Excise Tax 101: Need-to-Know Basics for Energy Traders
Unfortunately, energy traders often ignore indirect taxes when making decisions on the trading floor—and it’s easy to understand why. There’s already enough price risk to worry about without having to factor in state and federal excise taxes and fees. They all even out in the end, right?
No, not really.
Indirect taxation of energy commodities can get highly complex, and failing to account for liabilities at the outset of a trade can result in some significant unintended consequences.
Energy trading companies often believe that their trades are not subject to excise tax. This may be true for many trades, but most traders will have a subset of trades that do require tax withholding. And if tax is ignored or calculated incorrectly on even a few trades, tax penalties can be severe.
At a minimum, energy trading companies should understand the fundamentals of what’s at stake.
Energy Trades and Profitability
In the U.S., many fuel trading transactions are exempt from excise taxes. But any number of variables could come into play, transforming an assumed-to-be-exempt trade into a multi-million-dollar tax liability. (We’ve seen it happen here at Avalara.)
To recap: There’s always the potential for an array of taxes and fees, such as:
- Indirect taxes including federal, state, and local excise tax, sales and use tax, VAT tax, and federal oil spill liability tax.
- Regulatory fees, such as environmental fees and state oil transfer fees.
- Processing fees ranging from inspection and container fees to demurrage, lightering, detention, and per diem fees.
How each of these variables might be applied to an energy trade will vary greatly based on a number of factors such as licenses and exemptions, origins and destinations, and methods of transport.
Often, unanticipated taxes and fees can be traced back to the determination process being used. Specifically, the systems most energy trading companies rely on are simply not capable of accurately predicting, calculating, or applying these indirect fees.
The Tax Limitations of ETRM Systems
The backbone of the modern commodity business is the Energy Trading and Risk Management, or ETRM, system. Companies rely on these systems to handle everything from price management to performing basic accounting functions.
However, ETRM systems are not designed to support complex excise taxes.
Excise tax rules and rates change constantly, and a lack of built-in rules or rates makes it nearly impossible to monitor and account for changes at the federal, state, and local levels.
As a result, an otherwise highly profitable deal could be swiftly transformed into a losing trade. This can happen when there’s an underlying assumption that tax liabilities will be the same regardless of the parameters of the trade. Excise taxation, in particular, is much more than a simple fixed cost, and any unanticipated fees can add up quickly.
What’s a trading company to do?
Often, their tax or accounting department will research and monitor for changes in tax code—and perhaps even turn to IT for customizations within the ETRM system to handle complex rule logic. But the pace at which excise rules and rates change can make this very difficult, if not impossible, to maintain.
Sometimes, a trading company will choose to do nothing and rely on the tax department to sort out taxes manually at the end of the month. But if the trade has already occurred, the taxes are due, and it’s too late to mitigate the margin impact. Creative traders are known to do deals outside of normal business practices, such as new products, new jurisdictions, or new counterparties to capture a price margin on a commodity. But unknown indirect taxes can easily turn a good deal into a bad one.
Bottom line: Taxation is often not factored in on the trading floor—but it should be.
In fact, by factoring in tax implications at the outset of the trade evaluation and sales order, the opportunities for greater profit margins can increase exponentially.
If you’d like to learn more, this is a topic that’s explored in greater detail in the Avalara Excise white paper: ETRM Systems & Taxation: Why You Still Need Independent Tax Determination.
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