Explained | What is windfall tax and why are countries imposing it on the energy sector right now?

Big energy companies clocked huge profits in the first half of this year, making record windfall gains which governments have tried to rein in  

The story so far: Finance Minister Nirmala Sitharaman on Monday, September 2, 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.

The Central government on July 1, 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. Ms. Sithraman explained the introduction of the windfall tax as a way to rein in the “phenomenal profits” made by some oil refiners who chose to export fuel to reap the benefits of skyrocketing global prices while affecting domestic supplies.

Besides India, a wave of countries including the United Kingdom, Italy, and Germany have either already imposed a windfall profit tax on super normal profits of energy companies or are contemplating doing so.

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 United States Congressional Research Service (CRS) defines a windfall as an “unearned, unanticipated gain in income through no additional effort or expense”.

Governments typically levy a one-off tax retrospectively over and above the normal rates of tax on such profits, called windfall tax. One area where such taxes have routinely been discussed is oil markets, where price fluctuation leads to volatile or erratic profits for the industry.

There have been varying rationales for governments worldwide to introduce windfall taxes, from redistribution of unexpected gains when high prices benefit producers at the expense of consumers, to funding social welfare schemes, and as a supplementary revenue stream for the government.