TTB updates guidance on "processing" rules for reduced excise tax rates

[Jedd Haas]

There was some previous discussion about what constituted "processing" when a DSP bottled spirits produced at another DSP. In particular, it was questionable as to whether simply proofing down the spirits was "processing" or not, relative to qualifying for reduced excise tax rates. TTB has issued some updated guidance and the answer is a clear NO. However, if the spirits are filtered, that does count as processing. 

Here is the full text of the guidance, see the section in bold below.

NEW TR-D12: What domestic activities constitute “processing” for the purpose of determining eligibility for the reduced distilled spirits tax rates provided in 26 U.S.C. 5001?

Reduced tax rates are allowed on distilled spirits that are distilled or processed by a DSP and removed by a DSP during the calendar year.  A DSP is considered a processor of distilled spirits if it “manufactures, mixes, or otherwise processes distilled spirits” or “manufactures any article.”  See 26 U.S.C. 5002(a)(5)(A).  “The term ‘processor’ includes (but is not limited to) a rectifier, bottler, or denaturer.”  See 26 U.S.C. 5002(a)(5)(B).  For distilled spirits removed after December 31, 2021, “[a] distilled spirit shall not be treated as processed [for reduced rate purposes] unless a process described in [26 U.S.C. 5002(a)(5)(A)] (other than bottling) is performed with respect to such distilled spirit.”  See 26 U.S.C. 5001(c)(5).

For purposes of the reduced rates, a DSP is considered a processor of distilled spirits if it:

• manufactures distilled spirits,
• mixes distilled spirits with materials including flavors, wines, water (except that the addition of water during the normal process of bottling for the purpose of ensuring label proof does not constitute “processing” for reduced rate purposes), or other distilled spirits of any type, and/or
• otherwise physically changes the distilled spirits inside the container, including filtering distilled spirits to remove material from those distilled spirits.

Processing does not include changing the marks or labels on distilled spirits containers or repacking containers of distilled spirits without physically changing the distilled spirits inside the containers.

Note: Eligibility for the reduced tax rates or new tax credits may be limited by application of the single taxpayer or controlled group rules.

Originally issued on 12/14/2021
Updated on 12/14/2021*

Source: https://www.ttb.gov/alcohol/craft-beverage-modernization-and-tax-reform-cbmtra#TR-D12

There are also two other new guidance sections on transfers in bond: https://www.ttb.gov/alcohol/craft-beverage-modernization-and-tax-reform-cbmtra#TR-D10 and https://www.ttb.gov/alcohol/craft-beverage-modernization-and-tax-reform-cbmtra#TR-D11

[daveflintstone]

I read that guidance differently than you.  I read it as a clear YES.

 

Quote

mixes distilled spirits with materials including flavors, wines, water (except that the addition of water during the normal process of bottling for the purpose of ensuring label proof does not constitute “processing” for reduced rate purposes)

To me this means that blending high proof spirits with water does count as processing, just as it says.  The bold disclaimer in parentheses refers to "the normal process of bottling".  That is clearly not the same as blending down high proof spirits, that is referring to minor adjustments to proof during the bottling process.

[EZdrinking]

As with anything related to TTB their guidance needs clarification.

I think I agree with @Jedd Haas's reading of the guidance that the addition of water to bring a spirit to labeled bottle proof does not constitute processing. So proofing NGS or other purchased spirit with water to bottling proof with no other filtering or processing would not count as "processing" for the reduced excise rates.

But the guidance seems to indicate the addition of water in other circumstances could be considered processing.

[Foreshot]

So what does it mean? We're paying to different rates for those spirits? How would we keep track of it on the current forms? Or should the originator pay it when they sell it? When does this take effect?

[JNorris]

The "processing" changes go into effect January 2022. 

If it is correct that proofing is not considered processing, and that is how I took it, I wonder how many people are going to be tax paying a large number of cases to get the reduced tax rate this year.  (If you do this be sure to keep your cases in a tax-paid area.)

For next year, if filtering is the minimum for processing, filter your spirits.  It does not specify what kind of filter, only "otherwise physically changes the distilled spirits inside the container, including filtering distilled spirits to remove material from those distilled spirits." 

If you have to justify the money, and you will, be sure to keep records of your filtering operations for audit purposes.

[Golden Beaver Distillery]

TCW better stock up on haze filters.  Suspect there will be a run on them Q1 2022.

[JNorris]

I went back through my notes, and on 2 separate occasions the same TTB higher up has said "we have stated that even adding water will count ... as to being a processor."  If the new guidance now does not include adding water to ensure label proof as a "processing" operation, I wonder what changed their minds in between then and now.  I hope my interpretation of this guidance is incorrect. 

I believe a call to the TTB for clarification is on my to do list today.  Of course, if you ask 3 different people there the same question you will, more than likely, get 3 different answers. 

[JNorris]

The answer from the TTB today was, we are actively working on further defining the addition of water and its effects on the rates. 

The 2 examples of adding water that I was given is someone proofing 190 down to 80 for bottling, or someone who proofed 190 to 81 then TIB'd it out for a bottler to add a little bit of water to get it to 80 before bottling.  I take it they see a distinction between these two and the tax rates associated with the addition of water, BUT we shall see.

The end result is that more information is coming...

[daveflintstone]

Using the helpful example above, blending with water to obtain the finished spirit, eg. 190 to 80, is processing.  Adding water to adjust bottling proof, eg 81 to 80, is not.

The guidance seems fairly clear to me, except as JNorris stated TTB is "working on further defining the addition of water..." .  I think this obviously means they will at some point supply a more exact minimum proof adjustment that would meet processing requirements.

But this is really moot isn't it?  Just filter tank to tank and call it a day if you are in the water addition business.

[Silk City Distillers]

On 12/22/2021 at 9:28 PM, daveflintstone said:

But this is really moot isn't it?  Just filter tank to tank and call it a day if you are in the water addition business.

Yeah, this is what I don't understand, how is this not as simple as just adding a filter cartridge after one of the pumps that the liquid will inevitably touch?  This is possibly even more trivial than the water additions, and something that folks are likely already doing as a standard course of operation.

[Hajiii]

In some states, like Texas, in order to sell a spirit as your own, you have to "rectify" it, even if you TIB it in. There is some dispute over exactly what "rectifiying" means to Texas, but I've usually understood it to mean that if you buy 190 proof GNS, you can't just add water to it to bottle it, you have to run it through a still at least once to pass muster. I believe this is how a certain large litigous Texas vodka maker does it. How this applies to aged product purchases is what is in dispute, but you can see that this requirement would trump the new TTB reg by actually distilling the product.