The United States Court of Appeals for the Federal Circuit recently affirmed the United States Court of Federal Claims’ decision to disallow approximately $20 million in alternative fuel mixture credits and allow the imposition of almost $40 million of penalties in Alternative Carbon Resources v. United States, No. 1:15-cv-00155-MMS, 124 AFTR 2d 2019-XXXX (Fed. Cir. Sept. 26, 2019), affirming Alternative Carbon Res., LLC v. United States, 137 Fed. Cl. 1, 37 (2018). The court found that the taxpayer, Alternative Carbon Resources (Alternative Carbon), could not show that it was entitled to claim the alternative fuel mixture credits nor could it show that it had reasonable cause to claim the credits.
Alternative fuel mixture credits
Although currently expired, section 6426(e) allowed for a credit equal to $0.50 per gallon of alternative fuel used by the taxpayer in producing an alternative fuel mixture for sale or for use in the taxpayer’s trade or business. Under section 6427, the credit is first used to offset any fuel excise tax liability under section 4041 or 4081, with any excess allowed to be claimed as a refundable credit. 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 % 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. Notice 2006-92 defines “sold for use as a fuel” as a producer’s sale of the fuel when the producer has reason to believe that the mixture will be used as a fuel. There is no established definition to determine when there is a “sale of alternative fuel.”
Alternative Carbon’s business
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 purchased from a supplier the feedstock it would use as the alternative fuel. 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 was then 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. 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. Many wastewater treatment plants, landfills, and farms use anaerobic digester systems. The other byproduct of anaerobic digestion is bio solids, 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 Des Moines Wastewater Reclamation Authority (“WRA”) and Amana Farms. The contract between Alternative Carbon and WRA provided that Alternative Carbon would pay WRA a disposal fee 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 disposal fees 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” of an alternative fuel 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 might qualify as a sale regardless of who pays whom. However, the attorney cautioned that this possibility was based on two private letter rulings that have no precedential value to the taxpayer. Further, the attorney indicated that he did not have a clear understanding of Alternative Carbon’s business. Alternative Carbon determined that it qualified for the alternative fuel mixture credit and 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% penalty, or $39,546,786, on the excessive claim amount. Alternative Carbon paid back the IRS in part and then filed for a refund and abatement of penalties with the Court of Federal Claims. On summary judgment, the Court of Federal Claims ruled in favor of the IRS and upheld the penalty. Alternative Carbon brought this suit before the United States Court of Appeals for the Federal Circuit arguing that it is entitled to the credits or that it at least had reasonable cause for claiming the credits and should be absolved of the excessive claim penalties. The appeals court affirmed the Court of Federal Claims and found that Alternative Carbon was not entitled to claim the credits nor did it have reasonable cause to do so.
Claims court decision
To determine whether Alternative Carbon was entitled to the alternative fuel mixture credit, the appeals court looked to the arguments brought at the lower court. The government argued that 1) the feedstock/diesel mixture was not an alternative fuel, 2) the mixture was not sold, 3) if it was sold, the mixture was not sold for use as a fuel, and 4) there was no reasonable cause to claim the credits.
Was the mixture a fuel?
Although the government abandoned this line of argument at the appellate court level, it originally claimed that the feedstock/diesel mixture was not a “liquid fuel” because it contained some solids in the water. The claims court dismissed this argument and found that the mixture was a fuel.
Was the mixture sold?
The government argued that Alterative Carbon did not sell the mixture, rather, that it purchased disposal services. The claims court concluded that the annual fee it charged to WRA and Amana lacked economic substance because the amounts were charged solely so Alternative Carbon could meet the “sell” requirement and be able to utilize the tax credits. In making this determination, the claims court emphasized that Alternative Carbon determined the amount of the mixture that would be transferred, only charged a flat fee, and did not collect or pay sales tax on the transfers. Thus, the claims court found that Alternative Carbon did not sell the fuel mixture.
Was the mixture sold for use as a fuel?
The government argued that the mixture was not used as a fuel, and even if it was, there was no way to determine what amount of Alternative Carbon’s mixture was used to produce energy. The claims court agreed that Alternative Carbon could not prove that its feedstock was used as a fuel. Many different types of fuel mixtures were put in to the digester tanks, from the various feedstock, some energy was produced and some byproduct was produced. The claims court determined that because Alternative Carbon could not show that its feedstock was the one actually being used to produce energy, it was not entitled to the credits.
Was there reasonable cause to claim the credits?
The excessive credit penalty under section 6675(a) can be avoided if the taxpayer demonstrates that it had reasonable cause to claim the credits. Reasonable cause is not defined in the code so the claims court looked to the extent of Alternative Carbon’s efforts to assess its proper tax liability based on its level of experience, knowledge, and education. The claims court determined that Alternative Carbon did not have reasonable cause for claiming the credits, emphasizing that Alternative Carbon’s claims that it relied on the advice of its attorney was unreasonable as he continually qualified his responses that he was unaware of its business practices and he informed it that it could not rely on the private letter ruling.
Alternative Carbon appealed the claims court’s decision arguing that it properly claimed the alternative fuel mixture credits and, in the alternative, that it at least had reasonable cause to claim the credits.
Alternative Carbon’s eligibility to claim the fuel mixture credit relies on whether there was a sale. The appellate court looks to Reg. section 48.0-2(a)(5) for the general definition of what constitutes a sale, that is, the agreement where a seller transfers property in goods to a buyer for consideration. Alternative Carbon argues that it transferred property (the fuel mixture) to a buyer for consideration (an annual fee and relief from the obligation to dispose of the mixture and waste). However, Alternative Carbon did not offer evidence that the annual fee reflected the value of the fuel mixture. Even if, the annual fee could be determined to be meaningful consideration, the court determined that it lacked economic substance because the fee was added solely for tax purposes. Alternative Carbon argued that the relief from the obligation to dispose of the mixture was consideration according to two private letter rulings. The court did not find this to be persuasive because the letter rulings could not be relied on as precedent. Ultimately, the court found that there was no sale.
To determine if Alternative Carbon is subject to the excessive penalty amount the court looked to see if it had reasonable cause for claiming the credits. Alternative Carbon alleged that it had reasonable cause for claiming the credits because it relied on expert advice from its attorney. To determine when expert advice can provide reasonable cause the court looked to whether the advice was based on all pertinent facts and circumstances, whether the advice was not based on any unreasonable factual or legal assumptions, and whether the taxpayer’s reliance on the advice was reasonable. The court determined that Alternative Carbon did not have reasonable cause from the reliance on its attorney’s advice. The court emphasized that the attorney frequently qualified his advice and demonstrated an incomplete understanding of Alternative Carbon’s business. Further, the court determined that Alternative Carbon did not establish that it actually followed the attorney’s advice. For these reasons, the court determined that Alternative Carbon did not have reasonable cause to claim the credits.
The court of appeals affirmed the lower court’s decision that Alternative Carbon was not entitled to claim the fuel mixture credits and that it did not have reasonable cause for claiming the credits. Alternative Carbon will be subject to the tax to repay the credits it received and subject to the 200% penalty for excessive fuel claims.
Although the specific fuel credit at issue in this case has expired, this case offers a look at how courts might treat other excess fuel credit claims. It is important to insure that when claiming a credit for fuel (i.e., off highway use, tax exempt fuel) there is reasonable cause for the claiming of the credit.