AUGUST 30, 2022

By Raghavan Ramabadran, Executive Partner &  Krithika Jaganathan, Joint Partner, Lakshmikumaran& Sridharan

THE idea of 'windfall taxation' -taxing supernormal profits earned by companies solely due to economic conditions without any particular acts by the company - is not new. In the most recent instance of windfall taxes, the Ministry of Finance had issued a notification to levy Special Additional Excise Duty ('SAED') on the oil industry. The Union Government levied a windfall tax of Rs. 6 per litre on export of ATF and petrol and Rs. 13 per liter on export of diesel.

Why the oil sector?

Oil companies are inherently profitable as they make up to 3 billion USD per day even after accounting for daily fluctuations, per the analysis of Professor Aviel Verbruggen (Energy & Environmental Economist) based on World Bank data. Oil companies purchase crude oil and refine it to result in end products such as petrol, diesel, natural gas which are then sold to the public. The sale price is a function of cost of crude oil, refining cost, profit margin and taxes. Of these, the variable component is the cost of crude, and the effect of this would be on the profit margin, because the other two components would typically be relatively stable.

An important term used in the oil industry is that of the Gross Refining Margin (GRM), which is an indicator of refiners' earnings, and this was recorded at an all-time high in 2022, jump starting a season of high profits to the oil industry. These fortuitous profits can be traced to the staggering demand that ensued after increasing hostilities in Ukraine intensified sanctions against Russian oil. Cut off from their regular supply, countries that were hitherto dependent on Russian oil had to look elsewhere for their energy requirements. This augured well for Indian oil companies largely owing to the equation that India balances with Russia as a result of which India could procure subsidised crude oil. Considering that crude oil is such a foreign exchange guzzler, this proved advantageous for India as well.

Interestingly, windfall gains taxes on the energy sector have been a trend of sorts, what with Italy and UK announcing it in Q1 of 2022-2023 while the USA has also been hinting at it for a while now. On 26.05.2022, the UK government imposed a windfall tax on the profits of oil companies by increasing the tax liability by 25%.The taxation would be levied in a phased manner accounting for the oil prices returning to the perceived normal levels as well. The UK government has also announced that these funds would be used to discount energy bills to low-income households. Italy has increased the tax imposed on oil companies by 15% and has also said that these funds would be used to help in reducing the rising energy prices for the public.

Policy impact

Windfall taxes were introduced with an accompanying mandate that oil companies meet domestic demand before exporting the diesel and petrol. Hence, the purchase of crude oil at lower rates coupled with the reductions in excise duty per liter by Rs. 8 for petrol and Rs. 6 for diesel has benefitted the public, for the domestic petrol and diesel prices have fallen. The net effect of the imposition of windfall taxes by the government is two-fold: one, it is an attempt to offset the loss of revenue from reduced excise duties on petrol and diesel, and two, it is a way of maintaining the value of Indian Rupee. The profits being as high as they have been for the recent past is not because of sustainable reasons, and hence they would see a fall eventually. This has already happened, so the taxation policy was revisited when global oil prices fell and intuitively so - rates of windfall taxes on diesel and ATF were reduced by Rs. 2 per litre while the windfall taxes on export of petrol was scrapped in entirety. The share price of Indian Oil companies stayed in step all along.

Conclusion: a Robinhood initiative?

There is a natural curiosity regarding the utilisation of the receipts from windfall tax - will they be used to shore up reserves for the future, will they form part of the corpus for energy efficient measures adopted by the country or will they be used to fund energy for the low-income households in the country? Would it be used to advance the cause of economic justice?Let us wait to see what the future beholds.

[The views expressed are strictly personal.]