The Indian government has recently notified a 40% tax on the windfall income of oil and gas companies, which is expected to generate Rs 10,000 crore in revenue for the fiscal year 2023-24. The tax, which was introduced in July 2022, is applicable to the profits earned by the companies from the surge in global crude oil prices, which have risen by more than 50% this year. The tax is aimed at curbing the excessive gains made by the oil and gas sector at the expense of the consumers and the economy, as well as mobilizing resources for the government’s welfare schemes.
What is windfall tax and how does it work?
A windfall tax is a levy imposed on an industry or a sector that benefits from an unexpected or extraordinary event, such as a natural disaster, a war, or a pandemic, that leads to a sharp increase in their profits. The tax is meant to redistribute the windfall income from the beneficiaries to the society, especially the vulnerable sections that may be adversely affected by the event.
In India, the windfall tax on oil and gas companies is calculated as a percentage of the difference between the actual price of crude oil and a base price of $70 per barrel, which is the average price of the Indian basket of crude oil in 2021-22. The tax rate is 40% for the companies that have production-sharing contracts with the government, and 20% for the companies that have revenue-sharing contracts. The tax is applicable only to the domestically produced crude oil, and not to the imported crude oil or refined products.
Why did the government introduce the windfall tax?
The government introduced the windfall tax on oil and gas companies for two main reasons: to reduce the fiscal deficit and to protect the consumers. The fiscal deficit, which is the difference between the government’s revenue and expenditure, is projected to be 6.8% of the GDP in 2022-23, which is higher than the target of 4.5% set by the Fiscal Responsibility and Budget Management Act. The windfall tax is expected to provide an additional source of revenue for the government, which can be used to fund its social welfare schemes, such as the Pradhan Mantri Garib Kalyan Yojana, the Pradhan Mantri Ujjwala Yojana, and the Pradhan Mantri Awas Yojana.
The windfall tax is also intended to protect the consumers from the high inflation and the rising cost of living caused by the surge in global crude oil prices, which have crossed $80 per barrel in September 2023. The high oil prices have a direct impact on the prices of petrol, diesel, cooking gas, and other essential commodities, which affect the common people and the poor. The windfall tax is meant to ensure that the oil and gas companies do not pass on the entire burden of the high oil prices to the consumers, and share some of the benefits with the society.
What are the arguments for and against the windfall tax?
The windfall tax on oil and gas companies has sparked a debate among the stakeholders, with different arguments for and against the tax. The supporters of the tax argue that the tax is justified and necessary for the following reasons:
- The tax is a fair and equitable way of redistributing the windfall income from the oil and gas sector, which is enjoying record profits due to the global energy crisis, to the society, which is suffering from the high inflation and the low growth.
- The tax is a temporary and flexible measure, which will be removed once the oil prices fall below $70 per barrel, as indicated by the government officials. The tax is not a permanent or a fixed burden on the oil and gas sector, and will vary according to the market conditions.
- The tax is a prudent and responsible way of managing the fiscal deficit and the public debt, which have increased due to the pandemic and the lockdowns. The tax will help the government to mobilize resources for its welfare schemes, which are essential for the recovery and the resilience of the economy and the society.
The opponents of the tax argue that the tax is unjustified and harmful for the following reasons:
- The tax is a retrograde and arbitrary measure, which violates the contractual obligations and the fiscal stability of the oil and gas sector. The tax is imposed on the profits that are already subject to the corporate income tax, the cess, the royalty, and the dividend distribution tax, resulting in double taxation and high effective tax rates.
- The tax is a disincentive and a deterrent for the investment and the exploration activities in the oil and gas sector, which are crucial for the energy security and the self-reliance of the country. The tax will reduce the profitability and the attractiveness of the sector, and discourage the domestic and the foreign investors from participating in the upcoming auctions and the projects.
- The tax is a short-sighted and a counterproductive way of addressing the fiscal deficit and the inflation, which are caused by the structural and the systemic issues in the economy and the policy. The tax will not solve the underlying problems of the low revenue base, the high expenditure, the inefficient subsidies, and the rigid pricing mechanism, which need to be reformed and rationalized.
What is the impact of the windfall tax on the banking sector?
The windfall tax on oil and gas companies has also raised concerns among the analysts and the experts about its impact on the banking sector, which has a significant exposure to the oil and gas sector. According to a report by CRISIL, the banking sector has lent Rs 4.5 lakh crore to the oil and gas sector as of March 2023, which accounts for 6.5% of the total bank credit. The report warns that the windfall tax will adversely affect the cash flows and the debt servicing ability of the oil and gas companies, especially the smaller and the weaker ones, which may lead to an increase in the non-performing assets (NPAs) and the credit risk for the banks.
The report also suggests that the windfall tax will have a differential impact on the public sector banks and the private sector banks, depending on their exposure and their asset quality. The public sector banks, which have a higher exposure and a lower asset quality, will be more vulnerable to the stress in the oil and gas sector, while the private sector banks, which have a lower exposure and a higher asset quality, will be more resilient and better positioned to cope with the situation.
