What is the windfall tax on oil and gas companies and how does it work?

Offshore drilling rig in ScotlandImage source, Getty Images

Prime Minister Liz Truss has ruled out using further windfall taxes on energy companies to fund measures to help people with their gas and electricity bills.

"I am against a windfall tax," she told MPs on 7 September.

"I believe it is the wrong thing to be putting companies off investing in the United Kingdom just when we need to be growing the economy."

A windfall tax on the UK oil and gas sector was introduced on 26 May. Labour, the Liberal Democrats and the SNP are calling for it to be extended.

What is a windfall tax?

A windfall tax is a one-off tax imposed by a government on a company.

The idea is to target firms that were lucky enough to benefit from something they were not responsible for - in other words, a windfall.

Energy firms are getting much more money for their oil and gas than they were last year, partly because demand has increased as the world emerges from the pandemic, but more recently because of supply concerns due to Russia's invasion of Ukraine.

How does the new windfall tax work?

Former Chancellor Rishi Sunak, who introduced the tax, described it as a 25% Energy Profits Levy.

It will apply to profits made by companies from extracting UK oil and gas, but not those that generate electricity from sources such as nuclear or wind power. The Treasury expects it to raise about £5bn in its first year.

When Mr Sunak announced the Energy Profits Levy in May, it was accompanied by a measure that allows energy companies to apply for tax savings worth 91p of every £1 invested in fossil fuel extraction in the UK.

When the BBC asked the Treasury how much the tax break would cost it received no reply.

Labour have accused the government of handing money to oil companies that could have been used to support households.

How much tax do oil companies pay?

Oil and gas firms operating in the North Sea are taxed differently to other firms.

Taxes on their profits are higher - they pay 30% corporation tax on their profits and a supplementary 10% rate on top of that. Other firms currently pay corporation tax at 19%.

But oil and gas firms have been able to reduce the amount of tax they pay by factoring in losses or spending on things like decommissioning North Sea oil platforms.

In recent years, such methods have meant that BP and Shell, for example, have paid almost no tax in the UK.

BP and Shell both received more money back from the UK government than they paid every year from 2015 to 2020 (except 2017, when Shell paid more than it received). Shell also paid a negative amount of tax in 2021 - BP has yet to publish its figures for last year.

How much have energy firms been making?

BP reported its biggest quarterly profit for 14 years, making £6.9bn in the three months to June.

Shell recorded even higher second quarter profits of £9bn.

However, despite the profits, the majority of the April to June takings won't be hit by the government's windfall tax as it only applies from 26 May.

But both have written off a lot of money as a result of exiting from investments in Russian oil firms following the invasion of Ukraine.

BP and Shell have both spent billions recently on what are called share buybacks, which is what companies do when they have money they can afford to spend on boosting their share price.

The BBC asked BP and Shell how much profit they were making in the North Sea, but both were unable to tell us.

Would a windfall tax affect investment?

BP plans to spend a maximum of £18bn on the UK's energy system by the end of 2030.

Chief executive Bernard Looney was asked by The Times on 3 May which of BP's planned UK investments would not go ahead if there were a windfall tax.

Mr Looney replied: "There are none that we wouldn't do."

Shell plans to spend £20bn-£25bn on UK energy over the next 10 years.

What have politicians said?

Boris Johnson's government adopted the windfall tax policy, having previously rejected it on the grounds that it would deter investment.

Prime Minister Liz Truss was part of that government, but said during her leadership campaign that a further windfall tax would "send the wrong message" to the world, adding that the government should be encouraging Shell and other companies to invest in the UK

Labour, the Liberal Democrats and the SNP all supported a windfall tax on oil and gas companies.

Labour would extend the tax to help fund its proposed six-month freeze on energy prices. It would apply the tax to profits from January 2022, rather than May and would get rid of the government's tax relief scheme for oil and gas companies.

The Liberal Democrats want the tax back-dated to the last three months of 2021.

Critics of a windfall tax argue that it might affect the money paid out to pensioners by some pension funds - as these funds benefit from energy firms' profits.

But it is important not to overstate the impact of this. Pension funds invest across countries and industries, so such a tax is unlikely to make a noticeable difference.

Image source, Getty Images
Image caption,
1997: Gordon Brown announced a windfall tax in his first budget

Have we had UK windfall taxes before?

The UK's best-known windfall tax was in 1997, when Labour Chancellor Gordon Brown placed the tax on companies formed after the Conservative governments' earlier privatisation of nationalised industries, including BT, Scottish Power and United Utilities.

The tax raised £5.2bn over two years (£8.7bn in today's money) according to the Institute for Fiscal Studies.

Conservative Chancellor Geoffrey Howe imposed a similar levy on banks in 1981, arguing they had benefited from high interest rates. He also imposed a special tax on North Sea oil and gas firms.