Executive summary: Energy company’s six million dollar fuel credit claim denied
On Sept. 26, 2023, the US District Court for the Southern District of New York held that Chemoil Corporation was not entitled to a 6.7 million dollar refund related to the now expired alcohol-fuel mixture excise tax credit because the fuel transactions it entered into lacked economic substance.
Chemoil Corporation v. United States: An overview
The US District Court for the Southern District of New York recently denied a fuel credit claim brought by Chemoil Corporation, a renewable fuels trader, holding the fuel transactions the company entered into served no economic purpose under the “economic substance doctrine.” The court concluded that the transactions Chemoil engaged in did not have a valid business purpose, absent the tax benefits..
This case stems from Chemoil’s initiation of a tax refund lawsuit against the government, seeking recovery of over $6.6 million in excise tax credits that the IRS disallowed during examination. The IRS not only rejected Chemoil's assertion that it was entitled to alcohol-fuel mixture credits but also imposed an excessive fuel credit claim penalty exceeding $4 million, along with accruing interest. The penalty assessed by the IRS was a response to what it deemed as the undue claiming of tax credits without reasonable cause. The government disputes the refund claims on the basis that the transactions lack economic substance and Chemoil allegedly failed to meet the statutory requirements necessary for claiming the tax credit.
In late 2011, Chemoil engaged in seven transactions in which it created alcohol fuel mixtures for which it claimed volumetric ethanol excise tax credits. The essence of the transaction is as followed: Chemoil purchased ethanol from one of two trading partners, added 1% gasoline to the ethanol to create an E-99 mixture, and then sold the E-99 mixture back to the trading partner that sold it the E-100 at a price that was 40 cents less than the amount for which it purchased the E-100. While there was a pre-tax loss on the transaction, it was profitable to Chemoil because, as the producer of the E-99 mixture, Chemoil claimed the excise tax mixture credit of 45 cents per gallon, netting five cents per gallon after-tax benefits. The purchase and sale transactions all occurred within the Vopak Deer Park Terminal outside of Houston, Texas, where Chemoil and one of its trading partners leased terminal storage space.
The court in Chemoil examined whether the transactions Chemoil entered into with its trading partners lacked economic substance. In the deals the taxpayer entered into with two other companies, it was stipulated that Chemoil’s purchase, and sale transactions resulted in a loss. Moreover, the Court looked at the structure of the deals and emails and other correspondence discussing the intent of the transaction as focused on obtaining the tax credits.
The court found that the transactions yielded no objectively reasonable expectation of profit absent the tax credits. In applying the principles of the economic substance doctrine, the court found that Chemoil’s transactions lacked a true business purpose as they did not have an objectively reasonable expectation of profit on the transactions outside of claiming the credit. Further, with respect to the penalty, the Court found that Chemoil did not have reasonable cause to claim the credits or that the penalty was illegally asserted by the IRS. Consequently, the court ruled in favor of the government and dismissed Chemoil’s complaint.
Washington National Tax Takeaways
While the alcohol-fuel mixture credit has now expired, the ruling in this case is still significant for the broader industry when engaging in clean energy credit transactions. The issue of whether renewable fuel excise tax credit transactions must have a pre-tax profit is a novel issue. The facts in this case were unique in that the ethanol was purchased, mixed, and then sold back to the original owner for a loss (absent the tax benefits).
It will remain to be seen whether the Chemoil case is appealed and whether the government will ultimately prevail. Regardless, we continue to see litigation of fuel excise tax cases due to the significant size of the credits claimed. It is important that businesses engaged in renewable fuel and clean energy credit transactions have a valid business purpose for entering into transactions, notwithstanding potential fuel tax credit opportunities. Thus, it is important for clean fuel producers to document their transactions and have supporting information to substantiate all elements of the claims, as well as to obtain advice from outside advisors for penalty protection purposes for transactions of significant size.
For more information, please consult your RSM US tax advisor.