Upheavals breed special taxes

This is demonstrated by a study conducted by JSC BDO Latvia. Typically, such special taxes are imposed on industries with high economic potential or resource wealth, as the state aims to generate income from these activities or regulate their impact on the economy and the environment. For instance, in the oil or gas industries, special taxes may be implemented to generate revenue for the state from the use of natural resources and to promote their sustainable utilization.

Historically, windfall taxes were significant during the First World War when at least 22 countries, including major nations such as Great Britain, the United States, France, Italy, and Germany, introduced some version of a tax on excessive corporate profits. Additionally, during the Second World War, these taxes reappeared, and countries like Great Britain, Canada, and the United States began to reapply them.

Before the war, such taxes were not widely applied in Ukraine for decades.

"Special taxes are nothing new in Europe, although in the context of Latvia, it has been a novelty for the past 30 years," says Jānis Zelmenis, a partner at AS BDO Latvia, as he analyzes the research data. He points out that in Latvia, there have already been different profit rates for various industries. In 1993, the Supreme Council decided that the profit tax rate for banks, insurers, traders, and currency changers would be 45%. Additionally, companies with a state or municipal stake paid an increased 35% profit tax instead of the usual 25% (except for those paying 45%). However, this arrangement did not last long.

Theoretical background

A characteristic feature of the tax systems of many countries is the existence of sectoral taxes, where specific rates are applied to particular sectors. The purpose is either to regulate, promote, or reduce the external factors related to a specific sector," J. Zelmenis illustrates tax theory. He explains that excise and natural resource taxes, which are also present in Latvia, can be considered classic industry taxes.

"At the same time, there is also a differentiated corporate income tax, not only based on the amount of income but also according to the sector. The essence of the reduced profit tax is to promote the development of the new sector, considered to be the engine of future growth. Another purpose of introducing a differentiated tax may be the economic recovery of sectors severely affected by economic downturns, natural disasters, or global events. Likewise, the differentiated tax can be introduced for industries with strategic importance for national security or self-sufficiency (especially important in the current geopolitical conditions)," explains J. Zelmenis. He points out that there have been both successful and unsuccessful attempts to introduce the idea of a higher profit tax (surplus profit) in different countries at specific moments of great upheaval or turbulence. "Also, in today's situation, with high inflation and the European Central Bank's decisions to raise base interest rates to suppress it, and the excellent profit indicators of many energy companies at all levels, the term 'unplanned profit' has popped up, the cause of which is external conditions, not the sweat of the entrepreneurs themselves," J. Zelmenis recently stated the situation.

According to him, it is precisely the amounts of unplanned profits in several sectors – banking, energy, and even retail – that are the main irritants for politicians, creating a desire to extract more from them.

A side effect of the Ukrainian war

After the start of the war in Ukraine last February, several European countries have also introduced temporary windfall taxes, mainly aimed at companies operating in the oil and gas sector. "Windfall profits are profits that arise as a result of unexpected changes in external market conditions, and they are common in the context of energy markets caused by temporary shocks in global supply chains. For example, in the US in 1980-1988 for crude oil, in the UK in 1997 for privatized utility companies," explains J. Zelmenis. He points out that Hungary applies a special tax rate of 95%, which oil product producers must pay from 2022-2024. This additional profit tax base is calculated by determining the difference between the price of Russian crude oil on the domestic market and the price of crude oil on the world market. On the other hand, in Austria, a tax of up to 40% will be applied to oil and gas companies on profits that exceed the average of the previous four years by 20%. Similarly, in Italy, as part of measures aimed at addressing the problem of rising energy costs for consumers, energy companies are subject to an extraordinary tax of 50% on additional income, capped at 25% of net asset value at the end of the year.

Special tax for large retailers

BDO Latvia's research reveals that Poland and Hungary have implemented a special retail sales tax, which can be seen as a response by the governing politicians of these countries to large retail chains and their pricing policies.

"As of January 1, 2021, Poland has adopted a differentiated retail sales tax system targeting outlets with the highest turnover by volume. Specifically, the tax consequences apply when a retailer's monthly revenues exceed the threshold of 17 million zlotys (3.74 million euros)," says J. Zelmenis. He notes that revenues up to 170 million zlotys (37.4 million euros) are subject to a tax rate of 0.8%, while income exceeding this threshold is subject to a tax rate of 1.4%. "Hungary's retail tax system is even more aggressive. In 2023, in addition to the regular retail tax, an additional 80% tax based on gross receipts from retail sales is expected to be paid. Its structure is progressive, with the highest possible tax rate reaching nearly 5% for a retailer in 2023," explains J. Zelmenis. He illustrates this with an example: if a Hungarian retailer has a basic retail tax rate of 3% of gross revenue, in 2023, they will have to pay an additional 2.4%

The Trend of Special Bank Taxes

"It is possible that the ruling politicians of Latvia looked at the example of the southern neighboring country, Lithuania, to understand how to generate additional revenue for the state budget and, simultaneously, gain the sympathy of some ordinary voters by imposing taxes on banks," explains J. Zelmenis. He hastens to add that the solidarity (surplus profit) tax for credit institutions is not unique to Lithuania; it is also present in Hungary, Spain, and the Czech Republic. As far back as the eighties of the last century, with a retroactive date, Great Britain introduced a solidarity tax for banks based on the profit they made, not from risking and lending money, but similarly to the current situation, arising from the Bank of England raising interest rates to suppress inflation.

In Lithuania, a tax rate of 60% will be applied to net interest income that exceeds 50% of the average in the last four financial years. In Latvia, it has been proposed for the financial sector (not limited to commercial banks but including all entities operating in this sector) to simply cancel the existing corporate income tax system. In this system, the tax is paid only on the part of the profit that the meeting of participants decides to pay out as dividends to the shareholders, and the proposal is to reinstate the profit tax to be paid in the same manner as before the 2018 tax reform, when it had to be paid regardless of whether dividends were distributed or not," explains J. Zelmenis. He points out that all the nuances will be discussed in more detail when the relevant bill receives the support of the majority of the Saeima. "In my opinion, the Latvian government's desire to extract additional funds from the financial sector solely because commercial banks have shown excellent indicators this year is adventurous. No one can predict whether such times will also occur in 2024 and the subsequent years, and it may not stimulate banks to issue new loans for both companies and private individuals. There is also a risk that they will simply pass on this additional tax to consumers - citizens and companies - by raising the prices of their services.

I doubt whether the politicians genuinely want this," J. Zelmenis shares his thoughts. Currently, the bill on amendments to the corporate income tax law is being forwarded to the government meeting for approval.

Special taxes on hydrocarbons

BDO Latvia's research reveals that in countries abundant in natural resources, specific taxes have been introduced, targeting oil and gas companies.

Interestingly, these tax rates often fluctuate depending on world prices and local environmental policies.

"In Denmark, the corporate income tax rate is 22%, but the total tax rate for hydrocarbon miners can reach around 64% (petroleum tax 25% and special tax 52%)," explains J. Zelmenis when asked to provide an example. He notes that in Ireland, a special tax of 25% of the sales income obtained from an oil and gas field is applied, in addition to the existing corporate income tax.

In Malta, the profit from the sale of oil is taxed at a 35% rate, provided a relevant agreement is concluded with the country's management. Without such an agreement, a 50% tax rate must be paid. "On the other hand, in Norway, the taxation of such companies is even more complex because there is a special tax, the nominal rate of which is 71.8%, to which an additional rate must be added, resulting in a combined tax rate of 78%," explains J. Zelmenis when asked about the potential heights of special tax rates for hydrocarbons.

Surplus profit tax for banks:

  • Latvia:
    • 20% of profits every year, regardless of profit sharing.
  • Lithuania:
    • 60% will be applied to net interest income exceeding 50% of the average of the last four financial years.
  • Spain:
    • Banks' net interest income and net commissions exceeding EUR 800 million are taxed with a bank profit tax of 4.8%.
  • Czech Republic:
    • From 2023 to 2025, a surplus income tax (60% additional tax) is applied to the surplus profits of large banks and energy companies. Surplus profit is calculated based on the company's 2018-2021 average corporate income tax base declared in the year, increased by 20%. In addition to the standard income tax rate of 19%, the calculated surplus is subject to an additional income tax surcharge of 60% (resulting in a total income tax rate of 79%).
  • Hungary:
    • From July 1, 2023, changes in determining the taxable base include net sales revenue for the first half of the year and pre-tax profit for the second half. The tax rate for the first half is 8%, and for the second half, it is divided: 13% for amounts not exceeding 10 billion Hungarian forints and 30% for amounts exceeding this limit.
Source: Dienas Bizness