A windfall tax by any other name: the European Commission’s legislative proposal to address rising energy prices

On 30 September 2022, the final text of the proposal for a Council Regulation with short-term emergency measures to address rising energy prices was agreed by EU energy ministers (the Regulation). Whilst the tax measures have deliberately not been badged as windfall taxes, both for political and legal reasons, to all intents and purposes they aim to achieve the same thing, funnelling excess profits over a specified level to mitigate the impacts of high electricity prices on final customers.

Tax measures

In addition to other, non-tax, measures that form part of the package, the Regulation provides for (i) a cap on market revenues for the generation of electricity from so-called inframarginal technologies, and (ii) a temporary solidarity contribution for the fossil fuel industry.

Cap on inframarginal market revenues

The cap on realised market revenues of electricity producers obtained from inframarginal generators at 180 EUR/MWh of electricity produced (lower than the previously discussed cap of 200 EUR/MWh) applies to the following energy sources: wind, solar (thermal and photovoltaic), geothermal energy, hydropower without reservoir, biomass fuel (solid or gaseous, excluding bio-methane), waste, nuclear energy, lignite, crude petroleum products, and peat.

The main justification for this approach is that these sources can provide electricity with relatively low and consistent costs, whereby due to the economic merit order principle (meaning that the most expensive electricity production source impacts the price level for the whole energy spot market) revenues for electricity producers using these input technologies have significantly increased since the beginning of this year.

The revenue cap covers all market timeframes, regardless of whether the trading of electricity takes place bilaterally (over-the-counter) or in centralised marketplaces, and applies to producers and certain intermediaries participating in electricity wholesale markets on behalf of producers. Member States can decide whether to apply the cap on revenues from the sale of electricity at the settlement of the exchange of energy or thereafter. They can also choose to limit the revenue cap to only 90 per cent of the revenues exceeding the cap of 180 EUR/MWh.

Member States are allowed to exclude from the cap (i) producers generating electricity with power-generating facilities with a capacity of up to 1 MW (the initial proposal was 20kW), (ii) electricity produced in hybrid plants which also use conventional energy sources, if there is a risk of increasing CO2 emissions and decreasing renewable energy generation, (iii) revenues from sales in the balancing energy markets, and from compensation for re-dispatching and countertrading, and (iv) electricity generated in small isolated systems or small connected systems. The cap does not apply to demonstration projects, to producers whose revenues are already capped by way of national or public measures, or in certain other cases (e.g. to outermost regions that cannot be interconnected with the EU electricity market).

Pursuant to the agreed text, Member States are, under certain conditions, allowed to (i) maintain or introduce national measures that further limit (e.g. lower) market revenues of covered producers, including for specific technologies, and other market participants (e.g. electricity traders), (ii) increase the revenue cap for covered producers if their investments and operating costs exceed the 180 EUR/MWh cap, (iii) maintain or introduce national measures to limit market revenues of producers generating electricity from sources not covered by the cap, (iv) set a specific cap for market revenues from the sale of electricity produced from hard coal, and/or (v) apply a revenue cap (i.e. not necessarily the cap of 180 EUR/MWh) to hydropower technologies not covered by the Regulation.

The incentives for renewables power purchase agreements initially proposed by the Commission have been removed from the agreed text due to their incompatibility with the Article 122 TFEU legal base.

The surplus revenues (i.e. the positive difference between market revenues per MWh and the cap of 180 EUR/MWh) must be channelled to support final electricity customers. However, the mechanism for doing this is left, subject to certain criteria, to Member States. This could involve, for instance, financial compensation to final electricity customers for reducing their electricity consumption.

Also, subject to approval by the regulatory authority, Member States would be allowed to use the surplus revenues resulting from the allocation of cross-zonal capacity to finance the above measures to support final electricity customers.

Member States are allowed to conclude agreements to share surplus revenues. Such agreements are mandatory where for the period between 1 January 2021 and 31 December 2021 a Member State’s net import dependence of electricity (i.e. the difference between the Member State’s total electricity imports and exports as percentage of the total production of electricity in such Member State) is equal to or higher than 100 per cent.

The market revenue cap will apply from 1 December 2022 (with the option for Member States to introduce it voluntarily even sooner) until 30 June 2023 (an extension from the original proposal that this would only apply for four months).

Solidarity contribution

The other tax measure, which applies unless an equivalent (in terms of objective, covered activities, taxable base, rate, etc.) national measure generating comparable or higher proceeds is enacted by a Member State, is a temporary solidarity contribution on surplus profits generated from “activities in the crude petroleum, natural gas, coal and refinery sector”.

This contribution seems to be intended, on the one hand, to spread the burden of mitigating the impacts of the energy price crisis to fossil fuel companies, using solidarity principles and the justification that those companies have also unexpectedly seen a significant rise in profits due to the current circumstances. On the other hand, it also avoids imposing windfall profit clawbacks only on inframarginal energy producers, which could be perceived as detrimental to the EU’s efforts to transition to renewable energy sources in line with its European Green Deal objectives.

The contribution applies to companies or permanent establishments (including those that are part of a consolidated group merely for tax purposes) that (i) are tax resident, including for the purposes of any applicable double tax treaties, in a Member State (for companies), or situated and subject to tax in a Member State (for permanent establishments), and (ii) generate at least 75 per cent of their turnover in the field of the extraction, mining, refining of petroleum and/or manufacture of coke oven products. Such contribution would be in addition to regular national taxes and levies, and Member States shall adopt measures to implement the solidarity contribution by 31 December 2022.

The rate of the levy will be “at least” 33 per cent of taxable profits (presumably of in-scope activities, as determined under national tax rules) in the fiscal year(s) 2022 and/or 2023 (to be decided by Member States), which are above a 20 per cent increase of the average taxable profits (again, presumably of in-scope activities) in the four fiscal years starting on or after 1 January 2018. If such average is negative, then for the purpose of calculating the solidarity contribution the average taxable profits would be zero.

The proceeds from the solidarity contribution are to be used for financial support measures, which are to be developed by Member States, including to support vulnerable households and energy intensive industries, to help reduce energy consumption, to develop energy autonomy in the EU and promote investments in renewables. Member States are also allowed to assign a share of the proceeds to common financial measures to reduce the harmful effects of the energy crisis.

Unlike the market revenue cap, which effectively applies for seven months, the solidarity contribution applies to surplus profits generated in the fiscal year(s) 2022 and/or 2023 and the relevant rules remain applicable for the entire application period of the Regulation – until 31 December 2023.

Next steps

In order to speed up the adoption process the proposal will be adopted under Article 122 para 1 TFEU (i.e. without the involvement of the European Parliament). Once adopted, which is likely to happen in the course of next week, the Regulation will enter into force on the next day after its publication in the Official Journal of the EU.

After the Regulation enters into force, the Commission will have to review the provisions concerning the market revenue cap by 30 April 2023. Depending on the findings of that review, the Commission could then propose an extension of the Regulation, to modify the level of the cap and the covered sources of electricity generation, or to otherwise amend the relevant provisions. The Commission will also have to carry out reviews for the solidarity contribution provisions by 15 October 2023 and 15 October 2024, and report its findings to the EU Member States.