07/07/2008 (The Star Online) - THE announcement by the government of a tax on ‘windfall profits’ of oil palm plantation operators and independent power producers (IPPs) represents a trend among economies where there are specific sectors benefiting from the bonanza in terms of high prices of certain commodities.

Historical perspective
The term ‘windfall tax’ is said to have originated from 'colonial times', when the new colonists in America were precluded by the Crown from using lumber wider than a foot except whereby by an act of God, such as a severe storm, a tree fell on one’s own property.

So if there was a big storm and a lot of trees fell down on your property, the resulting monetary reward was called ‘a windfall profit’.

Today, in the words of the Domestic Trade and Consumer Affairs Minister, Datuk Shahrir Abdul Samad, such profits are those made by industries ‘not affected by declines or improvements of the country’s economy’.

Recent trends
Britain mulled, but did not introduce windfall tax in 2001 when oil companies made large profits and in 2006 when banks were seen as making excessive profits. China levied windfall tax on crude oil from 2006 as part of a move to restructure its pricing mechanism of refined oil products so as to connect domestic prices more closely to the international market; it provided subsidies to consumers confronted by high prices of oil products.

In the US, there is renewed pressure to bring back the tax on oil companies, which was in force from 1980-1988.

The most recent move is Venezuela when it imposed early this year a 50% to 60% tax on foreign oil companies on the difference between the benchmark price and the actual sale price per barrel of crude oil. This move resulted in many of these companies pulling out of the country.

Structure of the tax
The windfall profits tax is a levy although in economics, a levy or duty is a kind of tax.

As a levy, it is collected by the Customs Department and represents a deductible expense for calculating the profits subject to income tax.

This differentiates it from the excess profits tax, the payment of which is not tax deductible for income tax purposes. The governing legislation for the tax levied on the Malaysian palm oil industry is the Windfall Profit Levy Act 1998 and the tax is now based on the following formula.

The excess profits tax was first introduced for companies for assessment years 1975 to 1988 at the rate of 5%, which was reduced to 3% for later years. It was intended as an anti-inflationary measure. The current tax (called a windfall tax) is at 30% levied on the profits of IPPs above a threshold i.e. 9% on the return on assets.

Thus profits exceeding this are the ‘excess profits’. The setting of thresholds across different industries can be problematic and care should be taken if the tax is to be extended to other industries.

For example, US oil majors in defending themselves before a Senate Committee for making exorbitant profits said that ‘their profits compared to capital expenditure were in line with other industries’.

Social agenda
In today’s environment of high oil prices sparking inflationary pressures and consumer hardships, economies seek to levy the windfall tax as part of a social agenda i.e. to fund programmes to provide relief to the broad segment of the population adversely affected.

President Chavez of Venezuela looked upon his measure to tax oil companies’ windfall profits as “21st–century socialism”.

Datuk Shahrir described Malaysia’s rationale for introducing the windfall tax as a measure “to ensure balanced distribution of income to deserving groups”.