IRS issues SCET guidance just before July 1 effective date: PwC

In brief

In the 10 days before the July 1 effective date of the reinstated Superfund Chemical Excise Taxes (SCET), the IRS issued informal guidance in the form of frequently asked questions (FAQs) and a rate table for taxable substances. The IRS followed with a revenue procedure setting forth the procedures for requesting a determination that a substance should be added to or removed from the list of taxable substances under the SCET, among other related matters. For background on the reinstated SCET, see PwC’s Insights: Infrastructure Bill Reinstates Superfund Excise Taxes; IRS Provides SCET Guidance; and Relief Provided for SCET Deposits.

[IR-2022-131 (SCET FAQs) and IR-2022-132 (SCET rates), 6/24/22; Revenue Procedure 2022-26, 6/28/22]

Be aware: The SCET taxable substances rate table provides taxpayers with tax rates for 121 of 151 listed taxable substances as of July 1, but taxpayers instead may support a tax determination based on a look-through to the underlying taxable chemicals used in the substance’s production. The determination of the appropriate rate will challenge both taxpayers and their customers as they seek to reconcile potentially differing effective tax rates depending on whether the SCET was paid on the component taxable chemicals or the listed taxable substances table rate.

Further, the procedure for adding or removing substances from the SCET taxable substance list will be consequential, as the current list of substances is based on the prior threshold for taxable chemical usage/composition (50%, as opposed to 20% under the new law) and has not tracked changes within the chemical industry for over 25 years. Additionally, refunds may be available retroactive to July 1 for taxpayers that successfully may benefit from list changes under the revenue procedure.

In detail

Guidance in FAQs

The IRS notes that the FAQs are informal guidance and that the law controls if there is a discrepancy. The IRS also states (FS-2022-31) that taxpayers that “reasonably and in good faith” rely on the FAQs will not be subject to a penalty under a general reasonable cause standard for relief, which affects the potential of any negligence penalty or other accuracy-related penalty, to the extent that reliance results in an underpayment of tax.

Some of the notable guidance items from the FAQs include:

When is the SCET effective? The FAQs note that a manufacturer, producer, or importer of a taxable chemical is subject to the Section 4661 tax on the sale or use of the taxable chemical on or after July 1, 2022. An importer of a taxable substance is subject to the Section 4671 tax on the sale or use of the taxable substance on or after July 1, 2022.

Observation: The IRS is applying the SCET on importers based on the first sale or use, and not contingent on the date of importation. For example, if taxable chemicals were imported on June 28, 2022, but the first sale or use was on or after July 1, the SCET is deemed to apply. Some members of industry have asked for the ability to make an election similar to the election available for the environmental excise tax on ozone depleting chemicals (ODCs) in imported taxable products -- to treat import as use of the material, i.e., an incidence of tax. So far, the IRS has not indicated that such an election is available.

What is a taxable substance? A taxable substance is any substance that, at the time of sale or use by the importer of the substance, is listed as a taxable substance.

Observation: With this FAQ, the IRS addresses a common misconception that any substance is taxable if more than 20% of the component chemicals (by weight or value) used to make the substance are taxable chemicals. The IRS states that in order to be taxable, a substance must be both (1) over the 20% threshold and (2) listed as a taxable substance.

How do importers calculate the section 4671 tax? The amount of the Section 4671 tax with respect to any taxable substance generally is the amount of Section 4661 tax that would have been imposed on the taxable chemicals used in the manufacture or production of the taxable substance if the taxable chemicals had been sold in the United States for use in the manufacture or production of the taxable substance. If the importer does not calculate or sufficiently support the Section 4671 tax for a taxable substance and the IRS has prescribed a tax rate for the taxable substance, the tax is calculated using the rate prescribed by the IRS. If the IRS has not so prescribed, the valuation method under Section 4671(b)(2) may apply.

Observation: The ODC regulations contemplate that taxpayers may use the exact method for determining the ODC weight of some imports and the table method for determining the ODC weight of other imports depending on the information available. The FAQs appear to be taking a similar approach for determining the SCET; this appears to align with the hierarchy detailed in the statute. Likewise, the FAQs provide that importers are not required to use the IRS-prescribed tax rates for the Section 4671 tax, and instead may calculate their own rates. The FAQs do not provide guidance on the requirement in Section 4671(b)(2) as to what will be “sufficient information” to establish the underlying taxable chemical usage in production of a taxable substance.

When is registration required? Persons wanting to engage in tax-free sales of intermediate hydrocarbon streams containing organic taxable chemicals and/or to conduct tax-free inventory exchanges must be registered by the IRS under Activity Letter G. Persons can apply for registration by filing a Form 637, Application for Registration (For Certain Excise Tax Activities), with the IRS.

Observation: The FAQs reflect that there are limited circumstances where an activity letter “G” registration is needed. Taxpayers do not need an activity letter “G” registration merely to report and remit SCET to the IRS. Further, taxpayers do not need a registration to claim export credits/refunds or assert other exceptions to tax.

Guidance in Rev. Proc. 2022-26. Revenue Procedure (Rev. Proc.) 2022-26 provides the exclusive procedures for requesting a determination under Section 4672(a)(2) that a substance be added to or removed from the list of taxable substances.

Any requests to modify the list that were submitted previously or in response to the request for comments in Notice 2021-66 are deemed not to have met the requirements of the revenue procedure. The IRS states that such requests “will not be processed and must be submitted in accordance with the procedures described in…this revenue procedure.”

Taxable substance determinations made during a calendar quarter will be effective and reflected in the list as of the first day of the second quarter following the quarter in which the determination is made. Therefore, importers liable for the tax imposed by Section 4671(a) on the sale or use of taxable substances added to the list and persons making export-related claims related to substances removed from the list of taxable substances will have a minimum of 90 days’ notice of the changes.

If the Treasury Department makes a determination to add a substance to the list and that substance is exported, for purposes of claims for refund that substance is deemed to have been added to the list as of the date the petition was filed. As a result, a person that paid the Section 4661(a) tax on taxable chemicals used in the production of a substance that was exported on or after the filing date of the petition may be entitled to a refund, if a determination ultimately is made to add the substance to the list.

A refund is available to the person that paid the tax if the person establishes that it has repaid or agreed to repay the amount of the tax to the exporter of the taxable substance or has obtained the written consent of the exporter to the making of the refund. Under certain circumstances, the exporter of the taxable substance may claim the refund if the person that paid the tax waives its claim to the amount of the refund. Protective refund claims may be filed while the petition is pending.

Note: Historically, Notice 89-61 was the procedure for adding or removing substances from the SCET taxable list. Notice 2021-66, issued in December 2021, satisfied the statutory requirement to provide a list of taxable substances for July 1, but also suspended the petitioning process in Notice 89-61. While many elements of Notice 89-61 have carried over to Rev. Proc. 2022-26, Notice 89-61 and the related Notice 95-39 are superseded.

Observation: Since the list of taxable substances in Notice 2021-66 was based on the prior threshold to constitute a taxable substance (50% of weight or value of the 42 base chemicals), the statutory change to 20% in the reinstated SCET, as well as developments in the last 25-plus years, it seems likely that Rev. Proc. 2022-26 will guide a busy period of activity as items will be added and potentially removed. Beneficially, the revenue procedure (as well as the FAQs) provides that petitions accepted prior to December 31, 2022, will be deemed to be filed on July 1, 2022, for purposes of making export claims.