Energy Company Suggests Diesel Fuel Dyeing Options.

Wyatt Stripling of Valero Energy Corporation, San Antonio, has submitted comments on the rules relating to the dyeing of diesel fuel. In his comments, Stripling suggests two options. The first would be to require that all diesel fuel sold be low-sulfur fuel and have producers collect and remit tax on all diesel fuel sold. Stripling's second option would be to require producers to dye diesel sold for off-road use regardless of sulfur level and to establish a rebuttable presumption that no tax has been paid on that diesel.

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September 27, 1993

Internal Revenue Service

Attn: CC:DOM:CORP:T:R (PS-52-93)

COMMENTS ON DYEING OF DIESEL FUEL

Gentlemen:

Valero Energy Corporation and Subsidiaries (collectively referred to as "Valero"), is involved primarily in the refining of high-sulfur atmospheric residual oil into premium products such as unleaded gasoline, at its specialized refinery in Corpus Christi, Texas, and the marketing of those products. Valero also produces low sulfur diesel which, because Valero usually does not produce high- sulfur diesel, is sold for both on and off-road use as permitted under EPA's enforcement guidelines.

Valero appreciates the opportunity to propose solutions and comments as requested by the IRS in the August 26, 1993 Federal Register and have diligently ascertain [sic] comments from its marketing and operational functions. A New Fuels Report dated September 20, 1993 (comments by Petroleum Marketers Association of America sent to Treasury Secretary Lloyd Bentsen and the EPA), states: "The most practical solution to this type of dilemma would be to sell low sulfur diesel fuel to all purchasers of diesel fuel, on- road and off-road." Valero, certainly, agrees that this is the most practical, uncomplicated solution to the problems arising from the various uses of diesel fuel. Furthermore, if all diesel fuel were taxed, and qualified off-road users reduced their tax liability, or applied for refunds, tax issues would also be greatly simplified. Valero therefore submits the following comments.

OPTION 1: ALL DIESEL FUEL SOLD TO BE LOW SULFUR DIESEL, AND PRODUCERS COLLECT AND REMIT TAX ON ALL DIESEL SOLD BY THE PRODUCER. If all diesel fuel sold is required to be low sulfur diesel, air quality will improve and the distribution and marketing of distillate fuel oils will be greatly simplified as only one grade of product would be required. The only people who benefit from two sulfur levels in diesel are those refiners who declined to make a commitment to clean air throughout the world. Those refiners also derive benefit from the isolation and protection of a class of users which continue to be allowed to pollute by burning high sulfur diesel. Valero contends that the protection of this class is reactionary and unnecessary (See paragraphs 4 through 6 below).

Valero supports the IRS' efforts to minimize the taxing points of diesel and reduce the incidence of tax cheating. Tax cheaters construct to their own advantage, an unlevel playing field that disadvantages responsible producers and marketers. Countering arguments will be made, including that the U.S. has insufficient capacity to produce all on-road and off-road low sulfur diesel demand. Today, that is true, but the reality is that three to four years from now all diesel fuel used in the U.S. can be low sulfur. Producers who say that, cloak their past resolution to avoid investment in clean air in equity and supply/demand arguments. It is indisputable that the following benefits will flow logically from this Option:

1. The IRS collects all the tax due on diesel fuel. The reduced

2. Market disparities will not arise because middle-men tax

3. Enforcement efforts of the EPA will be minimized since all

4. Exempt fleet volume purchasers of diesel fuel should be

5. End users (agricultural, home heating, and other off-road

6. Allowing deduction of diesel fuel tax paid from quarterly tax

OPTION 2: REQUIRE PRODUCERS TO DYE DIESEL SOLD FOR OFF ROAD USE REGARDLESS OF SULFUR LEVEL, AND ESTABLISH A REBUTTABLE PRESUMPTION THAT NO TAX HAS BEEN PAID ON THAT DIESEL. This proposal would move the taxing point to the first sale (usually the producer) in conformity with the taxing nexus on gasoline, and consistent with the stated intent of the '93 Act. It is also consistent with EPA's diesel enforcement policy that allows refiners to add dye to low-sulfur diesel purchased for high-sulfur diesel applications. The injection of dye is not to be costly or intricate. Therefore, any first seller into the off-road market can readily contrive a method for addition of the dye. Once dye has been added to diesel, there must be a presumption that the motor fuel tax has not been paid on the diesel. Presence of the dye, coupled with the presumption that no tax has been paid will give a visible signal to both the IRS and the EPA that the diesel has been diverted from off-road use to on-road market, and may contain more than 0.05 weight % sulfur. This allows the agencies to each achieve its objective while enabling efficient enforcement cooperation. If dyed diesel appears in vehicle dispensing tanks the presumption is that tax-exempt fuel has been illegally diverted. Because low sulfur diesel may validly and legally be sold into the off-road market, the diesel could legally be introduced into the on- road market by a sale which included assessment and payment of the diesel tax, so the presumption of illegal diversion must be accompanied by the right in the taxpayer to establish that the motor fuel tax has been assessed and remitted.

With connection with Option 2, Valero embraces The Society of Independent Gasoline Marketers of America's comment with respect to the obligation of the Secretary to determine that if a diesel is certified as having been purchased for a nontaxable use, and dyed, then no tax is due on the diesel.

Section 13242 of OBRA also amends IRC section 4082 to provide that the diesel fuel excise tax will not be imposed at the terminal rack on fuel that the Secretary has determined is destined for a nontaxable use, is dyed, and, if required by the Secretary, marked. Diesel fuel which is destined for a nontaxable use, is dyed, and for which the purchaser has certified is for nontaxable use should not be subject to tax. The enforcement system may then rely on the visual inspection of fuel to determine whether the tax has been evaded. For this modification to Option 2 to work effectively, a marketer should be permitted to certify to its supplier that the fuel is destined for a nontaxable use. The supplier will then inject the dye as the fuel is delivered or require the marketer to draw the diesel from separate storage of dyed fuel. If the fuel is later diverted from a nontaxable use, dyed fuel can be detected by visual inspection and traced back to the person who diverted the product which was certified for nontaxable use. In sum, the Secretary should determine that a fuel is destined for a nontaxable use pursuant to IRC section 4082(a)(1) if a purchaser certifies it as such. In this way, all fuel on which tax has not been paid at the rack will be dyed. (No ultimate vendor of diesel fuel should be permitted to convert clear fuel to dyed fuel after imposition of the tax at the terminal rack. If a marketer purchases clear fuel, that fuel must be sold tax-paid to an otherwise exempt user, who must apply for a refund, except in the case of sales to farmers and state and local governments. In these cases, registered vendors may sell clear fuel tax free and apply for the refund.)

The comparative deficiencies with this proposal are that:

1. The universe of regulated entities for both the EPA and the

2. Market disparities may still arise by way of diversion of

3. The continuance of two approved sulfur, and two approved

Valero's above Proposals would provide the same assurances and benefits to state taxing agencies, streamlining and making efficient their enforcement and tax collection efforts.

GENERAL COMMENTS. TYPE OF DYE. Valero sees no "magic" in the type of dye or marker; nor the concentration used so long as the type and concentration will not result in off-spec product. Since methods exist (as evidenced by the above Options) which will harmonize the goals of both the EPA and the IRS, we urge that the same dye be used. Use of multiple dyes, or varying concentrations of dye, would only serve to unnecessarily complicate the solution the IRS and the EPA seek, and should be avoided.

OFF-ROAD TANK SIGNS. Service stations which sell off-road fuel have traditionally had segregated tanks and dispensing stations which were marked "farm use only" or "off-road use only". Those signs were sufficient to regulate the use of the fuel. It is significant to note that the underlying thrust of this ANPR is to curtail tax evasion. The sign on the tank, no matter the words included, will not deter a determined tax cheat when success will net a profit of 24.4 cents per gallon. Valero's Option 1 offers the greatest potential of attainment of that goal. Valero's Option 2 achieves the goal, but leaves more opening for tax cheats to gain their unlawful profit.

ACCOUNTING CONSIDERATIONS. If off-road diesel is dyed by the first seller, the presence of the dye will visually alert any buyer that the diesel is sold tax-exempt. Although the bulk buyer rarely personally inspects the product, it is equally rare that a bulk sale will be conducted without an independent inspection of the product, so at bulk levels it is unlikely that a buyer would not be aware that he bought dyed diesel. Any diversion must necessarily occur at the "break bulk" distribution levels. Under Valero's Option 1, there would be no profit incentive to divert dyed diesel into the on-road market. Under Option 2, the incentive exists because the universe of taxpayers is greater, but one party to the diversion must be a bulk buyer for off-road use. Ultimately the presumption of diversion of tax-exempt product must rest with the bulk buyer for off-road use (revoke his 637, and distribute notification of the revocation). This liability should not be exclusively that of the bulk buyer since without a accomplice the diversion cannot work. The presumption of diversion integral to Valero's Options should offer disincentive to divert off-road diesel into the on-road market. Invoices accompanying diesel fuel sales should note "motor fuel tax paid" to support the tax deduction to a valid off-road end user; and if Proposal 2 is adopted, the invoice should report "for off-road use only".

Again, Valero appreciates the opportunity to submit these comments for consideration. Representatives of the Department of Treasury may feel free to contact the undersigned at (210)246-2116 should you have any questions or additional comments.

Respectfully submitted,

Wyatt Stripling, Director of Tax