Windfall profits are any type of additional income over expenses that is completely unexpected. In many countries, there are laws that specifically define windfall profit for the purpose of establishing the tax schedule that applies to the unanticipated additional revenue. For this reason, it is important for individuals and businesses to be clear on what is windfall profit and what constitutes a different class of revenue according to local tax laws.
Part of understanding what constitutes a windfall profit situation is to consider some of the ways in which a sudden windfall may come about. When real estate holdings owned by an individual suddenly appreciate in value, the owner can sell the holdings at a substantial and unanticipated level of profit. An unexpected increase in sales that drains products that have been setting in warehouses for some time can also be interpreted as windfall profits. The key factor in any windfall situation is that there is no advance indicators that demand or value is likely to increase dramatically in a short period of time.
Because the sudden appearance of a windfall can result in a substantial infusion of revenue, many countries pass windfall profit tax laws that make it possible to tax the unexpected profit separately rather than bundling it into other taxable income. One example would be windfall profit taxes enacted and applied to oil companies during the 1970’s and 1980’s. While some countries eventually repealed those laws, others remain in effect for many years and continue to be in place today.
When an individual or company experiences a sudden influx of windfall profits, it is important to track the extra income closely. Verifying current tax laws and reviewing relevant reporting procedures will make it possible to comply with any tax regulations that are in place, and prevent the business from paying penalties at a later date. It is not unusual for the accounting of these unanticipated profits to involve the creation of a special line item, making the process of keeping track of the amount of extra profits generated a little easier.
While the general concept of windfall profits is similar around the world, the guidelines used to identify what constitutes this type of income does vary from one country to another. This can make the process of tabulating and reporting windfall profits somewhat more difficult for corporations that maintain facilities in several different nations. Depending on how and where the windfall originated, prevailing laws in the country where the company is headquartered may apply, or laws governing taxes in the nation where the windfall took place may determine the qualification and proper taxation of any windfall profits.