Permanent tax reduction

[dhdunbar]

I'm surprised not to find someone commenting on this, but perhaps it comes as no surprise.  Here is what TTB has had to say, in summary:

Temporary reduced tax rates and tax credits made available by the Craft Beverage Modernization Act (CBMA) are now permanent. 

While some CBMA provisions have been made permanent, statutory changes include restrictions on the transfer of bottled distilled spirits in bond, changes to the type of processing activities that qualify for reduced tax rates for distilled spirits, and changes to the single taxpayer provision.

We will issue updated guidance in the near future. In the meantime, if you have questions about CBMA, please contact us. 

For more information on imported products, please contact U.S. Customs and Border Protection.

 

The important stuff is about the permanent reduction.  But do not ignore the phrase " restrictions on the transfer of bottled distilled spirits in bond, changes to the type of processing activities that qualify for reduced tax rates for distilled spirits, and changes to the single taxpayer provisions." 

I prefer to let TTB speak first, so I am not going to suggest an answer to what that might mean.  But, if I were "sourcing bulk spirits" which I then bottle, I'd want to know before the first of the year what I need to do to make sure that I've "processed" them within the meaning of that term as it is used in the CBMA. 

I think  - I've got to emphasis the I think -  that after the amendments the CBMA has made, the reduced rate provisions of §5001(c) provides, in pertinent part, that the reduced rate applies to spirits which have been distilled or processed by such operation and removed during the calendar year for consumption or sale.  However, a distilled spirit shall not be treated as processed for purposes of this subsection unless a process described in section 5002(a)(5)(A) (other than bottling) is performed with respect to such distilled spirit.’’  "Shall" means will.  It is an instruction given to the tax collector!

The "other than bottling" exclusion seems to preclude bottling from the processing operations that lead to the reduced rate.  

The problem with this approach is that, while we can read the regulations to say that some operations other than bottling are processing operations, the list we can make is not necessarily inclusive of all operations that may be construed to be qualifying processing operation.  It's almost necesarry to list what you can do in the production and storage accounts and then say everything else is processing.  But then, we still can't be sure that one of the leftovers might not be an operation that gives rise to the reduced rate. 

In the code, processing is described to be  manufacturing, mixing, or otherwise processing distilled spirits [§5002((a)(5)(A)], which is of course circular - processing is processing tells us nothing - and so of little use.    §19.1  defines processor to be, “Except as otherwise provided in 26 U.S.C. 5002(a)(6), any person qualified under this part who manufactures, mixes, bottles, or otherwise processes distilled spirits - yup, the damned circularity again.    [The exceptions include apothecaries and retailers who mix drinks for immediate consumption on their premises].  I think it is a rabbit hole we do not want to pursue.  None of these are trails that lead us out of the woods.  

Consider this. Storage while aging in oak is not a processing operation.  It is a warehousing operation.  Thus, TTB may hold that storing spirits, which are then further manufactured in the processing account, does not entitle the bottler to withdraw the spirits at the reduced rate of tax.  You tell me the impact that would have on your operations. 

If I were forced to wager, and I do not bet on such things, I would wager that, for beverage spirits, if you did not distill the spirits, then the processing operations necessary to entitle you to the reduced rate, other than bottling, are operations that changes the class or type of the spirits.  So, for vodka, the filtration of a neutral spirit not yet designated as vodka, through charcoal, according to a general use formula, to further purify it, thus changing the class and type from distilled spirits to vodka, could be construed to be a manufacturing operation.  However, the filtration of bourbon might not be.  This seems absurd, but it is not beyond  possibility, because, unless TTB can rub the bottle and make a genie pop out, no operation conducted in storage can be processing.  That would defy the organization of the system the law and regulations put into place.

Things get hazy from here on, at least for me.  You bottle in the processing account so you need to dump the spirits into the bulk account before you bottle them.  When you do that, you create a dump record.    However, you need only make batch records to report (1) the dumping of spirits that are to be used immediately and in their entirety in preparing a batch of a product manufactured under an approved formula; (2) the use of spirits or wines previously dumped - what is "use?" and (3) the use of any combination of ingredients under paragraph (b)(1) or paragraph (b)(2) of this section in preparing a batch of product manufactured under an approved formula.

Formulas are required (§19.348) only when you blend, mix, purify, refine, compound, or treat spirits in any manner which results in a change of character, composition, class, or type of the spirits, or you produce gin or vodka by other than original and continuous distillation.  So, it could be possible to receive spirits into the processing account on a dump record and transfer them to a bottling tank record without making a batch record.  Example, dump bourbon out of barrels and bottle it without any further manipulation.  Ditto for gin produced by original distillation. What then?  

In a debate, I could argue  that §19.597, which is headed “Manufacturing records,” requires daily records of of the spirits, wines, and alcoholic flavoring materials received into the processing account for the manufacture of distilled spirits products.  Since you must keep records of all spirits received into the processing account – the system demands that – the provisions of §198.597 imply that all  spirts received in the processing account are received for the manufacturing of distilled spirits products. 

Such arguments are perhaps clever, but surely shaky and subject to challenge based on intent.  Remember, none of the rules in part 19 were written while considering the the implications for reduced rates.  There is simply no direct statement of what is processing.  I am convinced it is something more than bottling; I am not convinced of what that something more might be. Here's an example - transfer rye whiskey from the original new charred barrel to an apple barrel.  It may not change the class and type (for bourbon it would), so is that processing within the meaning intended by the reduced rate provisions.  

These are the sorts of issues that TTB must work out and work out soon.  You are closing in fast on January 1 and not doing the minimum necessary to qualify could create tax liabilities. 

Now, that leads me to ask, if one has spirits already in a bottle, which one has not processed as required by some change to the type of processing activities that qualify for the reduced tax rate, what should one do now?  Should one withdraw the spirits on determination of tax before close of business 12/31/2020?  

I do not know the answer.  Maybe someone who was involved in making the reduction permanent can shed some light on that.

[Silk City Distillers]

Hugely insightful analysis - as always Mr Dunbar, you are a treasure to this community.

[dhdunbar]

Insightful?  No, but I think probably necessary as a warning of potential.  Here is something insightful.  I don't know what TTB will do with this , but when  they do, the answer to the question, "Why?"  will be "It is because they say it is."  They get one one regional director once described as "last bats."  

[Skaalvenn]

Not sure if I'm reading this correctly. Are you saying TIB of bottled spirits is no longer authorized?  I know bottle transfers were made legal with the original (temporary) tax reduction in 2017, but I was never sure if that was part of the temporary law or a permanent change.

[Jedd Haas]

Dave has hit on exactly the point I was wondering about when I read that provision, which is section 109 of the legislation. There are a couple other apparent loophole-closing provisions in sections 108 and 110.

I have attached the 25 pages of legislation, which I extracted from the full 5500+ pages of the final bill. See pages 22-25 of this file for sections 108-110.

CBMTRA-2020.pdf

[dhdunbar]

I did not address transfers in bond of bottled spirits and the truth be told, what I am saying about any of this is worth how much you paid to read it, which I assume is zip. 

However, there are provisions that say that if DSP A sends, to DSP B, for bottling, spirits that DSP A could have bottled and then claimed  the reduced rate it, if removed them on determination of tax, from DSP A, and if  DSP B bottles those spirits and returns them, in bond, to DSP A, which then withdraws them on determination of tax, and if DSP A maintained title to the spirits at all times, then DSP A may make that withdrawal at the reduced rate to which it is entitled at the time of the removal.  Sentences like that get dense with embedded clauses and phrases, which tend to mask clarity by their intended, at least, precision. 

Apply the worth zip rule to that, but I'm pretty sure I'm correct.

So, transfers in bond are not prohibited.  But, if DSP A sends to DSP C, the spirits it processed and had DSP B bottle, DSP C is not entitled to the reduced tax rate.  That is not a change.  The transfer of bottled spirits in bond is allowed, but you need to know the fact situation to determine the tax consequences.  

[Silk City Distillers]

Thanks Jedd - Making it easy:

 

[dhdunbar]

Yes, seemingly simply, except ...

Which operations that a DSP conducts are included in the the operations, other than bottling, described in 5002(a)? 

The problem, as I see it, is that the categories of operations - production, storage and processing - created, by law, in 1980, with the change from supervisor to "all in bond"  system, were not created with any tax consequences in mind.  Actually, there was, before that time, a rectification tax, and the system had, before that time, defined the acts of rectification that gave rise to liability for that tax.  Those acts took place after the tax was determined, which at that time was done when a government employee and the proprietor, together,  made a bulk gauge of the spirits, in a scale tank, before the the government released the spirits from its lock and key and turned them over to the proprietor, who then conducted operations on them and was allowed to make a claim for operational losses that occurred during the processing of the spirits that took place after the tax determination.  What a long sentence.  

When the system changed, and the rectification tax was repealed, the distinctions between production, storage, and processing were made largely on the basis of how the operations had been treated before the change to all in bond, with those operations that had been conducted after the release of the spirits to the proprietor, now being treated as processing operations.  However, the matter was simply one of establishing a consistent accounting system, so that persons reading the operating reports knew what operations and transactions the reports purported to represent.  It was a consistency requirement.

That accounting was not established with the consideration of the possibility that  someday, someone might decide that there would be any eligibility for a reduced rate of tax on spirits that a DSP withdrew on determination of tax, if the DSP had either distilled or conducted some processing operation other than bottling.  But someone did do that and now TTB has to figure out what operations congress intended to include among those that create the eligibility.

So, while in the past the question "what is processing?"  had been a simple matter of classification for purposes of reporting and could thus be somewhat arbitrary, the new rules create a tax consequence and many DSPs will be affected by how TTB interprets the intent of the term "processing operations under §5002(a)," when the only definition of processing offered by either the law or regulations is circular?

I think whiskey will be the biggest hurdle, since, unless it is flavored or used as an ingredient in a specialty item,  it is not generally subject to further "processing" after it is dumped out of the barrel in which it has been aged.  If you want to make the reduced rate as broad as possible, you can push for a determination that filtration is a qualifying operation.  Or that additional storage of whiskey that is received in barrels, and which it has been aged for less than two years, should qualify if it is held long enough to acquire two years of age, or ...

It will be interesting to see where TTB goes with this and how they justify where they go.  I think more than a few of you will have an interest in how that plays out.  And I don't see that as simple :-).

Stay tuned.  It is all you can do.

[dhdunbar]

Here is the news information from the website.  It follows what TTB said in the last newsletter. 

Note that the changes to the transfer in bond of bottled products is effective now, but the change in what constitutes an an authorized processing operation does is not effective until 1/1/2020.  That will give some of you who source whiskey that you store but do not process, other than by bottling, a chance to get your business plans in order.  I missed the effective date on my first reading of the bill language.  That is why we wait for TTB to say what they say it means :-). 

 

• Reduced Distilled Spirits Tax Rates
   
  • General: The 2020 Act makes permanent the reduced tax rates previously enacted on a temporary basis, with a change to the definition of eligible processing effective in 2022. Reduced rates are allowed on distilled spirits distilled or processed and removed during the calendar year or imported by the importer into the United States during the calendar year. These rates are $2.70 per proof gallon on the first 100,000 proof gallons removed or imported, and $13.34 per proof gallon on the next 22.13 million proof gallons removed or imported. (The tax rate for distilled spirits not subject to the reduced rates is $13.50 per proof gallon.) Beginning in 2022, only DSPs who perform a processing activity other than bottling are entitled to take a CBMA reduced rate on distilled spirits that they process and remove.
     
  • Imports and Foreign Manufacturer Election: In the case of distilled spirits produced outside the United States and imported, the 2020 Act makes permanent the provisions that allow foreign distilled spirits manufacturers to assign the reduced tax rates to importers who elect to receive them, with a transition in 2023 to a refund system of providing the benefit of assigned reduced rates to importers. U.S. Customs and Border Protection (CBP) maintains administration over imports subject to CBMA for 2021-2022. See CBP guidance, for example CSMS #45315560 of December 31, 2020.
     
• Transfer in Bond of Non-Bulk Distilled Spirits: The temporary CBMA provisions authorized the transfer in bond of distilled spirits for beverage purposes between distilled spirits plants irrespective of whether the distilled spirits are transferred in bulk or non-bulk containers. (Prior to 2018, transfers of non-bulk or bottled distilled spirits for beverage purposes were prohibited.) Under the 2020 Act, effective January 1, 2021, transfers of bottled spirits for beverage purposes are not authorized except transfers between bonded premises belonging to the same person or members of a controlled group, and except certain transfers for storage or bottling where the spirits are transferred back to the original transferor.

Exhale and start to figure out what you are going to need to do to make your business plan work, what changes in pricing you made need, etc.

[dhdunbar]

Has anyone heard any more about this issue?  The business plans of those who buy whiskey in bulk and then bottle it would appear to hang in the balance as TTB figures out what  processing activity other than bottling.  If I were you guys I'd be arguing hard that filtration ought be be included in that mix. 

[Jedd Haas]

I contacted TTB and they said they would post further guidance on their site.

[dhdunbar]

I take that  as another way of saying they have not reached a decision.  I too have a request for information pending.  I specifically asked if filtration alone is a processing activity under §5002(a)(5)(A) that establishes eligibility for the reduced rate.   I put it in writing and have not yet received a reply.  I anticipate that they will say they will tell me when they have decided what the rule will be.  I put it in writing just to express concern that, based on what they decide,  many of you may have to alter business plans or pricing arrangement.