Certainties in a Season of Change: Chemoil Corp. v. U.S.

November 6, 2023

My dad was the person in my family handing down the life lessons. One thing that I heard probably more than anything else was that there are only three certainties in life: death, taxes, and the fact that everything changes. Turns out he was right…though it will be a very long time before I tell him that…Speaking of taxes, recently, Chemoil Corp. ran into one of the more certain things in life.

I know, I know, taxes….blech. I promise, however, to give you a scintillating tale of a tax credit, a bad actor, and a court case.  I am certain (see what I did there?) that you will want to stick around and read what happened.

For some in the renewable fuel industry, at first glance, this court case was a little concerning. From a cursory review of the facts of the case, you can understand why. The tax credit that is central to the case is the Volumetric Ethanol Excise Tax Credit (“VEET”), which was an alcohol fuel mixture credit offered by the IRS from 2009-2011 for ethanol blended with non-aviation gasoline[1]. Similar to the requirements of the federal Biodiesel Tax Credit (BTC), VEET was supposed to be used as a credit against excise tax liability. The rate of the VEET credit was $0.45 per gallon and, like the BTC, could be claimed on the same form as your excise tax liability[2]. In other words, there were many aspects of VEET that echoed that of the BTC, which is why this case, at first glance, was a bit unnerving.

Our story starts with the following set of facts. Chemoil entered into seven different transactions with two different trading partners for the sale of its anhydrous (E99) product. Chemoil, filed for the credit, claiming a total amount of $6,682,529.25[3]. There is one additional piece of information that is integral to understanding the facts of this case. The important fact is that “if a claim was made…for an excessive amount, unless it [was] shown that the claim for such an excessive amount [was] due to reasonable cause the person making the claim shall be liable to a penalty[4].”

Enter the bad actor. Our story gives the bad actor two additional “plot points”: (1) in the absence of the tax credit, Chemoil would have been selling its alcohol mixture product at a loss of about $.40 per gallon and (2) on one transaction to one of the trading partners, Chemoil ordered their accountants to backdate one of the invoices to December 31, so that Chemoil could claim the amount of the credit for a load of anhydrous that they didn’t deliver to their trading partners until January 14, 2012[5]. This is significant because it means that Chemoil claimed gallons that were not eligible to be claimed.

As you might have predicted, IRS audited Chemoil’s claims and found that it was not entitled to a credit for any of those seven transactions. Chemoil appealed that decision to the IRS but the appeal was not able to be resolved between the parties. As a result of the lack of resolution, IRS formally disallowed Chemoil’s claims for VEET and filed an excessive penalty claim. Chemoil then filed a Motion for Summary Judgment with the Southern District of New York Court. Just in case you’re wondering what that means, a Motion for Summary Judgment is where one party is asking the court to dismiss the case before it. Typically, for a Motion of Summary Judgement, the moving party (the party bringing the motion) has to prove that there is no material dispute as to the facts of the case. It’s a little bit like saying there’s no dispute here, especially not one that the court needs to address and giving this to a jury would really just be a waste of the court’s time. The court did not grant Chemoil’s motion and instead upheld IRS’s claims of excessive penalty.

But why though? To deny the motion, the court relied on the “Economic Substance” doctrine, which says that a court may “…question the validity of a transaction an deny taxpayers benefits to which they are technically entitled under the [Internal Revenue] Code if the transaction at issue lacks ‘economic substance.’” In order for the doctrine to apply, the court looks for two different elements: (1) “whether the taxpayer had an objectively reasonable expectation of profit, apart from tax benefits, from the transaction;” and (2) “whether the taxpayer had a subjective non-tax business purpose in entering the transaction[6].”

Did Chemoil have an objectively reasonable expectation of profit? Here’s the thing. Chemoil had to provide IRS with emails during the appeals process that were then used again in court. The emails cited in the case note that Chemoil purchased Ethanol for $2.46 per gallon, but sold it at $2.06 per gallon, creating a net loss of $0.040 per gallon. However, with the $0.45 per gallon VEET credit, Chemoil netted a gain of $0.05 per gallon. Without all the math involved, this means that Chemoil did not have an objectively reasonable expectation of profit because, but for the VEET credit, Chemoil would have sold those gallons at a loss.

But did Chemoil have a subjective, non-tax business purpose for entering into the transaction? Chemoil backdated an invoice so that it could claim the credit for that transaction. If there was a subjective, non-tax purpose for entering into the transaction, Chemoil would not have needed to backdate the invoice. So, this element isn’t exactly in Chemoil’s favor either. Since Chemoil couldn’t show the first or the second element, they couldn’t have shown that the transactions at issue in the cases had economic substance beyond applying for VEET.

Should this case make people who apply for the BTC nervous? I don’t think so. To be clear, I am not a tax attorney and this case is brand new, which means how it applies in the future has yet to be determined. However, that being said, this case is much more about a bad actor trying to take advantage of a federal tax credit than it is about the tax credit itself.

While my dad *may* have been right about the certain things in life, only time will tell how this case gets applied.

[1] Chemoil v. IRS No. 19-CV-6314-LTS-JW, 2, (SDNY Sept. 2023).

[2] Id. at 2.

[3] Id. at 7.

[4] Id. at 2.

[5] Id. at 7.

[6] Id. at 10, citing BONY Mellon, 801 F3.d at 115