A Comparison of Windfall Tax Methodologies in Different Fiscal Regimes

Abstract

Abstract Designing fiscal regimes that maximize government take is not a simple task, as countries are tasked to develop an overall fiscal mechanism that optimizes government take while encouraging capital investment and domestic production. Windfall Profits Taxes ("WPT") have been used to increase the percentage of government take in many countries. However, the terms "windfall profits tax" or "windfall tax" are loosely used and regularly confused with other forms of taxation. In many cases, taxes billed as windfall taxes are often forms of taxation specific to the exploration and production (E&P) sectors of the oil and gas industry. A discussion, therefore, is needed to clarify the differences between the forms of taxation under the heading, windfall tax. In a period of historically volatile prices, it is crucial for both producers and governments to have a detailed understanding of the triggers and affects of such taxes in order to best prepare for the application of these additional levies. This paper aims to detail the differences in windfall profits tax schemes currently in use around the world and compare their effects on the division of revenues related to E&P activities. It will be shown that the triggers attributed to a Windfall Profits Tax are rarely profits; instead these triggers are at best indirectly related to profits. Introduction Windfall Profit taxes have been used to increase government take in many countries. Designing fiscal regimes that maximize government take is not an easy task, let alone choosing a windfall tax mechanism or methodology that is beneficial for all parties, providing incentives, foreign investment, and maximizing the country's gain from production. The term windfall tax is loosely used and regularly confused with other forms of taxation. Therefore we want to start the discussion by clarifying the difference between two commonly used taxation methods as a proxy for a windfall profits tax: excise and income-based taxes. An excise tax is a taxation mechanism based on a commodity price. For example, a rate is applied over the sales production if oil prices exceed a certain baseline. Income-based taxes are those taxes related to income or profit related measures. As this paper will discuss, the calculation of these additional levies are generally driven by proxies signaling the possibility of windfall profits and not the windfall profit itself. Effects Economic theory suggests that the stakeholders in question, companies and governments, will react differently to differing implementations of windfall tax regimes. Though there are many variations of a windfall regime, as discussed above, significant differences in the economic effects of these taxes can be noted between excise-based and income-based windfall taxes. For the purposes of this discussion, those taxes triggered specifically by a comparatively high commodity price will be considered excise taxes while those related more directly to rapid increases in income will be considered income-based taxes. These income-based taxes are typically those whose rates and calculations are, ROR and R-factor driven. Excise An excise tax, by definition, is applied in the expectation of a windfall in revenue. Depending on the cost structure, this windfall revenue may not result in a windfall profit. In fact, such a tax may prove to have distortionary effects both on the energy market and petroleum project economics. An excise-based windfall tax has been shown to dissuade companies from exploring and producing in countries with such a tax in place, as was the case in the United States during the early 1980s.