Rishi Sunak has confirmed that the government will introduce a windfall tax on oil and gas company profits. After weeks of rejecting calls for such a measure, the chancellor said he is now "sympathetic to the argument" for imposing a tax on the companies making money out of the energy crisis.
Announcing a package of economic support after regulator Ofgem predicted that the energy price cap will rise to around £2,800 in October, Mr Sunak told MPs in the House of Commons: “The oil and gas sector is making extraordinary profits not as the result of recent changes to risk-taking or innovation or efficiency, as the result of surging global commodity prices driven in part by Russia’s war. For that reason, I am sympathetic to the argument to tax those profits fairly.”
A temporary one-off tax of 25 per cent will be applied to extraordinary profits of oil and gas giants. Mr Sunak said this “energy profits levy” will raise around £5 billion in a year to assist with the surging cost of living.
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Addressing previous arguments made by the government that introducing a windfall tax could damage investment in the sector, Mr Sunak told MPs: "It is possible to both tax extraordinary profits fairly and incentivise investment.”
Mr Sunak avoided using the word 'windfall' after recently dismissing calls for one, but the move is being seen as yet another u-turn from Boris Johnson's government. So what is a windfall tax, how will it work and why has its introduction been so controversial? Here's what you need to know.
What is a windfall tax?
When a company's profit increases unexpectedly because of factors outside its control, it is called a windfall. While customers paying their energy bills are facing staggering increases, the companies selling oil and gas to energy companies are making a huge amount of money.
That is because the situation in Ukraine, as well as the global economic recovery from the pandemic, are leading to higher demand for oil and gas and therefore higher prices. The government said oil and gas prices have risen 'substantially', with oil prices nearly doubling since early last year, and gas prices more than doubling.
This has resulted in significant increases in the profits earned from UK oil and gas extraction. The Labour party, along with some members of the chancellor's own party, have been calling for the government to introduce a tax on these profits, which would raise money for the government to assist bill-payers struggling with the rising cost of electricity and gas.
Despite initial doubts, the chancellor has now succumbed to the calls and announced an energy profits levy, which is set to raise around £5 billion a year.
How will a windfall tax on energy companies work?
Announcing the new levy in Parliament, Mr Sunak said oil and gas companies would be charged a temporary 25 per cent tax on windfall profits.
“The new levy will be charged on profits of oil and gas companies at a rate of 25 per cent," he told MPs. “It will be temporary and when oil and gas prices return to historically more normal levels the levy will be phased out.” The money raised will "go towards supporting people with the new cost of living measures", the government said.
The levy will see an additional 25 per cent tax on UK oil and gas profits on top of the existing 40 per cent headline rate of tax, which takes the combined rate of tax on profits to 65 per cent, the government said.
The tax will take effect from today, May 26, and will be phased out when prices decline. Legislation for the levy will also include a sunset clause, meaning it will expire completely by December 2025 if it has not already been revoked.
In addition, Mr Sunak announced a new investment allowance to encourage oil and gas companies to reinvest profits to support the economy, jobs, and the UK’s energy security. According to the government: "The new 80 per cent Investment Allowance will mean businesses will overall get a 91p tax saving for every £1 they invest – providing them with an additional, immediate incentive to invest. This nearly doubles the tax relief available and means the more investment a firm makes, the less tax they will pay."
Mr Sunak stopped short of also slapping the new levy on electricity generators, although he said the Treasury was evaluating the scale of the profits being made in the industry and what steps could be taken.
Why is the government doing this now?
Ministers have spent months criticising the idea of a windfall tax because of its potential impact on investment. However, after the boss of Ofgem indicated earlier this week that the energy price cap is set to increase to £2,800 in October, the chancellor came under renewed pressure to announce further support for Brits.
Mr Sunak was heckled with shouts of “what took you so long” and “about time” after beginning today's statement by noting that high inflation is causing “acute distress” for people in the country. Shadow chancellor Rachel Reeves told the House it feels "like the chancellor has finally realised the problems the country are facing", adding that Labour first called for a windfall tax on gas and oil companies "nearly five months ago".
Responding to criticism from Labour, Mr Sunak said that “concrete information” on the autumn and winter energy price cap had allowed the government to better “design and scale” its policies. He added that the delay had meant that the government's new measures "are in fact more generous than those offered by the party opposite".
Why has a windfall tax been so controversial?
The idea of a windfall tax has been heavily criticised by ministers because of its potential impact on investment. The prime minister had previously said he was “not attracted” to the idea of new taxes and the chancellor had refused to be drawn on reports that one was being considered in the weeks leading up to today's announcement.
Mr Sunak told the House of Commons last week the UK government “do not believe that windfall taxes are the simple and easy answer to every problem”. However, he said: "We are pragmatic, and we want to see our energy companies, which have made extraordinary profits at a time of acutely elevated prices, investing those profits back into British jobs, growth and energy security. I have made it clear and said repeatedly that, if that does not happen soon and at significant scale, no option is off the table.”
Ahead of today's announcement, Offshore Energies UK (OEUK), which represents the offshore oil and gas industry, warned that a windfall tax on energy firms would see higher prices and do long-term damage to the oil and gas industry. Deirdre Michie, chief executive of the body, said: “This is an industry that thinks and plans long-term, so sudden new costs, like this proposed tax, will disrupt planning and investment and, above all, undermine investor confidence.”
Ms Michie said the sector was already the country’s most highly taxed industry and operators would already be sending the Treasury £7.8 billion this financial year. This, she said, was equivalent to £279 per household. She added that the industry was “actually very proud to pay our taxes” but warned “the problem is when new taxes are imposed suddenly and without consultation”.
