Let’s discuss what is a windfall tax and how it affects companies

The News

On 2nd December, the government announced the withdrawal of the ‘windfall gains tax’ that it used to levy on domestic production of crude oil and export of diesel, petrol, and aviation turbine fuel (ATF).

The government introduced this tax 30 months ago when the Russia-Ukraine war started.

So, why did the government introduce it, and what led to its withdrawal? Importantly, how does it affect companies?

Before we discuss these, let’s look at what windfall gain is.

Windfall Gain Tax

A windfall gain tax is a one-time tax levied by a government on companies that earn unusually high profits due to external factors or circumstances that they did not directly influence or control.

The rationale behind this tax is to ensure that the extraordinary gains (or “windfalls”) are shared with the government, which can then use these funds for public welfare.

Let me give you an example.

The most recent example of windfall tax

When the Russia-Ukraine war started, global crude oil prices shot up from about $90 to above $120. As things escalated, the price remained high.

For oil producers, this was a windfall. The operational cost more or less remained constant, but their margins expanded and profits skyrocketed.

The profits went up without any operational improvements and it was an unexpected gain (known as a windfall).

So, on 1st July 2022, the government announced the ‘windfall tax’ of ₹23,250 per tonne ($40 per barrel) on this surplus profit.

After the announcement, Oil India’s stock fell by nearly 15%, ONGC dropped by 13.53%, and Reliance’s stock also went down by 7.2%.

Since then, the government has fetched ₹44,000 crore from the windfall tax. So what led to its withdrawal?

Why did the government withdraw it?

Of the ₹44,000 crore collected by the government through the windfall tax, ₹25,000 crore came in FY23 when crude oil prices stayed high throughout the year.

In FY24, collections dropped to ₹13,000 crore, and by FY25, they fell further to ₹6,000 crore as crude oil prices declined to around $70 per barrel.

With crude prices now lower, there’s little reason to continue the windfall tax. Simply put, the tax has served its purpose.

To Conclude

Windfall taxes can significantly affect companies by reducing their profit margins. It is designed to take away the extra profits made during unusual situations, which often leads to a drop in the stock prices of the affected companies.

While corporates criticize the windfall taxes, the government sees it as a balancing act.