Ukraine may consider introducing a corporate excess profits tax due to budgetary needs. How feasible is its implementation?

As international aid diminishes and becomes more selective, Ukraine is seeking internal resources to increase the revenue side of the budget. The traditional solution, which is effective as a temporary measure and is used by states during times of war and other crises, is the so-called corporate excess profits tax (windfall tax) or solidarity tax.

In 2022-2023, it was introduced throughout most European countries, including Germany, the United Kingdom, Spain, Italy, and France. The exceptions so far are Latvia and Norway, where this tax has been announced, as well as Luxembourg, Poland, the Netherlands, and Ireland, which are considering the introduction of a windfall tax.

Mind was looking into whether such a practice can be applied in Ukraine, where it is challenging not only to increase taxes but even to restore them to pre-war levels.

How much is the average rate of windfall tax? Windfall tax rates vary significantly across different countries. For example, Belgium introduced a 100% windfall tax for energy-generating companies from 2022 until June 2023.

Austria has imposed a 90% tax on profits for corporations involved in electricity production and transportation since 2022, and a 40% tax for oil and gas companies. Finland has introduced a windfall tax for energy companies.

In the Czech Republic, a windfall tax has been introduced for a period of three years starting from 2022. Banks, oil, and energy companies will be taxpayers. The tax rate is 60%.

How can a company become subject to such a tax? Only extraordinary profits are taxed, which can be obtained under certain conditions. For example, in the case of a monopolistic position of players, exclusive ownership of natural resources, as well as in the event of unforeseen circumstances.

This can be defined as "profits that do not stem from direct and planned actions of a firm but from unanticipated external changes in the market conditions" as stated in the document "The effectiveness and distributional consequences of excess profit taxes or windfall taxes in light of the Commission’s recommendation to Member States", issued in March 2023 by the Internal Policy Directorate-General of the European Commission.

Another example is the high profits of banks in the Baltic countries. For instance, according to the Bank of Latvia, in the first quarter of 2023, bank profits increased by 76.7% compared to the first quarter of 2022.

This is not due to the actions of the very banks but rather the measures of state support for financial institutions during the COVID-19 pandemic and the specific characteristics of the Latvian economy.

In the EU, energy companies also receive windfall profits arising from the energy crisis. As a result, in 2022, most European countries introduced a temporary tax on windfall profits for oil and energy corporations.

Why does the state consider itself entitled to demand a portion of the profits from private business, with which it has no involvement? Sometimes, however, it is indeed involved.

For example, last year in Lithuania, they introduced a tax on bank windfalls, calling it a "temporary solidarity contribution". The funds will be allocated for defence needs.

According to the Ministry of Finance of Lithuania, the atypical situation of high profits arose due to a combination of external circumstances, the specific nature of economic processes, and the imperfections of the banking market, rather than being a result of business decisions made by financial institutions.

"During the outbreak of the coronavirus pandemic, the state allocated unprecedented support to business and people. This has not only reduced the credit risk of businesses and households as well as the loss potential for banks, but also increased the level of liquidity in the financial system. In Lithuania this led to the fastest growing level of deposits in the euro area – 52 % – and the residents’ deposits accumulated were by EUR 11 billion higher than the loans. The current excess limits banks’ incentives to raise deposit interest rates, while historically the largest liquidity excess is held by banks mainly in the central bank account. The ECB pays interest to commercial banks on these funds. As a result of the huge and unusual excess of liquid assets in such a situation, this income does not depend on business decisions taken by banks and are therefore regarded as unexpected," the Lithuanian Ministry of Finance report states.

It is clear that a scenario where the state provided so much assistance that private businesses obtained windfall profits is unlikely to occur in Ukraine.

Is the introduction of a 'solidarity tax' in Ukraine justified? The first logical reaction of experts and analysts to the increase in the tax burden is strongly negative.

Yaroslav Lomakin, the CEO of Honest & Bright LTD, is convinced that any tax increase always leads to attempts by corporations to minimise their fiscal burden by hiding a portion of their profits. "My opinion on any taxes and fees is clear: we only need a flat scale and equality for all taxpayers. As for windfall profits and increased taxes on them, it's a very populist option," says Lomakin.

Economist Vyacheslav Inozemtsev believes that the tax on windfall profits is quite subjective in its essence.

Is it possible for the 'solidarity tax' to have a destructive effect? Yes, as businesses are usually smarter than the average bureaucrat.

There are enough examples in history where taxes on windfall profits have led to a negative reaction from corporations and even entire industries. For instance, in the United States, the windfall profits tax on domestic oil extraction in the 1980s significantly reduced the results of the wells to which it was applied. Companies redirected their extraction to wells that were not subject to fiscal innovation.

In 2014, the Rothschild & Co investment bank in the United Kingdom considered early bonus payments to bypass the payment of the windfall profits tax. Therefore, EU countries are introducing this tax very cautiously, often as a temporary measure.

What are the advantages of this tax? Firstly, it satisfies the demand for a somewhat vague concept of social justice. Any situation in which the wealthy pay more is strongly supported by society. In Ukraine, even if corporations later compensate for the additional fiscal burden by raising prices for the same consumers who welcomed the innovation, there is a sense of satisfaction.

Who can theoretically fall under the windfall profits tax? Financial results can be easily concealed or understated through transactions with related parties. Therefore, the state will likely rely on market shares, involving the Antimonopoly Committee. In this case, there is a risk that the easiest way would be to ' peek into the wallet' of representatives of oligopolies in the electricity, oil, and poultry markets.