Windfall tax is a tax levied by governments on certain industries when they experience above-average profits or windfall profits as the term suggests, due to economic conditions. They are primarily levied on companies in the targeted industry that have benefited most from the economic windfall; most often they involve commodity-based businesses. Through the proceeds from the windfall tax, governments are able to bolster funding for social programs.
The flip side – its opponents claim that such taxes reduce companies’ initiatives to seek out profits. They also believe that the profits should be reinvested to promote innovation that will in turn benefit society as a whole.
IPPs – contentious issue
Windfall taxes will always be a contentious issue debated between the shareholders of profitable companies and the rest of society. The recent 30% windfall tax that was imposed on Independent Power Producers (IPPs), according to some, should be reviewed due to its wider implications on capital markets.
IPPs, which finance the construction of their power plants through the issuance of bonds, might see a reduced cash flow due to the tax payment. CIMB Group chief executive Datuk Seri Nazir Razak had said that the tax would affect raising funds for future infrastructure projects. IPPs accounted for 21% of all ringgit-denominated bonds issued.
The windfall tax, effective July 1, will be 30% of earnings before interest and tax (Ebit) that is above the 9% threshold on return on assets (ROA).
Penjanabebas, an association of 15 independent power producers, warned the levy could affect their ability to meet loan obligations. It said the sector issued bonds and loan notes estimated at RM20bil in 2006 and the new tax could lead to a downgrade of their bonds.
Nazir added: “There are no winners in this IPP windfall tax because ... borrowing costs in Malaysia will go up and further increase incremental cost of borrowings to the government and corporates. The higher cost of borrowings will far exceed the money that they (government) hope to raise from the IPPs windfall tax”.
Palm oil gets hit
Under the Windfall Profit Levy Act 1998, a windfall levy would be imposed on crude palm oil (CPO) and crude palm kernel oil (CPKO) when the prices are in excess of the threshold of RM2,000 per tonne.
Under the proposed windfall tax framework, palm oil producers in peninsular Malaysia would be charged tax amounting to 15%, and 7.5% for Sabah and Sarawak.
At the same time, the Government is also abolishing the existing cooking oil cess from July 1. However, the price of cooking oil will remain the same as it will be subsidised by proceeds from the windfall taxes.
The Government said plantation companies in Sabah and Sarawak were charged a lower windfall tax as they were already paying sales tax to their respective state governments.
Strangely and in stark contrast to the reaction from power players, not many palm oil companies were up in arms when the government levied windfall tax on CPO.
Utilities and plantations – the difference
It is safe to say that the windfall tax may be unfair to IPPs as they had raised funding for their business, while on the other hand, CPO companies generally invest from retained earnings.
Hold that thought. Does that mean that if CPO companies were to switch their capital requirements strategy to bonds, would it make the windfall tax inequitable to them as well?
This is my humble opinion. On paper, singling out industry sectors and corporates to pay up arbitrary taxes makes little sense. However, I would agree to a windfall tax if certain developments cause certain sector/companies to make supernormal profits and due to these developments, it has a direct and negative effect on a wider strata of the nation.
However, slapping tax arbitrarily on any sector that makes supernormal profits is not the way to go. The government needs to clearly explain the windfall tax and the actual disbursement of the income generated from such taxes.
It ought to be used directly to alleviate the “suffering and dislocation” triggered by the very developments that these companies and sectors have benefited enormously from.
On that premise, it may be easy to justify the imposition of windfall tax on CPO companies and IPPs.
Crying crocodile tears
Tariffs in Peninsular Malaysia are not subsidised.
Yet both TNB and independent power producers (IPPs) are profitable and credit-worthy. IPPs began selling to the national grid in late 1994 and today five IPPs account for around 35% of installed generation capacity in Peninsular Malaysia.
As these IPPs are virtually risk free (courtesy of long-term power purchase agreements – PPA) and profitable, the IPPs based in Peninsular Malaysia have agreed to contribute 1% of their audited annual revenue to a special fund – the Malaysian Electricity Supply Industry Trust Account (MESITA) in the 1997 –2000 period.
As part of its trust deed, the MESITA funds could be used for 5 approved activities and among them are energy-efficiency program and energy R&D.
The windfall tax is supposed to kick in ONLY IF their rate of return exceeds 9%. As such, the hoopla over that hitting IPPs fund raising activity in the future and that of other infrastructure projects, in my opinion, is a bit over the top.
Genuine bond investors who understand fully that the windfall tax would kick in above the 9% rate are likely to shrug their shoulders.
The main interest of bondholders is to get their money back, plus interest. Even if these IPPs were to make a rate of return of 6%, bond investors would be happy as they do not participate on the upside profits of the company. However, the windfall tax formula should be based on after EBIT has been deducted for interest paid out - that would be more equitable.
But on one aspect, I would side with the IPPs – the tax should not be recurring.
If the tax was recurring, the taxable amount would increase over time as net fixed asset falls, especially for IPPs with big-capacity plants like the 2,400MW Tanjung Bin plant and the 1,400MW Jimah plant. That would make little economic sense.
In that case, and if it’s not going to be one off, the government should adjust their windfall tax accordingly. For example, in 2008, 30% above 9% ROA; 2009 only on ROA above 10% and 2010, on ROA exceeding 11%. Even so, the time frame should not be over a prolonged period, one to three years is about right.
With that, for future infrastructure projects, I doubt very much that yields would go up solely due to the windfall tax issue.
Firstly, it’s not something completely new and alien. We have done it before and many countries have done it before without dire consequences. It just ought to be well planned and justifiable.
Secondly, the windfall tax would only kick in at supernormal levels which should not concern bond investors. If anything, it should concern the shareholders of IPPs more, not the bond holders.
But again, this is important – the government needs to clearly articulate that the windfall tax (es) will be used to alleviate hardship caused directly by the developments which have brought about the windfall in the first place.
Some say that the windfall tax may create a perverse incentive for mis-declaring profits. Well, that is a whole different kettle of fish but I believe we have in place appropriate rules and regulations to deal with that.
Narrow window
Generally, there is only a very narrow window when windfall tax is justifiable.
Investor confidence could be derailed if these taxes are perceived to be arbitrary and irrational. If that happens, risk premium is likely to rise for the entire market place.
The group that most affected by windfall tax is shareholders of the companies affected.
Their loss is equal to the actual windfall tax collected. The loss will be reflected in lower share price. For example, investors may have bought the stocks on the assumption of rising CPO prices or iron-clad agreements with IPPs, which paint a rosy earnings outlook picture. To penalise these investors may be unfair.
Intriguingly, there has been very little “noise” on the adverse impact such windfall tax would have on shareholders but a lot of hue and cry on the implications for bondholders.
Why treat shareholders with such dismiss while at the same time, molly coddle bondholders?
Windfall tax on gaming?
There are rumours that windfall tax will also be imposed on gaming companies. Such a move would be clearly arbitrary as gaming companies had nothing to do with or benefited from the oil price or commodity price surge. To do that would wreak havoc on the valuation and integrity of a properly functioning stock market. Yes, the government could easily raise taxes on gaming, but please don’t refer to it as a windfall tax. If that’s true, then gaming companies are likely to be whacked in the coming budget.
But what is truly fair?
In a booming property market, the government may impose a 50% additional property gains tax on property sales, or impose a restriction that one must hold a property for at least 12 months before selling. Is that fair? At the same time, it could be deemed equitable for the long term interest of the sector and economy.
I do not believe there exists a truly free market economy anywhere in the world. That only exists in economics theory. This is why – for every single fiscal decision made by the government, there will always be winners and losers.
photos: Maggie Cheung Hor Yee
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