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Alternative Carbon Resources, LLC v. United States

United States Court of Appeals, Federal Circuit

September 26, 2019

UNITED STATES, Defendant-Appellee

          Appeal from the United States Court of Federal Claims in No. 1:15-cv-00155-MMS, Chief Judge Margaret M. Sweeney.

          Vivian D. Hoard, Taylor English Duma LLP, Atlanta, GA, argued for plaintiff-appellant. Also represented by Brian Gardner, Kelly Mullally; William Sidney Smith, Smith & Kramer, PC, Des Moines, IA.

          Clint Carpenter, Tax Division, United States Department of Justice, Washington, DC, argued for defendant-appellee. Also represented by Teresa E. McLaughlin, Richard E. Zuckerman.

          Before O'Malley, Reyna, and Chen, Circuit Judges.

          O'Malley, Circuit Judge.

         Appellant Alternative Carbon Resources, LLC claimed nearly $20 million in energy tax credits meant for taxpayers who sell alternative fuel mixtures. The Internal Revenue Service ("IRS") later determined that Alternative Carbon should not have claimed these credits and it demanded repayment (along with interest and penalties). Alternative Carbon paid back the government, in part, and then filed this refund suit in the United States Court of Federal Claims ("Claims Court").

         After the parties filed cross-motions for summary judgment, the Claims Court decided that Alternative Carbon failed to establish that it properly claimed the credits or that it had reasonable cause to do so. Alternative Carbon Res., LLC v. United States, 137 Fed.Cl. 1 (2018). The Claims Court therefore granted summary judgment for the government.

         Alternative Carbon appeals, arguing that it is entitled to claim the credits or that it at least had reasonable cause for claiming them and so it should not have to pay any penalties. Because we conclude that Alternative Carbon cannot show it is entitled to the credits or that it had reasonable cause for claiming them, we affirm.

         I. Background

         A. Alternative Fuel Mixture Credits

         We begin with a brief overview of the tax credits that Alternative Carbon claimed. Section 6426(e) allows taxpayers to obtain a credit for "producing any alternative fuel mixture for sale or use in a trade or business of the taxpayer." 26 U.S.C. § 6426(e)(1). The statute then defines an "alternative fuel mixture" as "a mixture of alternative fuel and taxable fuel" that is either "sold by the taxpayer . . . for use as fuel" or "used as a fuel by the taxpayer producing such mixture." Id. at § 6426(e)(2)(A)–(B).

         As is typical in tax law, this definition of alternative fuel mixture incorporates other parts of the Internal Revenue Code by reference. For example, the statute relies on subsections (A), (B), and (C) of § 4083(a)(1) to supply a definition for "taxable fuel." See id. As relevant here, that definition includes "diesel fuel." Id. at § 4083(a)(1)(B). The statute also defines "alternative fuel" based on a list of examples that includes "liquid fuel derived from biomass (as defined in section 45K(c)(3))." Id. at § 6426(d)(2)(G); see also id. at § 45K(c)(3) (broadly defining biomass as "any organic material" besides oil, natural gas, and coal). The statute does not, however, define what it means for a mixture to be "sold by the taxpayer." Id. at § 6426(e)(2)(A).

         In 2006, the IRS issued a "notice" regarding § 6426. See I.R.S. Notice 2006-92, 2006-2 C. B. 774. Among other things, the IRS interpreted alternative fuel mixture to "mean[] a mixture of alternative fuel and taxable fuel that contains at least 0.1 percent (by volume) of taxable fuel (as defined in § 4083(a)(1))." Id. at § 2(b). It also explained that "[a] mixture producer sells a mixture for use as a fuel if the producer has reason to believe that the mixture will be used as a fuel." Id. § 2(f)(2). The notice does not address what it means for an alternative fuel mixture to be sold in the first place.

         To put all of this in plain English, a taxpayer can claim the alternative fuel mixture credit under § 6426 by selling a mixture of alternative fuel, e.g., liquid fuel derived from biomass, and taxable fuel, e.g., diesel fuel, so long as the mixture is ultimately sold for use as fuel.[1] The issues in this appeal are, thus, whether the taxpayer actually sold the fuel mixture here and, if so, whether any such sale was "for use as fuel."

         B. Alternative Carbon's Business

         Alternative Carbon argues that it is entitled to claim this alternative fuel mixture credit because it sold an alternative fuel mixture to third parties who, in turn, used the mixture as fuel in anaerobic digestion tanks. Before addressing this argument, we briefly discuss anaerobic digestion and Alternative Carbon's business model. See also Alternative Carbon, 137 Fed.Cl. at 7–12, 16–19.

         Some microorganisms produce methane when they digest organic matter. The input for this process of anaerobic digestion, i.e., the organic material that the microorganisms digest, consists of organic solids called feedstock mixed in a sludge with water.[2] Id. at 8; see also J.A. 550 ("[The] microbes basically eat the organics, and a by-product of that is methane gas."). Anaerobic digester tanks provide a place for the microorganisms to digest the feedstock. J.A. 872–73. Entities that operate these digester tanks then use the resulting methane to generate electricity (among other things). See, e.g., J.A. 552.

         Alternative Carbon began operating in 2011. Its business generally involved a few basic steps. First, Alternative Carbon bought feedstock from ethanol production plants. Next, it paid a trucking company to transport the feedstock. Along the way, the trucking company added diesel fuel to the feedstock. The trucking company then delivered this feedstock/diesel mixture to entities that operated anaerobic digestion tanks.[3] The digester operators ultimately fed the mixture to methane-producing microorganisms. Each step is discussed in more detail below.

         When Alternative Carbon purchased feedstock from its suppliers, the feedstock consisted of organic material that might otherwise be considered waste. For example, the process of distilling ethanol produces water and corn solids ("stillage") as a by-product. J.A. 1718. This solid stillage is then further distilled through a centrifuge to separate liquid ("thin-stillage") from other solids. Id. Alternative Carbon paid ethanol producers to acquire this thin-stillage. Id. In addition to thin-stillage, Alternative Carbon used other organic materials as feedstock. J.A. 1718–20.

         After purchasing the feedstock, Alternative Carbon paid a trucking company to mix enough diesel fuel with the feedstock so that the resulting mixture could qualify as an alternative fuel mixture under § 6426. Alternative Carbon, 137 Fed.Cl. at 9; see also J.A. 814 ("[Y]ou got to put a splash of diesel fuel in it, and here's why . . . it has a splash of diesel fuel in it before so we can generate tax credits."). Alternative Carbon's expert conceded that adding the diesel fuel "did not measurably change the methane production" of the microorganisms. J.A. 616; see also J.A. 1026 ("Q. And, in fact, you wouldn't recommend putting diesel in an anaerobic digester [tank]; is that right? A. Typically, no. I wouldn't recommend it.").

         Having made the feedstock/diesel mixture, the trucking company delivered the mixture to digester operators. Alternative Carbon paid a fee to the operators based on how much feedstock/diesel mixture they accepted. See, e.g., J.A. 794. In Alternative Carbon's contract with the Des Moines Wastewater Reclamation Authority ("WRA"), this "disposal fee" was "$0.02634 per delivered gallon" plus applicable taxes. Id. In its contract with Amana Farms, the "handling fee" was twenty-five dollars per ton. J.A. 1054. There are no contracts between Alternative Carbon and other digester operators in the record.

         Digester operators like WRA and Amana Farms also paid an annual fixed fee to Alternative Carbon. See J.A. 795; J.A. 1054. But the fees Alternative Carbon paid digester operators far surpassed the annual fees it collected from them. Alternative Carbon, 137 Fed.Cl. at 18 ("Throughout 2011, plaintiff received $8, 950.00 of income for the purchase of its alternative fuel mixtures and paid its customers a total of $1, 678, 029.07 in 'disposal fees.'"). There is also no evidence in the record that the fees paid by WRA or Amana were based on the value of the feedstock/diesel mixture. See, e.g., Oral Arg. at 2:24–40 ("Q. And what do you say the value of the goods transferred was? A. The value of . . . the goods transferred to the digester companies is not quantified in the record . . . ."),; J.A. 861 ("This is for their tax credit stuff. A once a year charge of $950 for us to 'buy' product (AD feedstock).").

         Once the feedstock/diesel mixture was delivered, it was fed into digester tanks along with other feedstocks. See, e.g., J.A. 878–79. Some of the resulting methane was flared, i.e., burned off as excess, and some was used to generate electricity. Alternative Carbon, 137 Fed.Cl. at 8; J.A. 1475.

         C. Alternative Carbon's Tax Planning

         From the outset, Alternative Carbon and its business plan were designed in view of the alternative fuel mixture tax credit. For example, James Huyser, one of Alternative Carbon's founders, testified:

We understood that if the tax credits . . . w[ere] going to be approved in 2011, we needed to have a vehicle whereby we could have a company that we could operate through that would be able to purchase waste products, transport waste products, and sell waste products as fuel for anaerobic digesters. And so there needed to be some sort of company structure in order to do all this and also be considered an entity for the tax credits that were a part of our business plan.

J.A. 851; see also J.A. 527–28.

         To ensure that Alternative Carbon could obtain the credits, its founders consulted with a tax attorney named Greg Sanderson. Initially, Sanderson sent them information about energy tax credits and advised them to register their company with the IRS. See, e.g., J.A. 528–29. Partners at Alternative Carbon also reached out to Sanderson with specific questions about their business.

         On January 21, 2011, Huyser emailed Sanderson about an agreement between Alternative Carbon and WRA that was signed the same day. J.A. 1083; see also J.A. 794. The agreement stated that WRA would charge a "disposal fee" for accepting the feedstock/diesel mixture, but it did not mention any money flowing from WRA to Alternative Carbon. J.A. 794. In his email, Huyser asked Sanderson whether the transaction between Alternative Carbon and WRA, in which Alternative Carbon paid WRA to accept the feedstock/diesel mixture, counted as a sale of the mixture for purposes of obtaining the tax credits. J.A. 1083 ("We are basing [the] 'sale' and its consideration on the service provided by the WRA in disposing of the 'non-combustible' materials."). Sanderson replied that Alternative Carbon would have "a better case if you charge the user of the mixture for the fuel value, and they charge you a disposal fee." J.A. 1082. But Sanderson added that he "d[id] not have a full understanding of the economics" of Alternative Carbon's business. Id. For example, Sanderson asked "[h]ow do you make money from this business if you pay the digester company to take the liquid" and "[d]oes this business cash flow without the 50 cent per gallon credit?" Id. He also cautioned that while "[t]wo private letter rulings [from the IRS] indicate that the IRS may consider the transfer as a 'sale' even if you do not receive payment for the fuel . . . [these private letter rulings] may not be technically cited as precedent by other taxpayers." Id.

         In June 2011, Alternative Carbon received a questionnaire from the IRS asking for additional information about its business. J.A. 1522–33; see also J.A. 399. Huyser drafted an initial response and then sent it to Sanderson. J.A. 1522. Sanderson ...

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