A constitutional challenge to the federal oil spill liability tax could have significant implications for the oil and gas industry. The Fifth Circuit Court of Appeals has upheld the decision of the District Court for the Southern District of Texas in Trafigura Trading, LLC v. U.S (5th Cir. No. 21-20127 (March 24, 2022)) and found the federal oil spill tax under IRC Section 4611(b) unconstitutional when imposed on exports of crude oil from the United States.
Section 4611 imposes a tax of nine cents per barrel on domestic crude oil received at a United States refinery and on petroleum products entered into the United States for consumption, use, or warehousing. Section 4611(b) imposes the tax on domestic crude oil that is “used in or exported from the United States” unless the tax was previously imposed before use or exportation. The oil spill liability tax is used to fund the Federal Oil Spill Tax Liability Trust Fund, which reimburses a company that is responsible for an oil spill for expenses above the statutory cap on liability.
The imposition of the tax on exports largely lay dormant until 2016. Prior to then, exports of crude oil from the United States were heavily controlled and licenses rarely issued. When the export ban was lifted at the end of 2015, exports of domestic crude oil rose significantly, and the IRS started collecting the oil spill tax on these exports.
In 2019, Trafigura Trading LLC filed suit against the IRS for a refund of the tax on crude oil exported from the United States. The company argued that Section 4611(b) is unconstitutional under the Export Clause of the Constitution, which states that “No Tax or Duty shall be laid on Articles exported from any State.” The IRS responded that Section 4611(b) is not a tax but a user fee paid by exporters in exchange for the statutory cap on liability.
The Supreme Court has recognized an exception to the export clause for a “legitimate user fee” and has developed a two-part test for whether a charge is a tax or a user fee. The first part of the test is whether the charge is determined based on its proportion to the quantity or value of the export. The second part of the test is whether the charge is excessive or whether it fairly matches the exporter’s use of the services provided by the funds raised from the charge.
Under the test, charges that are proportionate to the quantity or value of the export and that are excessive with respect to the exporter’s use of the service provided are more likely to be considered taxes. Charges that are not proportionate to the quantity or value of the export and that fairly match the cost of exporter’s use of the services provided are more likely to be considered legitimate user fees.
The District Court determined that Section 4611(b) is an unconstitutional tax on exports because it is determined based on its proportion to the quantity or value of the export and it does not fairly match the exporter’s use of the liability cap services provided by the funds raised from the charge. The Appeals Court upheld the District Court decision in determining that as the oil spill tax goes in part towards research and development into oil pollution technology, grants to universities and reimbursements to federal, state and Indian tribes, it is not a user fee designed to compensate for services, facilities or benefits supplied by the government. Judge Ho, writing for the majority, stated, “the Constitution forbids Congress from taxing exports. And that resolves this case.” However, not all members of the Court agreed. Judge Graves, writing a dissenting opinion, said that he would vacate the District Court’s decision on the basis that there are issues of fact as to whether or not the oil spill tax is a user fee. He also cited the language of the entire statute, not just section4611(b) and pointed out that exporters are not the only persons responsible for payment of the tax and the tax is only paid on exports if not previously paid on the crude oil.
What does this mean for oil exporters?
Taxpayers should continue remitting the oil spill tax with their quarterly Form 720 until it is known whether the government plans to file an appeal. Taxpayers who have been remitting federal oil spill tax on exports may file protective refund claims. The statute of limitations is the later of three years from the date the original tax return was filed or two years from payment of taxes. For most taxpayers Q1 2019 will be closing at the end of April.
*On May 23, 2022, the Fifth Circuit Court of Appeals denied the government's request to rehear the case with a full panel.
For help preparing and filing your protective refund claims, contact us. We are here to help.