Indian Stocks Intermediate

Everything you need to know about windfall tax

Windfall tax

Understanding windfall tax

Some taxes are levied as a one-time tax. Windfall tax is one such tax that broadly comes under capital gains tax. Profits or gains arising from the transfer of a capital asset are called capital gains, and such gains are taxed as capital gains tax. In normal usage, a capital asset is any kind of property, securities (stocks), jewelry, etc.

What is the windfall tax?

Some sectors or industries may unexpectedly make sudden significant gains from unforeseen circumstances, like an increase in prices or demand or supply crunches. In such cases, a windfall tax is levied.

The purpose of windfall tax

It is a means to equitably share part of the disproportionate wealth derived from unexpected events or exceedingly favorable circumstances.

Governments can use tax revenue to provide tax breaks to the needy, fund social projects, or reduce the national debt.

How windfall tax differs from other taxes

  1. Compared to other taxes, this tax is progressive as it targets only the richer sections of society, not the general public.
  2. Since windfall gains are a one-time event, this tax is temporary.

Windfall tax in different countries

How governments implement windfall tax in different countries? Here are some notable examples.

  1. In 2022, the disruptions to oil supply due to the Russia–Ukraine war resulted in unexpected profits for oil producers in the United Kingdom, Germany, and Italy. A windfall tax was levied.
  2. In 2018, in Norway, a windfall tax was levied on the enormous profits made by the country’s largest banks.
  3. In 2010, the Australian government levied the Mineral Resource Rent Tax on the mining companies, which made huge profits.
  4. In 2004, the Venezuelan government levied a windfall tax on the huge profits earned by foreign oil companies.

Comparison of windfall tax rates in different countries

Different countries levy windfall tax ranging from 30% to 70% beyond a prescribed profit limit.

In India, a windfall tax of 10% was introduced in 2008 on oil and gas companies but was withdrawn in 2009. In July 2022, India reintroduced the windfall tax on crude oil and has been progressively reducing it.

The impact of windfall tax on different industries

As this impacts the profitability of the oil and gas sector, it will not attract fresh investments. Employment opportunities shrink, and the cost of energy increases for consumers.

  1. Mining companies lose opportunities to cash in on high commodity prices, resulting in a lower infusion of capital, reduced employment, and an increase in commodity prices for consumers.
  2. Demand for information technology and digital services saw a spurt during the pandemic. But the levy of this tax could result in lower capital inflows, reduced employment opportunities, and an increase in the price of services.
  3. The pandemic saw an increase in demand for vaccines and treatments. However, a windfall tax in the pharmaceutical sector would impact fresh capital inflow, reduce employment opportunities, and lead to a rise in medical costs.
  4. Windfall tax on the real estate property developers sector would stifle the opportunity to benefit from a surge in property values. This affects employment opportunities and raises rental rates and the cost of buying homes.

Windfall tax and capital gains

It will be interesting to understand how windfall tax applies to capital gains.

Presently, the windfall tax levied in India is for the capital gains earned by the crude oil sector, and it is at stipulated rates per barrel of crude oil.

The impact of windfall tax on capital gains tax rates

Since the government has total control over crude production, whatever windfall tax or capital gains tax is levied, gets absorbed in the pricing mechanism.

How to minimize the impact of windfall tax on capital gains

  1. Familiarize yourself with the tax laws and be aware of eligible deductions/ exemptions.
  2. Retain the asset for a longer period. The tax rates could decrease.
  3. Explore options of tax-deferred accounts where the tax becomes payable only when withdrawn.
  4. Charitable donations could attract tax deductions.
  5. Windfall tax and dividends

Windfall tax and dividends

How windfall tax is applied to dividends

Windfall tax on dividends would apply to large companies paying out dividends to their shareholders. The company would need to pay this as an additional tax over and above the taxes on profits.

The impact of windfall tax on dividends

Dividends are paid out of the profits of the company, and the calculations factor in all taxes payable by the company. So, this will not impact current dividends. However, since the profits have been reduced, this could hurt future dividends. The windfall tax being a one-time event, may not affect investor sentiment.

How to minimize the impact of windfall tax on dividends

  1. If the dividend arises only from a single source, there are greater chances of a windfall tax being levied. Explore diversification.
  2. Explore tax-deferring strategies and options as discussed earlier.
  3. The reinvestment of dividends could be a viable option.
  4. Windfall tax and businesses

Windfall taxes and businesses

How windfall tax affects businesses

  1. It impacts the profitability of the enterprise.
  2. Less availability of capital hurts the growth prospects of the business.
  3. The business may change its approach toward product pricing or investment outlay.
  4. The business faces a competitive disadvantage in the market from peers.

How to minimize the impact of windfall tax on businesses

  1. Examine if you can defer some of the profits to the next year. Make donations to charity or make capital purchases that you can offset against profits.
  2. Try to convince the tax authorities that you were expecting some part of the profits to come in. Convince them that the tax levied is too high.
  3. Bifurcate your business into distinctly separate entities, splitting the profits into chunks.
  4. Explore tax deduction routes or credits by funding research projects, deploying renewable energy, etc.

How to plan for windfall tax as a business

  1. Familiarize yourself with tax laws and windfall tax calculations.
  2. Review your budget and set aside the anticipated amount of windfall tax
  3. Consult tax professionals and plan strategies to reduce the tax.
  4. Communicate with all stakeholders.
  5. Prepare for future eventualities.

Conclusion

While a windfall tax scenario does imply huge profits, you need to manage the repercussions it may cause in the future.

FAQs

What is windfall tax in India?

Windfall tax in India is a one-time tax imposed on companies with unusually high profits due to favorable market conditions. It aims to capture excessive gains from windfall profits.

Who benefits from windfall tax?

Oil and gas companies, particularly giants like Reliance Industries and ONGC, benefit from windfall tax reductions, gaining significant advantages in the stock market.

What is the meaning of windfall gains?

Windfall gains refer to unexpected and significant increases in income, often resulting from unforeseen events like winning the lottery or receiving an unexpected inheritance.

What is the effect of windfall tax on ONGC?

The windfall tax on ONGC has impacted its earnings, leading to a decline in share prices. The tax, initially imposed in July, was later increased, contributing to financial challenges.

Disclaimer: Risk is fundamental to the investment process in Indian stocks. Any discussion of securities in this article should not be considered a recommendation to buy or sell any security. The facts provided are for informational purposes only and should not be considered investment/financial advice from CoinSwitch.

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