SSCC Smurfit-Stone Container Corp. Common Stock

The U.S. Internal Revenue Service's interpretation of the requirements for federal tax breaks on biofuel has revived U.S. paper companies' interest in claiming tax credits on paper-mill waste used as fuel.

The paper industry was the unexpected recipient last year of a windfall of federal tax credits on the molasses-like residue known as black liquor that's left over from milling wood chips into paper pulp. The paper industry collected more than $6 billion in tax credits before the program expired at the end of 2009. Congress, outraged over the paper industry's exploitation of a program intended for fledging alternative-fuel producers, voted earlier this year to make black liquor off limits for future tax credits.

But an IRS memo released earlier this month reopened discussions about black-liquor tax credits and raised the possibility that paper companies' could use the credits to increase profits this year by lowering their tax expenses.

The IRS indicated that paper companies could have received twice as much in tax credits on black liquor last year. By registering as biofuel producers with the IRS, paper companies could retroactively claim a $1.01-a-gallon biofuel tax credit on black liquor, rather than the 50-cent-a-gallon credit for alternative-fuel mixtures, the tax collection agency said.

"Black liquor meets the definition of cellulosic biofuel," the memo said.

Black liquor had been widely seen as being unable to meet the government's standards for biofuel. Producers of black liquor include International Paper Co. (IP), MeadWestvaco Corp. (MWV), Temple-Inland Inc. (TIN), Domtar Corp. (UFS) and Smurfit-Stone Container Corp. (SSCC).

It isn't known whether these companies will actually pursue the $1.01 credit. Calls to the companies were either not returned, or the companies said they're considering their options.

"We're studying what it means for International Paper at the moment," said Patty Neuhoff, a spokeswoman for the Memphis, Tenn., company.

A host of unresolved issues likely will influence the companies' decisions. Foremost is the process for obtaining the $1.01 credit. The IRS says companies that received 50-cent credits can't collect a second, higher credit on the same black liquor. Companies, however, could return the money from the 50-cent credit and apply for the $1.01 credit instead.

"Companies would only be eligible for the biofuel credits to the degree that they didn't collect cash [tax credits] for black liquor or were willing to return the cash to take advantage of the income-tax credit" for cellulosic biofuel, said Mark Wilde, a Deutsche Bank Securities analyst, in a note to investors.

Moreover, the $1.01 credit would be applied as a noncash offset to companies' cash expenses for federal income taxes. The 50-cent credits were distributed as cash subsidies.

Given the complexities of acquiring the larger credit, companies could conclude that the reward isn't worth the effort. Pursuing the higher credit also could expose paper companies to further outrage from members of Congress who remain angry over the paper industry's use of a regulatory loophole to obtain the 50-cent credit.

"The political risks surrounding this issue remain difficult to ignore," Wilde said.

For decades, paper companies have burned black liquor in boilers at power plants that generate electricity for paper mills. Black liquor contains lignin and other chemicals that are extracted from wood chips in the pulping process.

By adding a small amount of diesel to black liquor, paper companies found they could claim an tax credit for production of alternative-fuel mixtures. Paper companies were accused of using a loophole to obtain the tax credits and abusing the tax program's intent.

-By Bob Tita, Dow Jones Newswires; 312-750-4129; robert.tita@dowjones.com

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