Earlier this year, our craft beverage lending team hosted 70+ American craft distillers for its first ever compliance webinar, which focused on the Alcohol and Tobacco Tax and Trade Bureau’s (TTB) audit process, how to prepare for audits, and strategies for reporting production.
The panel included Jason Lippa, former distiller and current President/Founder of Distillery Solutions in Westminster, Colorado, and Bernie Kipp, former TTB auditor and current Alcohol Compliance Advisor at Stoel Rives LLP in Portland, Oregon. Let’s review the top five most important questions that distillers posed, then offer our expert panel’s response to each.
#1 – What are some of the most common triggers for an audit?
Alcohol Content and Fill Non-Compliance. The TTB performs Product Integrity Audits, randomly purchasing finished products from the marketplace to test for label content, compliance, and to perform content testing. It is critically important that proprietors measure content and fill (taking into account atmospheric conditions) and record results during each bottling/packaging of finished products at the distilled spirits plant (DSP).
Missing/incomplete Federal Monthly Reports of Operations. Failure to file monthly reports with the TTB is the best way to ensure a phone call and visit to your distillery. If you have any outstanding monthly reports that have not been filed, get them filed as soon as possible.
Undocumented loss, excessive loss, inventory miscalculations, and missing inventories. Ensure accurate and meticulous record keeping for all spirit movement within your DSP and make certain that all documented loss is properly reported to the TTB. Affirm that quarterly inventory information is submitted on the Monthly Production Report and that all required periodic inventory reports are created and retained internally.
Export documentation. Because the Federal Excise Tax is remitted on bonded spirit that is exported to foreign countries, it is important that a proprietor files and retains all relevant export documentation required by the TTB. Failure to submit export paperwork without the payment of Federal Excise Tax is a big red flag.
Growth, success, and time. The inevitability of time marching forward will always produce a visit by the TTB. The TTB may review records and schedule periodic reviews to check in with DSPs. The purpose of these visits is to make certain that the distillery is compliant with TTB protocols and to address any potential issues within the DSP on reporting or compliance. When push comes to shove, it’s not a question of if you’ll receive a TTB visit, it’s when you’ll receive a TTB visit.The Top 5 TTB Audit Questions from American Craft Distillers- Read it here! Click To Tweet
#2 – How much time will I get to prepare for an audit?
If the TTB deems it necessary for an on-site visit to your distillery, it is typical to receive notice anywhere between one to four weeks in advance of the visit; however, this may vary on a case-by-case basis. Typically, the proprietor will receive written notification from the assigned TTB Investigator/Auditor.
Within the notification of visit communication, it is common for the TTB representative to outline both the information that will be reviewed as well as the amount of time the review will cover. If the TTB representative does not outline this information, it is important that the proprietor asks for clarification to understand how to best prepare for the site visit.
Common types of audits are cyclical, risk-based, and random. Cyclical is for large distilleries with annual tax liability greater than one million dollars. Risk-based is to ensure that distillers are complying with laws and paying the correct excise tax. Random is simply any distillery.
#3 – How does serial number labeling work?
Directly from the Code of Federal Regulations (27 CFR 19.490 b) – When a proprietor fills cases containing bottles or other containers of spirits during processing, the proprietor must identify the cases consecutively beginning with “1” and continuing the series until the number “1,000,000” is reached. When the identification in any series reaches “1,000,000”, the proprietor may begin a new series with “1”.
Case serial numbers are a part of the required markings that a proprietor must affix to the side of each case of spirits filled within the processing area. 27 CFR 19.489, outlines the required case label markings and consists of (a) a unique case serial number, (b) the kind of spirit (class and type of spirit as set forth in 27 CFR, Part 5) contained within the case, (c) the distilled spirits plant number where bottled, (d) the date in which the case was filled, (e) the labeled proof at which the spirit was bottled, and (f) the volume of spirit (in liters or proof gallons) contained within the case.
#4 – How does TTB measure the fill?
The TTB frequently performs a type of compliance review in the form of a Product Integrity Audit. Product Integrity Audits are typically performed without the knowledge of the proprietor as bottled spirits are purchased directly from the marketplace and tested and reviewed at TTB facilities. During these reviews, the TTB will look to verify the contents and information displayed on the product label to ensure adherence to the proprietor’s submitted and approved COLA on file for the product under review.
Additionally, the alcohol content and fill volume will be tested for adherence to information stated on product labels. The proof of the bottled spirit is typically verified through obscuration testing and lab redistillation, per TTB outlined protocol. Once obtained, the proof can be used in conjunction with the weight of the spirit contained within the bottle to get an exact volume of fill that is independent of atmospheric or environmental conditions (temperature and atmospheric pressure).
The CFR states that good commercial practice must be employed and that all fills should be checked for discrepancies resulting from errors in measuring that occur during filling. The volume quantity (fill) must be kept as close to 100 percent fill as the equipment and bottles in use will permit and the tolerance permitted for the quantity contained in a bottle may not vary from the quantity stated on the label or bottle by more than plus or minus (a) 1.5% for 1.0 & 1.5 L bottles, (b) 2.0% for 500 & 750 mL bottles, (c) 3.0% for 200 & 375 mL bottles, and (d) 4.5% for 50 & 100 mL bottles.
The variations in alcohol content, subject to a normal drop that may occur during bottling, must not exceed (a) 0.25% ABV for products containing solids in excess of 600 mg per 100 ml, (b) 0.25% ABV for all spirits products bottled in 50 or 100 ml size bottles, and (c) 0.15% ABV for all other spirits and bottle sizes.
#5 – What are the tolerances for losses for reporting and how do you properly document them?
The Code of Federal Regulations (CFR) stipulates that spirit loss within the storage account is deemed excessive when the quantity of spirits lost during a calendar quarter from all storage tanks and bulk conveyances exceeds 1.5% of the total quantity of stored spirits during the quarter. The TTB will not collect tax on spirits that are lost, destroyed, or otherwise unaccounted for while in bond, with the exception of some instances of theft, voluntary destruction, or unexplained shortages of bottled spirits.
The CFR outlines that a proprietor must determine if a loss of spirit has occurred each time a tank is emptied, upon discovery of an accident or unusual variation in gauge, and when required to take physical inventories (typically quarterly). The proprietor is liable for all taxes on spirits and must file a claim for remission of the tax on spirits lost in bond with the TTB. The details and requirements for filing claims of this nature can be found in 27 CFR 19.262 and 19.263.
It is best practice to document and record all spirit loss in as much detail as possible, recording loss date, gauges, and any related notes within daily batch records. In the case of an accident involving spirit loss, documenting the loss with photographs and creating a formal loss report (to be retained internally) will help to mitigate any questions that may arise at a later date related to investigations surrounding spirit loss.
Compliance issues and TTB audits can also present considerable risk to a distillery’s ability to access financial capital that’s needed to expand and grow. For example, if your distillery was to be fined or have its license revoked, this could impede your ability to repay the bank’s loan.
Banks also typically look at compliance reports before extending credit because it indicates whether the distiller has an inability to be compliant or that the distiller has questionable character. Also, all federal and state taxes supersede any bank liens, which increase the repayment risk of the bank.
Regardless of the tasks and challenges involved with compliance, aligning yourself with the proper industry experts is an important step to maintaining access to financing and other valuable resources that will keep your business growing. Consult an expert today to assist you with implementing a compliance and reporting program, as well as preparing for TTB audits.
Jeff Clark is the Craft Beverage Domain Expert at Live Oak Bank, the second largest SBA lender in the United States* and a nationwide small business bank – Member FDIC. The contents of this article were derived from a cooperative live webinar hosted by Live Oak Bank on March 23, 2016.
*Source: Small Business Administration – 100 Most Active SBA 7(a) Lenders by volume in U.S. in FY 2016.