Windfall tax may be applied, in cases where the government increases the official price.

The Ethiopian Revenues & Customs Authority (ERCA) is to probe petroleum distributing companies other whether they get windfall gains following the government's regularly price adjustments.

The ERCA will launch an investigation into the companies in the coming two weeks. If the investigation indicates that the companies are getting windfall gains, the ERCA will levy a windfall tax on them.

Windfall tax, introduced to the Ethiopia tax system when the income tax proclamation was amended in November 2010, is levied on profits made by businesses as a result of local or international economic or political factors. Such types of profit are not considered as gains as a result of the business's own efforts.

Anonymous informants tipped off the Authority two weeks ago that petroleum distributing companies are benefiting from such gains. The informants presented an investigative study on seven petroleum companies.

The companies have gained more than 150 million Br in windfalls that the government should have taxed, the study claims. Such profit is made either from stocks in depots or in transit, according to the study. After the government adjusts petroleum prices, the companies sell their previously purchased stock at the new rates and gain extra profits.

"Though such gains should be clearly indicated by the companies, they are declaring it as normal profit," the study reads.

The Ethiopian government used to subsidise petroleum and petroleum products until October 2008. Following to the lift, the government started adjusting prices of petroleum and petroleum products based on the international market performance, every three months. The period was later reduced to a month.

In 2011, alone, the government adjusted prices five times, and the investigative study analysed the windfall profits gained during these adjustments. Though the study was conducted on only seven companies, the ERCA decided to launch its own investigation in all petroleum distributing companies, according to sources.

There are nine petroleum companies operating in the country. Total Ethiopia has the highest market share at 32pc, followed by OiLibya and National Oil Company NOC with 28pc and 27pc, respectively, according to the study.

Managers of petroleum companies, who requested anonymity, fiercely opposed the ERCA's move. They get their highest profit margins from lubricants and they gain as little as four cents a litre from petroleum sales, they claim.

If the ERCA decides to levy such gains, it will severely affect the infant sector and discourage potential investors interested in engaging in petroleum distribution, they argue. They bring a logical question of "who will bear the loss when prices are cut during adjustments."

"Would the government compensate us when we sell at a reduced price following the adjusted price of petroleum?" a major shareholder at one of the petroleum companies questioned. "There is no need to tax our profit differently as we report the adjusted price is whether in favour of us or against us."

His company is subjected to a 30pc profit tax over the total profit that the company attains. If there are any windfall gains, they should fall under total profit, he argues.

"This does not bode well for the sector, at all," the shareholder, who has stayed in the sector for the last five years, warned.

The ERCA's move to levy windfall tax on petroleum companies did not get support from a tax expert that Fortune consulted on the issue, either. Although the circumstances of the companies might seem to fall under the definition of windfall tax, the government should be careful enough in selecting businesses suspected of benefitting from economic windfalls, according to the tax expert who wished to remain anonymous.

The amended income tax proclamation gave a mandate to the Ministry of Finance & Economic Development (MoFED) to identify businesses that are subjected to windfall tax. However, an explanation presented when the proclamation was amended in November 2010 indicated that businesses engaged in oil exploration, finance, and mining sectors were the major sectors to benefit from a windfall profit.

"The businesses subjected to windfall taxes should be those that are affected by external factors not so frequently, such as banks," the tax expert argues. "You cannot have devaluation every month. It is once in a blue moon which is more convenient for the government to tax."

The government devalued the Birr against a basket of major currencies by 20pc in September 2010. After three months, the MoFED issued a directive that ordered banks to pay 75pc of their revenue gain from foreign transactions.

The case of petroleum businesses is different from banks, as the sector is highly influenced by external factors, according to the expert. The frequency of the factors would also raise the enforcement cost for the Authority, he quipped.

"The Authority needs to check the stock and transiting cargo of each company every month in order to find out their windfall gains, which, in turn, might lead to corrupt practices," the expert argued.

The now-defunct QSAE has been in charge of checking the quantity of petroleum distribution through the companies at the end of every month. The government, however, abolished such regulation three years ago because it has created corrupt practices, according to a senior official at the defunct Authority.

"Tax should not be a tool for regulation, as the two of them are different concepts," the expert argued. If the companies are hoarding the product in order to get inappropriate profit, the government should control and penalise them for doing such acts, he indicated "tax should not be used as a regulatory tool".

"Whether these companies are getting undeserved profits, it will be wise to demand excess profit tax after conducting a thorough study," the expert suggested.

Excess profit tax is a type of tax levied by the concerned authority on certain businesses when they attain beyond a specified amount. Such types of taxes used to be levied during wartime. Companies, due to their nature of benefiting from wartime, were expected to pay excess profit tax, based on the difference in revenue they got during peacetime.

The industry players, however, are not happy with the expert suggestions.

"Since we are not allowed to claim compensation from our windfall losses, the government should not come after the windfall gains that we get," a shareholder insisted.

Officials at the ERCA declined to comment on the issue.