IRS Reopens Synfuel Window

IRS Reopens Synfuel Window

June 01, 2001

The Internal Revenue Service reopened the window in late April for rulings that output from coal agglomeration facilities qualifies as a “synthetic fuel from coal,” but it set a number of conditions with which projects will have to comply in order to get rulings.
The IRS will hold projects that apply for rulings to a cap on output.

The agency also put the industry on notice that it will deny tax credits to investors in syncoal projects in two situations when it finds them on audit.

Coal agglomeration facilities use chemical binders to glue together small particles of coal or to effect a chemical change in otherwise usable coal as it passes through the facility.

The IRS announcement represents a middle ground between coal companies who had lobbied the Treasury Department to deny tax credits to projects that they argued do little more than spray petroleum on usable coal and owners of the syncoal plants who argued that the coal lobby was trying to stifle competition for coal customers by putting them out of business. Both sides had significant political support.

BackgroundAnchor

The federal government has offered a tax credit under section 29 of the US tax code since 1980 as an inducement to Americans to look in unusual places for fuel. The aim was to reduce US demand for oil and gas from the Middle East by tapping more domestic energy sources. The tax credit can be claimed by anyone who produces gas from biomass, coal seams, tight sands or Devonian shale, or who makes a “synthetic fuel from coal.” Projects to make synthetic fuels from coal had to be in service for tax purposes by June 1998 to qualify. The tax credit last year was $1.059 an mmBtu. It is adjusted each year for inflation. Credits for most syncoal projects run through 2007.

Starting in the mid-1990s, several companies developed chemical binders that could be used for gluing together small particles of coal to make pellets or briquettes. The IRS refused initially to rule that use of these binders resulted in a “synthetic fuel,” but later changed its mind. More than 50 syncoal plants that use binders were placed in service by the June 1998 deadline. An active resale market has developed in the projects because many owners of projects cannot use the tax credits. Tax credits cannot be used efficiently by individuals or by corporations that are on the alternative minimum tax. Meanwhile, coal companies in the eastern US where most of the facilities are located have found it hard to compete with the synfuel plants for customers because of the large subsidy for synfuel.

Last October, the IRS stopped issuing private rulings that the projects produce a “synthetic fuel” while it studied the issue.

Future Rulings

The IRS said a number of things in late April when it reopened the rulings window.

It said it has decided not to tinker with the definition of “synthetic fuel.” A project is considered to make a synthetic fuel if the output from the project differs significantly in chemical composition from the raw material, or feedstock, used to produce it.

The agency will continue to rule that coal agglomeration facilities make synthetic fuel. However, investors in such projects will have to show three things in the future in order to get a ruling.

The feedstock must consist of “coal fines or crushed coal comprised of particles the majority of which, by weight, are no larger than 3/8 inch.” This test is applied at the point where the binder is added. Thus, the raw input to the project can be whole coal, and crushing can occur at the synfuel plant. Joseph Makurath, the IRS official who will sign any rulings, said the reason for imposing this condition is the government believes the greatest chemical change occurs when binder is applied to small particles.

The binder must fit into one of four categories. The IRS will not approve any new processes beyond those on which it had ruled by 1999. The four approved processes are “styrene or other monomers following an acid bath,” “quinoline or other organic resin and left to cure for several days,” “ultra heavy hydrocarbons,” and “aluminum or magnesium silicate binder following heating to a minimum temperature of 500 degrees Fahrenheit.”

The project must produce output in the form of a pellet, briquette or “extruded fuel product” or show that omitting this step “will not significantly increase the production output” through 2007. The change in output is measured against what the facility is capable of producing when it slows down to produce pellets or briquettes. The IRS did not say what it considers a “significant” increase in output. However, “significant” has usually meant in the past more than a 10% increase.

Makurath said future rulings will specify the “capacity” of the project. Taxpayers will be barred from claiming credits on output above this capacity.

Audits

The IRS said it will deny tax credits in two situations when it finds them on audit.

One is “spawned” projects. An example is where equipment is added after June 1998 to a conventional coal wash plant to convert it into a facility for making synfuel. Syncoal plants had to be in service for tax purposes by June 1998 to qualify for tax credits. The IRS said spawned projects failed to meet this deadline because they were not in service in June 1998 for the purpose of making synfuel.

Tax credits will also be denied on audit where a project is modified after June 1998 in a manner that significantly increases the production capacity or significantly extends the useful life. This is in keeping with past practice of denying tax benefits to projects that are “grandfathered” from a change in tax law if the projects are significantly altered after the deadline to qualify for grandfather relief. In this case, the deadline was June 1998.

It is a modification of a project to add or replace equipment or to move it to a new location.

The revenue procedure says that a project will remain grandfathered after a move only if “all essential components of the facility are retained and the production capacity of the relocated facility is not significantly increased at the new location.”

The IRS position in the past was that a move does not cause loss of tax credits as long as the amount spent on the move and reassembly is no more than 80% of the value of the synfuel plant at the new location. A senior Treasury official involved in drafting the revenue procedure confirmed that the IRS has now set up two more hoops through which taxpayers who move their synfuel plants will have to leap: “all essential components” must be retained after the move, and the plant must be reassembled in a way that does not significantly increase production capacity or extend the useful life.

Many synfuel plants have already been moved. Projects that already have private rulings covering the moves should not be affected. However, anyone who moved before getting such a ruling will have to prove compliance with all three tests.

by Keith Martin, in Washington