What is a windfall tax and what does it mean for me?

Government has faced calls for tax on energy firms to help with the cost of living crisis - but how would it work?

Britain faces skyrocketing energy prices underpinning a crippling cost-of-living crisis that is also exacerbated by rising food and rental prices.

As millions across the country brace themselves for a difficult winter the government is attempting to find ways to ease the burden on the population.

One way it has decided to do that is to introduce an energy price cap. To help fund this the government introduced a £5bn temporary windfall tax of 25 per cent on oil and gas companies in May.

Now, Business Secretary Jacob Rees-Mogg has announced plans to cap the revenues of low-carbon electricity generators in what experts say amounts to a temporary windfall tax. It will also help with the costs of the prize freeze.

The government plans to cap the amount of money renewable and nuclear firms can keep after selling their electricity and to take the revenue they would have received from the market above this price into the public purse.

In other words, if the government capped the price at £150 per megawatt hour, similar to the level set by the EU, any revenue firms made selling electricity above this price on the open market, where prices have recently been significantly higher, would go to the government.

The revenue limit for renewables and nuclear electricity generators has yet to be determined and will be consulted on before coming into force at the beginning of next year. The fact the revenue limit has yet to be fixed means it remains unclear how much money the government will raise from the measure.

The government has pushed back against the framing of the measure as a windfall tax but experts say this is effectively what it is but on revenue rather than profit.

“It’s a windfall tax in all but name,” said Dr Simon Cran-McGreehin, Head of Analysis at the Energy and Climate Intelligence Unit.

Wind turbines at RWE’s Gwynt y Mor off the coast of North Wales. (PA)

It comes after then Chancellor Rishi-Sunak announced a £5bn temporary windfall tax of 25 per cent on oil and gas companies in May to help fund a £15bn package of assistance for struggling households.

He said almost all of the 8m of the worst-off households will get support measures including a £650 cost-of-living payment for families on benefits, a one-off £300 payment to pensioner households and £150 each to 6m disabled people. He announced that the government will also double help with energy bills on offer to all households this autumn from £200 to £400 and convert the payment from a loan to a grant.

What is a windfall tax?

A windfall is a sum of money you receive unexpectedly or by luck, for example, if you won the lottery.

A windfall tax is a one-off levy on the profits of companies that are seen to be unreasonably high and raised through good fortune.

Prior to the announcement in May, there had been calls from opposition parties, and some Conservative politicians, for the government to impose a windfall tax on oil and gas producers. That’s because these energy giants have recently reported bumper profits thanks to surging oil and gas prices pushed to record highs by Russia’s invasion of Ukraine, as well as pumped-up demand as economies emerge from the Covid pandemic.

Renewable and nuclear electricity generators have also done well from the recent high gas prices because currently in the UK market wholesale electricity prices are set by the most expensive form of generation - presently gas. Hence the newly-announced revenue cap.

What has the government said so far?

Boris Johnson’s government resisted calls for a windfall tax, before making a U-Turn in May. Liz Truss’ government also has said it does not favour windfall taxes and has pushed back against framing the energy revenue limit as a windfall tax.

Both governments had argued that one-off levies could deter future investment by firms, risking the security of the country’s energy supply, as well as jobs.

Business department insiders have insisted that the “cost-plus revenue limit” is not a windfall tax, as it applies only to excess revenues resulting from unusual trading conditions, and not to all profits.

Mr Rees-Mogg told BBC Radio 4’s The Today Programme: “It is not a windfall tax, it’s clearly not a tax. It’s nothing to do with the profits these companies are making.”

General view of Dungeness B nuclear power station on the south Kent coast. (PA)

It is understood that the revenue limit will apply to low-carbon generating assets not currently covered by a contract for difference and will be applied in England and Wales and will remain in place until markets return to normal.

Mr Rees-Mogg has said in a statement that businesses and consumers across the UK should pay a fair price for energy.

“We have been working with low-carbon generators to find a solution that will ensure consumers are not paying significantly more for electricity generated from renewables and nuclear,” he said, announcing the plans.

Is a windfall tax popular?

Almost two-thirds– 63 per cent – of the UK public support the idea of a one-off levy on energy giants, according to a poll shared exclusively with The Independent earlier this year.

However, there is concern among energy experts that by capping income, rather than profit, for renewable electricity generators the government is not taking into account companies’ costs.

The industry body, Renewable UK, has also said that in capping income the government is effectively taxing revenue above a certain level by a 100 per cent when oil and gas profits are taxed at 25 per cent.

This, CEO Dan McGrail said, “risks skewing investment towards the fossil fuels that have caused this energy crisis.”

Has a government ever imposed a windfall tax before?

Yes. In 1997, then Chancellor Gordon Brown imposed one on the profits of utility companies after they were privatised by previous Conservative governments.

Then Labour MP Geoffrey Robinson said at the time that the tax “puts right the bad deal which customers and taxpayers got from the privatisation of the utilities”.

May was not the first time a Conservative government has imposed such a tax either.

In 1981, Conservative Chancellor, Geoffrey Howe, introduced a one-off levy on banks. Later in his term, he also imposed a tax on North Sea oil firms.

Have any other European countries imposed a windfall tax this year?

European governments agreed last month to tax the windfall profits of oil and gas companies.

And Britain’s move to introduce a revenue limit on low-carbon electricity generators follows a similar proposal by the European Commission to introduce a limit of 180 euros per megawatt hour on the revenue renewable generators get for their electricity on the open market.

What would it mean for me?

The windfall tax announced in May was introduced to fund a plan to send eight million people on the lowest-income households a one-off payment of £650. Pensioners will also receive a one-off £300 payment, while there will also be a one-off disability cost of living payment of £150. Mr Sunak also scrapped the £200 energy bills loan in favour of a grant of £400 which will not have to be paid back.

As for the cap on the revenues of low-carbon electricity generators it remains unclear because the revenue limit on electricity has yet to be fixed. The revenue limit money taken by the government will offset some of the costs of paying for the energy price freeze, meaning we’re likely to pay less tax in the long run. But the revenue limit and the energy price freeze are both temporary measures.