Windfall Tax Decoded: Unnecessary Regulation or Need of the Hour?

With the ongoing Russia-Ukraine conflict reaching its 100th day recently, oil prices have once again sky-rocketed reaching prices of up to $139 per barrel, reigniting the discussion about whether a ‘windfall tax’ must be levied on oil companies that have gained huge profits through economic expansion, to which they have made no contribution. Recently, countries such as Italy and Hungary imposed a windfall tax on beneficiaries of the economic windfall. UK followed suit by levying a temporary windfall tax of 25% on oil and gas producers.1 A pertinent question that therefore arises is whether India ought to follow the European countries and impose a windfall tax on oil and gas companies, in aid of the government as well as the public at large.

A ‘windfall tax’ is a type of one-time tax levied by governments in instances where companies unanticipatedly start gaining profits due to external factors. Such a tax is usually levied on commodity-based businesses and is retrospective in nature. The factors that lead to this surge in profit generally have little to do with an increase in efficiency or innovation - rather, they are largely based on favourable market conditions, availability of natural resources and prevalent political conditions, which result in a surge in profit. The ongoing war between Russia and Ukraine is currently such a catalyst. Russia is the world’s largest exporter of oil to global markets, as well as the second largest exporter of crude oil. Be that as it may, sanctions and economic measures taken by European countries in support of Ukraine have inevitably caused a disruption in the supply chain, which has led to a massive surge in oil prices, through no contribution of oil and gas corporations. Governments globally have therefore levied a windfall tax to redistribute excess profits by reducing the prices of these commodities for consumers. Moreover, the amount so raised through taxation is generally invested by governments in promoting social welfare and competition in the market.

Governments in Italy, Hungary and the United Kingdom have imposed a windfall tax to protect vulnerable sections from the rapidly-rising and rampant inflation, and to boost the finances of the country. Such a measure, although drastic, aids the process of correction of surging oil prices and attempts to restore normalcy in the relevant market. In India, such a tax could have a significant positive impact in light of the central government’s neoteric measure to rein in inflation - the Finance Minister recently announced to cut central excise duty by Rs. 6 on petrol and Rs. 8 on diesel. Such a move would lead to an additional cost of up to Rs. 1 lakh crore for the exchequer. Therefore, imposing a windfall tax could lead to significant earnings for the central government, which would help ease the burden on the exchequer.

However several considerations need to be kept in mind, which are strong deterrents to imposing a windfall tax in India. The Indian Government needs to consider the fact that it has signed Production

Sharing Contracts (‘PSCs’) with various oil and gas companies such as Oil and Natural Gas Corporation (‘ONGC’). PSCs are contracts wherein the majority of risk involved, inter-alia, in the exploration and production of oil and natural gas, are borne entirely by oil companies that are awarded the rights to explore in a specified area, and in return the government gets a share in the profit that these companies make.2 Due to oil companies experiencing a surge in profits, the government’s share in the profit consequently also increases. The pertinent question that arises therefore is whether the government would be willing to take a hit on their profit obtained through these PSCs by imposing such a tax.

Furthermore, the probable impact of a windfall tax on the foreign direct investment (‘FDI’) climate for India is also a valid concern that needs to be considered before levying such a tax. The current FDI climate has recently become more investor-friendly due to the government allowing 100% FDI through the direct route in most sectors. Implementing a windfall tax could deter FDI and create hurdles for foreign investors to enter India.

While the question as to whether the government will implement such a policy remains unanswered, experts as well as stakeholders such as ONGC are of the opinion that such a drastic measure would not see the light of day. Windfall taxes are a contentious concept that are likely to cause significant harm to the market. This form of taxation would discourage investment as well as companies' initiatives to seek out profits. Not only does such a retrospective tax cause uncertainty about the future - tax systems are successful when they are stable, certain and predictable and windfall taxes are a glaring antithesis. What is needed is suitable reforms of the existing taxation system to raise revenue in a reasoned and democratic manner.

By - Muskaan Ahuja and Nikhil Javali

  1. Asha Menon, 'What is a windfall tax and why is it back in discussion?', (Moneycontrol, 31 May 2022), , accessed 1st June 2022
  2. 'How Oil Production Sharing Contracts Work', (Shamaran Petroleum Group), accessed 1st June 2022
  3. Sapna Das, 'Windfall Tax explained- why ONGC, Oil India are spooked by it', (CNBC, 27 May 2022), accessed 1st June 2022