In a recent decision, the United States Court of Federal Claims upheld the IRS’s determination that a taxpayer was not entitled to approximately $20 million of fuel tax credits and, as such, was liable for approximately $40 million in excessive claim penalties. In Alterantive Carbon Resources, LLC v. United States, No. 1:15-cv-00155-MMS (Fed. Cl. March 22, 2018), the issue before the court was whether the taxpayer qualified for alternative fuel mixture credits it claimed for alternative fuel mixtures it produced and dispensed in 2011. The court granted the IRS’s motion for summary judgment, finding that the taxpayer did not meet the requirements for claiming the credit and that it could not avoid excessive claim penalties because it did not have reasonable cause. Although the case hinged on the payment of alternative fuel mixture credits, (a provision that has since terminated) the court’s findings may be applicable to other fuel credit requirements under section 6426 and 6427. The alternative fuel credit and the biodiesel mixture credit were recently retroactively extended through Dec. 31, 2017. Please reference our alert about prior coverage.
Section 6426 allows for a credit equal to $0.50 per gallon of alternative fuel sold for use or used as a fuel in a motor vehicle or motor boat or used by a taxpayer to produce an alternative fuel mixture for sale or use in the taxpayer’s trade or business. If a taxpayer is eligible for a credit under this section it may offset its fuel excise tax liability under section 4041 or 4081. In 2011, pursuant to section 6427, if the fuel tax credit exceeded the fuel tax liability, eligible taxpayers could claim a refundable credit for the difference in the form of a payment. Currently, payment of the fuel tax credit in excess of the liability is only available for biodiesel mixtures and alternative fuel, not the credit for alternative fuel mixtures.
In order to qualify for the alternative fuel mixture credit a taxpayer must show that it blends an alternative fuel with at least 0.1 percent of a taxable fuel to produce a mixture that is used or sold for use as a fuel and that the taxpayer is registered with the IRS to perform those activities. The alternative fuel credit has the additional requirement that the fuel be sold or used as a fuel in a motor vehicle or motor boat.
Alternative Carbon Case
In 2011, Alternative Carbon began producing alternative fuel mixtures consisting of liquid fuel derived from biomass (an alternative fuel under section 6426(d)(2)(G)) and diesel fuel (a taxable fuel under sections 4041 and 4081). Alternative Carbon registered with the IRS using Form 637 and ultimately received the designation “AM” for an “alternative fueler that produces an alternative fuel mixture that is sold for use or used in the alternative fueler’s trade or business.”
To produce its alternative fuel mixtures, Alternative Carbon first purchased the feedstock that would be used as the alternative fuel in the mixture from a supplier. A trucking company, contracted by Alternative Carbon, would pick up the feedstock and add the required amount of diesel fuel to create the alternative fuel mixture. The mixture would then be delivered to the party that contracted to receive and use the alternative fuel mixture as a fuel in its business.
Alternative Carbon entered into several contracts with entities who could use the alternative fuel mixture as a fuel in their anaerobic digester systems. Anaerobic digester systems are used by many wastewater treatment plants, landfills and farms. In anaerobic digester systems a feedstock is placed in an anaerobic digester which then breaks down biodegradable materials, in the absence of oxygen, and produces methane as a byproduct. Methane is then used to produce electricity or heat or can be cleaned and turned into compressed natural gas. The other byproduct of anaerobic digestion is biosolids, which are dry nutrient rich organic materials, similar to dirt, which can be used as a fertilizer to improve soil and stimulate plant growth.
Although Alternative Carbon engaged with several entities throughout 2011, the case focuses on the transactions with the Des Moines Wastewater Reclamation Authority (“WRA”). The contract between Alternative Carbon and WRA provided that Alternative Carbon would pay WRA to take the alternative fuel mixtures from Alternative Carbon. Alternative Carbon consulted with an attorney who advised the company that it would “look better” if it charged the customers “anything” for the fuel mixtures. Thus pursuant to the WRA contracts, WRA paid Alternative Carbon $950 for the year for all alternative fuel mixture deliveries and Alternative Carbon was charged a $950 administrative fee for the year. WRA charged Alternative Carbon a “disposal fee” for accepting the alternative fuel mixtures in the amount of $0.02634 per gallon for up to 50,000 gallons per day. Alternative Carbon was one of 30 to 40 different companies delivering such loads to WRA. The various alternative fuel mixtures were mixed together to produce WRA’s biogas with no way to specifically measure how much of the total gas produced was due to a specific alternative fuel mixture.
Alternative Carbon considered these transfers of its alternative fuel mixtures as sales for “use as a fuel” even though Alternative Carbon was the party that paid the fee for the transaction. Alternative Carbon again consulted with an attorney who advised them that the transaction qualifies as a sale regardless of who pays whom. Alternative Carbon determined that they qualified for the alternative fuel mixture credit and it filed for $19,773,393 in alternative fuel mixture excise tax credits in 2011, using Form 8849, “Claim for Refund of Excise Taxes.”
In 2012, the IRS audited Alternative Carbon’s claims for the credits. The IRS determined that Alternative Carbon was not entitled to the alternative fuel mixture credit payments which it had already received and assessed tax of $19,773,393 to recoup the payments. Furthermore, the IRS determined that Alternative Carbon was liable for the excessive claim penalties under section 6675, which assesses a 200 percent penalty, or $39,546,786, on the excessive claim amount.
The court’s decision
In rendering it decision, the Court of Federal Claims looked to whether Alternative Carbon was eligible for the alternative fuel mixture credit. The court determined that Alternative Carbon was properly registered and produced a qualified alternative fuel mixture, and would satisfy the credit requirements if it could show that its alternative fuel mixtures were sold for use as a fuel. This requirement can be broken down into two requirements: use as a fuel and sale of the mixture.
Use as a fuel
The term “use as a fuel” is not defined in the Internal Revenue Code, nor does the alternative fuel mixture credit have the same limitation that the fuel be used in a vehicle as required by the alternative fuel credit. The IRS argued that the alternative fuel mixtures were not used as a fuel because they did not produce energy directly, but rather they produced a biogas that then produced energy. The court rejected this approach and instead looked to Notice 2006-92 which states that an alternative fuel mixture is used as a fuel when it is consumed in the production of energy. Applying this definition and the examples given in the notice, the court found that “use as a fuel” can apply to the anaerobic digester systems.
However, despite Alternative Carbon’s apparent success at meeting the “use as a fuel” requirement, the court determined that in order to fulfil the “production of energy” requirement in the “use as a fuel” definition, a taxpayer must demonstrate a net production of energy. The court reasons that without a net production of energy, Congress’s intent to development new energy sources would be thwarted. Ultimately, the court found that the different sources of alternative fuel mixtures could not be definitively measured to show which feedstock was producing energy and which may be burned off or disposed of, and thus Alternative Carbon had no way to prove that its mixtures created a net energy production. Without proof that the mixtures resulted in a net production of energy, Alternative Carbon’s mixtures failed the “use as a fuel” requirement.
Sale of the mixture
The court went on to reason that even if Alternative Carbon could show that its mixtures were used as a fuel, the transfers of the mixtures to its “customers” were not sales. The court found that the small flat fee that Alternative Carbon charged lacked economic substance because they were collected solely for the purpose of receiving tax credits. Further, the court notes that Alternative Carbon never collected sales tax on these transactions, thus supporting the conclusion that legitimate sales did not occur. Ultimately, the court found that Alternative Carbon was not eligible for the alternative fuel mixture credits.
Excessive claim penalties
Under section 6675, a taxpayer who makes a claim for fuel tax credits under section 6427 for an excessive amount is liable for a penalty equal to 200 percent of the excessive amount. The excessive claim amount is the amount claimed minus the amount that was allowable to be claimed. If the taxpayer can demonstrate reasonable cause for the excessive credit claim, then it can avoid this penalty.
In determining whether Alternative Carbon had reasonable cause for claiming the excessive credits, the court first outlines what constitutes reasonable cause for purposes of the excessive claims penalty. Reasonable cause is not defined in section 6675, causing the court to examine other cases to determine what the standard for reasonable cause is. The court determined that the taxpayer must demonstrate that it acted with reasonable cause and good faith. Alternative Carbon argued that it acted reasonable because it relied on advice of an attorney as well as other professionals. The court recognized that the reliance on the advice of a professional could constitute reasonable cause but determined that the advice of the professionals was not reasonable and ultimately, was not relied on. The court upheld the 200 percent excessive claim penalty of $39,546,786
The Alternative Carbon case is centered on the payment provision of the alternative fuel mixture credit, which terminated as of Dec. 31, 2011. However, similar credits exist for biodiesel mixtures and alternative fuels through Dec. 31, 2017. Alternative Carbon brings to light some issues that taxpayers should consider when determining if they are eligible for fuel tax credits.
Use as a fuel
The alternative fuel credit requires that the taxpayer sells the alternative fuel for sale or use as fuel in a motor vehicle, motorboat, or as fuel in aviation. The limitation that the fuel be used in a specific way, i.e. to power a vehicle, gives more structure to the use requirement as opposed to the general “used as a fuel” requirement found in the mixture credit. Despite this bright line, taxpayers should be aware that the service can question whether the fuel was sold for use in a motor vehicle and should be prepared to defend the position that the sale was for such purpose.
Sale of the fuel
The fuel tax credits require the sale or use of the fuel. Taxpayers need to have a business purpose for making sales of their fuels, other than to utilize the credits. Taxpayer should familiarize themselves with the rules around sham transactions and the economic substance doctrine to steer clear of language or intent that could negate a transaction as a bona fide sale.
Excessive claim penalties
Section 6675, specifically allows for a 200 percent penalty on excessive claims for fuel tax credits claimed under section 6427. Taxpayers who claim fuel tax credits using a Form 720, Schedule C, or a Form 8849 are claiming the credit through section 6427. Taxpayer who might have an excessive claim should consider whether they have reasonable cause for the claim or if they should file the credit claim under a different provision.
There are many factors to take into account when utilizing the fuel tax credits and taxpayers should consult their tax advisers to ensure that all requirements are being met and that the correct processes are in place for defending a credit position.