst with windfall taxes came in 2018. But almost everyone shot back at the proposal including ONGC.

However that still doesn’t explain why companies don’t want to share a part of their spoils.

Well, let’s suppose you rephrase the “definition” of a windfall tax and call it a “punishment.” A punishment meted out simply because one entity had a good year.

The thing is — Companies will argue that there is no such thing as a “normal year.” Some years are good. Some years not so much. Profits are never guaranteed and arbitrary taxation affects business sentiment. If companies come to expect that windfall gains could be taxed in the future, they’ll likely adjust their spending. They may shy away from investing in projects that drive growth and simply spend most of their profits away. For instance, a company like ONGC and Reliance may hesitate to set up new exploration projects and scale back expansion efforts.

And you also have to ask — In industries that are prone to cyclical adjustments what counts as “supernormal” anyway?

Remember in 2020, these companies had a horrid time dealing with a complete capitulation in oil prices. They had to bear the costs themselves. And now that they’re doing well for a brief period, you want to tax away their gains?

That’s what the companies will want to know.

So yes, you could make an argument that these companies need to pay more in years of plenty. However, considering that oil and gas companies are often subject to the mercy of demand-supply mismatches, is it fair to ask them to do so?

Let us know your thoughts…

Until then...

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