The IRS recently released a program manager technical advice (PMTA) memorandum addressing the taxability of diesel fuel used in diesel particulate filters (DPF). The memorandum, PMTA 2018-3, supplements the advice the IRS previously provided in its Chief Counsel Advice (CCA) 201421017. (See our prior coverage Diesel fuel used in EPA-required filter exempt from excise tax.)
Diesel emission standards
In 2007, the Environmental Protection Agency (EPA) implemented new vehicle emission standards for diesel powered vehicles. The new standards require, among other things, the adoption of specific procedures for ‘exhaust regeneration.’ To meet the exhaust regeneration requirements, DPFs are installed on all new highway vehicles and on some retrofitted vehicles. A DPF is a device designed to trap and remove particulate matter, including soot, from the exhaust of the diesel engine propulsion motor to which it is attached. The trapped particulate matter accumulates in the DPF until a filter element located in the DPF raises the temperature to a point where the particulate matter combusts, resulting in the regeneration. Upon combustion, the particulate matter is converted primarily to ash, gaseous carbon dioxide, and water.
Methods of Regeneration
DPFs effectuate regeneration by one of two methods, passive or active. Passive regeneration occurs during normal operation of the propulsion motor, when the exhaust gas temperatures are high enough to initiate combustion of the particulate matter without added fuel, heat, or driver action. Active regeneration can occur either during normal vehicle operation or while the vehicle is stationary as part of a controlled event. Active regeneration requires extra diesel fuel to raise the temperature in the DPF in order to combust the accumulated particulate matter. The diesel fuel is typically injected directly from the vehicle’s fuel supply tank using a separate fuel supply line into the exhaust system. Diesel fuel does not enter the combustion chamber of the engine during active regeneration.
Fuel Excise Taxes
Section 4081(a) imposes an excise tax on the removal, entry, and sale of taxable fuel, including diesel fuel. Section 4041(a)(1)(A) imposes a similar tax on any liquid, other than gasoline, sold for use or used as a fuel in a diesel powered highway vehicle or a diesel powered train. An exception to the section 4041 tax exists for those liquids that were already taxed (but not credited or refunded) under section 4081.
Section 6427(l)(1) provides that for any diesel fuel that was taxed pursuant to either section 4041 or section 4081 and that was used by a person for a nontaxable use, the Secretary will pay the ultimate purchaser of the fuel the amount of such aggregate tax. Section 6427(l)(2) defines “nontaxable use” as any use which is exempt from the tax imposed under section 4041(a)(1) other than by reason of a prior imposition of tax. Under Reg. section 48.6427-8(b)(1), a claim for an income tax credit or payment can be made if the taxpayer satisfies certain requirements and if the fuel is used in a designated way. One such instance is for diesel used other than as a fuel in a propulsion engine of a diesel powered highway vehicle.
Excise Tax Application to DPFs
The memorandum affirmed that when diesel fuel is used to combust the particulate matter in the DPFs through an active regeneration process, no fuel enters the combustion chamber of the vehicle’s propulsion engine. The diesel fuel is, therefore, used other than as fuel in the propulsion engine of a diesel powered highway vehicle. The memorandum concludes that the use of diesel fuel in a DPF through active regeneration is a nontaxable use of the fuel within the meaning of section 6427(l). If the diesel fuel were to enter the combustion chamber (passive regeneration) of the vehicle’s propulsion engine the fuel would not qualify as a nontaxable use under section 6427(l).
Although PMTAs are not to be used or cited as precedent, this memorandum, along with the previous CCA, provides insight as to how the IRS will treat claims for credits or payments under section 6427(l) for fuel used in DPFs. As all new and some retrofitted diesel powered vehicles are required to have DPFs, the nontaxable use of diesel fuel used to promote the combustion process in the DPFs can result in tax credits for taxpayers who satisfy the remaining requirements of Reg. section 48.6427-8(b)(1). Taxpayers should consult with their tax advisers to determine if the use of their diesel fuel is a nontaxable use and if they meet the requirements to apply for an income tax credit or payment.