Page last updated at 12:27 GMT, Monday, 7 December 2009

Q&A: Windfall tax on bankers' bonuses

London skyline showing the City
Some City bankers face the threat of a tax on bonuses

Speculation that the government is considering a windfall tax on bankers' bonuses is growing ahead of the chancellor's pre-Budget report. So what is a windfall tax and why is it being considered?

What is a windfall tax?

A windfall tax is essentially is a one-off tax imposed on a company or industry by a government. They are usually imposed when an industry is perceived to have made excessive or undeserved profits.

In the UK, the precedent was set in 1997 when the government imposed a windfall tax on energy utility companies including British Gas and National Power, which had been privatised in the early 1980s.

They argued that the utilities were sold off too cheaply, and that taxpayers deserved a share of the profits the companies had made since privatisation. They imposed a one-off tax, earning the government £4.5bn.

Why is there talk of a windfall tax now?

Since the global financial crisis that engulfed the banking sector last year, many banks have returned to profitability.

Much of that profit will be reinvested into the banks, but some of it will be used to pay bonuses to individual bankers. RBS, for example, plans to pay out £1.5bn in bonuses.

Given that many of the banks have the taxpayer to thank for the multi-billion-pound bailout that kept them in business, some people argue that these bonuses aren't justified.

So the government is considering a windfall tax.

They are concerned, however, that a tax on bank profits could harm the banks at a time when they are still recovering from the financial crisis, so they're considering taxing bankers' bonuses directly instead.

Can the government really impose such a tax?

If it really wants to, yes. In 1997 the new Labour government brought in new tax legislation to allow a one-off tax, with little opposition in Parliament given its large majority.

But the practicality of a one-off tax on bonuses is unclear.

Calculating exactly how much to tax the energy utility companies was a complex process. Calculating how much to tax individual bankers is likely to be even harder.

Some observers have warned of other practical challenges.

"It's unprecedented for a group of employees to be singled out for a particular tax rate regime," said George Bull, head of tax at the accountants Baker Tilly.

"Taxation is supposed to be blind with everyone treated the same. There are human rights issues here."

He added that there would be further problems classifying which bank employees should be taxed.

What are the arguments against a windfall tax?

The banking industry says any tax on bonuses - even a one-off tax - will harm London's competitiveness as a financial centre.

Alistair Darling
Alistair Darling is said to be considering a windfall tax on bonuses

Bonuses are also seen by banks as an important part of the way they reward and motivate staff.

The industry warns that if the government is seen to be clamping down on bankers and their bonuses, banks could move abroad.

That could be bad news for the UK economy, which receives billions in taxes already from the banking sector.

Will the government go ahead with it?

They're said to be actively considering it, and it would probably prove popular with the wider public given the amount of bad feeling bankers' bonuses have created.

However, since 1997, there have been numerous occasions where windfall taxes have been called for. But despite pressure on the government, no further taxes have been levied.

At the beginning of 2008, two major London-listed oil companies - BP and Royal Dutch Shell - reported massive profits, thanks largely to record highs in oil prices. Calls for a tax on those profits were rejected.

In the summer there were further calls for a windfall tax on energy utility companies, who - despite making big profits - had raised energy bills by more than 40%.

Again, the government chose not to impose a tax.

On the other hand, the political cost of doing nothing about bank bonuses could prove difficult to ignore.

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