What is a windfall tax?

Windfall taxes are levied on industries that have benefited the most from unusual economic conditions, earning above average profits. They are often associated with the energy sector.

Rishi Sunak
Rishi Sunak has performed a U-turn on windfall taxes
(Image credit: © Hollie Adams/Bloomberg via Getty Images)

Windfall taxes are a one-off tax on a company’s profits. The idea behind them is to make firms pay for conditions that they had no hand in creating, but which they were lucky to benefit from.

Energy producers are earning significantly higher profits from getting oil and gas out of the ground than they were a year ago. This is primarily because demand for energy has roared back to life with the resumption of economic activity as the world reopens after the pandemic.

Critics of energy companies say windfall taxes should be levied on firms to alleviate some of the burden of crippling energy prices which has contributed to a major cost of living crisis for consumers in recent months.

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How do windfall taxes work?

The Labour Party proposed in early 2022 that oil and gas companies should pay ten percentage points more in corporation tax. The government estimates the introduction of windfall taxes would generate £1.2bn for the exchequer.

Supporters of a windfall tax argue that it is necessary to generate money and help consumers with large bills.

Critics of the policy, such as UK chancellor Rishi Sunak, argue that such a tax would deter companies from investing in the North Sea as well as in new energy projects. This is why Sunak refrained from introducing a windfall tax in the latest spring Budget.

But last week, he seems to have made a U-turn on his position and refused to rule them out if energy firms do not invest in the sector, saying: “if we don’t see that type of investment coming forward… then of course that’s something I would look at and nothing is ever off the table in these things.”

Are windfall taxes new to the UK?

Windfall taxes, even if they are introduced, aren’t new to the UK. in 1997, the then chancellor Gordon Brown imposed a windfall tax on the profits earned by utilities after they had been privatised by the Conservative government.

Sectors affected included water and sewerage companies, and telephone company BT.

The policy wasn’t confined to Labour as the Conservatives also introduced a windfall tax in 1981 that targeted the excess profits of banks.

While the taxes paid by UK oil and gas companies are usually higher than other companies – 30% corporation tax and an additional 10% – the amount paid has fallen in recent years.

This is because they can offset taxes if they are investing money. As such, the amount of tax relief paid by the government to oil and gas companies has been higher than the amount it has received in taxes over recent years, hence the current debate around whether to levy windfall taxes or not.

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Saloni Sardana

Saloni is a web writer for MoneyWeek focusing on personal finance and global financial markets. Her work has appeared in FTAdviser (part of the Financial Times),  Business Insider and City A.M, among other publications. She holds a masters in international journalism from City, University of London.

Follow her on Twitter at @sardana_saloni