March 28, 2023
FIRST IMPRESSIONS | Proposed Superfund Tax regulations address many issues, but leave others open
On Monday March 27, 2023, the IRS published an advanced copy of proposed regulations (REG-105954-22) on the Superfund Chemical Tax and Superfund Imported Substance Tax (hereafter, Superfund Tax), which are excise taxes that apply to certain chemicals and certain imported substances effective July 1, 2022 (see Tax Alert 2021-2059). The proposed regulations are expected to be published in the Federal Register and open for public comment on March 29, 2023.
These are the first proposed regulations on the Superfund Tax in over 40 years. While the regulations are detailed and informative, the IRS requested comments in seven specific areas to help address uncertain issues and to assist in the administration of the tax.
The proposed regulations provide a detailed analysis and discussion of IRC Section 4661 and various issues associated with taxable chemicals. While the discussion of taxes under IRC Section 4671 references back to the proposed regulations that overlap with IRC Section 4661, the IRS spent considerably less time and attention clarifying uncertainties around the importation or exportation of taxable substances. Taxpayer comments are expected to focus on these omissions around IRC Section 4671.
While the proposed regulations consist of approximately 50 pages of text, their Preamble, which outlines the IRS's thought process, its response to taxpayer comments and the regulations' remaining areas of uncertainty, runs almost as long. A more robust analysis of the proposed regulations will follow in a future Tax Alert; the following provides EY's first impressions of the issues addressed in the proposed regulations.
Definitions: The proposed regulations define numerous terms used in the statutes, including "manufacturer," "importer," "ton," "predominant method of production," "intermediate hydrocarbon stream," "inventory exchange," "ores," "sale," and "use." These definitions clarify some, but not all, of the uncertainty that taxpayers previously expressed in comments concerning ambiguity in the use of these terms.
Form 637 registrations: Many taxpayers sought additional guidance on Form 637 registrations, not only for exchanges and intermediate hydrocarbon sales, but also for sales between manufacturers or other registrants. While the proposed regulations describe the procedural requirements for claiming each of these exemptions, the IRS's prefatory comments note that, in spite of taxpayers' comments and requests to the contrary, the Superfund Tax does not contain a statutory directive for a broader interpretation of sales between registrants. As such, the IRS declined to adopt taxpayer suggestions in the proposed regulations.
Chemical mixtures: The proposed regulations clarify that the Superfund Tax attaches upon the first sale or use of an imported chemical mixture that is not a taxable substance. A chemical mixture means a substance composed of two or more physically combined components that are not chemically bonded. Chemical mixtures include alloys, solutions, suspensions and colloids. The Superfund Tax applies to the actual weight of each taxable chemical included in a chemical mixture. Previously, uncertainty existed as to whether certain compounds containing one or more taxable chemicals (that were not bonded), but were also not distinct taxable chemicals, would be taxed when imported. The proposed regulations do not elaborate on whether a similar rule applies to mixtures of taxable substances.
Methane and butane: The proposed regulations clarify that methane and butane are not taxable until used "otherwise than as a fuel." In clarifying the term "used as a fuel," the proposed regulations distinguish uses that produce energy (used as a fuel) from other uses such as a coolant (used otherwise than as a fuel). The proposed regulations specifically noted that use as a fuel occurs when methane or butane is consumed in the production of energy, including in a furnace, cooking appliance or lighter to produce heat.
Predominant method of production: The proposed regulations confirm that Revenue Procedure 2022-26 is the exclusive process for requesting the addition of taxable substances to the IRS list. Among the requirements set forth in Revenue Procedure 2022-26, taxpayers must provide the IRS the predominant method of producing the taxable substance in question. The term predominant method of production means the method used to produce the greatest number of tons of a particular substance worldwide, relative to the total number of tons of the substance produced worldwide. It is less clear, however, how the predominant method of production should be evaluated for substances that can be produced in a variety of ways and, as a result, may require varying weights of taxable chemicals in their production. (For more on Revenue Procedure 2022-26, see Tax Alert 2022-1015.)
Foreign manufacturers and foreign drop shipments: The proposed regulations attempt to distinguish foreign manufacturers selling into the United States from importers subject to tax. For example, a foreign manufacturer that sells a substance in the table under Section 4661(b) to the "importer" will not be subject to the Section 4661 Superfund Tax because the substance is not a taxable chemical at the time of sale; rather, the tax attaches to the importer's first sale or use of the taxable chemical.
The proposed regulations do not elaborate on situations where the foreign manufacturer may also be the importer. They do, however, distinguish between a US and foreign drop ship business. A drop ship business in the United States is an importer. Where, however, a drop shipper outside the United States arranges for a person outside the United States to ship a chemical directly to a purchaser in the United States, the purchaser is the importer of the chemical. Drop shipping occurs when a person uses a third party to fill an order by shipping a chemical directly to the purchaser. This appears to be an attempt by the IRS to minimize the need to pursue tax against foreign entities by shifting the tax burden (and definition of "importer") to the first US taxpayer.
Tax-free sales / refunds: The proposed regulations set forth specific documentation guidance for various tax-free sales and/or corresponding refund claims. This includes the publication of various model certificates and exemption forms intended to document particular uses or exports. In publishing this guidance, some provisions in the proposed regulations refer to certificates being in "substantially the same form" as the model certificate, while others specifically state that the certificate must be "in the form prescribed."
Conditions to allowance rules: In setting forth the procedures for claiming refunds, the proposed regulations refer to a more general excise tax concept known as the "conditions to allowance" rules. These rules outline additional conditions that must be met before the IRS will refund an otherwise exempt or tax-free use of an otherwise taxable chemical or substance. These "conditions to allowance" rules impose significant documentation burdens on both the claimant and the original taxpayer.
Topics requiring additional comments as noted by the IRS
The IRS has specifically requested additional comments on the following issues or concerns not currently resolved by the proposed regulations:
In addition to publishing the proposed regulations, the IRS also released a new draft notice and revenue procedure addressing penalty relief and the timing of when taxable substances become eligible for refunds. Notice 2023-28 extends Notice 2022-15 penalty relief to deposits made in the second, third, and fourth quarters of 2023, even if the deposits are computed incorrectly, provided (a) the taxpayer makes timely deposits and (b) any underpayment is paid in full by the due date for filing the Form 720 return for that calendar quarter. In addition, the IRS agreed not to withdraw a taxpayer's right to use the deposit safe harbor in the fourth quarter of 2023 and the first and second quarters of 2024.
For purposes of claiming a refund, Revenue Procedure 2023-20 clarifies that a petition received and accepted by the IRS after December 31, 2022, is considered to have been filed on the first day of the calendar quarter during which the petition was received. This additional guidance emphasizes the IRS's view that a refund for exports of taxable substances will only be made if the taxable substance is "listed" as such by the IRS.
In the Preamble to the proposed regulations, the IRS speculates that as many as 30,000 taxpayers could be impacted by these regulations. The inclusion of chemical mixtures as subject to tax upon importation likely contributes to this increase in the number of taxpayers potentially subject to the Superfund Tax. In addition, the proposed regulations solidify substantial documentation requirements for taxpayers seeking to make tax-free or exempt claims for taxable chemicals and taxable substances.
Even though the proposed regulations are incredibly detailed, specific and complex, there still remains numerous areas for which additional taxpayer comments and further guidance are needed.
Published by NTD’s Tax Technical Knowledge Services group; Jennifer A Brittenham, legal editor