Government Regulation of Artisan Distillers Bernard J Kipp

Government Regulation of Artisan Distillers Bernard J. Kipp Alcohol Compliance Advisor Stoel Rives, LLP 1

Main alcohol laws administered by TTB • Internal Revenue Code • Federal Alcohol Administration Act 2

TTB’s Tax Collection-FY 2015 • • • Total –$ 25. 4 billion Tobacco - $14. 3 billion Distilled Spirits - $5. 7 billion Malt Beverage - $3. 7 billion Wine - $ 1. 1 billion 3

“PROHI” Agents 4

Distillery Owner is scheduled for arraignment involving his distillery company and nearly $880, 000 in taxes • Eugene Register-Guard – 10/14/12 • A Cottage Grove man is accused of filing a false federal excise tax return and failing to pay nearly $880, 000 in federal taxes owed by his distillery company. (Side Pocket Foods) • The government alleges that Meyers filed more than 70 federal tax forms between October 2008 and August 2011 on which he falsely reported that Side Pocket owed no federal excise taxes. 5

Man Sentenced to Prison Term, Restitution in Fake Excise Tax Return Scheme • The Oregonian – 01/29/13 • A Cottage Grove man was sentenced Tuesday to one year and one day in prison for failing to pay $879, 000 in federal excise taxes and submitting more than 70 fake returns to cover it up, the U. S. Attorney’s Office said. (Side Pocket Foods) • Chief U. S. District Court Judge Ann Aiken also ordered William Meyers, 66 to pay restitution of more than $873, 000 and to serve three years of supervised release after his prison term is over. He also must serve 100 hours of community service. 6

TTB Administrator – 9/15 • 1. Last year TTB did over 100 audits of DSPs, Wineries, and Breweries • 2. The audits resulted in an additional $40 million dollars in revenue • 3. Audit disclosed on 32% of required reports are timely filed • 4. Regarding DSPs - TTB has done 800 investigations/audits (undefined time period • Referred 89 cases for Criminal Prosecution 7

TTB Audit Findings • • • Main problems in order were: A. Proof and Fill out of compliance B. Bond coverage exceeded C. Incomplete or nonexistent records D. Conducting operations off the bonded premises. 8

Artisan or Not? • Is there a category of distilled spirits plant for small/artisan distillers? The answer is “No. ” • • Small “artisan” distilled spirits plants: Need the same Federal basic permit and plant registration to engage in business as a distilled spirits plant and • Must follow the same laws [FAA and IRC] and regulations [e. g. , Part 5 and Part 19] 9

State vs. Federal Law • There may be significant differences: Licensing requirements • Labeling requirements • Tax rates and periods for filing • Reporting of operations • Trade practice restrictions • Distribution/direct shipment • Operations allowed on premises 10

Labeling Requirements [State vs. Federal Law] • State Requirements: Some States adopt Federal labeling requirements • Some States do not impose any labeling requirements • Some States have minimal “brand registration” • Federal Requirements: You must also comply with all of the labeling requirements imposed by the IRC, FAA Act, and the Alcoholic Beverage Labeling Act [as well as all State requirements 11

Restrictions as to Location • Distilled spirits plants shall not be located: In any dwelling house, or in any shed, yard, or enclosure connected with any dwelling house • On board any vessel or boat • On premises where beer or wine is produced • Where liquors of any description are retailed • On premises where any other business is conducted (except as provided in § 19. 133) 12

“Where Wine or Beer are Produced • DSP must be physically separated from a winery or brewery. Separate building; or same building but different floor; • Different rooms on the same floor with separate means of entrance/egress. • Alternation of equipment may occur only after TTB approval. Wine, beer, or spirits must be removed to permanent premises at the conclusion of alternation of equipment. 13

No Retail Sales • Unlike brewpubs and bonded winery premises, DSPs cannot sell at retail from the bonded premises: DSP premises must be physically separated from retail sales area. • That means separated by a wall with a separate means of access. 14

Standards of Identity • There are 12 standards of identity for distilled spirits under 27 CFR part 5. Issue: Small DSPs may have difficulty meeting certain standards. – We will cover two of them to highlight certain issues: – 5. 22(a)(1)Vodka – 5. 22(d) Brandy 15

Vodka [Standards of Identity] • Class 1; neutral spirits or alcohol • “Neutral spirits” or “alcohol” are distilled spirits produced from any material at or above 190°proof, and, if bottled, bottled at not less than 80°proof. • Vodka is produced from neutral spirits 16

Vodka[Standards of Identity] • If it wasn’t distilled at or above 190°proof…Then you cannot label it as vodka – The label must identify an accurate class/type designation; for example: “Spirits distilled from corn” – “Spirits distilled from grape wine” 17

Vodka[Standards of Identity] • Production of Vodka: – Neutral spirits can be “re-designated”as vodka, or vodka can be “produced after distillation” by treatment with charcoal or other materials… – Provided, that the spirits are without distinctive character, aroma, taste, or color (citric acid and sugar) 18

Brandy Class 4 -27 CFR 5. 22(d) • Class 4; Brandy • Distillate from fermented juice, mash, or wine of fruit, or from the residue thereof • Distilled at less than 190°proof and bottled at not less than 80°proof • Possesses taste, aroma, and characteristics generally attributed to Brandy 19

Brandy Class 4 -27 CFR 5. 22(d) – Different types: Fruit Brandy – Grappa • Pomace Brandy • Neutral Brandy • Immature Brandy ( Eau de vie) 20

Brandy “Fruit Brandy” must be stored in oak for a minimum of two years to be labeled as such • If stored for less than 2 years, then statement of class and type shall be immediately preceded, in the same size and kind of type, by the word “immature

Gauging Instruments • Tanks w/ sight glass or on scales, etc. • Hydrometers and Thermometers: Should be “precision” instruments • Should include manufacturer’s charts for correction over a range of different proof/temperature readings

Gauging Procedures • Determination of proof. • Shall be determined to nearest tenth of a degree. – If solids content not more than 600 milligrams: If 400 milligrams or less, then proof can be determined directly; – If over 400 milligrams, then see 27 CFR 30. 32. – Solids content greater than 600 milligrams Requires distillation of test sample 23

• Why make such a big deal about gauging? – Tax Ramifications: Improper gauging may result in unexplained shortages – $13. 50 per Proof Gallon – Standards of Identity Concerns - The identity of spirits produced must be clearly established [e. g. , proof limits for vodka] • Bottle Labeling Considerations

Why make such a Big deal about gauging? • Current federal excise tax rates • Tobacco –$50. 33 per 1000 -$1. 01 per pack of 20 cigarettes • Distilled Spirits – $13. 50 pg - $2. 14/ 750 ml @ 80 proof • Malt Beverages – $18/7 per barrel -. 05 Budweiser /. 02 Pyramid 12 oz • Wine – $1. 07/. 17 per gallon -. 21 Ch Ste M. . 03 De. Lille Cellars 750 ml

• Why make such a big deal about gauging? – 27 CFR 19. 386(b) –Variations in alcohol content and fill: The proprietor shall rebottle, recondition, or re-label spirits if the bottle contents do not agree with the respective data on the label or bottle as to: Alcohol Content (Proof) – Quantity (Fill)

Tolerance –Proof • 27 CFR 19. 386(b)(2) –Alcohol content, subject to a normal drop in alcohol content which may occur during bottling operations not to exceed: 0. 25% alcohol by volume for spirits containing solids in excess of 600 mg per 100 ml or • 0. 25% alcohol by volume for any spirits product bottled in 50 or 100 ml size bottles or • 0. 15% alcohol by volume for all other spirits and bottle sizes 27

Proof –Example • A product with a solids content of less than 600 mg per 100 ml, labeled as containing 40 percent alcohol by volume and bottled in a 750 ml bottle, would be acceptable if the test for alcohol content found that it contained 39. 85 percent alcohol by volume: 80 proof can be 79. 7 to 80 proof • 80. 1 proof is taxable at a higher rate 28

Small Distillers and their Records • Proprietors of small DSPs “wear many hats” • They often do not have accounting staff • Records are often hand-written • Records are often done at end of a busy day • Recordkeeping is the least enjoyable task • Intention behind record keeping is different 29

Records • • What the DSP is interested in: Profit and Loss Statement Quality Control Considerations Selling their Product • What TTB/WSLCB are interested in: ($5. 4 billion) • Verification of Tax Returns and Reports • Verification of labels on bottled distilled spirits 30

Records • What TTB often encounters: • All records kept in a spiral notebook • Not all mandatory information • Do not support reports, returns, and label claims. • What the regulations require: • Separate records by DSP account (i. e. , Production, Storage, Processing) • Mandatory information • Audit trail from source records to tax returns. 31

Records • Distilled spirits are tracked the moment they come into existence. As distilled spirits come off the still and are collected in condenser (or doubler if used), the production gauge is the starting point for tracking spirits produced • Every drop must be accounted for from that gauge • Thorough daily records and the monthly reports help to accurately track spirits 32

Monthly Reports • 5110. 40 – Monthly Report of Production Operations • 5110. 11 – Monthly Report of Storage Operations • 5110. 28 – Monthly Report of Processing Operations

Audit Trail[Records] • Provide TTB the ability to verify and trace the quantity and movement of materials, spirits, denatured spirits, wines, or alcoholic flavoring materials involved in each transaction or operation. • Daily records - (Very Detailed) • • Summary records/reports DSP Monthly Reports Excise Tax Returns Labels on bottled spirits

5010 Credit Under 26 U. S. C. 5001 and 7652 a tax is imposed on all spirits produced in or imported into the United States at $13. 50 per proof gallon. Wines containing more than 24 percent of alcohol by volume are taxed as spirits. A credit against this tax is allowed under 26 U. S. C. 5010 on each proof gallon of alcohol derived from eligible wine or eligible alcoholcontaining flavors which do not exceed 2. 5 percent of the finished product on a proof gallon basis. Eligible wines are other than standard (OTS) wines that have not been subject to distillation at a distilled spirits plant and that contain no more than 0. 392 g of carbon dioxide per 100 ml. Eligible flavors are those that have been approved by the Nonbeverage Products Laboratory. The producers or importers of distilled spirits are eligible for this credit if the distilled spirits contain an eligible wine and/or eligible flavor used in producing a batch of spirits produced in accordance with an approved formula.

STOEL RIVES LLP 900 SW Fifth Avenue, Suite 2600 Portland, Oregon 97204 Bernie Kipp – 503 -294 -9834 – bjkipp@stoel. com Elaine Albrich – 503 -294 -9394 – eralbrich@stoel. com Chris Hermann – 503 -294 -9236 – crhermann@stoel. com