PLR 1326005: Refined coal process qualifies for the section 45 credit rules

Plain-English summary

The IRS ruled that a taxpayer's additive process could produce refined coal eligible for the section 45 credit, subject to the statutory emissions-reduction requirements. The ruling also addressed how coal from the same source regions and rank would be treated during redetermination periods, approved specified pilot-scale and laboratory testing methods, and allowed a laboratory analysis method for recurring sulfur and mercury checks. The conclusions depended on the taxpayer using the process and feedstock as represented and satisfying the applicable requirements of Notice 2010-54. The IRS did not rule on whether the taxpayer had sufficient risks and rewards to be treated as the producer or when the facility was placed in service.

Ruling snapshot

• Question: Did the described additive process, feedstock treatment, and testing methods satisfy the requirements for the refined coal credit under section 45?
• Outcome: Approved
• Key authorities: IRC §§ 45 and 613(c); Notice 2010-54, sections 3.01, 3.03, 3.04, and 6.01 through 6.05

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201326005 Third Party Communication: None
Release Date: 6/28/2013 Date of Communication: Not Applicable
Index Number: 45.00-00
Person To Contact:
---------------------------- ------------------------, ID No. --------------
-------------- Telephone Number:
----------------------------------- ----------------------
------------------------------ Refer Reply To:
CC:PSI:B6
PLR-129100-12
Date:
March 19, 2013

LEGEND:

Taxpayer = ---------------------------------------------------------

Company A = ------------------------------------------------------------------------------------------
Company B = ------------------------------------
Company C = -------------------------------
Company D = ----------------------------------------
Company E = -----------------------------------
Company F = ----------------------------------------------------
Company G = -----------------------------------------------------------
Company H = ----------------------------
Company I = -----------------------------
Company J = --------------------------------------------
City = -----------------------
State A = --------------
State B = ---------------------
Technology = ---------------------------
Manager = ----------------------
a = ------
b = ------
c = ------
d = ------
e = --------
Testing Center = ---------------------------------------------------------------------------------
Generating Station = ---------------------------
Date a = ----------------------------
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Location a coal = ----------------------------------
Tested Coal = ---------------------

Dear ----------------:

   This is in response to your request for rulings, submitted by your authorized

representative, concerning the federal income tax consequences of the transaction
described below.

Background

   Company E (Operating Company), is a limited liability company organized under

the laws of the State A. The Operating Company owns the refined coal facility (Facility)
located adjacent to Generating Station owned by Company A (Generating Station
Owner) and located near City.

     The Operating Company is owned as follows: (i) Company B, a State A limited

liability company as a member holding a% of the outstanding membership interests; (ii)
Company C, a State A corporation, as a member holding b% of the outstanding
membership interests; and (iii) Company D, a State B corporation as a member holding
c% of the outstanding membership interests.

  Operating Company has not elected and will not elect to be classified as an

association taxable as a corporation, and accordingly, Operating Company is classified
as a partnership for federal income tax purposes. Manager acts as the non-member
manager of the Operating Company.

  The only material asset of Company B is its interest in the Operating Company

(and another similar operating company). Company B is owned as follows: (i)
Company J, as a member holding c% of the outstanding membership interests; and
Taxpayer, a State A limited liability company, as a member holding d% of the
outstanding membership interests.

   Company F owns e% of the stock of Company C. Company F is a publicly

traded corporation.

     Taxpayer is a special purpose entity created for the purpose of entering into the

transactions described herein. Company E is owned by Company H, a State A limited
liability company. Company E is treated as a disregarded entity for federal income tax
purposes, and as a division of Company H. Company H is classified as an association
taxable as a corporation for U.S. federal tax purposes, and has in effect an election
under section 1362(a) to be an S corporation. Company H is the holding company for a
financial services firm better known as Company I.
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  Pursuant to the purchase agreement between Company J and Taxpayer,

Taxpayer bought a d% of the membership interest in Company B in exchange for a
purchase price closely approximating Taxpayer’s proportionate share of the total cost of
constructing and installing the Facility.

The Facility

  The Operating Company has constructed and installed the Facility, and has

commercially deployed the Technology at the Generating Station. The Facility was
constructed by Company G who certified that construction of the Facility was
mechanically complete on Date a.

    The Operating Company entered into a site lease with Generating Station Owner

that allows Operating Company to construct and locate the Facility at the Generating
Station. Pursuant to the terms of the Lease, the Operating Company has rights of
ingress and egress as appropriate.

   The Operating Company entered into a coal supply agreement whereby it will

purchase coal feedstock from Generating Station Owner at the Generating Station.
Under that agreement, the Operating Company will buy all of its feedstock coal from
Generating Station Owner, except that the Operating Company may buy feedstock coal
from third parties to the extent Generating Station Owner fails to provide the Operating
Company with sufficient feedstock coal to operate the Facility in an economical manner.
The feedstock coal purchased by the Operating Company from Generating Station
Owner will be coal that Generating Station Owner itself purchased from third party
vendors, consistent with its coal procurement specifications.

    The Generating Station is designed for Location a coal firing with natural gas or

Number 2 fuel oil for startup, flame stabilization and shutdown. Location a coal is
classified by the American Society of Testing Materials (“ASTM”) as a sub-bituminous
coal. The Generating Station Owner purchases these Location a coals from a number
of source mines located in several states. The Operating Company (or a subcontractor)
will buy feedstock coal from Generating Station Owner and apply the Technology to the
coal feedstock. In this regard, the Operating Company has entered into an operation
and maintenance agreement with Operator to operate and maintain the Facilities as an
agent on behalf of the Operating Company. The Operator is not related to Generating
Station Owner, the Operating Company, Company B, or any of the members of
Company B or the Operating Company.

    Thereafter, the Operating Company will sell the resulting Refined Coal to

Generating Station Owner. Pursuant to this agreement, Generating Station Owner will
purchase from the Operating Company all Refined Coal produced by the Facility, except
that to the extent that the Operating Company produces Refined Coal which the
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Generating Station Owner cannot consume, the Operating Company has the right to
sell such excess production to third parties.

Technology

   Company C owns certain licensing rights to a proprietary coal–refining process,

referred to as Technology. When the Technology is applied as part of an electric and
steam generating facility (by adding chemicals to coal prior to burning the coal in a
furnace), it has the effect of reducing emissions of certain pollutants from the burning of
the resulting refined coal, increasing fuel efficiency, and reducing boiler maintenance.
The by-product of this process is a valuable fly ash which can be used in a diverse array
of applications in the steel, mining and cement industries.

    The Technology is a dual-injection sorbent system in which separate sorbents for

mercury and NOx control are added to and mixed with input coal. Technology owner's
patent-pending process starts with several chemical additives being added to coal prior
to its combustion in a furnace. The additives provide the chemical structure to create a
“ceramic matrix” using chemical bonds to capture emissions of regulated pollutants.
The matrix has a certain structure of chemicals in certain positions. At the interior
corners of the matrix, the structure will pick up and hold pollutants such as mercury,
arsenic, or lead. The structure also picks up and includes elements such as oxygen,
chlorides and fluorides, which are freely available in a boiler's gas stream when they
have been released from the coal during combustion but become locked up in the
ceramic matrix.

   In short, the Technology converts coal into a refined coal (Refined Coal) that is

used as a clean fuel to be fired in boilers to raise steam. The emissions from burning
the clean Refined Coal produced by this Technology are significantly less than the
emissions otherwise produced by burning unprocessed coal. This is true not only for
the emissions of mercury and NOx as required by section 45, but also for emissions of
arsenic, lead and other metals (which are not currently regulated) as well as for sulfur.

Testing

   The Technology has been tested numerous times at Testing Center. Testing

Center is located at a major U.S. university recognized as one of the world’s leading
developers of cleaner, more efficient energy and environmental technologies to protect
and clean air, water, and soil.

   In connection with this testing, an emissions monitoring system was used to

measure the effect of the Technology on NOx, SOx, mercury, CO, and O2 emissions.
In addition, the mercury weight content of the fly ash was tested to measure mercury
capture by the Technology.
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   During testing, Tested Coal was burned in one of the boilers at the Testing

Center's boiler house. The boiler and the combustion conditions were designed to
replicate the combustion and other operating conditions for the Generating Station. The
samples of Tested Coal were collected consistent with applicable ASTM standards. For
each test, the Testing Center divided each sample of Tested Coal into two sub-samples,
one of which was burned to establish a baseline, and the other of which was subjected
to the Technology before burning to measure the changes resulting from application of
the Technology.

    Going forward, the Operating Company may perform pilot scale testing to satisfy

the redetermination requirement of Notice 2010-54, or alternatively may undertake
laboratory testing of the feedstock coal and the Refined Coal to satisfy this requirement.
To the extent that the Operating Company is required to do so, the Operating Company
will collect samples of feedstock coal and Refined Coal, consistent with applicable
ASTM standards, and pursuant to a protocol for the regular collection of sample
feedstock coal and Refined Coal. Any such samples would be utilized for a number of
purposes, including potentially conducting periodic laboratory tests for mercury and
sulfur content, and maintaining rolling averages of the results in order to comply with
Notice 2010-54.

RULINGS REQUESTED

Based on the foregoing, you have requested that we rule as follows:

1. The refined coal produced and sold by using the Technology constitutes “refined
   coal” within the meaning of §45(c)(7) of the Code, provided that such refined coal is
   produced from feedstock coal that is the same source or rank as the Tested Coal and
   provided further that the refined coal satisfies the qualified emission reduction test
   stated in §45(c)(7)(B) of the Code.

2. Provided that the feedstock coals used to produce refined coal during any
   redetermination period are from the same coal source regions and of the same rank as
   the Tested Coal, all such feedstock coal shall be treated as feedstock coal of the same
   source and rank for purposes of section 6.04 of Notice 2010-54, regardless of the mine
   from which such feedstock coal is purchased.

3. Testing by the Testing Center for qualified emissions reduction as set forth in its test
   reports satisfies the requirements of Notice 2010-54 with respect to the Tested Coals
   and any blend of them. The pilot scale testing conducted at Testing Center (and
   subsequent permitted laboratory testing as required for a redetermination described in
   section 6.04(2)(a) or (b) of Notice 2010-54) to satisfy the qualified emission reduction
   test of §45(c)(7)(B) of the Code may be relied upon regardless of subsequent normal
   fluctuations in operating conditions and emissions at the Generating Station.
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4. Pursuant to section 6.04(2)(b) of Notice 2010-54, the redetermination requirement of
   section 6.04 of Notice 2010-54 may be satisfied by laboratory analysis establishing that
   the sulfur and mercury content of both the feedstock coal and the refined coal, on
   average, do not vary by more than 10% below the bottom (nor by more than 10 percent
   above the top) of the range of the sulfur content and range of the mercury content of the
   feedstock coal and the refined coal used in the most recent determination of section
   6.03 of Notice 2010-54.

LAW AND RATIONALE

     Section 45(a) of the Code generally provides a credit against federal income tax

for the use of renewable or alternative resources to produce electricity or fuel for the
generation of steam. Section 45(e)(8) of the Code provides that, in the case of a
producer of “refined coal”, the credit available under §45(a) of the Code for any taxable
year shall be increased by an amount equal to $4.375 per ton of qualified “refined coal”
(i) produced by the taxpayer at a “refined coal production facility” during the 10-year
period beginning on the date that the facility was originally placed in service, and which
is (ii) sold by the taxpayer to an unrelated person during such 10-year period and such
taxable year.

   For purposes of §45 of the Code, section 3.01 of Notice 2010-54 provides that

the term “refined coal” means a fuel which – (i) is a liquid, gaseous, or solid fuel
(including feedstock coal mixed with an additive or additives) produced from coal
(including lignite) or high carbon fly ash, including such fuel used as a feedstock, (ii) is
sold by the taxpayer with the reasonable expectation that it will be used for the purpose
of producing steam, and (iii) is certified by the taxpayer as resulting (when used in the
production of steam) in a qualified emission reduction. Section 3.04 of the Notice
provides that the term “qualified emission reduction” means, in the case of refined coal
produced at a facility placed in service after December 31, 2008, a reduction of at least
twenty percent (20%) of the emissions of nitrogen oxide and at least forty percent (40%)
of the emissions of either sulfur dioxide or mercury released when burning the refined
coal (excluding any dilution caused by materials combined or added during the
production process), as compared to the emissions released when burning the
feedstock coal or comparable coal predominantly available in the marketplace as of
January 1, 2003.

  Section 45(d)(8) of the Code generally provides that the term “refined coal

production facility” means a facility which is placed in service after October 22, 2004
and before January 1, 2012.

   Section 6.01 of Notice 2010-54 generally provides that a qualified emissions

reduction does not include any reduction attributable to mining processes or processes
that would be treated as mining (as defined in §613(c)(2), (3), (4)(A), (4)(C), or (4)(I)) if
performed by the mine owner or operator. Accordingly, in determining whether a
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qualified emission reduction has been achieved, the emissions released when burning
the refined coal must be compared to the emissions that would be released when
burning the feedstock coal. Feedstock coal is the product resulting from processes that
are treated as mining and are actually applied by a taxpayer in any part of the
taxpayer’s process of producing refined coal from coal.

    Section 613(c)(5) of the Code describes treatment processes that are not

considered as mining unless they are provided for in §613(c)(4) or are necessary or
incidental to a process provided for in §613(c)(4). Any cleaning process, such as a
process that uses ash separation, dewatering, scrubbing through a centrifugal pump,
spiral concentration, gravity concentration, flotation, application of liquid hydrocarbons
or alcohol to the surface of the fuel particles or to the feed slurry provided such cleaning
does not change the physical or chemical structure of the coal, and drying to remove
free water, provided such drying does not change the physical or chemical identity of
the coal, will be considered as mining.

   Section 6.03(1) of the Notice provides, in part, that emissions reduction may be

determined using continuous emission monitoring system (CEMS) field testing. Section
6.03(a)(1) provides, in part, that CEMS field testing is testing that meets all the following
requirements: (i) the boiler used to conduct the test is coal-fired and steam-producing
and is of a size and type commonly used in commercial operations; (ii) emissions are
measured using a CEMS; (iii) if EPA has promulgated a performance standard that
applies at the time of the test to the pollutant emission being measured, the CEMS must
conform to that standard; (iv) emissions for both the feedstock coal and the refined coal
are measured at the same operating conditions and over a period of at least 3 hours
during which the boiler is operating at a steady state at least 90 percent of full load; and
(v) a qualified individual verifies the test results in a manner that satisfies the
requirement of section 6.03(1)(b).

     Section 6.03(2) of the Notice provides that methods other than CEMS field

testing may be used to determine the emission reduction. The permissible methods
include (a) testing using a demonstration pilot-scale combustion furnace if it establishes
that the method accurately measures the emission reduction that would be achieved in
a boiler described in section 6.03(1)(a)(i) and a qualified individual verifies the test
results in a manner that satisfies the requirements of section 6.03(1)(c)(i), (ii), (v) and
(vi) of the Notice; and (b) a laboratory analysis of the feedstock coal and the refined coal
that complies with a currently applicable EPA or ASTM standard and is permitted under
section 6.03(2)(b)(i) or (ii).

     Section 6.04(1) of the Notice provides that a taxpayer may establish that a

qualified emission reduction determined under section 6.03 applies to production from a
facility by a determination or redetermination that is valid at the time the production
occurs. A determination or redetermination is valid for the period beginning on the date
of the determination or redetermination and ending with the occurrence of the earliest of
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the following events: (i) the lapse of six months from the date of such determination or
redetermination; (ii) a change in the source or rank of the feedstock coal that occurs
after the date of such determination or redetermination; or (iii) a change in the process
of producing refined coal from the feedstock coal that occurs after the date of such
determination or redetermination.

     Section 6.04(2) of the Notice provides that in the case of a redetermination

required because of a change in the process of producing refined coal from the
feedstock coal, the redetermination required under section 6.04 must use a method that
meets the requirements of section 6.03. In any other case, the redetermination
requirement may be satisfied by laboratory analysis establishing that – (a) the sulfur (S)
or mercury content of the amount of refined coal necessary to produce an amount of
useful energy has been reduced by at least 20 percent (40 percent, in the case of
facilities placed in service after December 31, 2008) in comparison to the S or mercury
content of the amount of feedstock coal necessary to produce the same amount of
useful energy, excluding any dilution caused by materials combined or added during the
production process; (b) the S or mercury content of both the feedstock coal and the
refined coal do not vary by more than 10 percent from the S and mercury content of the
feedstock coal and refined coal used in the most recent determination that meets the
requirements of the Notice.

    Finally, section 6.05 of the Notice provides that the certification requirement of

section 3.01(1)(c) of the Notice is satisfied with respect to fuel for which the refined coal
credit is claimed only if the taxpayer attaches to its tax return on which the credit is
claimed a certification that contains the following: (1) a statement that the fuel will result
in a qualified emissions reduction when used in the production of steam; (2) a statement
indicating whether CEMS field testing was used to determine the emissions reduction;
(3) if CEMS field testing was not used to determine the emissions reduction, a
description of the method used; (4) a statement that the emissions reduction was
determined or redetermined within the six months preceding the production of the fuel
and that there have been no changes in the source or rank of the feedstock coal used in
the process of producing refined coal from feedstock coal since the emissions reduction
was most recently determined or redetermined; and (5) a declaration signed by the
taxpayer in the following form: “Under penalties of perjury, I declare that I have
examined this certification and to the best of my knowledge and belief, it is true, correct,
and complete.”

   With respect to the first issue, the Process starts with several chemical additives

being added to the feedstock coal prior to its combustion in a furnace. The additives
provide the chemical structure that results in the reduction of emissions of nitrogen
oxide and mercury during combustion. Section 6.01 of the Notice provides generally
that a qualified emissions reduction does not include any reduction attributable to
mining processes or processes that would be treated as mining if performed by the
mine owner or operator. In the instant case, the Process is not a mining process.
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Further, section 3.01 of the Notice clarifies §45(c)(7) of the Code and specifically
provides that refined coal includes feedstock coal mixed with additives. Thus, additive
processes that mix certain chemicals or other additives with the coal in order to achieve
emissions reductions may qualify for the refined coal production tax credit. Additionally,
section 3.03 defines comparable coal as coal that is of the same rank as the feedstock
coal and that has an emissions profile comparable to the emissions profile of the
feedstock coal. Accordingly, we conclude that the refined coal produced by using the
Technology constitutes a “refined coal” within the meaning of §45(c)(7) of the Code,
provided that the refined coal (i) is produced from feedstock coal that is the same
source or rank as the Tested Coal and (ii) satisfies the qualified emission reduction test
stated in §45(c)(7)(B) of the Code.

    With respect to the second issue, the emissions profile of the refined coal product

is compared to the emissions profile of either the feedstock coal or a comparable coal
predominantly available in the marketplace as of January 1, 2003. Section 3.03 of the
Notice provides that a “comparable coal” is defined as coal that is of the same rank as
the feedstock coal and that has an emissions profile comparable to the emissions profile
of the feedstock coal. Section 6.04 of provides that a determination or redetermination
of a qualified emissions reduction is valid until the occurrence of the earliest of the
following events: (i) the lapse of six months from the date of such determination or
redetermination; (ii) a change in the source or rank of the feedstock coal that occurs
after the date of such determination or redetermination; or (iii) a change in the process
of producing refined coal from the feedstock coal that occurs after the date of such
determination or redetermination. Accordingly, we conclude that provided the feedstock
coals used to produce refined coal during any redetermination period are from the same
coal source regions and of the same rank as the Tested Coal, all such feedstock coal
shall be treated as feedstock coal of the same source and rank for purposes of section
6.04 of Notice 2010-54, regardless of the mine from which such feedstock coal is
purchased

    With respect to the third issue, section 6.03(3) of the Notice provides that any

permissible testing method provided for in the Notice can be used in emission testing for
any pollutant. That is, a taxpayer can use different testing methods for each of nitrogen
oxide, sulfur dioxide or mercury, provided the method used for any pollutant is a
permissible method. Section 6.04(1) provides that an emission test establishing a
“qualified emission reduction” qualifies the refined coal for a six-month period provided
there is no change in the process for producing the refined coal or in the source or rank
of the feedstock coal. Therefore, a taxpayer must “redetermine” the emission
reductions to qualify for the succeeding six-month period using one or more approved
methods. In the instant case, Taxpayer will arrange for pilot-scale combustion testing,
and will not rely on any continuous emissions monitoring system or other field testing,
which is permitted under section 6.03 of the Notice. Specifically, Testing Center will
conduct testing (including redetermination testing) at its testing facility to determine the
emissions reductions associated with burning the refined coal product compared to the
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feedstock. For purposes of qualifying the refined coal produced at the facilities, the
Testing Center has conducted pilot-scale combustion tests and documented them. In
conducting such tests, the Testing Center conducted tests on the feedstock, and then
mixed a separate sample of the feedstock with the additives so that it could conduct
tests on the refined coal product. In each of its reports, the Center reported that the test
results indicated that the blend of coal and additives achieved the required emissions
reductions. Based on the foregoing, we conclude that Testing by the Testing Center for
qualified emissions reduction as set forth in its test reports satisfies the requirements of
Notice 2010-54 with respect to the Tested Coals and any blend of them. The pilot scale
testing conducted at Testing Center (and subsequent permitted laboratory testing as
required for a redetermination described in section 6.04(2)(a) or (b) of Notice 2010-54)
to satisfy the qualified emission reduction test of §45(c)(7)(B) of the Code may be relied
upon regardless of subsequent normal fluctuations in operating conditions and
emissions at the Generating Station

   With respect to the fourth issue, section 6.04(2) of Notice 2010-54 provides that,

where a redetermination is required because of a change in the process of producing
refined coal, the redetermination must use one of the general methods for satisfying the
emissions reduction requirements listed in section 6.03 of the Notice. However, in any
other case section 6.04(2) of the Notice provides that the redetermination requirement
may be satisfied by laboratory analysis establishing that the sulfur and mercury content
of both the feedstock coal and the refined coal do not vary by more than 10% from the
sulfur and mercury content of the feedstock coal and the refined coal used in the most
recent determination that meets the requirements of Notice 2010-54. In the instant
case, periodic bench tests will be performed to confirm that the sulfur and mercury
content of the coal taken from the pile and input into the Facility (as well as the sulfur
and mercury content of the Refined Coal output from the Facility), regardless of the
actual blend of types of coal or the source of the mines will not vary by more than 10%
below the bottom range for sulfur and mercury or ten percent above the top of the range
of these chemicals in the tested feedstock coals. Accordingly, we conclude that
pursuant to section 6.04(2) of Notice 2010-54, the redetermination requirement of
section 6.04 of Notice 2010-54 may be satisfied by laboratory analysis establishing that
the sulfur and mercury content of both the feedstock coal and the refined coal, on
average, do not vary by more than 10% below (nor more than 10% above the top) of the
range of sulfur content and range of the mercury content of the feedstock coal and the
refined coal used in the most recent determination that meets the requirements of
section 6.03 of Notice 2010-54.
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This ruling expresses no opinion about any issue not specifically addressed in
this ruling letter, including (1) whether any person has sold refined coal to an unrelated
person, or (2) when the facility was “placed in service.” In particular, we express or
imply no opinion that the Taxpayer has sufficient risks and rewards of the production
activity to qualify as the producer of the refined coal. The Service may challenge an
attempt to transfer the credit to a taxpayer who does not qualify as a producer, including
transfers structured as partnerships, sales or leases that do not also transfer sufficient
risks and rewards of the production activity.

    In accordance with the Power of Attorney on file with this office, we are sending a

copy of this letter to your authorized representatives. A copy of this ruling must be
attached to any income tax return to which it is relevant. Alternatively, taxpayers filing
their returns electronically may satisfy this requirement by attaching a statement to their
return that provides the date and control number of the letter ruling.

    This ruling is directed only to the Taxpayer who requested it. Section 6110(k)(3)

of the Code provides it may not be used or cited as precedent. We are sending a copy
of this letter ruling to the Industry Director.

                                  Sincerely,



                                  Peter C. Friedman
                                  Senior Technician Reviewer, Branch 6
                                  Office of Associate Chief Counsel (Passthroughs
                                  & Special Industries)