Cl i e n t A l e r t

December 2009

Contacts IRS Issues Section 45 Guidance Regarding Refined Facilities David S. Lowman, Jr. 1900 K Street, NW On December 7, 2009, the Internal 2009, the inflation adjustment factor is Washington, DC 20006-1109 Revenue Service (“IRS”) issued Notice 1.4171 and the resulting credit amount (202) 419-2070 [email protected] 2009-90 (the “Notice”), providing guid- is $6.20 per ton for calendar year 2009. ance relating to the tax credit under Laura Ellen Jones Section 45 of the Internal Revenue Code Section 4.01 of the Notice refers to Riverfront Plaza, East Tower (“Code”) for . Section 45 of this credit amount as the “tentative 951 East Byrd Street the Code provides a tax credit for the credit” and provides rules for a taxable Richmond, Virginia 23219-4074 production of refined coal at a refined year that is a calendar year and for a (804) 788-8746 taxable year that includes parts of two [email protected] coal production facility during the 10-year period beginning on the date the facility calendar years. In the former case, the Timothy L. Jacobs was originally placed in service, and tentative credit for the taxable year is 1900 K Street, NW sold by the taxpayer to an unrelated the tentative credit for the calendar year. Washington, DC 20006-1109 person (defined in the same manner In the latter case, the tentative credit (202) 955-1669 as with respect to other Section 45 for the taxable year is the sum of the [email protected] facilities) during such 10-year period. tentative credits for each partial calendar year included in the taxable year. Computation of Credit The tentative credit is reduced by an Under Section 45(e)(8)(A) of the Code, amount that bears the same ratio to the refined coal production credit is equal the tentative credit as the “excess to $4.375 per ton (or, in the case of reference price” for the calendar year steel industry fuel, $2.00 per barrel-of-oil bears to $8.75. The “excess reference equivalent) of qualified refined coal price” is the amount by which (a) the (i) produced by the taxpayer at a refined reference price for the calendar year coal production facility during the 10-year of fuel used as a feedstock exceeds period beginning on the date the facility (b) an amount equal to 1.7 multiplied was originally placed in service, and by $31.90 and further multiplied by (ii) sold by the taxpayer (I) to an unre- the inflation adjustment factor for the lated person and (II) during the 10-year calendar year. For 2009, the excess period and the tax year. The $4.375 per reference price is $39.72 per ton and ton amount is multiplied by the inflation no phaseout of the credit is applicable. adjustment factor for the calendar year In the case of a facility producing steel to adjust for inflation since 1992. The industry fuel, the references to the inflation adjustment factor and excess 10-year period in Section 45(e)(8)(A) are reference price (discussed below) are changed to refer to the period beginning provided by the IRS by notice published on the later of the date such facility in the Internal Revenue Bulletin. For was originally placed in service, the

Hunton & Williams LLP date that modifications were made a taxpayer that leases or operates a the definition of “coal.” Section 3.02 to an existing facility to allow such facility owned by another person may of the Notice provides as examples facility to produce steel industry fuel, claim the credit for refined coal that of waste coal: fine coal of any of or October 1, 2008, and ending on the taxpayer produces in the facility. the listed ranks, coal of any of the the later of December 31, 2009, or the listed ranks obtained from a refuse date that is one year after the date Refined Coal bank or slurry dam, culm, such facility or such modifications bituminous gob and waste. The term “refined coal” means fuel were placed in service. No phaseout Special rules apply for waste coal in that (a) is a liquid, gaseous or solid of the credit applies in the case of a mining processes (discussed below). fuel produced from coal (including facility producing steel industry fuel. lignite) or high carbon , including Qualified Emission Reduction The tentative credit is reduced by a such fuel used as a feedstock; (b) is prescribed percentage if the project sold by the taxpayer (producer), to an The definition of a “qualified emis- received government grants, subsidies unrelated person, with the reasonable sion reduction” differs depending on or other credits. The reduction expectation that it will be used for whether a refined coal facility was percentage for a tax year is the lesser the purpose of producing steam; and placed in service before or after of 50 percent or the percentage that (c) is certified by the taxpayer as December 31, 2008. In the case of is determined by dividing the sum for resulting (when used in the production refined coal produced at a facility the taxable year and all earlier taxable of steam) in a qualified emission placed in service after December 31, years of the following items listed reduction (defined below). Refined 2008, the term “qualified emission below by the aggregate additions coal includes steel industry fuel (as reduction” means a reduction of at to the capital account attributable defined in Section 45(c)(7)(C)) that is least 20 percent of the emissions to the project for the taxable year produced and sold after September of nitrogen oxide (NO) and at least and all earlier taxable years: 30, 2008. Refined coal does not 40 percent of the emissions of either include fuel (other than steel industry sulfur dioxide (SO2) or mercury (Hg) (1) governmental grants fuel) that is produced and sold from released when burning the refined received for the project; a facility placed in service before coal (excluding any dilution caused January 1, 2009, unless such fuel by materials combined or added (2) proceeds from tax-exempt state is produced in such a manner as during the production process), as or local government bonds to result in an increase of at least compared to the emissions released used to finance the project; 50 percent in the market value of the when burning the feedstock coal (3) directly and indirectly provided fuel (excluding any increase caused by or comparable coal predominantly subsidized energy financing materials combined or added during available in the marketplace as of under a federal, state or the production process) as compared January 1, 2003. In the case of pro- local program in connec- to the feedstock coal. This market duction at a facility placed in service tion with the project and value test was eliminated by the before January 1, 2009, a reduction Energy Improvement and Extension of only 20 percent is required for (4) any other credit allowable Act of 2008 for facilities placed in emissions of SO2 or Hg. The Energy with respect to any property service after December 1, 2008. Improvement and Extension Act of that is part of the project. 2008 raised this reduction requirement Coal and Waste Coal to 40 percent for facilities placed in Producer Entitled to Credit service after December 31, 2008. Section 3.02 of the Notice defines Under Section 45(e)(8)(A), the pro- “coal” for purposes of Section 45 Section 3.03 of the Notice defines ducer of the refined coal is entitled to as anthracite, , “comparable coal” as, with respect the refined coal credit. Section 5.01 of subbituminous coal and lignite. The to any feedstock coal, coal that is the Notice clarifies that the producer is Notice specifically includes “waste of the same rank as the feedstock entitled to the credit without regard to coal (that is, usable material that is coal and that has an emissions whether the producer owns the refined a byproduct of the previous process- profile comparable to the emissions coal production facility in which the ing of anthracite, bituminous coal, profile of the feedstock coal. refined coal is produced. Accordingly, subbituminous coal or lignite)” in

2 Client Alert Section 6.02 of the Notice sets ÆÆ Emissions of Hg are measured emissions reduction that would forth the testing procedures for upstream of any SO2 scrubber be achieved in a coal-fired and determining emission reductions. or Hg control device (such as steam-producing boiler of a size The Notice provides that emission injection). and type commonly used in com- reductions are determined by compar- mercial operations and a qualified ÆÆ ing the emissions that result when Emissions of NO are measured individual (as defined above) veri- feedstock coal and refined coal are upstream of any NO controls. fies the test results (in the same used to produce the same amounts manner described above). A verification of the CEMS test results of useful thermal energy. In other must be provided by a “qualified ÆÆ words, the comparison between Laboratory analysis of the individual”: (i) someone who is not the coal feedstock and the refined feedstock coal and the refined related (within the meaning of Section coal is made on an MMBtu basis. coal. The laboratory analysis must 45(e)(4)) to the taxpayer claiming comply with a currently applicable Section 6.03 of the Notice describes the refined coal credit, (ii) is properly EPA or ASTM standard and may two categories of testing methods: licensed as a professional engineer be used only for purposes of and (iii) has the requisite qualifications determining the emissions reduc- CEMS Field Testing. The emissions to provide the verification. The verifica- tion for SO2 and Hg. reduction may be determined using tion must contain a statement that the continuous emission monitoring testing satisfied all the requirements Under Section 6.04 of the Notice, a system (CEMS) field testing. CEMS above and that the amount of the taxpayer may establish that a qualified field testing is testing that meets emissions reduction was determined in emissions reduction applies to produc- all the following requirements: accordance with the Notice provisions, tion from a facility by a determination declared under penalties of perjury. or redetermination that is valid at ÆÆ The boiler used to conduct the test the time the production occurs. A is coal-fired and steam-producing Section 6.03(1)(d) of the Notice determination or redetermination and is of a size and type com- provides that if CEMS field testing is valid for the period beginning on monly used in commercial is used to determine the emissions the date of the determination or operations. reduction, the IRS will not, on exami- redetermination and ending with the nation, require any additional proof occurrence of the earliest of the follow- ÆÆ Emissions are measured using a of the emission reduction achieved. ing events: (i) the lapse of six months CEMS. The Notice provides further that from the date of such determination the IRS may, however, require the ÆÆ If the EPA has promulgated a or redetermination; (ii) a change in taxpayer to establish that the testing performance standard that applies the type, source or rank of feedstock used qualifies as CEMS field testing. at the time of the test to the pol- coal that occurs after the date of such determination or redetermination; or lutant emission being measured, Other Testing Methods. Section (iii) a change in the process of produc- the CEMS must conform to that 6.03(2) of the Notice provides that ing refined coal from the feedstock standard. methods other than CEMS field coal that occurs after the date of such testing may be used to determine ÆÆ Emissions for both the feedstock determination or redetermination. the emissions reduction. However, coal and the refined coal are if a method other than CEMS field measured at the same operating In the case of a redetermination testing is used, the IRS may require conditions and over a period of required because of a change in the the taxpayer to provide additional at least three hours during which process of producing refined coal from proof that the emission reduction the boiler is operating at a steady the feedstock coal, the redetermina- has been achieved. Permissible state and at least 90 percent of tion must use one of the methods methods include the following: full load. described above. In any other case, the redetermination requirement may ÆÆ A testing method using a dem- ÆÆ Emissions of SO2 are measured be satisfied by laboratory analysis onstration pilot-scale upstream of any SO2 scrubber. establishing that the SO2 and Hg furnace if it is established that the content of both the feedstock coal method accurately measures the and the refined coal do not vary by

www.hunton.com 3 more than 10 percent from the SO2 from the waste or residue of prior a refined coal. Thus, based on the and Hg content of the feedstock . Notice, typical coal washing or clean- and refined coal used in the ing processes that are employed by a ÆÆ recent determination that meets the Other Processes. Under Section mine owner or operator do not qualify. testing requirements of the Notice. 613(c)((4)(A), in the case of coal, that cleaning, breaking, sizing, The Notice identifies two excep- Coal Cleaning Processes are dust allaying, treating to prevent tions to this special rule. Excluded freezing and loading for shipment ÆÆ by a mine owner or operator shall Excepted Processes. Section Section 6.01 of the Notice effectively be considered as mining. 6.01(2) of the Notice states that excludes processes employed by Section 613(c)(5) describes a mine owner or operator that are ÆÆ Sorting and Other Pre-Shipping treatment processes that are considered part of the mining process. Processes. Under Section not considered as mining unless That section provides that a qualified 613(c)(4)(C), in the case of miner- they are provided for in Section emission reduction does not include als that are customarily sold in the 613(c)(4) or are necessary or any reduction attributable to mining form of a crude mineral product, incidental to a process provided processes or processes that would sorting, concentrating, sintering for in Section 613(c)(4). These be treated as mining if performed and substantially equivalent pro- processes include: electrolytic by the mine owner or operator. cesses to bring coal to shipping deposition, roasting, calcining, Accordingly, in determining whether a grade and form are considered as thermal or electric smelting, refin- qualified emission reduction has been mining. ing, polishing, fine pulverization, achieved, the emissions released blending with other materials, ÆÆ Drying. Under Section 613(c)(4)(I) when burning the refined coal must treatment effecting a chemical and Treas. Reg. § 1.613-4(f)(5), be compared to the emissions that change, thermal action, and mold- drying to remove free water, would be released when burning the ing or shaping. provided that such drying does not feedstock coal. Feedstock coal is the change the physical or chemical ÆÆ Exception for Waste Coal. Section product resulting from processes that identity or composition of the 6.01(3) of the Notice provides that are treated as mining processes. mineral, is treated as mining. a cleaning process is not treated Section 6.01(2) of the Notice defines as a mining process in the case ÆÆ Cleaning Processes. Any cleaning the processes that are treated as of refined coal produced from process — such as a process that mining and includes any process waste coal at a facility placed uses ash separation; dewatering; described in Section 613(c)(2), in service before January 1, scrubbing through a centrifugal (3), (4)(A), (4)(C) or (4)(I) of the 2010, for the primary purpose of pump; spiral concentration; Code, or that would be described producing refined coal from waste gravity concentration; flotation; in those provisions if performed coal. Waste coal is defined as the application of liquid hydrocarbons by the mine owner or operator. waste materials that are separated or alcohol to the surface of the through ordinary mining processes ÆÆ Treatment Processes. Under fuel particles or to the feed slurry, during the process of producing Section 613(c)(2), mining includes provided such cleaning does not a merchantable product from not only the extraction of the ores change the physical or chemical the coal extracted from a natural or minerals from the ground but structure of the coal; and drying deposit. also the treatment processes to remove free water, provided considered as mining described in such drying does not change the The exception for waste coal above Section 613(c)(4). physical or chemical identity of does not apply with respect to the the coal — will be considered as refined coal produced at a facility ÆÆ Waste Coal. Under Section mining. during a taxable year unless a 613(c)(3), the extraction of ores or verification of waste coal supply is minerals from the ground includes In other words, any process that is available for such facility. The verifica- the extraction by mine owners considered part of the mining process tion must be provided by a “qualified or operators of ores or minerals cannot be considered to produce individual” (as defined above). The

4 Client Alert verification must contain a statement Section 5.02 of the Notice confirms when used in the production of that the coal to be processed by the the application of the “80/20” test to steam. facility is waste coal and must be refined coal production facilities. A ÆÆ signed under penalties of perjury. refined coal production facility will A statement indicating whether not be treated as placed in service CEMS field testing was used to Placed-in-Service Date after October 22, 2004, if more than determine the emissions reduc- 20 percent of the facility’s total value tion. In order to qualify for the Section 45 (the cost of the new property plus the credit, the refined coal production ÆÆ If CEMS field testing was not used value of the used property) is attribut- facility must be placed in service within to determine the emissions reduc- able to property placed in service certain timeframes. For purposes tion, a description of the method on or before October 22, 2004. The of the refined coal credit allowable used. Notice also states that the IRS will with respect to steel industry fuel, not issue private letter rulings relating ÆÆ A statement that the emissions the facility (or any modification to the to when a refined coal production reduction was determined or rede- facility) must be placed in service facility has been placed in service. termined within the six months before January 1, 2010. For purposes preceding the production of the of the refined coal credit allowable Certification fuel and that there have been no with respect to refined coal other than changes in the type, source or steel industry fuel, the facility must be Under Section 6.05 of the Notice, the rank of feedstock coal used or in placed in service after October 22, certification requirement of Section the process of producing refined 2004, and before January 1, 2010. 45(c)(7)(A)(i) (III) of the Code is coal from the feedstock coal since The Notice provides that the year in satisfied with respect to fuel for which the emissions reduction was which property is placed in service the refined coal credit is claimed only determined or was most recently is determined under the principles of if the taxpayer attaches to its tax redetermined. Treas. Reg. § 1.46-3(d); i.e., when return on which the credit is claimed a the property is placed in a condition certification that contains the following: ÆÆ A penalties of perjury declaration or state of readiness and availability signed by the taxpayer. ÆÆ for a specifically assigned function. A statement that the fuel will result in a qualified emissions reduction A copy of Notice 2009-90 is available.

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