Rev. Rul. 85-18

1985-1 C.B. 15, 1985-10 I.R.B. 5.

ALCOHOL USED IN FUELS; CREDITS AND EXEMPTIONS

Published: March 11, 1985

Section 40.-Alcohol Used as Fuel

(Also Sections 4041, 4081; 48.4041-14, 48.4081.2)

  Alcohol used in fuels; credits and exemptions. Ethanol produced as a by- product of the manufacture of ethylcellulose derived from ethane does not qualify as alcohol for purposes of the alcohol fuels credit under section 40 of the Code or for purposes of the exemptions from the excise tax of gasoline and special fuels under sections 4081 and 4041.

ISSUE

  Does ethanol produced as described below qualify as an alcohol for purposes

of the alcohol fuels credit under section 40 of the Internal Revenue Code or the alcohol fuels provisions of sections 4041(b)(2), 4041(k) and 4081(c)?

FACTS

  X is a manufacturer of ethylcellulose by a process in which ethanol is a by- product. The important reactants in the process consist of cellulose, sodium hydroxide, and ethyl chloride and the products include ethylcellulose, sodium chloride, ethanol, and diethyl oxide. The ethanol by-product is derived from the ethyl chloride. The ethyl chloride used by X is produced by treating ethylene with hydrochloric acid. The ethylene, in turn, is derived by the thermal cracking of ethane (a constituent of natural gas) or crude oil.

LAW AND ANALYSIS

  Section 40 of the Code, which prior to the Tax Reform Act of 1984 was designated section 44E of the Code, provides for a credit against federal income tax for certain producers, sellers and users of alcohol-based fuels. In general, the amount of the credit is 60 cents for each gallon of alcohol that is used as a fuel or blended into a fuel mixture.

  Section 4041(a) of the Code imposes a tax on the sale or use of diesel fuel and special motor fuels. Section 4041(b)(2) exempts from the tax imposed by section 4041(a) qualified methanol or ethanol fuel which is defined as any liquid at least 85 percent of which consists of methanol, ethanol, or other alcohol produced from a substance other than petroleum or natural gas.

  Section 4041(k) of the Code provides for a reduction in the rate of the tax imposed by section 4041(a) in the case of liquid fuel at least 10 percent of which consists of alcohol as defined in section 4081(c).

  Section 4081(a) of the Code imposes a tax on the sale of gasoline. Section 4081(c) provides for a reduction in the rate of tax imposed by section 4081(a) in the case of gasohol, which is defined as any mixture of gasoline if at least 10 percent of the mixture is alcohol.

  Under sections 40(d)(1) and 4081(c)(3) of the Code, the term 'alcohol' is defined for purposes of sections 40, 4041, and 4081 as including methanol and ethanol but not including alcohol produced from petroleum, natural gas, or coal (including peat).

  The special treatment accorded gasoline-alcohol blends under sections 4041(k) and 4081(c) of the Code (originally a full exemption from tax) was intended to apply to ethanol, methanol, or other alcohol produced from agricultural or forestry products or urban wastes. See, S. Rep. No. 95-1324, 95th Cong., 2d Sess. 48 (1978), 1978-3 (Vol. 2) C.B. 309, 320. As in the case of gasoline- alcohol blends under sections 4041(k) and 4081(c), the credit against tax provided under section 40 was not intended to apply to alcohol produced from any derivative or product of petroleum, natural gas, or coal. See, H. Rep. No. 96-817, 96th Cong., 2d Sess. 143 (1980), 1980-3 C.B. 245, 303. The exemption from tax provided under section 4041(b)(2) was intended to apply to fuels derived from sources other than petroleum or natural gas. See, Conf. Rep. No. 97-987, 97th Cong., 2d Sess. 178 (1982), 1983-1 C.B. 434, 435.

  In this case, the ethanol produced by X as a by-product in its manufacture of ethylcellulose is produced from ethylene which is made by the thermal cracking

of ethane (a constituent of natural gas) or crude oil.

HOLDING

  Since the ethanol by-product of X's ethylcellulose process is produced from a derivative or product of natural gas or petroleum, it does not qualify as alcohol for purposes of the provisions of sections 40, 4041(b)(2), 4041(k) and 4081 of the Code.

Rev. Rul. 85-18, 1985-1 C.B. 15, 1985-10 I.R.B. 5.