- Context
By statement of the Minister of Economy, last April 8, the Portuguese Government referred to the taxation of windfall profits of companies. The statement was made during the debate on the Government Programme and has been stimulating the discussion on the method companies should be taxed, in general, and on companies operating in the energy sector, in particular.
In a context dominated by a succession of extraordinary events, such as the pandemic situation conflicts at an international scale and, more recently, the reappearance of the economic phenomenon known as stagflation, the debate on the optimal way to tax the profits of companies, which constitute the supply side of the economic spectrum, has seen increasing relevance.
- Origins of the windfall profits tax
The origin of the windfall profits tax can be traced back to the crude oil windfall profits tax introduced in the tax legislation of the United States of America in the 1980s. This tax aimed to control the price of fossil fuels in view of the exponential increase that their price had been experiencing at the time.
More recently, the discussion around the introduction of this form of taxation was pushed by the European Commission. In its answers on the “REPowerEU” programme (Joint European action for more affordable, secure and sustainable energy), on the subject of energy production – on 8 March last – it admitted that Member States “can consider temporary tax measures on windfall profits and exceptionally decide to capture a part of these returns for redistribution to consumers“.
On the other side of the Atlantic, the idea of taxing companies on windfall profits has also been supported. In this regard, on 3 November 2021, representatives of the US Democratic Party presented a legislative proposal aimed at imposing an excise tax on windfall profits from oil production or imports.
- Possible settings and criticism of a Portuguese windfall profits tax
As seen above, the feasibility of a windfall profits tax can follow two different models: income taxation and taxation of expenses.
If the model adopted were to be the taxation of windfall profits through income, major questions would arise regarding the logic of the functioning of the corporate income tax (“CIT”) levied on corporate profits in Portugal. In this regard, three main hypotheses for the appearance of this tax on income taxation may be considered:
- The establishment of an additional tax on company profits, the cost of which would not, by default, be included in the calculation of taxable profit at the level CIT level;
- The establishment of an autonomous tax on company profits, similar to the autonomous taxation that exists today (although focused on the taxation of corporate expenses), with the particularity of taxing unexpected profits (or that the State understands as unexpected); or
- The creation of a mechanism to introduce or increase progressivity in the calculation of the effective CIT rate, as happens today with the State and Municipal Surcharges.
In our view, however, the proposal presents several possible grounds for criticism.
First and foremost, we would like to highlight the difficulties in making the measure compatible with the constitutional obligation which determines that the taxation of companies is fundamentally based on their actual income. In fact, the calculation of the actual income is currently supported by the rules of CIT which determine that the taxable income of companies is the profit (or positive net result) determined on the basis of accounting. In this sense, and as accounting is a technique based on the precise demonstration of the economic situation of the company, how can unexpected profits be defined? In fact, the meaning of the expression “unexpected profits” would require a calculation exercise, prior to the financial year itself, in which the company would determine what the expected net profit would be, which is clearly impossible, especially in the more volatile productive sectors. The determination of the objective incidence of a tax, based on and as a central element of an undetermined concept, comes up against legal certainty and the need to respect basic constitutional principles.
It is also worth pointing out that the measure is in conflict with the general principle of tax law prohibiting double taxation. It is considered that the imposition of an additional or autonomous tax on profits, even if unexpected, would result in a clear contradiction with that principle, to which the tax system cannot be subjected to.
Finally, the creation of a mechanism aimed at introducing or increasing progressivity in the calculation of the effective CIT rate would seriously undermine the principle of preferential taxation of corporate profits through proportional rates followed by the vast majority of OECD tax systems. In this respect, it should be recalled that the recent Pillar 2 of the Global Anti-Base Erosion Model Rules (GloBE) – which, briefly, determines the progressive adoption of a 15% minimum tax rate on profits – did not drop the above-mentioned system of proportional taxation of profits – but rather encouraged it.
The US proposal shows, however, how a windfall profits tax can be constructed through indirect taxation. The model of implementation of a windfall profits tax on the expenditure side could be based on the experience of the proposal presented in the USA. In this, the measure consists of taxing the difference between the current oil price and the average price of fuel for the period between 2015 and 2019. In the American case, the rate defined was 50%, but it may be freely adopted by each State.
The last-mentioned taxation model faces, even so, serious implementation difficulties. First, when compared with the American experience of the last century, the imposition of a windfall tax has resulted in the natural reduction of the advantages normally associated with sectors whose price formation is more volatile. When analysing the market structure, namely the energy market, it can be seen that the risk associated with investment in the production, transformation and commercialisation of energy products such as gas and oil is associated with the potential return that this investment may suffer from price fluctuations which, naturally, are not guaranteed. In other words, just as we have seen record energy prices in recent times, it should be remembered that, precisely in the years 2015 to 2019, the price of energy reached historic minimum levels.
It is believed that imposing a measure of this nature will bring uncertainty to the area, leading to disinvestment which, with the imbalance between supply and demand, may have precisely the opposite effects to those intended – i.e. higher prices.
- Conclusions
The reaction to price escalation, notably in the energy sector, deserves a considered and adequate response from each State in a logic of avoiding a disproportionate increase in the cost of essential goods.
As we understand it, the intention of creating a windfall profits tax on companies has a double difficulty: firstly, its justification in the tax field and, secondly, the potential adversities it may face in maintaining investment and supply, especially in a post-pandemic economic recovery context.
Thus, even if the effort against price escalation is crucial to maintain the economic and social balance required of the Government, we have reservations that a tax response of this type is the right option. Other alternatives will have to be considered.
Diogo Feio
maio 2022