Rev. Rul. 88-64

1988-2 C.B. 10, 1988-32 I.R.B. 5.

                       Internal Revenue Service

                                 Revenue Ruling

                              ALCOHOL FUELS CREDIT

                           Published: August 8, 1988

SECTION 40. - ALCOHOL USED AS FUEL

(Also Sections 4041, 4081, 4091; 48.4041-18, 48.4081-2.)

  Alcohol fuels credit. The producer of a "qualified mixture", as that term is defined in section 40(b)(1)(B) of the Code, is identified in two situations.

  A corporation produces and sells an octane-enhancing additive for gasoline. Twenty-five percent of the additive consists of ethanol ('eligible alcohol ') that (1) is not produced from petroleum, natural gas or coal, or any derivative of petroleum, natural gas or coal, and (2) has a proof of more than 190. The remaining 75 percent of the ingredients consists of alcohol derived from petroleum.

  In Situation 1, the additive producer acquires all the components of the additive and mixes them together to form the additive. The producer then blends the additive with gasoline that the producer owns to create a mixture of one part additive to nine parts gasoline. The producer sells the blended gasoline to a distributor who, the producer has established, sells the blended gasoline to a service station for sale to customers as a fuel.

  In Situation 2, the producer acquires all the components of the additive and mixes them to form the additive. The producer then stores the additive at a terminal. A buyer sends a tank truck containing gasoline to the terminal. At the terminal, the producer sells the additive to the buyer, delivering the additive in a quantity that results in a final mixture composed of one part additive and nine parts gasoline. The buyer then sells the mixture to a distributor who, in turn, sells it to a service station for sale to customers.

  ISSUE. At issue is whether, in either of the two situations, the additive producer is a producer of a 'qualified mixture' as that term is defined in section 40(b)(1)(B), and may, therefore, claim the alcohol mixture tax credit.

  HOLDING. The Service has held in Situation 1 that the additive producer is a producer of a qualified mixture because the producer is able to establish that its buyer sold the alcohol mixture for use as a fuel. In Situation 2, the Service held that the additive producer is not eligible for the alcohol mixture credit because when it sells the additive to the owner of the gasoline, the additive producer has not produced a qualified mixture.

  ANALYSIS. The two keys to the Service's holding in Situation 1 were (a) the additive producer's actual production of the qualified mixture and (b) the producer's having demonstrated that its buyer will resell the qualified mixture to parties who will use it as a fuel. Since the additive producer owned and mixed all the ingredients of the gasoline mixture, the producer cleared the first requirement of section 40(b)(1)(B)(i). Then, noting that section 40(b)(1)(B) does not require that the mixture producer's buyer use the mixture as a fuel, the Service held that the fuel use requirement would be met as long as the producer can demonstrate that the retail buyer will use the mixture as a fuel.

  Turning to Situation 2, the Service found that the additive sold by the producer is not a qualified mixture sold for use as a fuel, but is merely sold as an octane enhancer. Since the additive producer does not own the gasoline mixed with the additive, the additive producer is not a producer of a qualified mixture. Rather, the Service concluded, the buyer who owns both the additive bought from the additive producer and the gasoline with which it is blended is the qualified mixture producer who is entitled to the alcohol fuels credit.

                                     ISSUES

  Whether X is the producer of a 'qualified mixture' as that term is defined in section 40(b)(1)(B) of the Internal Revenue Code in the two situations described below.

                                     FACTS

  X is in the business of blending and selling a product (the 'Product') that is used as an octane-enhancing additive for gasoline. About 25 percent of the Product consists of ethanol ('eligible alcohol') and (1) is not produced from petroleum, natural gas or coal, or any derivative of petroleum, natural gas or coal, and (2) has a proof of more than 190. The other 75 percent of the ingredients (the 'Other Ingredients') in the Product consists of alcohol derived from petroleum.

  In SITUATION 1, X acquires all the components of the product and mixes them together to form the Product. X then blends the Product with gasoline that X owns to create a mixture of one part Product to nine parts gasoline. This blend thus consists of 2.5 percent eligible alcohol. X sells the blended gasoline to a distributor and X is able to establish that the distributor sells it to a service station for sale as a fuel to consumers.

  In SITUATION 2, X acquires all the components of the Product and mixes them together to form the Product. X stores the Product at a terminal for sale to buyers. Buyer Y sends a tank truck containing gasoline that Y owns to X's terminal where the Product is sold by X to Y and delivered into Y's tank truck in such quantity that the final mixture is composed of one part Product to nine parts gasoline. Y then sells it to a service station for sale to consumers.

                                LAW AND ANALYSIS

  Section 40(b)(1)(A) of the Code allows an alcohol mixture credit for alcohol used by the taxpayer in the production of a qualified mixture.

  Section 40(b)(1)(B) of the Code provides that the term 'qualified mixture' means a mixture of alcohol and gasoline or of alcohol and a special fuel that - (i) is sold by the taxpayer producing such mixture to any person for use as a fuel, or (ii) is used as a fuel by the taxpayer producing such mixture.

  Section 40(c) of the Code provides that the amount of the credit determined under section 40 with respect to any alcohol shall, under regulations prescribed by the Secretary, be properly reduced to take into account any benefit provided by the rate reductions in the special fuels and gasoline excise taxes under section 4041(b)(2), (k), or (m), section 4081(c), or section 4091(c).

  Section 40(d)(1) of the Code provides that the term 'alcohol' includes methanol and ethanol but does not include - (i) alcohol produced from petroleum, natural gas or coal, or (ii) alcohol with a proof of less than 150.

  Section 40(d)(2) of the Code provides that the term 'special fuel' includes any liquid fuel (other than gasoline) that is suitable for use in an internal combustion engine.

  Section 4081(c)(1) of the Code reduces the gasoline tax rate for gasoline used, at the time of sale or removal, in producing any mixture of gasoline if at least 10 percent of such mixture is alcohol. Section 6427(f) follows a refund equivalent to this rate reduction if gasoline purchased at the regular tax rate is later used to produce such a mixture.

  In SITUATION 1, when X blends the Product with gasoline that it owns, it produces a qualified mixture of alcohol and gasoline within the meaning of section 40(b)(1)(B) of the Code, provided it sells such mixture to any person for use as a fuel. Because section 40(b)(1)(B)(i) does not specifically require that the mixture producer's buyer itself use the mixture as a fuel, this latter condition is met even if X's buyer resells the mixture to others who use it as a fuel. This conclusion is supported by an example in the Conference Report on the Crude Oil Windfall Profit Tax Act of 1980, which enacted the credit. In this example, the credit is allowed to a taxpayer that produces a qualified mixture for sale to a service station rather than directly to consumers. See H.R. Rep. No. 817, 96th Cong., 2nd Sess. 143 (1980), 1980-3 C.B. 303.

  The conclusion that X is eligible for the credit even though X's buyer resells the mixture for fuel use, rather than so using the mixture itself, is further supported by a comparison of section 40(b)(1)(B)(i) of the Code with section 40(b)(2)(A)(ii). Section 40(b)(2)(A)(ii) grants a credit for straight alcohol (as opposed to a mixture) that is used as a fuel and specifically requires for allowance of the credit that the fuel be sold 'by the taxpayer at retail to a person and placed in the fuel tank of such person's vehicle.' Section 40(b)(1)(B)(i) is broader than section 40(b)(2)(A)(ii) in that it has neither an 'at retail' limitation nor a requirement that the fuel be placed in the fuel tank of the buyer's vehicle.

  In SITUATION 2, X blends the Other Ingredients with the alcohol to form the Product. The Product itself is not a qualified mixture because it is not sold for use a fuel; it is sold as an octane- enhancer. Because X does not own the gasoline into which the Product is then blended, X is not the producer of the qualified mixture. Rather, the producer is X's buyer who owns both the Product and the gasoline with which the Product is blended to produce the mixture.

  This conclusion is supported by a statement made by Senator Long, Chairman of the Senate Finance Committee, during the debate on the bill that added the alcohol mixture credit to the Code. When he was asked whether the measure was intended to preclude producers of alcohol from receiving these credits, Sen. Long responded:

    No, not at all. An alcohol producer could receive the alcohol mixture credit as long as HE OWNS ALL OF THE INGREDIENTS of the alcohol fuel mixture at the time of the blending process.

126 Cong. Rec. 6641 (1980) (emphasis added).

                                    HOLDING

  In SITUATION 1, X is a producer of a qualified mixture because X is able to establish that its buyer sold the alcohol mixture for use as a fuel. Assuming that X is also able to establish that no person has claimed or will claim either the excise tax reductions specified in section 40(c) or the refund allowed under section 6427(f) for production of a mixture described in section 4081(c), X is eligible for the alcohol mixture credit.

  In SITUATION 2, when X sells the Product to the owner of the gasoline, X has not produced a qualified mixture and is not eligible for the alcohol mixture credit.

                              DRAFTING INFORMATION

  The principal author of this revenue ruling is Frank Boland of the Individual Tax Division. For further information regarding this revenue ruling contact Mr. Boland on (202) 566-3410 (not a toll free call).

Rev. Rul. 88-64, 1988-2 C.B. 10, 1988-32 I.R.B. 5.