The oil industry has often said that dilbit, a heavy crude oil from Canada's tar sands, isn't much different from conventional crude oil. But when it comes to paying into a federal fund used to clean up oil spills, it's different enough to deserve a sizeable tax break.

Dilbit is exempt from the tax, because the 1980 legislation that created the tax states that "the term crude oil does not include synthetic petroleum, e.g., shale oil, liquids from coal, tar sands, or biomass..."

The Internal Revenue Service cited that 1980 text in a 2011 memo that confirmed the exemption for at least one company.

The tax helps support the federal Oil Spill Liability Trust Fund, whose primary funding comes from an 8-cent-per-barrel excise tax on domestically produced and imported crude oil and on imported refined products such as gasoline.

Money from the fund is helping to clean up the 2010 oil spill in Michigan, where a ruptured pipeline spewed more than 1 million barrels of diluted bitumen, or dilbit, into the Kalamazoo River. Unlike conventional crude oil, which floats on water, much of the dilbit sank into the river. Removing it has been so difficult that cleanup crews are still struggling to mop it up, making the Michigan disaster the most expensive oil pipeline spill in U.S. history.

The accident has cost $809 million so far, with $765 million paid by Enbridge, Inc.—the Canadian company whose pipeline ruptured—and its insurance company. The remaining $44 million is coming from the fund.

The nation's refineries pay the excise tax for imported crude oil, and these fees are considered standard practice in industry, said Esa Ramasamy, an editorial director at Platts, a global energy, petrochemicals and metals information provider. "It is accepted as part of the daily business routine. It's like an insurance policy ... [for] anything that can harm the environment."

Ramasamy said the 1980 definition of crude oil dates back to a time when it wasn't financially feasible to produce tar sands oil on a large scale. The first sizeable shipments of dilbit into the U.S. didn't occur until 1999.

Tar sands production is now "a huge industry," he said, and Congress didn't expect that when the tax was created.

The U.S. currently imports more than 1.2 million barrels of Canadian dilbit and synthetic crude (another kind of tar sands oil) per day. The tax exemption is worth at least $35 million a year, and that figure will grow as the industry seeks to build thousands of miles of new pipelines—including the much-debated Keystone XL—to handle increased imports.

Watchdog and environmental groups say it makes no sense to exempt tar sands oil from a tax that is used to clean up tar sands spills.

"The key issue is, is tar sands crude oil?...When it comes to taxes, [the industry] get[s] to make the argument that tar sands isn't crude oil," said Anthony Swift, an attorney at the Natural Resources Defense Council who has spent years advocating for better pipeline safety. "But when it comes to the safety of moving tar sands in pipelines, they say it's just like crude oil."

Swift and other watchdogs say the exemption is particularly galling because dilbit is more corrosive to pipelines than conventional crude—something that the industry disputes.

"The question is why we should continue this exemption given that it's clear tar sands oil is more likely to spill because it's more corrosive...and more and more tar sands is coming into the U.S.," said Lorne Stockman, research director at Oil Change International, an advocacy group that supports clean energy.

The National Academy of Sciences has launched a study on dilbit and pipeline corrosion, but it will be limited to a review of the existing literature and won't involve any new research.

Ramasamy, the Platts oil expert, said tar sands imports might be subject to some other kind of environmental tax.

"Oil sands tend to be more acidic and corrosive than conventional crude," he said. "It takes a special kind of refinery to process them, because of the toxicity of [the] crudes. So I find it hard to believe there is no environmental tax on those crudes."

An IRS spokesman said he could not provide information about other taxes the industry might by paying. InsideClimate News also contacted three pipeline companies (TransCanada, Enbridge and Kinder Morgan), three refineries that process tar sands crude (Valero, Suncor Energy U.S.A. and BP Whiting), and the Canadian Association of Petroleum Producers (CAPP) to ask about possible taxes on tar sands imports.

Spokesmen from TransCanada and CAPP said questions about tax policy should be directed to tar sands refiners, producers or the IRS. Enbridge, Kinder Morgan and the refineries did not respond.

A Convoluted History

Some of the confusion over the excise tax can be traced to the Trust Fund's convoluted history.

Congress set up the crude oil tax in 1980 as part of the legislation that established Superfund—a federal program that manages hazardous waste cleanup. Although crude oil was taxed, the money could only be used to clean up hazardous materials, not crude oil (the government used a separate fund for oil spill cleanup).

That limitation was removed in 1990, when the crude oil excise tax was funneled into the newly created Oil Spill Liability Trust Fund along with several other pollution-control funds. That change was triggered by the Oil Pollution Act, which President George H. W. Bush signed into law a year after the Exxon Valdez spilled about 11 million gallons of oil into the Alaska coast.

The Fund is used to support speedy initial cleanup as well as costs and claims throughout a disaster response. It grew from 1990 to 1994, as crude oil was taxed at a nickel per barrel. The excise tax expired in 1994 and wasn't reinstated until 2006.

In 2008 Congress passed legislation to extend the tax through the end of 2017. The measure also raised the tax from 5 to 8 cents from 2009 to 2016 and to 9 cents in 2017. The fund now stands at $2.5 billion.

But even as conventional oil was taxed, "tar sands has always been considered different ... [and] the exemption was always there as a default," said Stockman, the Oil Change International research director.

In Jan. 2011, the IRS issued a Technical Advice Memorandum on tar sands imports and the excise tax.

The memo analyzed the tax as it applies to a U.S. refinery that imports Canadian tar sands. It found that the tax code doesn't say whether tar sands should be taxed, but that the 1980 legislation that set up the tax explicitly excluded tar sands. Therefore, the agency concluded, "Tar sands imported into the United States are not subject to the excise tax on petroleum imposed by §4611 of the Internal Revenue Code (Code)."

Stockman says the effect of the memo was to "do away with any ambiguity about whether they (tar sands importers) should pay or not."

But IRS spokesman Anthony Burke said technical memos don't set a precedent, because they only apply to the particular facts mentioned in the memo—in this case, the specific refinery.

Because tax returns are confidential, Burke said the IRS can't explain why this memo was created or reveal the name of the refinery involved.

Most technical advice memos are initiated when the IRS examines tax returns and discovers a situation that requires further clarification, Burke said. The facts are then forwarded to the Office of Chief Counsel, which issues a memo to determine how the tax code applies to that unique situation.

A different taxpayer probably wouldn't have the exact same facts and circumstances, Burke said, and that's why these memos don't set a precedent.

Swift, the NRDC attorney, said that may not be true in this case, because the IRS based its decision on a set of facts that would apply to all tar sands refineries. "The facts they used were interpretation of Congressional intent when it wrote the excise tax [in 1980], and that's a very general interpretation that would cover other companies as well."

It remains unclear if any tar sands refineries had paid the tax prior to 2011. Burke said the agency doesn't track the kind of industry-wide data needed to answer the question.

Swift says it would probably take an act of Congress to remove the current exemption. "Congress could certainly amend the definition of crude oil for the purposes of the excise tax to include tar sands and synthetic crude."

"It's surprising that the definition has remained unchanged since 1980, he said. "I think ... it's one of these issues that has fallen under the radar, just as the expansion of tar sands in the U.S. [did] until recently. Until a couple of years ago, people had no idea what was running through [pipelines]."

In a document released in May, Oil Change International, the NRDC and another watchdog group called Earth Track calculated that the tar sands exemption could be worth more than $66 million a year by 2017.

Enbridge Will Reimburse the Fund

The U.S. Coast Guard, which administers the Oil Spill Liability Trust Fund, has authorized $53 million so far to help clean up Enbridge's Michigan oil spill. To date, the government has spent $44 million of that $53 million.

Paul Rhynard, a Coast Guard spokesman, said the agency will recover the $44 million in stages. The first bill, for $26 million, will be sent to Enbridge in August, and more bills will follow until the cleanup is complete.

An Enbridge spokeswoman told InsideClimate News that "If any monies from the Fund are used, then yes, as the responsible party, we would reimburse the Fund."

Allen Thuring, senior financial analyst at the Coast Guard's National Pollution Funds Center, said the agency has "a very aggressive cost-recovery process" when it comes to seeking reimbursement from the responsible parties.

Since the BP Gulf spill, he said, the Coast Guard has billed BP for $716 million used from the fund. BP has paid $711 million and the agency is waiting for the remaining $5 million.

Elizabeth McGowan contributed to this report.

Update, Aug 1, 2012

Earth Track founder Doug Koplow offered this comment on the scope of the IRS memo: "The IRS quote on technical advice memoranda (TAM) not setting legal precedent is technically true, but practically irrelevant. For complicated tax issues, there is often ambiguity on how to treat something. The TAM[s] clarify how the IRS looks at particular issues, and this is hugely helpful to firms making decisions on which way to go on similar—though not identical—tax issues."

On July 31, after the InsideClimate News report was published, the Democratic staff of the House Natural Resources Committee released a report on the tar sands tax exemption. In a letter accompanying the report, Rep. Ed Markey (D.-Mass.), ranking member of the committee, urged Treasury Secretary Timothy Geithner to reverse the IRS exemption.