Ethanol credits cannot be claimed by a company that hires out the actual work of producing the ethanol to a factory under a contract manufacturing or tolling arrangement, the IRS said.

The US government offers small ethanol producers tax credits of 10¢ a gallon on the ethanol they produce. A “small” producer is someone with a capacity to produce no more than 30 million gallons a year. Credits can only be claimed on the first 15 million gallons that such a person produces each year.

A company claimed small producer credits in the following situation. It buys hydrous ethanol outside the United States and then contracts with a factory to convert it into anhydrous ethanol before importing the ethanol into the United States. The company argued that it was the “producer” of the ethanol because it owned the ethanol while it was being converted by the factory to an anhydrous state. This is no different than where a US toy manufacturer hires out the actual sewing of its dolls to a factory on mainland China.

The IRS national office ruled in a “technical advice memorandum” that no tax credits are allowed in this case because the US company is not producing ethanol but merely purchasing ethanol and having it further processed. A “technical advice memorandum” is a ruling by the IRS national office to settle a dispute between a taxpayer and an IRS field agent that came up on audit. The IRS made the ruling public in April.

Interestingly, the IRS did not try to disallow credits on grounds that the ethanol production was outside the United States. The ruling is TAM 200613032.

By Keith Martin