Are You Properly Paying the Ozone-Depleting Chemicals Excise Tax?

By Deborah Karet, J.D., LL.M., and Ruth Hoffman, J.D., Washington, DC

Excise Taxes

Importers may be unaware of their federal excise tax responsibilities for taxable articles they import into the United States. In recent years, IRS excise tax examinations have focused on taxpayers that import articles potentially subject to the excise tax imposed on certain ozone-depleting chemicals (ODCs) under Sec. 4681 (the ODC tax). For example, importers of certain electronics may be subject to the ODC tax if taxable ODCs were used in manufacturing the electronics.

This item provides an overview of the rules related to the ODC tax and describes the documentation required to support an electronics importer’s determination that the tax does not apply for a particular imported product. Most importers of electronics may not be focused on the tax because the use of taxable ODCs in the manufacturing of these products has generally been eliminated; however, it has been the authors’ experience that the IRS has been looking closely at the issue of whether an importer’s documentation supports its conclusion that no ODC tax is due. Although this item focuses on electronic products, note that the ODC tax also may be imposed for other imported products if taxable ODCs were used in their manufacture for purposes of refrigeration or air conditioning or creating an aerosol or foam.

Background

The Montreal Protocol is an international agreement relating to substances that deplete the stratospheric ozone layer, first entered into by the United States and other countries in 1987 and effective beginning January 1, 1989 (Montreal Protocol on Substances That Deplete the Ozone Layer, September 16, 1987, Treaty Doc. 100-10, 1987 U.S.T. Lexis 207 (as either adjusted and/or amended in London (1990), Copenhagen (1992), Vienna (1995), Montreal (1997), Beijing (1999), and Montreal (2007))). The Montreal Protocol identifies many ODCs. Its intent was to eliminate the production and use of these chemicals worldwide. Generally, with respect to taxable ODCs, under the terms of the Montreal Protocol developed countries would not produce or use these chemicals after 1995, and developing countries would not produce or use them after 2009. Congress chose to implement the Montreal Protocol by imposing an excise tax on certain ODCs and on imported products manufactured using those ODCs.

ODC Tax

Effective January 1, 1990, Sec. 4681 imposed tax on any imported taxable product sold or used by its importer. The amount of tax imposed on any imported taxable product is the amount of tax that would have been imposed on the taxable ODCs used as materials in the manufacture of the product if the taxable ODCs had been sold in the United States on the date of the sale of the product. Sec. 4682(a)(2) lists the taxable ODCs. Under 1991 Treasury regulations relating to the ODC tax on imported products, the term “imported taxable product” means any product that is “entered into the United States for consumption, use, or warehousing” and is listed in the imported products table in the regulations (Regs. Sec. 52.4682-3(b)). Tax generally is imposed on an imported taxable product when the product is first sold or used by its importer. The importer is the person liable for the tax. Under the regulations, an imported product is subject to the ODC tax if it is listed in the table (at Regs. Sec. 52.4682-3(f)(6)) and if taxable ODCs were used in the manufacture of the product. Generally, electronics are products listed in the table. A product is not subject to the ODC tax if taxable ODCs were not used in its manufacture.

Determination of Amount of ODC Tax Due

The amount of tax is based on the weight of the taxable ODCs used in the manufacture of the product. Under the regulations, the importer must determine whether taxable ODCs were used in the manufacture of the product and must support its determination with sufficient and reliable information, such as representations by the product’s manufacturer to the importer as to the weight of any taxable ODCs used as materials in the manufacture of the product. For example, a letter to the importer signed by the manufacturer (manufacturer letter) that adequately identifies the product and states the weight of each taxable ODC used as a material in the product’s manufacture may constitute sufficient and reliable information.

The regulations provide the following methods to calculate the ODC weight:

  • The exact method, using the actual weight of each taxable ODC used as a material in manufacturing the product.
  • The table method, using the ODC weight listed for the product in the table if the actual weight cannot be determined.
  • The value method, using 1% of the U.S. Customs and Border Protection agency entry value of the product if the actual weight cannot be determined and no table weight is listed for the product.

When the ODC tax was enacted in 1989, manufacturers of most electronic products listed in the table were using taxable ODCs (primarily CFC-113) as solvents to clean solder residue from printed circuit boards during the soldering process. The table method provided a simple way to determine the tax due without additional information or documentation. By the mid-1990s, improvements were made to the soldering technology and most manufacturers changed their manufacturing processes to eliminate the use of taxable ODCs. Importers began to switch to the exact method to demonstrate that no tax was due and to stop filing Form 720, Quarterly Federal Excise Tax Return. Manufacturer letters stating that no taxable ODCs were used (that is, that the ODC weight is zero) were at that time accepted as sufficient and reliable by the IRS examiners. Furthermore, the term “manufacturer” was understood to mean the last assembler of the product; this person was the person from whom the importer was to obtain the letter describing the use, if any, of taxable ODCs in the manufacture of the product. At that time, letters were not required from persons that made component parts of the product.

IRS Audits

For the past several years the IRS has been focusing on the ODC tax and conducting a detailed review of manufacturer letters. Many importers are now facing multimillion-dollar proposed assessments because IRS excise tax examiners have decided that the importers’ manufacturer letters generally do not establish that no taxable ODCs were used in manufacturing. The IRS approach to ODC tax audits has changed under the examination guidelines set forth in its Ozone Depleting Chemicals (ODC) Excise Tax Audit Techniques Guide (September 16, 2008) (ODC Audit Guide), which details examination procedures. Note that the ODC Audit Guide is not an official pronouncement of the law or the IRS’s position and cannot be used, cited, or relied upon as such.

Under an agreement with the U.S. Customs and Border Protection agency, the IRS receives information about the importation of potentially taxable articles into the United States. The information that the IRS receives for each importer includes the name and harmonized tariff schedule classification of products listed in the table that are imported by that taxpayer. Under the current IRS initiative, IRS excise tax examiners usually begin an ODC excise tax audit by reviewing this information because importers today often are not filing Form 720. Examiners generally assume that any product imported into the United States that is listed in the table is subject to the ODC tax. Examiners require the importer to establish that taxable ODCs were not used in the manufacture of the product. IRS excise tax examination policy has changed so that manufacturer letters are no longer deemed sufficient, and extensive additional documentation is being requested. This documentation includes letters from manufacturers of the electronic components of the product, especially from printed circuit board assembly manufacturers.

Chapter 4 of the ODC Audit Guide sets forth a detailed list of eight examiner requirements for an acceptable manufacturer letter. These include a description by the component manufacturer of the changes it made to its soldering process to eliminate taxable ODC use (referred to as the replacement technology), the type of equipment involved, the month and year the replacement technology was placed in service, and the name and address of the seller of the replacement technology. In addition, IRS examiners may require that foreign manufacturers provide purchase invoices to establish the acquisition of the replacement technology. For most importers, compliance with these requirements is especially difficult because these process changes were often made in the early 1990s. It is important to note that these detailed requirements were developed by IRS excise tax examination personnel and are not supported by any guidance published by Treasury or the IRS Office of Chief Counsel.

Based on the authors’ experience with recent IRS examinations, it appears that IRS examiners now are solely focused on the printed circuit board assembly components of the electronic product. The examiners have been requiring a detailed letter from each printed circuit board assembly manufacturer that describes the soldering process used in manufacturing that assembly. These letters may be difficult for an importer to obtain, as the manufacturers of the printed circuit board assembly often are foreign entities with no relationship to the importer. Importers should make sure they have letters from the manufacturers of the printed circuit board assemblies used in their electronics and review those letters to determine whether they contain sufficient information to support the determination that no ODC tax is due.

Conclusion

This item provides an overview of the rules related to the ODC tax and describes the documentation required to help support an electronics importer’s determination that the tax does not apply for a particular imported product. Taxpayers that import electronics into the United States need to be aware that information from documents prepared when they import products can be furnished to the IRS by the U.S. Customs and Border Protection agency for use in IRS compliance initiatives. They also need to be aware that they may incur federal excise tax liability for those products unless they prove to the satisfaction of the IRS that no taxable ODCs were used in manufacturing the imported products.

It should be noted that Ruth Hoffman was the principal drafter of the ODC tax regulations, T.D. 8370.

Editor: Mary Van Leuven, J.D., LL.M.

EditorNotes

Mary Van Leuven is Senior Manager, Washington National Tax, at KPMG LLP in Washington, DC.

For additional information about these items, contact Ms. Van Leuven at (202) 533-4750 or mvanleuven@kpmg.com.

Unless otherwise noted, contributors are members of or associated with KPMG LLP.

This article represents the views of the author or authors only and does not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

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