Windfall Tax

Windfall Tax Meaning

A windfall tax is a charge levied by federal governing bodies on business entities when they make abnormal gains from financial windfalls. The idea behind such taxes is to reallocate favorably abnormal profits in one sector for social causes. Taxes like lottery tax or tax on winnings from game shows and horse racing, gambling or betting are examples of windfall taxes.

How does Windfall Tax Work?

  • Keeping in view of all tax schemes proposed and implemented by the government, there lies a rift between those are for and against the tax schemes. The merit of a windfall tax is that the taxed funds can be used by the governments to maintain the state of the economy and fight several glaring social causes.
  • On the other hand, those who oppose such taxes reduce the business interest to reap profits. They also are of the view that such profits should be reinvested by business entities to encourage scientific and business development, which in some way will empower the social status of the country and its regions.
  • Windfall taxes are levied with the objective of tax companies to bring down the general price levels of goods and services so that it benefits the end consumer. The policy of the government may backfire as it may lower the investment by private sector companies as it may hit theirs after-tax profits (PATPATProfit After Tax is the revenue left after deducting the business expenses and tax liabilities. This profit is reflected in the Profit & Loss statement of the business.read more), which in turn would affect their bottom line and jeopardize their survival in the market.
  • As an instance, the government as of mid-2018 was mulling over the idea to levy a Windfall Tax on Oil and natural gas producing companies to bring down the prices of fuel and petrol. Under this scheme, fuel-producing companies are paid at international rates for the fuel they produce domestically and will have to be part of the earnings they have generated from prices surpassing a particular limit.
  • These taxes will always remain an arguable or debatable issue between the equity shareholders of well-performing companies and people from the other sections of the society. The concern of such taxation got attention when oil and gas companies, namely Exxon Mobil that reported a profit of $36 Billion for the fiscal year encountered super profits due to surging fuel prices.
  • Windfall taxes also relates to individual and non-corporate entities who suddenly see a surge in their income levels by receiving a large corpus of wealth from gifts, inheritance, the game of chance, gambling or lottery winnings. In many a case, inheritance, gifts from friends or relatives are tax exempt in the hands of the recipient. However, central or regional taxes may be levied on the giver of such inheritance. Income from winnings from lottery and gambling is charged to tax either in the hands of the recipient or the giver of such income. These winnings have to be reported in the income tax returns to be filed with the federal tax authorities. An individual who has been rewarded a huge monetary settlement after winning a legal case is expected to pay central income tax on the amount received. In comparison, monetary settlements such as damages for personal physical ailments or sickness received are not considered taxable by the Tax authorities.
Windfall Tax

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Benefits

  • The most certain benefit of windfall taxes is that it boosts government revenues. It enables them to substantially provide public services and other benefits to the citizens of the country like building civil infrastructure, health facilities, sanitation, and also building the nation’s military strength.
  • The additional funds raised through this tax can service the debts by the countries to various global financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more and may bolster the national economy. However, it may also act as a disincentive to companies.
  • If companies become aware that windfall gains will be taxed, they may not seek out such profits with innovative business plans. A part of these receipts has to be parked in a personal contingency fund in bank fixed deposits.
  • The beneficiary of windfall gains can repay interest-bearing consumer or car loans, in which case the asset depreciates to lower than the loan outstanding. The other part of windfall gains can be used to repay housing loans to bring down interest costs and EMI’s.
  • The other viable option can be to invest the windfall proceeds in gold deposits. One part of the corpus can be given to a charitable organization of repute who is catering to the cause of education or health or child welfare. The donations made to charitable causes can be used to claim deductions from 50% to 100% from the income liable to tax.

Drawbacks

  • The economic impact of windfall taxation should lead to its immediate rejection. Firstly, such an arbitrary taxation system would increase the risks of investing. As a result, investors will demand a higher return on their investments, or they may choose to stop investing altogether.
  • These taxes may reduce the dividend payout to investors investing in oil-producing companies. These companies are not owned by cash-rich investors but by pension funds and insurance companies. Finally, it would reduce the funds available for investment in sources of fuel, thereby spiking the energy costs. Windfall tax may affect people it was created to help and reduce long term tax income.

Conclusion

Windfall taxes provide a good source of revenue to the government as it follows the principle that those who have earned a surplus through windfalls to be taxed and also discouraging businesses of the lottery, gambling, horse racing, etc. It affects the companies which earn huge profits in the business of oil and gas as they have lesser income in the form of dividends to be distributed to its investors.

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