As a result of the Russian-Ukrainian war oil and gas prices have risen, resulting in inflation and rising energy prices for citizens and businesses in many countries. However there are not only economic losers. Enterprises that have activities in the field of oil, gas, coal and refinery sectors benefit from the rising oil and gas prices.

The aforementioned resulted in several governments taking measures to soften the pain of the higher energy prices for citizens. Costs for this are high and therefore governments also look for ways to finance such measures. In several countries, and even EU-wide, the possibility to introduce a so-called windfall tax is/has been discussed.

 

What is a windfall tax?

A windfall tax is a higher tax rate on profits that result from a sudden windfall gain to a particular company or industry, often as the result of a geo-political disturbance, war or natural disaster that creates unusual spikes in demand and/or interruptions to supply.

On September 14, 2022 the European Commission released a proposal for a Council Regulation that also contained a proposal to introduce a so-called temporary solidarity contribution. In short the temporary solidarity contribution is a  The temporary solidarity contribution applies to EU companies and permanent establishments performing activities in the field of oil, gas, coal and refinery sectors. The contribution shall be calculated on the taxable profits, as determined under national tax rules in the fiscal year starting on or after 1 January 2022, which are above a 20% increase of the average taxable profits for the previous three fiscal years, as determined under national tax rules. The contribution is levied against a rate of 33%.

Although named differently, in my view the temporary solidarity contribution in principle is a a windfall tax.

 

The 4 components used to calculate a windfall tax

In my view the amount of windfall tax due by a taxpayer is calculated by using the following formulas:

 

Windfall Tax  = Windfall Tax Rate x the windfall profit

 

Wherein the windfall profit (or surplus profit) is calculated as follows:

 

Windfall profit = the taxable profit for the year -/- ((100% +y%) x the normal profit))

 

Therefore, what amount of windfall tax that will be due by a taxpayer is influenced by the following 4 components:

1. The taxpayers that the windfall tax applies to;
2. The rate of the windfall tax;
3. The annual profit realized by a company in the fiscal year to which the windfall tax applies; and
4. The normal/average profit of the company.

 

The taxpayers that the windfall tax applies to

First of all a legislator will have to determine to which companies a windfall tax should apply. All taxpayers that realize a surplus profit? Taxpayers that are active in a certain sector? Or one specific taxpayer?

In the case of the temporary solidarity contribution the European Commission is proposing to have the solidarity contribution to apply to a certain group of taxpayers. Namely EU companies or permanent establishments generating at least 75% of turnover in the field of the extraction, mining, refining of petroleum or manufacture of coke oven products.

The choice for this group of companies as the group of companies to which the windfall tax will apply seems logical, since it is the high prices of gas and oil on the one hand that lead to higher costs for civilians and on the other hand are beneficial to enterprises that are active in the field of the extraction, mining, refining of petroleum or manufacture of coke oven products.

 

The rate of the windfall tax

The rate of the windfall tax is a rate to be set by the legislator. However, since the windfall tax  is meant to be an additional tax the rate of the windfall tax has to be higher than the rate against which the taxable profits of a company are normally taxed.

For the temporary solidarity contribution the European Commission proposes a rate of at least 33%. With the 33% being significantly higher than the corporate income tax rates that apply in most EU Member States, the 33% rate seems be in line with the goals of a windfall tax, namely taxing the windfall profits against a higher than normal rate.  

 

The annual profit realized by a company in the fiscal year

The annual profit realized by a company in the financial year follows from the activities of the company in the underlying fiscal year. It seems logical that the annual profit is the annual taxable profit, since the windfall tax is an additional tax that is raised over a ‘surplus profit’.

 

The normal/average profit of the company

In my view this last component the most difficult one to come up with a good definition.

 

Taking into account a long period

In my view the longer the period taken into account the better the normal/average taxable profit of a company can be determined. Reason here for is that over time the increases and decreases might even out to an average. Or because one takes into account a longer period one for example notices a clear development (for example that every three-year period the taxable profit of the company increases with 5%).

However, in this respect it should be noted that the longer the period is that is taken into account the greater the risk is that over time the size of the business or the activities of the business have changed by for example take-overs or divestments. Big changes in size of the business or its activities obviously also might have an impact on the revenues and profits of an enterprise. Therefore if a long period is taken into account to determine the normal/average profit of an enterprise one has to figure out how such changes in size or activities is to be handled.

Another problem that might arise when looking at a longer period to determine the normal/average taxable profit of a company there is a risk that the taxable profit is impacted by changes in law. For example when in year -5 the country in which the company is a taxpayer has introduced the right to depreciate assets. Consequently the taxable profits of the company for the fiscal years -5, -4, -3, -2 and -1 are determined in accordance with a different set of rules than the set of rules that applied to for example the fiscal years -10, -9, 8, -7 and -6.

 

Taking into account a short period

However if one chooses a too short period to determine what the normal/average profit of a company is, then a fiscal year in which the taxable profit (either upwards or downwards) significantly deviates from the taxable profits of the other years then this deviation also significantly impacts the outcome of what should be considered a normal taxable profit.

 

The choice of the European Commission

In its proposal the European Commission chose to determine the normal/average taxable profit based on the taxable profits of the previous three fiscal years whereby this average cannot be negative. Since the intention is that the temporary solidarity contribution will only be levied over the fiscal/tax year 2022 this means that the normal/average taxable profit will be determined based on the fiscal/tax years 2019, 2020 and 2021. The issue I have with this, is that the these years include the fiscal year 2020. The year of the covid-19 outbreak and the year that the commercial profits of many companies that are active in the field of the extraction, mining, refining of petroleum or manufacture of coke oven products took a big hit.

In the table below you’ll find the consolidated commercial commercial of several major oil companies. We admit that these are commercial results and not the taxable results of these, but still we feel that they show the point that we want to make. Furthermore please note that we do not mention the currencies these results are reported in (although most of them were reported in US-dollars). All amounts are (x 1,000):

Name	2019	2020	2021	Average
Exxon Mobil	14,340,000	-22,440,000	23,040,000	4,980,000
TotalEnergies	14,544,000	6,404,000	20,209,000	13,719,000
BP	11,706,000	-21,740,000	18,082,000	2,682,667
Chevron	5,536,000	-7,453,000	21,639,000	6,574,000
Shell	16,432,000	-21,534,000	20,630,000	5,176,000

In our opinion the above tale shows perfectly how difficult it is to determine what the normal (taxable) profit of a company is based on the data of only 3 financial years. In the cases of Exxon Mobil, BP and Shell the average of the consolidated commercial results for the years 2019, 2020 and 2021 is even lower than the their respective consolidated results for the financial year 2019.

 

A simplified example

Company A is active in the in the field of oil, gas, coal and refinery sectors. For each of the years from 2010 through 2019 the annual taxable profit of Company A amounted to 10 billion Euro. However, in the fiscal year 2020 the taxable profit of Company A took a huge hit as a result of which Company A incurred a taxable loss of 14 billion Euro. In 2021 the taxable profit of Company A recovered and amounted to 10 billion Euro again. In the fiscal year 2022 the taxable profit also amounts to 10 billion Euro. So what does this mean for the temporary solidarity contribution that Company A will have to pay for 2022.

Calculation of the average taxable profit for the fiscal years 2019 through 2021:

Taxable profit for 2019	10,000,000,000
Taxable profit for 2020	-/- 14,000,000,000
Taxable profit for 2021	10,000,000,000
Average taxable profit (2019-2021)	2,000,000,000

The proposal for the Council Regulation arranges that the temporary solidarity contribution is only due over the amount with which the taxable profit of Company A for the fiscal year 2022 exceeds 120% of the average profit. In our example therefore the amount with which the 2022 taxable profit of Company A exceeds 120% of EUR 2,000,000,000 (2,400,000,000).

Consequently, in our example in which the profit only recovered back to it normal level, an amount of EUR 2,508,000,000 solidarity contribution will be due by company.

In other words in our example a solidarity contribution would be due by Company A where after a temporary dip in 2022 Company A’s taxable profit returned to the level it had during the years from 2010 through 2009. In our view one can question whether the recovery of a taxable profit to the level it had over many years should be considered a windfall gain or surplus profit.

Obviously when Company A would indeed realize a windfall gain 2022, the solidarity contribution to be paid by Company A comes even higher.

 

What would be a suitable period to determine the normal profit of a company?

So what would be a suitable period to be taken into account when determining the normal profit of a company. As you might understand from the example given above, we feel that a 3 year period is to short. Certainly in the situation where the world is in right now, where we are recovering from a pandemic.

On the other hand, taking into account a very long period seems attractive, but it carries the risk that the characteristics of the company, or the tax regulations, have changed in such manner that the taxable profits of different years are not comparable.

In light of the aforementioned in our view it seems preferable if the normal taxable profit of a company is determined based on the average taxable profits of the 5 previous years, where these profits are adjusted for changes that the company or the tax regulations have undergone.

 

Copyright – internationaltaxplaza.info

 

 

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