Congress’ $50 billion battle with oil companies over whether butane mixed with gasoline should qualify for alternative fuels tax credits appears to be heading to its next phase — a court challenge to what critics say amounts to unconstitutional retroactive taxation.

Companies including San Antonio-based refiner Valero Energy Corp. and Appleton, Wisconsin-based fuel distributor U.S. Venture Inc., seeking refunds on back taxes have gone to court to battle lawmakers’ December move to deny their claims.

That argument could be a tough sell as courts have long recognized lawmakers’ right to rewrite the past, as long as the fix is explicitly retroactive. That’s what Congress did in December when a year-end spending package barred the IRS from paying butane-related claims that came in after the agency ruled on Jan. 8, 2018, that they wouldn’t qualify.

The law also includes “no inference” language declaring that it was never lawmakers’ intent to allow alternative fuels tax credits for such butane-gasoline mixtures, even prior to the formal IRS guidance in early 2018. That’s meant as a message to the courts that the IRS’ interpretation is correct and companies shouldn’t expect to win their cases.

To press the point further, Senate Finance Chairman Charles E. Grassley, R-Iowa, and the panel’s ranking member, Ron Wyden, D-Ore., engaged in a floor colloquy for the record on Dec. 19, the day the omnibus spending bill passed the Senate. 

The senators pointed out butane is typically contained in every gallon of gasoline.

“I can assure the senator that it was never Congress’ intent for gasoline to qualify for this tax credit,” Grassley, who helped write the alternative fuels credit into the 2005 surface transportation law, told Wyden.

There’s a lot of taxpayer money still in play: Although the December law eliminated most of a potential $50 billion windfall, according to the Joint Committee on Taxation, claims filed prior to Jan. 8, 2018, could still be worth $8.4 billion if plaintiffs prevail.

Valero, the second-largest U.S. oil refiner, on April 26, 2018, filed an amended 2015 tax return seeking $120 million worth of alternative fuels credits based on their interpretation that butane-gasoline mixtures are eligible. On April 1, 2019, Valero sued the IRS, arguing the agency hadn’t responded despite their clear legal right to the money.

With claims still outstanding in late December, Congress spoke on the matter. In a March 30 case filing in U.S. District Court for the Western District of Texas, Valero attorneys argued that Congress had tread on the company’s constitutional rights and that it was being “deprived of life, liberty, or property, without due process of law.”

Others, such as U.S. Venture, which is seeking $33 million from the IRS, say that even though their claims were filed prior to Jan. 8, 2018, their rights are being trampled when Congress effectively told the courts not to rule in their favor.

U.S. Venture’s February case filing in the U.S. District Court for the Eastern District of Wisconsin claimed that Grassley and Wyden’s floor statements represent only the views of individual senators.

Despite the fact that Grassley was Finance chairman at the time the original law was enacted, U.S. Venture attorneys argue his and Wyden’s comments don’t offer evidence of congressional intent 14 years earlier. “These statements say nothing about what Congress intended at the time it enacted the alternative fuel mixture credit in 2005, and thus should not be considered,” the filing states.

What’s in a name?

The 50-cents-per-gallon tax credit was enacted to spur the use of cleaner-burning motor fuels such as natural gas. The definition of “alternative fuels” also included the term “liquefied petroleum gas.” While that’s commonly assumed to include propane as well as butane, what constitutes liquefied petroleum gases wasn’t specifically defined in the 2005 law.

The definition was ambiguous enough that oil industry lawyers eventually figured out a loophole: Refiners had a legitimate claim on the credits since they typically mix butane, an easily liquefied natural gas, into gasoline to reduce emissions and help engines run smoother in cold weather.

That discovery led to an avalanche of claims, and IRS scrutiny culminating in their updated guidance issued in January 2018. By late 2018, the JCT had upped its estimate of a one-year extension of alternative fuels credits from less than $600 million to over $7 billion.

The following year, House Democrats and the bipartisan leadership of the Senate Finance Committee began trying to choke off the butane loophole, but efforts to pass “tax extenders” legislation sputtered until late 2019. The final straw came in November, when the JCT said refund claims covering 2013 through 2017 could cost taxpayers nearly $50 billion if companies seeking refunds won their cases. 

During the December floor colloquy, Wyden explained that refiners had been adding butane to every gallon of gasoline for the better part of a century. 

“Adding butane during the gasoline refining process is simply how gasoline is produced,” Wyden said. “The idea that Congress intended oil companies to benefit from a credit intended to reduce our dependence on traditional gasoline, by rewarding them for making  traditional gasoline, doesn’t pass the commonsense test.”

Grassley added that if lawmakers thought oil companies would benefit from a tax credit for “activity they already engaged in, the credit would never have been enacted.” For one thing, he said, the JCT’s “revenue score associated with the provision would have been so large that its passage wouldn’t have been feasible.”

U.S. Venture attorneys said the courts should pay more heed to the views of 20 GOP senators, mostly representing oil-producing states. A Dec. 9 letter led by James M. Inhofe of Oklahoma and Bill Cassidy of Louisiana urged Senate Majority Leader Mitch McConnell to reject the retroactive fuels credit changes, arguing it “might violate a taxpayer’s due process rights” and was a matter best left for courts to decide. 

Other companies seeking alternative fuels credits against back taxes include Philadelphia Energy Solutions, which has filed claims for $416 million as it seeks to exit bankruptcy under new ownership. Vitol Group, the London-based oil trading giant, is seeking $52 million.

Experts and attorneys in the cases have said they expect to see more appeals arguing the government violated the Fifth Amendment’s due process guarantee by retroactively changing the rules.

Modest and rational

The Supreme Court last ruled on retroactive tax changes in 1994. The high court found that Congress could make retroactive changes so long as they were labeled as such, were for a “modest” period of retroactivity, were “rational” and had a “legitimate legislative purpose.”

University of Denver law professor Jan Laitos, who published research on the issue in the late 1990s, said a conservative-tilting Supreme Court appears interested in issues involving property rights and might be inclined to take a look if cases involving retroactive taxes get that far.

Laitos cited a 2019 case in which the high court overturned precedent that required property owners to start in state court rather than federal court when alleging a “taking,” or a violation of the Fifth Amendment prohibition against a government taking property without compensation.

One issue largely unaddressed in the 1994 case is how far back can retroactive tax code changes be made and still be considered “modest.” In 2017, according to research by tax lawyers at Eversheds Sutherland, the Supreme Court chose not to hear two cases involving state lawmakers applying retroactive tax code changes. One case involved a retroactive period of 27 years, the other a period of seven.

“This is an issue maybe whose time has come,” Laitos said.

Valero argued in its March 30 filing that a “modest” period of retroactivity is a year or two. But the definitions of alternative fuels went into effect in 2006 and butane met those definitions until December’s change in the law, the company argued.

“Congress did not act promptly and instead amended the statute fourteen years after enactment,” Valero attorneys wrote, arguing a violation of the Constitution’s Due Process Clause.

The Justice Department countered in an April filing in the Valero case that there was no violation of the Due Process Clause; that the change barred tax refunds, but did not impose a new tax or increase a previous tax.

“At best, Plaintiff’s argument is that Congress retroactively took away a retroactive gift before the Plaintiff could take advantage of that yet unconsummated gift,” DOJ lawyers wrote.