Understanding the excise tax on ozone-depleting chemicals

Understanding the Excise Tax on Ozone-Depleting Chemicals

Background

There has been mounting international concern over the depletion of the ozone layer caused by increasing concentration of chlorofluorocarbons (CFCs) and brominated compound (halons) gases in the upper atmosphere. On April 21, 1988, the United States ratified and implemented the "Montreal Protocol on Substances that Deplete the Ozone Layer." The Protocol, which went into effect on July 1, 1989, requires the United States to control the production and consumption of ozone-depleting chemicals (ODCs), and represents the first coordinated attempt to control and progressively reduce the use of CFCs by the mid-1990s. The initial phase of the Protocol requires the signatory countries to achieve a near-term reduction in total CFC production and consumption down to the 1986 level. This is to be followed by a phased reduction to 80 percent and 50 percent of 1986 levels beginning in mid-1993 and mid-1998, respectively. It also limits production and consumption of halons to 1986 levels beginning in 1992.

As part of its efforts to ensure that the United States meets its obligation under the Protocol, Congress in 1989 enacted an excise tax on ODCs. The tax was viewed as providing an easily administered, economically efficient mechanism for encouraging the development and use by the private sector of compounds that do not dissipate the stratospheric ozone layer shielding the earth's surface from dangerous ultraviolet radiation. The excise tax will cause the price of the ODC to increase, thereby stimulating the private sector to reduce its dependency on ODCs by reducing use, increasing reclamation, and providing incentives to the development of alternative chemicals.

Enacted as section 7506 of the Revenue Reconciliation Act of 1989, new sections 4681 and 4682 of the Internal Revenue Code require that most manufacturers, producers, and importers pay an excise tax for the sale or use of ODCs in the production process. The new tax is imposed not only on the sale or use by a manufacturer, producer, or importer of any ODC, but also on any product imported into the United States in which an ODC was used as a material in its manufacture or production. On August 31, 1990, the Internal Revenue Service issued final and temporary regulations (T.D. 8311) relating to the ODC excise tax. (*1)(1) This article summarizes the new excise tax, which applies to a wide range of industries and transactions not previously covered by the Code's environmental taxes.

Computation of Tax

Under section 4682(a)(2) of the Code, the specific chemicals subject to the excise tax are CFC-11 (trichlorofluoromethane), CFC-12 (dichlorodifluoromethane), CFC-113 (trichlorotrifluoroethane), CFC-114 (1,2-dichloro-1,1,2,2,-tetrafluoroethane), CFC-115 (chloropentaflouroethane), Halon-1211 (bromochlorodifluoromethane), Halon-1301 (bromotrifluoromethane), and Halon-24-2 (dibromotetrafluoroethane). (2) The tax, which will be phased-in over a four-year period, is determined by multiplying a base tax amount (per ODC weight) by an "ozone-depleting factor." Ozone-depleting factors have been calculated through a comparison of the ozone depletion that occurs from the dispersion of one kilogram of the given ODC when compared to CFC-11 (trichlorofluoromethane). There is no tax on ODCs that are recovered in the United States as part of a recycling process (and not part of the original manufacturing process), nor is the tax imposed on ODCs used or sold for use as a feedstock. To qualify for the feedstock exemption, the ODC must be consumed entirely in the manufacture of another chemical, and the buyer of the ODC must certify to the supplier that the ODCs will be used as feedstock.

Base Tax Amount(3)

Year Amount of Tax 1990 & 1991 $1.37 1992 $1.67 1993 & 1994 $2.65

Ozone-Depleting Factor(4)

Chemical Factor CFC-11 1.0 CFC-12 1.0 CFC-113 0.8 CFC-114 1.0 CFC-115 0.6 Halon-1211 3.0 Halon-1301 10.0 Halon-2402 6.0

According to Temp. Reg. [section] 52.4682-4T(d)(1)(ii), the amount of tax imposed during 1990 is, as follows:

ODC Tax Per Pound CFC-11 $1.37 (1.0 X $1.37) CFC-12 1.37 (1.0 X $1.37) CFC-113 1.096 (0.8 X $1.37) CFC-114 1.37 (1.0 X $1.37) CFC-115) .822 (0.6 X $1.37)

The tax on certain substances -- Halons-1211, -1301, - 2402, and chemicals used in rigid foam insulation -- is reduced for the years 1990-1994. Qualifying sales of chemicals used in manufacture of rigid foam insulation are not taxable in 1990 and are taxed at reduced rates for 1991, 1992, and 1993. A qualifying sale is one where registration certificate requirements are met. Temp. Reg. [subsection] 52.4682-2T(a) and (d) set forth the certificate requirements for tax-free and tax-reduced sales, and the recommended IRS Registration Certificates are reproduced in Temp. Reg. [section] 52.4682-2T(d)(2).

The term "rigid foam insulation" is defined in Temp. Reg. [section] 52.4682-1T(d)(3) as any rigid foam designed for use as thermal insulation. To support a claim that rigid foam is designed as thermal insulation, taxpayers may cite test reports and advertising material reflecting R-values. For years 1991 through 1993, the tax applicable to these chemicals is determined by the following table:

During the years 1991 through 1993, the excise tax on chemicals used in rigid foam insulation is determined by multiplying the tax, as calculated under section 4682(g)(2)(B), by the applicable percentages set forth in Temp. Reg. [section] 52.4682-2T(d)(1). Applicable percentage for 1991 is 18 percent; it is 15 percent for 1992 and 10 percent for 1993. For 1994 and subsequent years, the tax is calculated as described in section 4681(b)(1)(C).

Mixtures in which an ODC is contained are also subject to the excise tax imposed under Temp. Reg. [section] 52.4682-1T(b)(2). To calculate the tax, it is necessary to first determine what percentage of ODC is contained in the mixture.

Example: An electronics manufacturer purchases a chemical blended with an ODC. Assume that this mixture contains 94-percent CFC-113. The tax imposed on each pound of this mixture for 1990 is $1.03. This is computed by multiplying the 1990 "base tax amount" ($1.37) by the percentage of ODC in the mixture (94 percent), the result of which is then multiplied by the applicable "ozone-depletion factor" (0.8).

Tax on Imported Prjoducts

Temp. Reg. [section] 52.4682-3T addresses the excise tax on imported products. The amount of tax imposed under section 4681(a)(2) is based upon the weight of the ODC used as material in the manufacture of the imported product. It is then calculated in the same fashion as the tax that would have been imposed on the chemicals had they been sold in the United States. (5) The importer of the taxable product -- the person entering the article into the United States for consumption, use, or warehousing -- is liable for the tax when the importer uses or sells the products. In accordance with Temp. Reg. $S 52.4682-3T(c)(2), an election may be made on Form 6627, Environmental Taxes, to impose the tax on the date the product enters the country. (6) If this election is made, it can only be revoked with the consent of the Commissioner. No tax is imposed on products that entered the United States before January 1, 1990.

Temp. Reg. [section] 52.4682-3T(b)(1) provides that a product is considered an imported taxable product only if it enters the country for consumption, use, or warehousing and is listed in a table published by the IRS. The initial "Imported Products Table" is set forth in Temp. Reg. [section] 52.4682-3T(f)(6), and subsequent tables will be published in the form of revenue procedures. Products listed in the table are considered imported taxable products. Each listing in the table identifies an imported product by name and Harmonized Tariff Schedule item number where applicable. The table is divided into three parts. Part I lists those products whose ODC weight is not considered to be de minimis when the product is produced under the predominant method of manufacturing and the ODCs used as material in the normal manufacture of the product are not used for the purpose of refrigeration or air conditioning, creating an aerosol or foam, or manufacturing electronic components. A product is listed in Part I if the Commissioner has determined that the ODCs used as materials in the manufacture of the product under the predominant method are used for the purpose of refrigeration or air conditioning, creation of an aerosol or foam, or manufacturing electronic parts. Prjoducts listed in Part I of the Table have been determined not to be imported taxable products. The Table ODC weight is given in pounds per single unit of product unless otherwise specified.

The excise tax is not imposed on imported products under two circumstances: first, where the taxable product is brought into the country by an individual who will use it in his or her service as an employee; and second, where a product is brought into the country for repair.

ODCs are used in the manufacture of products to the extent the chemcials are:

* incorporated into the product;

* released into the atmosphere in the manufacturing process; or

* otherwise used in the manufacture of the product (but only to the extent the cost of the ODC is properly allocable to the product).

Recycled chemicals are not considered a chemical used in the manufacturing process. A chemical is considered recycled if--

* it is not incorporated into the product; and

* any release of the ODC into the atmosphere during the manufacturing process is insignificant and incidental to a process in which the ODC is recovered for use in further manufacturing.

Under Temp. Reg. [section] 52.4682-3T(b)(2)(ii), in determining if the ODC weight of a product is de minimis, it is necessary to calculate the "adjusted tax," which means the tax that would be imposed under section 4681 on the ODCs used as materials in the manufacture of such products if such ODCs were sold in the United States and the base tax amount were $1.00. If the adjusted tax is less than 0.1 percent of the product's cost, then the product is considered to have a de minimis ODC weight. (7)

Computation of Tax on Imported Taxable Products

The excise tax on imported taxable products is computer by reference to the weight of the ODCs used as materials in the manufacture of the product. temp. Reg [section] 52.4682-3T(e) prescribes four allowable methods for computing the amount of excise tax imposed on imported taxable products: the exact method, table method, combination method, and value method.

Exact Method

The Exact Method, which is discussed in Temp. Reg. [section] 52-4682-3T(e)(2), permits an importer who can determine the weight of each ODC used as a material in the manufacture of an imported taxable product to use that weight in calculating the amount of tax. Determination of the weight must be made through the use of reliable information (i.e., information received from the manufacturer of the product).

Table Method

If the exact weight cannot be established, Temp. Reg. 52.4682-3T(3) permits taxpayers to use an alternative approximate method of determining the ODC weight. As previously explained, the regulations contain tables specifying the approximate ODC weight relating to certain products, which weights can be used in computing the tax. The initial table, which was developed through a combined effort of the IRS and industry, will be revised to reflect any changes in ODC usage.

Temp. Reg. [section] 52.4682-3T(g) provides that a manufacturer or importer of a product may request that products be added to or removed from the table. Such a request, which is to be filed with the Commissioner of Internal Revenue, should contain the following information:

* Name of the product.

* The Harmonized Tariff Schedule item number prescribed by the United States Customs Service for the product.

* Type of modification requested.

* Description of the predominant method of manufacturing the product.

* The requester's name, address, employer identification number, and principal place of business.

In the case of modifications such as adding a product to the table, changing or specifying the predominant method ODC weight of such product, removing a product from the table, or moving the product from one part of the table to the other, the following information should also be provided:

* the amount that the requester claims would be the weight of the ODCs used as materials in the manufacture of the product if the product were produced using the predominant method;

* the amount that the requester claims would be the cost of the product if the product were produced using the predominant method of manufacture;

* a claim by the requester that the ODCs used as materials in the predominant method of manufacturing the product are used for purposes of refrigeration or air conditioning, creating an aerosol or foam, or manufacturing electronic components, or that no such chemicals are used for such purposes.

Combination Method

Where an imported product is comprised of two or more ODCs and the importer has sufficient and reliable information to determine the weight of one or more of the ODCs under the Exact Method but cannot so determine the weight of the other ODCs, then the importer may use the Exact Method for ODCs for which information is available and the Table Method for ODCs for which reliable information is not available. This result is sanctioned by Temp. Reg. [section] 52.4682-3T(e)(3)(ii)(B).

Value Method

Where the ODC weight of the imported taxable product cannot be determined under the Exact Method and the Imported Product Table does not specify the predominant ODC weight of the taxable imported product, Temp. Reg. [section] 52.4682-3T(e)(4) provides that the excise tax is computed as one percent of the entry value of the product on the date of entry into the United States. Entry value of the imported product and date of entry into the United States is determined as of the date a properly executed Customs Form 7501 is filed with the Customs Office. The Value Method is to be used only where neither the Exact Method nor the Table Method can be used.

A weakness in using any of the tree safe-harbor approximate methods -- Table, Combination, or Value -- is that the resulting tax may not be the lowest amount. In general, use of the Exact Method will yield a lower tax. The tradeoff, however, is additional complexity and administration. Under the Exact Method, the manufacturer of the imported product should be requested at least annually to provide a written analysis of the ODC weight used in the manufacturing of each imported taxable product. This weight would then be applied to each imported taxable product during the year. This information should also be requested whenever the manufacturing process of the producer is altered.

Floor Stock tax

Under section 4682(h)(1), an excise tax is imposed on the amount of ODC held as floor stock on each January 1 starting in 1990. Temp. Reg. [section] 52.4682-4T contains a special rules relating to the floor stock tax, and Temp. Reg. [subsection] 52.4682-1T(a)(3) and (c) set forth general rules and definitions relating to the tax.

ODCs that have been recycled or reclaimed, incorporated into a manufactured article, or mixed with other ingredients are not subject to the floor stock tax. For example, the tax is not imposed on ODCs contained in the cooling coils of a refrigerator but the tax is imposed on a can of ODC used to recharge an air conditioning unit because the ODC must be expelled from the can in order to be used. Similarly, beginning in 1991, the tax is imposed on halons, including halons contained in fire extinguishers held for sale.

For floor stock tax imposed after 1990, Temp. Reg. [section] 52.4682-4T(b)(2)(i)(B) provides that the mixture exemption does not apply unless the other ingredients contribute to the purpose for which the mixture will be used. Thus, the tax is not imposed on the amount of ODC contained in metal cleaning agents that are a mixture of ODC and other non-ODC ingredients.

The person who owns the chemical on the date the tax is imposed is subject to the floor stock box. Floor stock tax is equal to the amount of tax computed under Temp. Reg. [section] 52.4681-1T(a)(3) reduced by the amount of any tax previously imposed on the ODC.

Temp. Reg. [section] 52.4682-4T(e)(1) provides a de minimis exception from the floor stock tax (applicable in 1990, 1992, and 1993) if less than 400 pounds of ODCs are held in stock on January 1. The 400-pound threshold is to be determined without taking into account either (i) ODCs that are used in the manufacture of rigid foam insulation or (ii) halons. For 1991, a slightly different rule applies. The de minimis amount specified under Temp. Reg. [section] 52.4682-4T(e)(2) is still 400 pounds, but only ODCs used in the manufacture of rigid foam insulation and halons are taken into account.

Example: On January 1, 1990, M holds 450 pounds of ODC for use in M's production process and 600 pounds for use in the manufacture of rigid foam insulation. M is liable for the floor stock tax on the 450 pounds of ODCs used in M's production process. Assuming the same facts except now it is January 1, 1991, the 600 pounds of ODCs that will be used to manufacture rigid foam insulation will be taken into account in determining the tax, but the remaining 450 pounds of ODCs are not taken into account because the base tax amount does not increase in 1991. In 1994, the taxability threshold is reduced to 200 pounds of ODCs or 20 pounds of halons.

It will be necessary to have an inventory of ODCs as of January 1 of each year so that it can be determined whether the floor stock tax applies and, if so, the amount of the tax. Temp. Reg. [section] 52.4682-4T(f) provides that this inventory may be taken prior to year-end and adjusted for acquisition, use, and dispositions that occurred after the inventory date or taken after year-end and adjusted accordingly.

Filing of Return

Temp. Reg. [section] 52.6701(a)-2T sets forth the rules for filing returns under section 4681. A quarterly Form 720, Quarterly Federal Excise Tax Return, relating to ODC excise tax must be filed on or before the last day of the second month following the quarter for which the returnis due. These forms are due May 31, August 31, November 30, and February 28/29. Temp. Reg. [subsection] 52.6071(a)-1T(a)(3) and (4) extend the date for filing the first and second quarter returns for 1990, without application, to October 9, 1990; there was no extension, however, with respect to the due date of tax payments themselves.

The excise tax must be deposited with Form 8109, Federal Tax Deposit Coupon, at an authorized Federal Reserve Bank in compliance with section 6302(c)(1). Payment for the first and second quarter were due on April 30, 1990, and September 7, 1990, respectively. If the Form 720 was filed for the first or second quarter of 1990, but the liability relating to the tax imposed under sections 4681 and 4682 was not included, a "supplemental" Form 720 was to have been filed on or before October 9, 1990.

The extension for reporting the liability for floor stock tax does not extend the date on which the payment was due--April 1, 1990. for 1991 through 1994, the returns for floor stocks tax are due on or before May 31 of the year the tax is imposed.

Obtaining Required Information

In order to use the Exact Method to calculate the ODC weight, a taxpayer may need information not readily available from suppliers. To determine and properly evaluate the best method to use in computing the tax liability, an information request should be distributed to each supplier requesting that each product pruchased by the taxpayer be evaluated for total CFC content, by weight, and by the type of CFC used. Thus, a questionnaire such as that set forth in Exhibit I should be used to secure the information. In addition, a written certification should be secured for any products that are produced free of CFCs or halons. Upon audit, this documentation would be used to demonstrate that the taxpayer had relied upon third-party information in determining its tax liability.

Conclusion

The new excise tax on ozone-depleting chemicals represents a significant tax issue for many companies. All planning opportunities should be explored and stringent adherence to the procedures should be followed owing to increased IRS scrutiny and substantial potential tax liability. In addition to assessing the tax liability, there may be a need to meet increasing demands by purchasers for information on the use of ODCs used in a company's products. Thus, a chemical engineer's analysis may be required at all stages of component or assembly manufacturing or packaging.

(1) The temporary and final regulations were published in the Federal Register on September 6, 1990 (55 Fed. Reg. 36612) and in the October 1, 1990, issued of the Internal Revenue Bulletin (199-40 I.R.B. a 4). A related notice of proposed rulemaking (Ps-73-89) was also issued on August 31, 1990, which was reprinted at 55 Fed. Reg. 36659 and 40 I.R.B. at 35.

(2) Under section 11203 of the Omnibus Reconciliation Act of 1990 (Public Law No. 101-508), Congress added the following 12 chemicals to the list of chemicals subject to the ODC excise tax: carbon tetrachloride, methyl chloroform, CFC-13 CFC-111, CFC-112, CFC-211, CFC-212, CFC-213, CFC-214, CFC-215, CFC-216, and CFC-217.

(3) Under the Omnibus Budget Reconciliation Act of 1990, the base amounts for the newly listed OCCs (see note 2) will be $1.37 in 1991 and 1992, $1.67 in 1993, $3.00 in 1994, and $3.10 for 1995. For post-1995 years (post-1994 years for ODCs taxable under pre-1990 law), the base amount will be the base amount for the last year plus 45 cents for each subsequent year.

(4) Under the Omnibus Budget Reconciliation Act of 1990, the ozone-depletion factors in respect of the 12 new chemicals subject to the tax are as follows:

ODC Ozone-Depleting Factor

carbon tetrachloride 1.1 methyl chloroform 0.1 CFC-13 1.0 CFC-111 1 .0 CFC-112 1.0 CFC-211 1.0 CFC-212 1.0 CFC-213 1.0 CFC-214 1.0 CFC-215 1.0 CFC-216 1.0 CFC-217 1.0

(5) The term "United States" means the 50 states, District of Columbia, Commonwealth of Puerto Rico, and any possession of the United States, Commonwealth of Northern Mariana Islands, and the Trust Territory of the Pacific Island.

(6) Date of entry is the date of Customs Form 7501 is filed with the appropriate officer, provided that such date is within 10 business days of arrival of the products in the United States.

(7) Under the Omnibus Budget Reconciliation Act of 1990, the de minimis exception in respect of certain imported taxable products is not available with respect to methyl chloroform.

GREGORY A. ORLANDO is a Manager of Taxation with Motorola, Inc. in Arlington Heights, Illinois. He holds a Master of Science (Taxation) degree from Depaul University and received his undergraduate degree in accounting from Loyola University in Chicago. Mr. Orlando is an active member on the Federal Tax Committee of the Chicago Chapter of Tax Executives Institute. He was formerly a Revenue Agent with the Chicago District of the Internal Revenue Service.

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