Assessing the motives of an energy windfall tax

In recent weeks, energy companies have seen a dramatic soar in their profits due to the increase in oil and gas trading post-pandemic and also as a result of Russia’s invasion of Ukraine. As such, the UK Government has come under pressure to introduce a windfall profits tax on these energy companies. 

The purpose of a windfall profits tax is to tax profits that companies have made as a result of external circumstances beyond their control – in other words to tax luck, not labour.

Windfall profits taxes have been introduced in the UK before. In 1997, the Labour government introduced a windfall profits tax on the excess profits of privatised utilities. Previously, in 1981 the Conservative government introduced a windfall profits tax on banks as they were seen to be escaping the effects of the recession at the time and profiting on the high rates of interest.

So the concept of a windfall profits tax is certainly not a new one in the UK, but the question is whether a windfall profits tax on the energy sector is the right regime to introduce at this time.

Energy prices in the UK are continuing to rise, meaning that households across the UK are struggling to pay their energy bills. The introduction of a windfall profits tax in the energy sector could exacerbate this problem. Whilst the proposed tax is intended to only target the ‘unearned’ profits of the energy companies, it is possible that this additional cost could be passed on to consumers.

A company and its consumers are not always easy to separate from one another, therefore increased costs to the company could mean increased costs to the customer.

Furthermore, the motive for introducing such a tax needs to be considered. It could be argued that the purpose of introducing a windfall profits tax is to rectify the unjust enrichment that the energy sector is receiving through its unexpected profits. However, is the most appropriate way to resolve this unjust enrichment through tax that is collected by the government?

In order for the public to be satisfied with this rectification, it will need to be clear how and where the money collected from the windfall profits tax is being used – is it being channelled to those who are suffering most from the cost of living crisis? Otherwise, a more obvious way to reverse this perceived unjust enrichment is to leave the additional profits with the energy companies so that they can use the profits to benefit customers.

Another potential motive for the introduction of a windfall profits tax is so that the government can get at the wealth and income of the energy company shareholders. If that is the case, it makes more sense to implement measures that will directly affect these shareholders (e.g. dividend embargoes).

Charlotte Sallabank is partner, and Christy Wilson, associate, at Katten Muchin Rosenman, which is a full-service law firm with nearly 650 attorneys in locations across London, Shanghai and US.