[Federal Register Volume 70, Number 1 (Monday, January 3, 2005)]
[Rules and Regulations]
[Pages 194-237]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-28460]



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Part III





Department of the Treasury





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Alcohol and Tobacco Tax and Trade Bureau



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27 CFR Parts 7 and 25



Flavored Malt Beverage and Related Regulatory Amendments (2002R-044P); 
Final Rule

  Federal Register / Vol. 70 , No. 1 / Monday, January 3, 2005 / Rules 
and Regulations  

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DEPARTMENT OF THE TREASURY

Alcohol and Tobacco Tax and Trade Bureau

27 CFR Parts 7 and 25

[TTB T.D.-21; Re: TTB Notice No. 4]
RIN 1513-AA12


Flavored Malt Beverage and Related Regulatory Amendments (2002R-
044P)

AGENCY: Alcohol and Tobacco Tax and Trade Bureau, Treasury.

ACTION: Final rule; Treasury decision.

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SUMMARY: The Department of the Treasury and its Alcohol and Tobacco Tax 
and Trade Bureau adopt as a final rule certain proposed changes to the 
regulations concerning the production, taxation, composition, labeling, 
and advertising of beer and malt beverages.
    This final rule permits the addition of flavors and other 
nonbeverage materials containing alcohol to beers and malt beverages, 
but, in general, limits the alcohol contribution from such flavors and 
other nonbeverage materials to not more than 49% of the alcohol content 
of the product. However, if a malt beverage contains more than 6% 
alcohol by volume, not more than 1.5% of the volume of the finished 
product may consist of alcohol derived from flavors and other 
nonbeverage ingredients that contain alcohol. This final rule also 
amends the regulations relating to the labeling and advertising of malt 
beverages, and adopts a formula requirement for beers.
    We issue this final rule to clarify the status of flavored malt 
beverages under the provisions of the Internal Revenue Code of 1986 and 
the Federal Alcohol Administration Act related to the production, 
composition, taxation, labeling, and advertising of alcohol beverages. 
This final rule also will ensure that consumers are adequately informed 
about the identity of flavored malt beverages.

DATES: This rule is effective January 3, 2006.

FOR FURTHER INFORMATION CONTACT: Charles N. Bacon, Alcohol and Tobacco 
Tax and Trade Bureau, Regulations and Procedures Division, P.O. Box 
5056, Beverly Farms, MA 01915; telephone (978) 921-1840.

SUPPLEMENTARY INFORMATION:

Table of Contents

Notes to Readers
    A. ATF-TTB Transition
    B. Use of Plain Language
I. Background Information
II. TTB Notice No. 4
III. Discussion of Specific Proposals in TTB Notice No. 4
    A. Standard for Added Alcohol and Alcohol from Fermentation
    B. Proposed 0.5% Added Alcohol by Volume Standard for ``Beer'' 
under the IRC
    C. Proposed 0.5% Added Alcohol by Volume Standard for Malt 
Beverages under the FAA Act
    D. Alternative 51/49 (Majority) Alcohol Standard
    E. Proposed Alcohol Content Labeling Statement for Flavored Malt 
Beverages
    F. Use of Distilled Spirits Terms in Malt Beverage Labeling and 
Advertising
    G. Filing Formulas for Fermented Beverages
    H. Samples; Formulas and Samples for Imported Malt Beverages
    I. Other Issues Raised in Notice No. 4
IV. Rulemaking History
V. Comments Received in Response to Notice No. 4
    A. General Discussion of Comments
    B. Overview of Comments
    C. Summary of TTB Final Rule Decisions
VI. Comments on Whether the Rulemaking Is Necessary and Fair
    A. Is There a Need to Engage in Rulemaking on this Issue?
    B. Fairness and Notice Issues
VII. Regulatory Burden and Cost-Related Issues
    A. Costs of Complying with the Proposed 0.5% Standard
    B. Effect on Current Products and New Product Development
    C. Effect on Competition
    D. Effect on the Retail Licensing System and Overall Marketplace
    E. TTB Response
VIII. The 0.5% Standard vs. the 51/49 Standard--Other Issues
    A. Comments in Favor of the 0.5% Standard
    B. Comments in Favor of the 51/49 Standard
    C. TTB Response
IX. State Concerns
    A. Comments by State Regulatory Agencies
    B. Other Comments in Support of the 0.5% Standard
    C. Other Comments in Support of the 51/49 Standard
    D. TTB Response
X. Mandatory Alcohol Content Labeling for FMBs
    A. Comments Supporting the Proposal
    B. Other Comments
    C. TTB Response
XI. Use of Distilled Spirits Terms on Labels and in Advertisements
    A. Comments Received
    B. TTB Response
XII. New Formula Requirements
    A. Fermented Products Requiring Formulas under Sec.  25.55
    B. Standards for Formula Approval
    C. Alcohol Information in Formulas
    D. Reasonable Range of Ingredients
    E. Formula Confidentiality
    F. Standard Form for Formulas
    G. Formula Proceedings
    H. Placement in the CFR
XIII. Other Issues Raised by Commenters
    A. Information Quality Act
    B. ``Alcohol is Alcohol''
    C. Marketing of FMBs to Underage Drinkers
    D. More Explicit Labeling of FMBs
    E. Establishing Another Category of Alcohol Beverages
    F. Other Comments
XIV. Implementation Dates
    A. Effective Date for Compliance with the New Added Alcohol 
Standard
    B. Effect on Products in the Marketplace
    C. Additional TTB Comment on the Effective Date
XV. Comments on the Proposed Regulatory Text; Regulatory Text 
Changes
    A. Reference to Malt Beverage Standards, Sec. Sec.  7.10 and 
7.11
    B. Comments on Alcohol Flavoring Material Reference, Sec. Sec.  
7.11 and 25.15
    C. Malt Beverages Above 6.0% Alc/Vol; Status of ATF Ruling 96-1
    D. Changes to Sec.  7.31
    E. Reference to Standards for Beer, Sec. Sec.  25.11 and 25.15
    F. Other Sec.  25.15 Issues
    G. Comments on Formula Proposals, Sec. Sec.  25.55-25.58
XVI. Regulatory Analysis and Notices
    A. Executive Order 12866
    B. Regulatory Flexibility Act
    C. Paperwork Reduction Act
XVII. Drafting Information
XVIII. List of Subjects
XIX. Amendments to the Regulations

Notes to Readers

A. ATF-TTB Transition

    Effective January 24, 2003, section 1111 of the Homeland Security 
Act of 2002 (Public Law 107-296, 116 Stat. 2135), divided the Bureau of 
Alcohol, Tobacco and Firearms (ATF) into two new agencies, the Alcohol 
and Tobacco Tax and Trade Bureau (TTB) in the Department of the 
Treasury, and the Bureau of Alcohol, Tobacco, Firearms and Explosives 
in the Department of Justice. The regulation and taxation of alcohol 
beverages remains a function of the Department of the Treasury and is 
the responsibility of TTB. References to the former ATF and the new TTB 
in this document reflect the time frame, before or after January 24, 
2003.

B. Use of Plain Language

    In this document, ``we,'' ``our,'' and ``us'' refer to the 
Department of the Treasury and/or the Alcohol and Tobacco Tax and Trade 
Bureau (TTB). ``You,'' ``your,'' and similar words refer to members of 
the alcohol beverage industry and others to whom TTB regulations apply.

I. Background Information

    Flavored malt beverages are brewery products that differ from 
traditional malt beverages such as beer, ale, lager, porter, stout, or 
malt liquor in several respects. Flavored malt beverages

[[Page 195]]

exhibit little or no traditional beer or malt beverage character. Their 
flavor is derived primarily from added flavors rather than from malt 
and other materials used in fermentation. At the same time, flavored 
malt beverages are marketed in traditional beer-type bottles and cans 
and distributed to the alcohol beverage market through beer and malt 
beverage wholesalers, and their alcohol content is similar to other 
malt beverages--in the 4-6% alcohol by volume range.
    Although flavored malt beverages are produced at breweries, their 
method of production differs significantly from the production of other 
malt beverages and beer. In producing flavored malt beverages, brewers 
brew a fermented base of beer from malt and other brewing materials. 
Brewers then treat this base using a variety of processes in order to 
remove malt beverage character from the base. For example, they remove 
the color, bitterness, and taste generally associated with beer, ale, 
porter, stout, and other malt beverages. This leaves a base product to 
which brewers add various flavors, which typically contain distilled 
spirits, to achieve the desired taste profile and alcohol level.
    While the alcohol content of flavored malt beverages is similar to 
that of most traditional malt beverages, the alcohol in many of them is 
derived primarily from the distilled spirits component of the added 
flavors rather than from fermentation. A review of approved formulas 
showed that more than 99% of the alcohol in some flavored malt 
beverages was derived from added flavorings containing distilled 
spirits instead of from fermentation at the brewery.
    Flavored malt beverages are sold under many proprietary names and 
include alcohol beverages such as alcoholic lemonades, alcoholic colas, 
cooler-type products, and other flavored alcohol beverages. In recent 
years, brewers have partnered with distilled spirits producers in order 
to label flavored malt beverages using prominent distilled spirits 
brand names.
    In ATF Ruling 96-1 (ATF Quarterly Bulletin 1996-1, p. 49), our 
predecessor agency announced its intention to engage in rulemaking on 
the issue of whether it should consider the prohibition, restriction, 
or limitation of the use of flavor materials containing alcohol at any 
stage in the production of malt beverages. Pending rulemaking, the 
ruling held that for malt beverages with an alcohol content in excess 
of 6% alcohol by volume, a maximum of 1.5% alcohol by volume could be 
derived from alcohol flavoring materials. Six years later, in ATF 
Ruling 2002-2, ATF set forth guidance on the labeling and advertising 
of flavored malt beverages and again reiterated its intention to engage 
in rulemaking on the use of alcohol flavoring materials in the 
production of malt beverages.
    In the interim, State regulatory and taxation agencies started to 
express concerns about the status of flavored malt beverages, and these 
agencies requested that ATF or TTB take action to clarify the status of 
these products as either malt beverages or distilled spirits.
    In 2002, ATF examined the formulation of 114 alcohol beverage 
products labeled and marketed as flavored malt beverages. ATF undertook 
this study to find out how these products were produced, what 
ingredients were used, and from where the alcohol in them was derived. 
This study did not examine malt beverages labeled and marketed as 
flavored beers, flavored ales, and so forth (such as ``cherry beer'' or 
``pumpkin ale'') since these types of malt beverages typically have the 
character of malt beverages and their alcohol is derived primarily from 
fermentation. The major results of the study are set forth in the 
tables below:

    Table 1.--Alcohol Derived From Added Alcohol Flavoring Materials
------------------------------------------------------------------------
                                                              Number of
                                                               flavored
    Alcohol percentage derived from added alcohol favors         malt
                                                              beverages
------------------------------------------------------------------------
0-25%......................................................            4
26-0%......................................................            0
51-75%.....................................................           >5
76-100.....................................................          105
                                                            ------------
Maximum alcohol derived from added alcohol flavors: 99.98%.   Total: 114
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    Table 2.--Volume of Beer Base Present in Flavored Malt Beverages
------------------------------------------------------------------------
                                                              Number of
  Volume of flavored malt beverage derived from fermented      flavored
                         beer base                               malt
                                                              beverages
------------------------------------------------------------------------
0-25%......................................................           95
26-50%.....................................................            4
51-75%.....................................................            1
76-100%....................................................           14
------------------------------------------------------------------------

    ATF concluded that the great majority of the alcohol in most 
flavored malt beverages was not derived from fermentation of malt and 
grain. Instead, most of the alcohol in these products was derived from 
distilled spirits contained in added alcohol flavors. ATF found that 
over 75% of the alcohol in most of the flavored malt beverages studied 
was derived from alcohol flavoring materials and that in some cases 
this figure rose to more than 99%. In contrast, the alcohol derived 
from flavors constituted 50% or less of the overall alcohol in only 4 
of the 114 products studied.
    Based on the study's results, ATF also concluded that most flavored 
malt beverages contained very little actual beer base. Only 15 out of 
the 114 flavored malt beverages studied contained 51% or more by volume 
fermented beer; the remaining volume of those 15 products consisted of 
flavors, water, and other ingredients. Two of the flavored malt 
beverages studied contained only 1% fermented beer by volume.

II. TTB Notice No. 4

    On March 24, 2003, we proposed a number of regulatory changes 
concerning beer and malt beverages in TTB Notice No. 4 (published in 
the Federal Register at 68 FR 14292; corrected at 68 FR 15119). Among 
other things, Notice No. 4 solicited comments on whether certain 
products marketed as flavored malt beverages should be classified as 
malt beverages or distilled spirits products under the Federal Alcohol 
Administration Act (FAA Act) and the Internal Revenue Code of 1986 
(IRC). We recognized that the answer to this question would affect the 
rate of tax applicable to these products, the premises on which they 
may be produced, and the way that the products are labeled, advertised 
and marketed. Furthermore, their classification as malt beverages or as 
distilled spirits under Federal law could affect State oversight and 
control of these products, since many States follow the Federal 
classification of alcohol beverages.
    Notice No. 4 included a proposal to limit the quantity of alcohol 
derived from added flavors or other ingredients containing alcohol to 
less than 0.5% alcohol by volume. The notice also requested comments on 
an alternative standard requiring that a malt beverage derive a minimum 
of 51% of its alcohol content from fermentation at the brewery, thus 
allowing no more than 49% of the alcohol content to be derived from 
added flavors containing alcohol.
    As discussed below, Notice No. 4 also included proposed amendments 
to the regulations involving the filing of formulas, and the labeling 
and advertising of malt beverages.

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III. Discussion of Specific Proposals in TTB Notice No. 4

A. Standard for Added Alcohol and Alcohol From Fermentation

    In Notice No. 4, we proposed to delineate how much of the alcohol 
content of a beer or malt beverage must be derived from fermentation at 
the brewery, and how much of the product's alcohol content may be 
derived from alcohol added through the use of flavors and other 
ingredients containing alcohol.
    Neither the IRC nor the FAA Act provides specific limits on the 
quantity of flavors that may be added to beer or malt beverages; nor 
does either statute set forth how much of the alcohol content of those 
products must result from fermentation at the brewery. While neither 
statute expressly sanctions the direct addition of distilled spirits or 
other alcohol to beer or malt beverages, TTB and its predecessor 
agencies, as set forth in ATF Rulings 96-1 and 2002-2, have 
historically allowed flavors, including flavors containing alcohol, to 
be added to these products.
    In Notice No. 4, TTB suggested that the definition of ``beer'' in 
the IRC, which refers to beer, ale, porter, stout, and ``other similar 
fermented beverages,'' requires that a product derive a substantial 
portion of its alcohol from fermentation at a brewery since the 
definition does not contemplate a product that derives most of its 
alcohol content from distilled spirits. As the ATF study referred to 
above demonstrated, few products marketed as flavored malt beverages 
derive a substantial portion, or even a bare majority, of their alcohol 
content from fermentation.
    We also stated that a similar standard should apply to the 
definition of a ``malt beverage'' under the FAA Act. The FAA Act 
defines a malt beverage as a product made from the fermentation of 
malted barley with the addition of hops. While the definition in the 
FAA Act allows for the addition to malt beverages of ``other wholesome 
food products'' such as flavors, we stated that we do not believe that 
Congress intended for these added materials to represent the dominant 
source of a product's alcohol content.

B. Proposed 0.5% Added Alcohol by Volume Standard for ``Beer'' Under 
the IRC

    In Notice No. 4, TTB proposed adding to the regulations a new Sec.  
25.15 (27 CFR 25.15) that would have the effect of treating as a 
distilled spirits product any fermented product that contains 0.5% or 
more alcohol by volume derived from flavors, taxpaid wine, or other 
ingredients containing alcohol. As a consequence of the proposed new 
section, those products would be taxed and classified as distilled 
spirits. This proposed section also would allow the use of barley malt, 
malted grains other than barley, unmalted grains, sugars, syrups, 
molasses, honey, fruit, fruit juice, fruit concentrate, herbs, spices 
and other food materials in the production of a beer. It did not 
provide any standards for the use of these ingredients.
    In Notice No. 4, TTB noted that this 0.5% alcohol standard had long 
been used to determine whether a beverage is considered an alcohol 
beverage. For example, many beverages, including juice, soft drinks, 
and soda, contain a small amount of alcohol derived from the use of 
flavoring materials containing distilled spirits. As long as the 
overall alcohol content of the product is below 0.5% alcohol by volume, 
these products are not considered alcohol beverages, and are not taxed 
as such. If the alcohol content of the a product reaches 0.5% alcohol 
by volume, the product would be subject to the tax imposed on distilled 
spirits products, since it would fall within the statutory definition 
of a distilled spirits product.

C. Proposed 0.5% Added Alcohol by Volume Standard for Malt Beverages 
Under the FAA Act

    In Notice No. 4, TTB proposed adding to the regulations a new Sec.  
7.11 (27 CFR 7.11) that would classify a fermented product as a malt 
beverage only if it contains less than 0.5% alcohol by volume derived 
from flavors or other ingredients containing alcohol. This proposed 
section would also have explicitly permitted filtration or other 
processing to remove color, taste, aroma, bitterness, or other 
characteristics derived from fermentation. We specifically solicited 
comments on this proposed standard and on any other standard that might 
be consistent with the FAA Act definition of a malt beverage.
    Notice No. 4 noted that the FAA Act's definition of ``malt 
beverage'' was intended to cover all products made by brewers at the 
time of the enactment of that Act in 1935. As already noted above, this 
definition requires that a malt beverage be made from the fermentation 
of malted barley with hops, with or without the addition of ``other 
wholesome food products.'' For years, brewers have used many 
substances, including starches, sugars, honey, fruits, flavors 
(including those containing alcohol), colors, and adjuncts to aid in 
fermentation, clarification, and preservation of malt beverages. TTB 
and its predecessor agencies have allowed these ingredients in malt 
beverage products.
    TTB and its predecessor agencies have rarely examined the question 
of what constitutes ``wholesome food products'' under the FAA Act, 
other than to state that the ingredients added to malt beverages must 
be recognized as safe for food use by the Food and Drug Administration 
and must have some intended purpose in malt beverage production. We and 
our predecessor agencies have considered flavorings containing 
distilled spirits to be wholesome food products and have allowed their 
use in producing malt beverages.
    The use of flavors containing distilled spirits can introduce a 
significant amount of distilled spirits into a malt beverage. Adding 
alcohol or distilled spirits in this fashion reduces the need to use 
fermented malt in the production of a malt beverage in order to attain 
alcohol content. When carried to extremes, this practice results in a 
product in which most of the alcohol content is derived from added 
flavors rather than from fermentation at a brewery.
    Based on the above considerations, we stated in Notice No. 4 our 
belief that the definition of a malt beverage in the FAA Act supports 
limiting the amount of alcohol that is not ``made by the alcoholic 
fermentation * * * of malted barley with hops.'' Further, we stated our 
belief that labeling a beverage that derives most of its alcohol 
content from added alcohol flavors as a malt beverage is inherently 
misleading since consumers expect that malt beverages derive a 
significant portion of their alcohol content from fermentation of 
barley malt and other ingredients at the brewery.

D. Alternative 51/49 (Majority) Alcohol Standard

    Although Notice No. 4 stated that both the IRC and the FAA Act 
would support a 0.5% added alcohol standard, it also stated that the 
IRC would support the issuance of a regulation requiring that a beer or 
malt beverage product must derive a majority of its alcohol content 
from fermentation at the brewery. Accordingly, TTB sought comments on 
both the 0.5% standard and a 51/49 standard, which would allow up to 
49% of the alcohol in a beer or malt beverage to be derived from 
flavors or other materials containing alcohol.

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E. Proposed Alcohol Content Labeling Statement for Flavored Malt 
Beverages

    In Notice No. 4, TTB suggested that, due to the unique character of 
these new types of flavored malt beverages, many consumers have limited 
experience with them. At the same time, due to their label appearance 
and the use of the brand names of well-known distilled spirits 
products, TTB believed that consumers are likely to be confused as to 
the actual alcohol content of the products. TTB suggested that 
consumers are likely to assume that some flavored malt beverages are 
high in alcohol content like the distilled spirits products whose brand 
names they bear. Likewise, while other brands of flavored malt 
beverages are not labeled with distilled spirits brand names, their 
labeling or packaging, which often resembles that of nonalcoholic 
beverages such as juices, sodas, bottled water, and energy drinks, is 
likely to confuse consumers as to their identity as alcohol beverages.
    To avoid consumer confusion over the alcohol content in flavored 
malt beverages, we proposed the addition of a new paragraph (a)(5) in 
Sec.  7.22, (27 CFR 7.22), setting forth a mandatory requirement to 
state on the brand label the alcohol content of any malt beverage that 
contains any alcohol derived from added flavors or other ingredients 
containing alcohol. We suggested that this requirement would help 
consumers identify these products as alcohol beverages and would help 
consumers to understand that their alcohol content is similar to that 
of traditional malt beverages. This alcohol content labeling would also 
draw attention to any flavored malt beverages that might lie outside 
the customary 4 to 6% alcohol by volume range for malt beverages. For 
example, if a flavored malt beverage contained 10% alcohol by volume, 
alcohol content labeling would inform consumers about this important 
fact.
    Since there is no provision in the TTB regulations that uniquely 
identifies flavored malt beverages, we proposed that the mandatory 
alcohol content labeling apply to any malt beverage that contains 
alcohol from a source other than fermentation at the brewery. For 
example, if a brewer adds a flavoring containing alcohol to a malt 
beverage, whether it is labeled as a flavored malt beverage, as a 
flavored beer or ale, or as a specialty malt beverage product, the 
requirement to display alcohol content on the brand label would apply. 
We proposed no changes to the form of the alcohol content statement, to 
the tolerances provided in 27 CFR 7.71, or to the type size 
requirements in 27 CFR 7.28.

F. Use of Distilled Spirits Terms in Malt Beverage Labeling and 
Advertising

    Notice No. 4 pointed out that some newer flavored malt beverages 
use the names of well-known brands of distilled spirits as part of 
their own brand names. The labels of these flavored malt beverage 
brands are often designed to resemble the labels of the distilled 
spirits brand used in their names. In addition, when first introduced, 
some of these flavored malt beverages bore label statements referring 
to the class and type of distilled spirits used in producing the 
nonbeverage-flavoring component. For these reasons, a number of State 
regulatory and taxing authorities questioned the classification of 
flavored malt beverages and requested that we take action to clarify 
their status as either malt beverages or distilled spirits.
    As previously noted, ATF Ruling 2002-2 clarified permissible 
labeling and advertising practices for flavored malt beverages, and 
gave brewers and importers labeling guidelines to prevent the 
misleading impression that flavored malt beverages are distilled 
spirits or contain distilled spirits. Notice No. 4 proposed to 
incorporate the holdings of the ruling in a new 27 CFR 7.29(a)(7) for 
labeling purposes and a new 27 CFR 7.54(a)(8) for advertising purposes. 
These proposed provisions would add to the malt beverage regulations 
language similar to that found in the FAA Act wine regulations 
regarding distilled spirits statements. The proposed language would 
prohibit labeling and advertising statements that imply that malt 
beverages are similar to distilled spirits or that malt beverage 
products are made with, or contain, distilled spirits.
    The two new provisions in question would allow the use of a brand 
name of a distilled spirits product as the brand name of a malt 
beverage. However, the proposed provisions would have the effect of 
prohibiting the use of a distilled spirits brand name in any other malt 
beverage labeling or advertising context. The use of a cocktail name as 
a brand name or fanciful name would be permitted if the malt beverage's 
overall formulation, label, or advertisement did not present a 
misleading impression about the identity of the product.

G. Filing Formulas for Fermented Beverages

    Notice No. 4 noted that the TTB regulations at 27 CFR 25.62 and 
25.67 require brewers to file a statement of process with TTB's 
National Revenue Center in Cincinnati, Ohio, as part of the Brewer's 
Notice for any fermented beverage that the brewer intends to market 
under a name other than ``beer,'' ``lager,'' ``ale,'' ``porter,'' 
``stout,'' or ``malt liquor.'' Under 27 CFR 25.76, a brewer must file 
an amended Brewer's Notice if there are changes to an approved 
statement of process. When a brewer files a statement of process with 
the National Revenue Center, a specialist at TTB's Advertising, 
Labeling and Formulation Division in Washington, DC, examines the 
proposed statement of process to ensure that authorized materials will 
be used, to determine the correct class and type, and to ensure that 
the fermented product may be made at a brewery.
    Notice No. 4 proposed significant changes to the filing 
requirements described above. These changes included the removal of 
Sec. Sec.  25.62(a)(7), 25.67 and 25.76 and the addition of new 
Sec. Sec.  25.55 through 25.58 (27 CFR 25.55 through 25.58). These 
changes would:
     Replace the statement of process requirements found at 
Sec. Sec.  25.62(a)(7) and 25.67 with a formula requirement;
     Describe more clearly the fermented products for which a 
formula is necessary;
     Require brewers to provide specific information about 
ingredients, processes, and alcohol content in formulas;
     Allow brewers to file formulas directly with the 
Advertising, Labeling and Formulation Division in Washington, DC;
     Permit brewers to produce certain fermented beverages 
solely for research and product development purposes without having to 
receive formula approval;
     Allow brewers to file formulas to cover production at 
multiple breweries; and
     Allow brewers to file superseding formulas.
    Proposed Sec.  25.55 would require the filing of a formula with TTB 
for specified products made at a brewery, including sak[eacute], 
flavored sak[eacute], and sparkling sak[eacute]. A formula also would 
be required for products to which any coloring or natural or artificial 
flavors are added, or for any product to which fruits, herbs, spices or 
honey are added. This new section also would require the filing of a 
formula for any fermented product that undergoes special processing or 
filtration, or undergoes any other process not used in traditional 
brewing. The proposed Sec.  25.55 text included examples of processes 
that would require the filing of a formula, including reverse osmosis, 
ion exchange treatments, filtration that changes the

[[Page 198]]

character of beer or removes material from beer, concentration or 
reconstitution of beer, and freezing or superchilling of beer. However, 
the proposed Notice No. 4 text would not require filing a formula for 
traditional brewing processes such as pasteurization, filtration prior 
to bottling, filtration in lieu of pasteurization, centrifuging (for 
clarification), lagering, carbonation and the like.
    Notice No. 4 also proposed more specific requirements for the 
information required in formulas, especially in the realm of flavoring 
materials and special processes. Proposed Sec.  25.57 spelled out in 
more detail the information required in formulas, and included 
requirements found in ATF Rulings 94-3 (which concerned the production 
of ice beer), 96-1, and 2002-2. In keeping with the current practice of 
listing ranges of ingredients in statements of process, proposed Sec.  
25.57(a)(1) would permit brewers to indicate a ``reasonable range'' of 
ingredients used in formulas. However, in order to establish a useful 
limit, Notice No. 4 requested comments on how to define a ``reasonable 
range'' for the quantity of ingredients used in making fermented 
products. Also in keeping with current policy that permits using 
special processes in making fermented products, the proposed Sec.  
25.57 text specifically permitted such special processes, but required 
brewers to describe them in detail in their formulas.
    As noted in Notice No. 4, Sec.  25.67 requires brewers to file a 
statement of process prior to producing any fermented product at the 
brewery that is not to be marketed under a traditional designation. 
This regulation does not provide any exception permitting research or 
development of fermented products without a statement of process. With 
the removal of Sec.  25.67, a brewer could produce certain fermented 
beverages for research and development purposes under proposed Sec.  
25.55(c)(2) without receiving formula approval; however, a brewer could 
not sell or market such products until receiving formula approval.
    Proposed Sec.  25.55(e) stated that previously approved statements 
of process would remain valid after adoption of the new regulation, 
provided that the finished product is in compliance with any new 
requirements relating to the definition of beer.
    The proposed formula regulations did not specify any Government 
form to be used for their filing. TTB also solicited comments on 
whether the proposed regulations on the preparation and filing of 
formulas would be easier and less confusing than the present statement 
of process requirement.

H. Samples; Formulas and Samples for Imported Malt Beverages

    Notice No. 4 also included a proposed new section, Sec.  25.53 (27 
CFR 25.53), specifically authorizing a TTB officer at any time to 
require the submission of samples. This section recognized TTB's 
authority to require a brewer to submit a sample of a beer or a 
material used in producing a beer. For example, we occasionally examine 
samples of beer or ingredients in connection with our review of 
statements of process or formulas and in order to determine the proper 
tax classification of fermented products.
    Finally, Notice No. 4 also included a proposed amendment to Sec.  
7.31 (27 CFR 7.31) to reflect TTB's statutory authority to require an 
importer to submit a formula for a malt beverage, or a sample of a malt 
beverage or materials used in producing a malt beverage, in connection 
with the filing of a certificate of label approval on TTB Form 5100.31. 
This proposal recognized the fact that, occasionally, TTB has had to 
examine a statement of process or analyze samples of a malt beverage in 
order to determine the proper classification of a product, whether a 
particular product is a malt beverage, or whether a product is 
correctly labeled under the part 7 regulations.

I. Other Issues Raised in Notice No. 4

    In addition to the very specific proposals made by Notice No. 4, 
TTB requested comments and information on a number of general topics 
relating to the production and labeling of flavored malt beverages.
    TTB requested comments on the proposed 0.5% added alcohol standard 
for beer. Specifically, we solicited information regarding any studies, 
laboratory trials, or other empirical data that may have existed for 
added alcohol in flavored malt beverages. We also sought comments on 
how adoption of the proposed standard would affect the taste, shelf 
life, stability, or other characteristics of flavored malt beverages. 
In addition, we sought comments on whether production practices are 
available to produce flavored malt beverages with the desired product 
profile that would comply with the proposed standard. We also solicited 
comments relating to the effect of the proposed regulation on the 
viability of products currently on the market. Notice No. 4 further 
stated that we were particularly interested in comments addressing 
whether products on the market could be made under the proposed 0.5% 
added alcohol standard.
    Finally, as previously noted, TTB requested comments on whether 
another standard, such as a standard requiring that a minimum of 51% of 
the alcohol in a malt beverage be derived from fermentation at the 
brewery (in other words, setting a maximum limit of 49% for the alcohol 
content derived from added flavors or other materials), would be more 
appropriate than the proposed 0.5% added alcohol standard. We asked for 
supporting data, facts, or studies to back up any suggestions or 
comments for different added alcohol standards. Since we recognized 
that any new standard would constitute a substantial change from 
existing regulations and policy, we also sought comments on the amount 
of time needed to comply with any new rule limiting the amount of 
alcohol that may be added to products taxed as beer. Notice No. 4 
encouraged comments on the amount of time necessary to develop and 
implement new formulas for these products and the possible costs 
involved.

IV. Rulemaking History

    Notice No. 4 provided for the submission of comments through June 
23, 2003. At the request of the E. & J. Gallo Winery, on June 2, 2003, 
we published Notice No. 10 (68 FR 32698) to extend the period for the 
submission of comments for an additional 120 days, until October 21, 
2003.
    In Notice No. 4 we stated our intention to place all comments on 
the TTB Web site on the Internet. We stated that the names of 
commenters would be included in the posting of comments on our Web 
site, but that street addresses, telephone numbers, or e-mail addresses 
would be deleted on these postings. We did state that this information 
would appear on copies of comments available in the TTB reference 
library in Washington, DC.
    Due to the large number of comments, we were unable to redact 
street address, telephone number, or e-mail address information from 
the comments we posted on our Web site. Redacting this information from 
the large number of comments received would have prevented us from 
posting comments on the Web site in a timely manner. Therefore, we 
issued TTB Notice No. 23 on December 2, 2003 (68 FR 67388). This notice 
advised the public of our inability to redact the information from 
comments posted on the Web site and provided an opportunity for 
commenters to request that we redact this information from their 
individual

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comments if we received their request to do so by December 23, 2003.

V. Comments Received in Response to Notice No. 4

A. General Discussion of Comments

    Before the close of the comment period, TTB received over 15,000 
comments in response to Notice No. 4. Of these, over 14,000 consisted 
of variations on several form letters, which were submitted by mail, 
facsimile transmission, or e-mail.
    In addition, we received over 1,000 comments after the close of the 
comment period. Due to the large volume of comments received in 
response to Notice No. 4, and because of the need to provide 
expeditious guidance to State regulatory agencies, the industry, and 
consumers on this issue, we determined that it was not practical to 
consider the late-filed comments.
    Most of the comments focused on the proposed 0.5% standard or the 
51/49 standard for beer and malt beverages. In particular, the ``form 
letter'' comments, which made up the vast majority of the comments, 
generally commented for or against the proposed rule, and either 
explicitly or implicitly commented on the standard for added alcohol. 
The hundreds of comments received from State legislators also focused 
primarily on this issue. While Notice No. 4 solicited comments on 
whether there was a different standard that would be appropriate, only 
a few comments addressed this question.
    Furthermore, only a small percentage of the total comments focused 
on issues such as alcohol content statements or formula requirements. 
Accordingly, the following breakdown of comments focuses on the 
commenters' position on the proposed 0.5% standard.

B. Overview of Comments

    In the following comment discussion, the abbreviations ``FMB'' and 
FMBs'' are used in place of ``flavored malt beverage(s).''
1. Form Letters
    Of the over 14,000 form letter submissions referred to above, over 
8,000 supported adoption of the proposed 0.5 percent standard and over 
5,000 opposed adoption of that standard. The submissions in support of 
the proposed rule (or specifically in support of the 0.5 percent 
standard) break down as follows:
     Over 5,000 e-mail comments came from individuals who 
identified themselves as employees of one major U.S. brewer and its 
subsidiaries. These commenters stated that the proposed standard is the 
best way to maintain clear distinctions between beer and liquor 
(distilled spirits) and to preserve the flavored malt beverage 
category.
     Over 2,000 comments were received from beer distributors 
across the United States. Many of these commenters stated that the 
proposed rule is consistent with the historical interpretation of what 
constitutes beer and other malt beverages. They suggested that beer is 
a unique product that has been regulated and taxed differently from 
other alcohol beverages throughout our Nation's history. The commenters 
advocated adopting the proposed 0.5% standard in order to ensure the 
integrity of beer and the brewing process. They also stated that the 
proposed rule would help maintain an orderly marketplace and avoid 
costly and confusing disruptions in State licensing, taxation, and 
distribution policies, any of which would deal a blow to beer 
wholesalers.
     Approximately 900 comments were received from individuals 
who identified themselves as employees of another major brewer. These 
comments supported the proposed rule as a clarification that will 
ensure that if FMBs were sold as malt beverages, they would be made 
according to traditional brewing methods and practices. The commenters 
suggested that without the proposed rule, retailers and wholesalers 
would face a patchwork of individual State laws and regulations.
     Over 170 submissions came from beer consumers located 
primarily in two States. Many of these commenters stated that the 
proposed rule would provide a clear understanding to legislators, State 
and Federal regulators, and beer consumers as to what beer is and what 
beer is not.
     More than 50 employees of a domestic subsidiary of a 
foreign brewer expressed their support for the proposed rule. They 
suggested that the proposed rule would maintain an orderly marketplace, 
meet consumer expectations for consistent products, and help sustain 
the long-term development of the product category. These commenters 
suggested that the reformulated products would be consistent with State 
tax, license, and distribution laws, allowing wholesalers and retailers 
to continue their operations. Furthermore, they stated that without a 
standard, individual States would adopt their own regulations and 
create a patchwork of different standards.
    The submissions in opposition to the 0.5 percent standard break 
down as follows:
     Over 4,000 e-mail submissions came from consumers of FMBs. 
These comments opposed the proposed rule and suggested that there was 
no need to amend the regulations. Many of the commenters stated that 
they like FMBs just the way they are and that the proposed changes will 
be expensive and will result in increased costs to consumers.
     Over 600 comments came from employees of a large producer 
of FMBs. These commenters opposed the proposed rule and suggested TTB 
instead adopt the ``51% compromise.'' The commenters suggested that 
compliance with the proposed standard would cost millions of dollars in 
new equipment purchases, reformulation of products, and development of 
new processes. They urged TTB to adopt regulations that promote fair 
competition and provide a level playing field, and they suggested the 
proposed rule would mark a dramatic change in how these products have 
been produced, marketed, and sold for 30 years. Finally, the commenters 
stated that the proposed rule could regulate FMBs out of the 
marketplace, depriving consumers of a drink they enjoy, costing 
millions in tax revenue, and resulting in the loss of thousands of 
jobs.
     Over 400 small retailers located across the United States 
expressed their opposition to the ``new regulations'' and ``rule 
changes.'' Many of these retailers asked TTB to reach a ``compromise'' 
that would allow FMBs to remain in existence. The commenters suggested 
that the regulatory changes would raise the price of FMBs, sabotage 
this category of products by making it impossible or costly to sell 
them, and adversely impact small businesses.
     More than 40 comments were received from employees of FMB 
distributors. These commenters opposed the 0.5 percent standard and 
urged TTB to adopt a ``more reasonable'' majority standard instead. The 
commenters focused on the potential impact of the proposed rule on the 
future of FMB producers and the businesses that rely on the viability 
of these products.
2. Other Comments
    FMB Producers. We received comments from several major producers of 
FMBs. The Beer Institute submitted a comment in support of the proposed 
0.5% standard, on behalf of Anheuser-Busch, Miller Brewing Company 
(``Miller''), and Coors Brewing Company (``Coors''). The Beer Institute 
stated that these three senior and sustaining members produce or import 
well over 75% of the beer and other malt beverages sold in the United 
States,

[[Page 200]]

including many successful FMB brands. In addition, these three brewers 
each submitted individual comments in support of the proposed 0.5% 
standard.
    These commenters argued that the proposed 0.5% standard is 
consistent with TTB's statutory authority and will preserve the 
integrity of the products known as beer or as malt beverages. More 
importantly, these commenters suggested that only a 0.5% standard would 
maintain an orderly marketplace and foreclose actions by individual 
States, which could adopt their own potentially differing and 
conflicting standards. Anheuser-Busch and Miller stated that they could 
take steps to reformulate their products within the 0.5% standard and, 
in fact, have produced FMBs that achieve the same taste and appearance 
as existing products.
    The Flavored Malt Beverage Coalition (FMBC) submitted a comment on 
behalf of its members: City Brewing Company; Diageo North America, 
Inc.; High Falls Brewing Company; Mark Anthony Brands, Inc.; Pernod 
Ricard USA; Todhunter International; and United States Beverage LLC. 
The FMBC stated that, together, its members marketed and/or produced 
approximately 56% of the FMBs sold in the United States in 2002. The 
FMBC also stated that its members, as companies that collectively spent 
hundreds of millions of dollars to develop products now threatened by a 
change in Federal policy, have a particular interest in the outcome of 
the rulemaking.
    The FMBC, and several of its individual members, questioned TTB's 
statutory authority to impose restrictions on the current practice but 
also stated that, as a matter of policy, they would support a final 
rule that adopts the 51/49 standard. Furthermore, these commenters 
raised a number of legal challenges to the basis for the proposed rule, 
and they argued that the proposed 0.5% standard was not supported by 
either the consumer protection rationale or the need to take action 
before the States do so.
    Several of these commenters stressed the economic impact of the 
proposed rule. Many FMB producers suggested that the proposed 0.5% 
standard would require reformulation of popular FMB products, with a 
potentially adverse impact on consumer acceptance of those products. 
The FMBC submitted an economic study indicating that adoption of the 
proposed rule would have an adverse impact on the FMB industry, 
amounting to over $600 million over the next 4 years. Comments from a 
few small brewers that produce and bottle FMB products indicated that 
their survival would be in jeopardy under the proposed rule.
    Brown-Forman Corporation (``Brown-Forman''), the producer of an FMB 
known as Jack Daniel's Country Cocktails, also commented in favor of 
the 51/49 standard. Finally, E. & J. Gallo Winery (Gallo), which 
produces 13 FMB products, submitted a comment in which it took no 
position on whether it preferred the 0.5% standard or the 51/49 
standard.
    Other Comments from the Beer Industry. The National Beer 
Wholesalers Association (NBWA) and the Brewer's Association of America 
(BAA) both commented in favor of the proposed 0.5% standard. TTB also 
received many comments from craft brewers, beer wholesalers, employees 
of the major brewers, and others in the beer industry supporting the 
proposed rule. Many of these comments suggested that FMBs are not beer 
or malt beverages as consumers understand these terms and that the 
proposed rule would preserve the integrity of the malt beverage 
category. Some brewers suggested that competition from FMB producers is 
hurting the beer industry.
    Consumer/Taxpayer Groups. The Center for Science in the Public 
Interest (CSPI), the Pacific Institute for Research and Evaluation, and 
several other associations commented in favor of the proposed rule. 
CSPI stated that the use of popular, well-known distilled spirits brand 
names in the advertising and labeling of malt beverage products 
misleads consumers. CSPI also suggested that these ``alcopops'' are 
extremely popular with underage drinkers, and that since most 
``alcopop'' products currently do not comply with the 0.5% standard, 
classifying and taxing them as distilled spirits products would help 
reduce youth access to such products by placing them in liquor stores 
in many States rather than in grocery and convenience stores.
    The National Consumers League (NCL) commented against the 0.5% 
standard, stating that it opposed the perpetuation of policies that 
differentiate malt-based alcohol beverages from distilled alcohol 
beverages, and suggesting that ethyl alcohol is the same, regardless of 
whether it is in beer, wine, or distilled spirits. NCL agreed, however, 
that requiring compliance with a ``majority'' standard will ensure that 
an FMB actually contains malt, and in a significant concentration. 
While NCL questioned whether source of alcohol is in any way material 
to consumer choice, it concluded that FMB compliance with the majority 
rule would ensure that consumers are not deceived as to product 
content.
    TTB also received comments opposing the proposed rule from taxpayer 
and citizen organizations. These commenters suggested that the proposed 
rule would limit consumer choice, decrease competition, and waste 
taxpayer dollars. The commenters stated that the Government should 
accommodate legitimate consumer, industry, and employment needs. They 
suggested that the majority standard would achieve these goals better 
than the proposed 0.5% standard.
    State Regulatory Agencies and Lawmakers. TTB received comments from 
31 State regulatory or tax agencies and one county liquor commission. 
Most of these comments specifically supported the proposed rule. The 
remaining comments generally supported the concept of a uniform 
standard for FMBs, without specifically supporting the proposed 0.5% 
standard. Two States simply provided information about their State 
laws, without taking a position on the standard. We also received 
comments in support of the proposed rule from three Governors, one 
Lieutenant Governor, and over 200 State legislators. A smaller number 
of State legislators commented in favor of the 51/49 standard.
    Some comments that specifically favored the proposed rule suggested 
that, in many States, malt beverages containing distilled spirits would 
be classified as spirits rather than malt beverages. Several States 
indicated that if TTB does not take expeditious action on this issue, 
they would go ahead and issue their own standards. Other States, 
however, simply stressed the need for a uniform standard and urged TTB 
to take expeditious action to create a standard for FMBs.
    Members of Congress. We received comments in favor of the proposed 
rule from nine members of the United States House of Representatives. 
We received comments in favor of the 51/49 (or majority) standard from 
28 members of the House of Representatives and eight United States 
Senators.
    Many of the members of Congress who commented in favor of the 51/49 
standard expressed concern about the negative economic impact that the 
proposed rule would have on employers and jobs within their districts 
or States. Many of these comments noted that existing FMB products were 
formulated in reliance on the longstanding policies of our predecessor 
agency.
    Miscellaneous comments. We received a comment from the Flavor and 
Extract Manufacturers Association of the U.S. (FEMA), the national 
trade

[[Page 201]]

association of companies that create and manufacture flavors for use in 
a wide variety of products, including FMBs. FEMA urged TTB to 
reconsider the proposed 0.5% standard, stating that it would 
significantly restrict the amount of alcohol contributed to the 
finished product from flavors and thus make it technically impossible 
for flavor chemists to satisfy the consumer desire for the distinctive, 
fresh, fruity malt beverages currently being sold.
    We received a few comments suggesting revisions to the system of 
taxing alcohol beverages as a way to take care of the classification 
issue posed by FMBs. These comments could not be adopted without 
legislative amendments to the IRC. Since the rest of the comments 
focused primarily on the two standards that we aired in Notice No. 4, 
the 0.5% standard and the 51/49 standard, our discussion of the 
comments will focus on those two standards.
    A small number of commenters focused on the remaining issues raised 
for comment in Notice 4. While we received several comments from States 
and consumer groups in support of the proposed mandatory alcohol 
content labeling for FMBs, many comments from industry members 
suggested that FMBs were being unfairly singled out, and that any such 
requirement should apply to all malt beverages or to none. We also 
received a few comments in opposition to the proposed limitations on 
the use of distilled spirits terms in malt beverage labeling and 
advertising. Some of these commenters claimed that the proposed 
restrictions violated the First Amendment.
    Finally, we received a small number of comments from brewers and 
brewery trade associations regarding the proposed new formula filing 
requirements. These commenters generally favored the new requirements, 
but they expressed concerns regarding certain aspects of the proposal 
and requested that TTB clarify some of the proposed formula 
requirements.

C. Summary of TTB Final Rule Decisions

    After carefully analyzing the comments, which are discussed in 
greater detail below, we are adopting the proposals set forth in Notice 
No. 4 with certain important modifications. The final rule adopts the 
less stringent ``51/49 standard'' (allowing up to 49% of the alcohol 
content to come from flavors and other nonbeverage ingredients) for 
beers and malt beverages. We are providing affected industry members 
one year to reformulate their FMB products or otherwise conform to the 
standards adopted in the final rule. In reaching these decisions, we 
note that Executive Order 12866 provides that, when an agency 
determines that a regulation is the best available method of achieving 
an objective, it shall design its regulation in the most cost-effective 
manner to achieve that objective.
    The comments on Notice No. 4 have persuaded us that implementation 
of the proposed 0.5% standard might impose economic burdens on a sector 
of the FMB industry and have adverse effects on the viability of small 
brewers who produce FMBs, as well as their ability to compete within 
the malt beverage industry.
    We believe that adoption of the alternative ``51/49 standard'' for 
beers and malt beverages would achieve the important regulatory goals 
of protecting the revenue, ensuring that consumers have adequate 
information about the identity of FMB products, and establishing a 
Federal standard for such products, while at the same time reducing the 
compliance costs to the FMB industry. It is noteworthy that, with the 
exception of one producer that remained neutral on this issue, comments 
from the producers of FMBs all supported either the more restrictive 
0.5% standard or the more liberal 51/49 standard. Thus, most of the FMB 
industry expressed support for creating some type of standard for FMBs 
that would set a limit on the alcohol derived from added flavors.
    The final rule also adopts the other proposals aired in Notice 4, 
with certain modifications in response to the comments. We are adopting 
the proposed mandatory alcohol content labeling requirements, as we 
have concluded that this requirement will provide consumers important 
information about these FMBs. Since we specifically stated in Notice 
No. 4 that we were not proposing mandatory alcohol content labeling for 
all malt beverage products, comments advocating such a position were 
considered to be outside the scope of the current rulemaking. We may 
consider such a proposal in the future.
    We are also adopting the labeling and advertising proposals, with 
modifications to respond to the First Amendment concerns raised by 
several commenters. As modified, the regulation will prohibit the use 
of labeling or advertising statements, designs, devices, or 
representations that tend to create a false or misleading impression 
that the malt beverage contains distilled spirits or is a distilled 
spirits product. These modifications clarify that we are only 
prohibiting labeling and advertising statements that are false or tend 
to mislead consumers.
    Finally, we have modified the language of the formula regulations 
in response to several comments about whether the proposed requirements 
were overly burdensome. For example, we are no longer requiring 
formulas to disclose the alcohol content of the product at each interim 
stage of production. We have also clarified the language of these 
provisions in response to several technical comments.

VI. Comments on Whether the Rulemaking Is Necessary and Fair

    In this section, we discuss some of the general issues raised by 
commenters regarding the need for engaging in rulemaking and the 
fairness of the proposed change in agency policy.

A. Is There a Need To Engage in Rulemaking on This Issue?

    The first issue presented is whether there is a need to engage in 
rulemaking at all. Many commenters suggested that TTB should not amend 
its regulations in any manner, but should instead allow the continued 
production of FMBs according to current policy. Other commenters 
supported the idea of rulemaking on FMBs.
1. Comments Opposed to Rulemaking
    As indicated above in the comment overview, TTB received over 4,000 
e-mail comments that questioned the need for rulemaking on FMBs. These 
comments came from consumers who stated that they enjoyed drinking 
FMBs, and that they opposed the proposed regulation, which would 
mandate changes in the way those products were made. The commenters 
stated that they liked FMBs the way they are, that the changes would be 
expensive, and that consumers will end up paying more under the 
proposed rule.
    Many of these commenters suggested that the Federal Government 
should not waste tax dollars on ``trivial'' issues such as how FMBs are 
made, and that companies should make changes that consumers want, not 
what the Government demands. Finally, many of these comments suggested 
that the Government should focus on bigger issues, such as job 
creation, improving the economy, and fighting terrorism. These comments 
did not directly address the 51/49 standard.
    A few comments were also received from organizations representing 
taxpayer and citizen groups, including Americans for Tax Reform, the 
National Taxpayers Union, and Citizens Against Government Waste. One of 
these commenters stated that the proposed

[[Page 202]]

rule would limit consumer choice, decrease competition, and waste 
taxpayer dollars. This commenter suggested that the Government should 
accommodate legitimate consumer, industry, and employment needs before 
engaging in rulemaking. Another commenter expressed concerns that the 
0.5% standard would force either a significant tax increase and/or a 
change in the production process for FMBs. It should be noted that 
while these comments generally criticized the proposed rule, they 
expressed a preference for either the 51/49 standard or some compromise 
over the 0.5% standard.
2. Comments Supporting Rulemaking
    TTB also received approximately 11,000 comments urging that TTB set 
a limit on the quantity of alcohol derived from added flavors in malt 
beverages. While these comments were divided over whether the limit 
should be set at the 51/49 standard or the proposed 0.5% standard, 
these commenters believed that it was important that TTB set a standard 
and clarify the classification of these products as malt beverages or 
distilled spirits. It should be noted that we received comments in 
support of setting a standard from the beer industry, producers of 
flavored malt beverages, consumers, members of Congress and other 
elected officials, and State regulatory agencies.
    These commenters supported the setting of a uniform Federal 
standard for a variety of reasons. Some commenters expressed concern 
that current labels mislead consumers. Many consumers and brewers 
suggested that the Federal government has the responsibility to 
maintain a distinction between traditional beer products and distilled 
spirits, and that the line between these two well-established 
categories should not be blurred by allowing the production of malt 
beverages that derive most of their alcohol content from the distilled 
spirits components of added flavors.
    Many commenters expressed concern that, in the absence of a Federal 
standard, the States would each set their own standards, leaving 
members of the beer industry facing a confusing patchwork of regulatory 
standards. Finally, of the FMB producers who commented on this issue, 
almost all supported action to set a standard to limit the quantity of 
alcohol derived from added flavors. While one major FMB producer 
expressed neutrality on the issue, the rest favored either the proposed 
0.5% standard or the 51/49 standard.
3. TTB Response
    We acknowledge that FMBs are a popular category of alcohol beverage 
and that many consumers enjoy drinking these products. We recognize the 
concerns of many consumers that proposed regulatory changes may 
increase the cost of these beverages, and we have given serious 
consideration to cost issues in drafting this final rule. We have also 
given serious consideration to the issues of decreased competition and 
consumer choice.
    Nonetheless, after reviewing the thousands of comments received in 
response to this notice, we believe more strongly than ever that 
rulemaking on this issue is necessary. The overwhelming majority of the 
State regulatory agencies that commented on FMBs urged TTB to adopt a 
Federal standard for these products in order to avoid a patchwork of 
inconsistent State requirements. In addition, comments from the beer 
industry overwhelmingly favored the adoption of a Federal standard, 
including many commenters who pointed to the importance of maintaining 
a distinction between malt beverages, in which alcohol is derived from 
fermentation, and distilled spirits, in which alcohol is derived from 
distillation.
    Treasury and TTB believe it is important, in order to protect both 
the revenue and the consumer, to set a limit on the use in FMBs of 
alcohol not derived from fermentation at the brewery and prevent the 
unlimited use of alcohol derived from distilled spirits in FMB 
production. Thus, we do not adopt the views of those commenters who 
urged that TTB take no action on this matter.

B. Fairness and Notice Issues

1. Comments Received
    Many commenters argued that it is unfair for TTB to change a policy 
upon which brewers and importers have relied for several decades. These 
commenters made the following arguments:
     Since the 1950s, TTB and its predecessor agencies have 
required the review and approval of a statement of process (SOP) for 
any beer produced with flavors. By reviewing and approving SOPs for the 
various FMBs on the market today, TTB has accepted them as beer and 
malt beverages, and has endorsed the use of nonbeverage flavors up to 
the quantities indicated in the SOPs.
     Our predecessor agencies have officially recognized the 
use of flavoring materials in the production of malt beverages since 
the Internal Revenue Service issued Revenue Procedure 71-26 over 30 
years ago.
     In 1980, ATF issued Industry Circular 80-3, which advised 
brewers that adjunct materials listed in the beer industry's Adjunct 
Report (later referred to as the Adjunct Reference Manual (ARM)), were 
suitable for use in beer and cereal beverages when used in accordance 
with the conditions described in the report. That Adjunct Report, as 
well as all subsequent editions of the ARM, lists ethyl alcohol as a 
permitted additive for use in flavoring beer, without any limitations.
    Several commenters stated that they have relied on these policies 
to create beverages that consumers enjoy and that they have invested 
millions of dollars promoting those brands.
    Some commenters argued that the industry had ample warning that 
TTB's predecessor agency was contemplating a limitation on the use of 
flavors containing alcohol in the production of beer and malt 
beverages. These commenters noted that in 1996 ATF notified the 
industry, through ATF Ruling 96-1, that rulemaking limiting the alcohol 
contribution from flavors in FMBs under 6% alc/vol was forthcoming. 
This ruling clearly stated that TTB would initiate future rulemaking to 
consider the prohibition, restriction, or limitation on alcohol derived 
from the distilled spirits components of added flavors, a statement 
that was reiterated in ATF Ruling 2002-2.
    However, commenters who opposed the proposed 0.5% standard 
suggested that ATF's actions after 1996 sent mixed signals to the 
industry. For example, a U.S. Senator stated that although the Bureau 
in 1996 suggested that rulemaking ``in the near future'' might limit 
the use of flavors in such products, it abandoned that rulemaking 
project and did not even mention it in the unified regulatory agenda 
that every Federal agency must publish on a semi-annual basis. Another 
U.S. Senator noted that although the 1996 ruling mentioned rulemaking, 
no such rulemaking proposal appeared until 2003. The Senator suggested 
that:

    In the intervening 7-year time period, manufacturers have relied 
on the existing law and the Bureau's formula approvals to invest 
hundreds of millions of dollars in the formulation and marketing of 
new products. These investments have created hundreds of jobs and a 
vibrant fast-growing U.S. market sector in which tens of millions of 
cases of FMBs have already been sold. Without a reasonable public 
health or safety rationale, it does not seem prudent or fair to 
revise these rules dramatically at this stage of the game.


[[Page 203]]


Accordingly, the Senator urged TTB to adopt the 51/49 standard, as it 
would ``accomplish the same goals and have a lesser impact on these 
products and the industry that produces them.''
    Other members of Congress made similar comments. A letter signed by 
26 members of the House of Representatives supported the ``majority'' 
standard, stating that over the past 5 years, ``hundreds of millions of 
dollars have been invested in the development of the FMB category. 
These investments, and the thousands of jobs created, were all made on 
the reliance of long-standing federal policy and rules.'' The letter 
suggested that Notice No. 4 intends to ``change the established rules 
mid-stream on those who have successfully created the category. This is 
especially troubling in that it threatens to stifle the only growth 
sector in the brewing industry over the last several years.''
    Diageo stated that, in the summer of 2000, company officials met 
with ATF representatives and revealed Diageo's plans to enter the FMB 
market in the near future in reliance on existing policy. Diageo stated 
that company officials advised ATF that it would reconsider these plans 
if ATF planned to place new limits on the use of flavors in FMBs 
containing not more than 6% alc/vol. Diageo also stated that, after the 
meeting, ATF officials indicated that the agency did not plan to change 
existing policy towards FMB formulation. Diageo claims that, in 
reliance on those assurances, Diageo introduced Smirnoff Ice in 
December 2000.
    The FMBC also stated that a number of its members had received 
assurances from ATF, in the summer of 2000, that ATF planned no change 
in policy towards the addition of alcohol to FMBs containing 6% alcohol 
by volume or less. The FMBC stated that it sought these assurances 
after an ATF official sent a letter indicating that the Bureau was 
considering rulemaking, which might limit the alcohol from added 
flavors to no more than 25% of the total alcohol content of the 
product.
    A commenter pointed out that although ATF Ruling 96-1 stated that 
ATF would undertake rulemaking to limit alcohol from flavors in beer 
and malt beverages, ATF labeling and formula specialists never 
qualified approvals of statements of process or labels by stating that 
the approval was conditioned on future rulemaking. Instead, these 
commenters claimed that ATF continued to approve statements of process 
and labels without qualification. Another commenter stated that ATF 
personnel did not immediately implement the provisions in ATF Ruling 
96-1 that require explicit ingredient listing and alcohol content 
information in statements of process, but instead delayed enforcement 
of these provisions until the issuance of ATF Ruling 2002-2 in 2002.
2. TTB Response
    TTB agrees with the commenters who note that for many years ATF and 
its predecessors allowed brewers to use alcohol-flavoring ingredients, 
without limitation, when producing malt beverages. Our predecessor 
agencies approved statements of process and certificates of label 
approval for these products and, before 1996, never suggested that 
there was any limit on the use of flavoring materials in FMBs. 
Accordingly, we acknowledge that the FMB industry relied on existing 
policies in formulating these products.
    It is important to note, however, that we know of no evidence that 
would suggest that producers of FMBs in the 1970s or 1980s were using 
nonbeverage flavors in their products at the high levels disclosed in 
the 2002 ATF study. To the best of our knowledge, the production of 
FMBs that derived the majority (and in some cases, up to 99%) of their 
alcohol content from added flavors is a trend that began in the 1990s. 
As the trend accelerated, ATF concluded that it was necessary to 
reevaluate the prior policy and consider the need for placing limits on 
the quantity of alcohol derived from added flavors. Furthermore, many 
State regulatory agencies began requesting that ATF create a Federal 
standard for the production of FMBs because of the confusion caused by 
the marketing and labeling of these products.
    Agencies may change policies, as long as the agency follows the 
appropriate procedures under the Administrative Procedure Act. The 
Supreme Court has recognized that ``[r]egulatory agencies do not 
establish rules of conduct to last forever.'' (See American Trucking 
Assns., Inc. v. Atchison, T. & S. F. R. Co., 387 U.S. 397, 416 (1967).) 
The Court has also stated that agencies must be given ample latitude to 
``adapt their rules and policies to the demands of changing 
circumstances.'' (See Permian Basin Area Rate Cases, 390 U.S. 747, 784 
(1968).) Furthermore, the Court has recognized that ``[a]n agency's 
view of what is in the public interest may change, either with or 
without a change in circumstances. But an agency changing its course 
must supply a reasoned analysis * * *.'' (See Motor Vehicle Mfrs. Ass'n 
v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 57 (1983), quoting 
Greater Boston Television Corp. v. FCC, 143 U. S. App. D. C. 383, 394, 
444 F.2d 841, 852 (1970) (footnote omitted), cert. denied, 403 U.S. 923 
(1971).)
    New manufacturing processes and marketing trends created a need for 
TTB and our predecessor agency to reevaluate longstanding policies on 
the use of flavors containing alcohol in the production of beer and 
malt beverages. As the above-cited cases demonstrate, an agency may 
make changes in policy, as long as the interpretation of the applicable 
statutes and the rest of the administrative record reflects reasoned 
deliberation.
    Finally, even if the agency in the two rulings referred to by the 
commenter had not given notice of its intention to engage in rulemaking 
on this issue, and even if the agency sent mixed signals on this issue 
prior to 2002, an agency is not precluded from engaging in rulemaking 
simply because it would change even a longstanding policy. By 
publishing a notice of proposed rulemaking and soliciting comments on 
this issue, we have clearly met the notice and comment requirements of 
the Administrative Procedure Act (APA). Notice No. 4 provided specific 
notice of the proposed changes to the industry and the public, and we 
provided the industry and the public almost 7 months to submit comments 
on those proposed changes.
    As reflected in this discussion of comments, we have carefully 
considered the comments from all interested parties, and we have given 
full consideration to options that would minimize any adverse economic 
impact flowing from the rule and that would afford industry members an 
adequate period of time to reformulate their products, if necessary. In 
crafting a standard on the use of flavors containing alcohol in the 
production of FMBs, we have also taken into consideration past and 
current agency policy. Accordingly, we have taken fairness and equity 
into consideration in drafting the final rule.

VII. Regulatory Burden and Cost-Related Issues

    One of the most important issues raised in the comments is the 
difference in regulatory burdens and costs associated with the proposed 
0.5% standard and the 51/49 standard. Opponents of the proposed 0.5% 
standard gave more weight to this issue than did supporters of that 
standard. However, many commenters who would be directly impacted by 
the proposed 0.5% standard urged TTB to adopt the 51/49 standard 
instead because it would be less costly and because it would not 
distort competition in the FMB market.

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The major issues raised by commenters on both sides of this question 
are summarized below.

A. Costs of Complying With the Proposed 0.5% Standard

1. Comments in Support of the 0.5% Standard
    Many industry members who commented in support of the 0.5% standard 
downplayed the importance of economic issues. For example, the Beer 
Institute stated that the economic well being of certain sectors of the 
economy should not be a consideration in straightforward application of 
properly enacted Federal statutes. It also suggested that some of the 
comments were based on erroneous information that was provided to 
retailers, notably the false threat that FMBs will disappear from the 
marketplace if the proposed TTB standard is finally adopted. Instead, 
the Beer Institute suggested that these products would continue either 
as distilled spirits products or as reformulated FMBs.
    Some individual FMB producers also suggested that the economic 
issues were not significant. Anheuser-Busch acknowledged that, as with 
any new process, there may be associated transition costs, and it 
stated that even the 51/49 standard would require process changes and 
associated transition costs for most producers. Anheuser-Busch 
commented that it expected the total cost impact across the company's 
system to be minimal, ranging between a small investment in capital and 
a net cost savings due to process and material changes. In either case, 
the brewer did not anticipate that the slight change in cost would 
impact FMB prices for its wholesalers, retailers or consumers.
    Miller commented that there are costs that have been, and will be, 
incurred as a result of the proposed new standard; however, it accepted 
those costs as a part of doing business in a regulated industry. 
Neither brewer submitted an estimate of the costs they expected to 
incur; nor did they explain precisely how they would reformulate their 
products to minimize the cost of compliance.
    Some supporters of the 0.5 percent standard commented that the 
standard would not adversely affect wholesalers or retailers, and that 
in fact, the standard will bring clarity to the marketplace and 
preserve the FMB category for wholesalers and retailers. Without a 
clear standard, these commenters believe that the States would take 
action and may ultimately classify these products as distilled spirits. 
Such reclassification would negatively affect wholesalers and retailers 
because in certain States they would no longer be able to sell these 
products.
2. Comments Opposed to the 0.5% Standard
    Opponents of the proposed 0.5% standard submitted a great deal of 
data about the estimated economic impact of the proposed rule. The FMBC 
submitted an economic study indicating that adoption of the proposed 
rule would have an adverse impact on the FMB industry amounting to over 
$600 million over the next 4 years. Other commenters argued that the 
proposed 0.5% standard would have negative cost implications for the 
industry, the public, and the Federal Government, as set forth below.
    Consumer Prices. Many commenters expressed concerns that the cost 
of FMB products would rise if the proposed rule were adopted. As 
previously noted, several thousand consumers commented against the 
proposed rule on various grounds, including the concern expressed by 
many that the 0.5% standard would result in higher prices for 
consumers.
    Disruption to Existing Businesses. The FMBC commented that the 
proposed 0.5% standard would profoundly threaten the FMB business of 
its members. It stated that these companies had relied on longstanding 
Federal policies to create beverages that consumers enjoy and had 
invested millions of dollars in promoting these brands. The FMBC 
suggested that any change would disrupt and possibly damage the 
business of its members; however, they were willing to adjust to a 
majority standard. The FMBC argued that the proposed 0.5% standard 
presented a much more dire threat to the business investment of its 
members, without a sound policy justification behind it.
    Research and Development Costs. Many commenters suggested that 
compliance with a new standard would force brewers to incur extensive 
upfront manufacturing costs for research and development to create new 
formulations for existing products. According to these commenters, the 
0.5 percent standard would require most manufacturers to reformulate 
their existing products. They stated that reformulation would be quite 
costly in that it would require large amounts of capital to purchase 
new equipment, investment in expensive technologies and treatment 
processes, and to advertise the newly reformulated products.
    Loss of Sales Due To Reformulation. Several FMB producers commented 
that even if they can reformulate their products to comply with the 0.5 
percent standard, they believe they may not be able to achieve the same 
taste profile as their existing products. They indicate that this would 
cause them to lose customers, thereby reducing their sales and revenue.
    ECS Study. The FMBC contracted with Economic Consulting Services, 
LLC (ECS) to conduct an economic assessment of the impact that both the 
0.5 percent standard and the majority standard would have on the 
domestic industry. The ECS assessment relied on information available 
to the public as well as information it obtained by surveying the 
FMBC's members. Sales by the members of the FMBC comprise approximately 
56 percent of the FMB market.
    The ECS found that, for various reasons, the FMBC's members 
unanimously responded that they would choose to reformulate their 
products to comply with either standard rather than sell them as 
distilled spirits specialty products. They expected substantial costs 
associated with reformulating current products to comply with either 
standard. ECS estimated losses based on expected loss in volume, 
expected upfront capital costs, expected upfront research and 
development and test marketing costs, expected losses in operating 
income, and expected capital losses. ECS then extrapolated the data 
they obtained from FMBC members to the entire FMB industry based on 
market share data.
    Specifically, the ECS estimated the cost to comply over the next 
four years to be:

               Costs To Comply (in Millions) Over 4 Years
------------------------------------------------------------------------
                                                     Majority     0.5%
                     Costs to                        standard   Standard
------------------------------------------------------------------------
FMBC Members......................................      186.2      340.5
Entire FMB Industry...............................      332.5      608.1
Federal Taxes Foregone............................      139.1      291.8
------------------------------------------------------------------------

    ECS indicated that the 0.5 percent standard imposes significantly 
higher costs because it ``would drive several of the products off 
retailer shelves completely, denying the producers, distributors and 
retailers a source of business and profits and denying customers a 
product they have come to enjoy.''
    Indirect Costs. Several commenters focused on the indirect costs 
associated with the proposed rule. For example,

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some commenters suggested that Federal Government's revenue collections 
would suffer because the 0.5% standard would cause sales of FMB 
products to decline. Several FMB wholesale distributors and other 
commenters expressed concern that the 0.5 percent standard would cause 
existing FMBs to be reclassified as distilled spirits, with the result 
that wholesale distributors would no longer be permitted to distribute 
them in certain States. These commenters also noted that this 
reclassification would affect retailers because, in many States, only 
State stores can sell distilled spirits.
    Effect on Small Businesses. Many commenters suggested that the 
proposed 0.5% standard would have adverse effects on small businesses. 
Some of these commenters suggested that the costs of complying with any 
new standard would hurt small companies the most since larger companies 
possess economy of scale advantages.
    TTB received a few comments from companies that identified 
themselves as small brewers that would be adversely impacted by the 
proposed rule. It should be noted that, pursuant to the regulations 
issued by the Small Business Administration, a small brewer is one that 
has no more than 500 employees. (See 13 CFR 121.201). These commenters 
urged TTB to adopt the 51/49 standard. They suggested that the proposed 
rule would have a disproportionately large impact on small businesses 
because they are less able to adapt to the new technology necessary to 
comply with the proposed 0.5% standard.
    Mark Anthony Brands (MAB), a member of the FMBC, is the national 
distributor and marketer of several popular FMB products. MAB and its 
production affiliate, Mark Anthony Brewing, Inc., contract with four 
U.S. co-packing facilities to produce its FMB products. [In this 
document, references to ``co-packing'' cover situations where one 
brewer produces and bottles for another brewer pursuant to a contract 
or where a brewer uses another brewer's premises under an alternating 
proprietor arrangement.] MAB suggested that TTB should abandon the 0.5% 
proposal in favor of the majority standard because the latter did not 
threaten the competitive viability of small companies like MAB and its 
co-packers. MAB suggested that the 0.5% standard would threaten the 
viability of the few regional breweries that currently co-pack FMB 
products for MAB and others.
    City Brewing Company stated that it owns and operates a 5-million 
barrel capacity brewery in La Crosse, Wisconsin, which employs 350 
people. The brewery was closed in 1999, but resumed operations in 2000 
capitalized with funds contributed by employees and local investors. It 
adopted a contract-brewing business strategy because the beer brands 
formerly produced by the brewery were purchased and are now controlled 
by a major brewery. City Brewing Company stated that the consolidation 
of U.S. breweries had virtually eliminated all excess brewing capacity 
for beer marketers other than the largest U.S. brewers. The brewery 
stated that it has been profitable since resuming operation, but it 
expressed concerns that the proposed rule might result in a loss of 
business for FMB producers, which would have a significant negative 
impact on the brewery.
    A small brewery in North Carolina, Carolina Beer & Beverage 
Company, stated that adoption of the 0.5% standard would have a 
``profound adverse impact'' on both this brewery and similar small 
brewers. The brewery urged adoption of the majority standard instead. 
Carolina Beer & Beverage stated that 70% of its revenues are derived 
from FMBs, and it noted that it had invested significant amounts of 
capital and resources in order to produce FMBs that comply with 
longstanding Federal policies. This brewery suggested that if TTB 
adopted the 0.5% standard, it was unlikely that it could to maintain 
its competitiveness in the FMB industry and that such a standard could 
even threaten the company's ability to stay in business.
    In addition, many distributors commented on the adverse impact of 
the 0.5% standard. For example, United States Beverage, a small 
distributor located in Connecticut, commented that it employs 85 people 
and that FMB products support over 70% of its revenues. This commenter 
stated that the proposed 0.5% standard would have ``devastating'' 
effects on the industry. United States Beverage also suggested that 
while reformulation might be only an inconvenience to the largest 
brewers, it would be an ``operational impossibility'' for a smaller 
brewer.

B. Effect on Current Products and New Product Development

    In Notice No. 4, TTB sought comments relating to the effect of the 
proposed regulations on the viability of products currently on the 
market. We stated we were particularly interested in comments 
addressing whether products on the market could be made under the 
proposed standard. Additionally, we sought comments on how the adoption 
of the 0.5% added alcohol standard would affect taste, shelf life, 
stability, or other characteristics of these products. We also sought 
comments on whether production practices are available to produce FMBs 
with the desired product profile and still comply with the proposed 
standard. Finally, we sought comments as to whether another standard, 
such as the 51/49 standard, would be more appropriate for these 
products.
1. Comments Supporting the 0.5% Standard
    Anheuser-Busch commented that it is capable of producing FMBs under 
the 0.5% standard and is preparing to do so. The brewer stated that its 
brew masters have already developed reformulated products that will be 
indistinguishable from the current FMB products they produce and sell. 
Anheuser-Busch indicated that these reformulated products would have 
the same clarity, aroma, and taste profile of their current products. 
Anheuser-Busch further stated that reformulation could be done and that 
no FMB producer should lead TTB to believe otherwise.
    Miller also commented that its products could be produced under the 
proposed standard without compromising their taste or their high 
quality standards. Furthermore, the brewer indicated that it has 
successfully produced prototype products that comply with the 0.5% 
standard and has tested the acceptability of these products with expert 
tasters and others. These tests confirm that the reformulated product 
satisfies the taste profile of the original product.
    Miller further stated that shelf life and product stability are not 
expected to be barriers to complying with the new standards. Miller 
stated that:

    Shelf life will be reduced to that of a traditional beer, i.e., 
approximately four months which is a significant reduction from the 
six to 12 month shelf life currently applicable to Flavored Malt 
Beverages produced today. Because it will be consistent with 
traditional beers, however, we do not anticipate shelf life or 
product stability to be an insurmountable problem with the 
reformulated products.

    Other commenters stated that since certain brewers have already 
demonstrated their ability to produce FMBs in accordance with the 0.5% 
standard, they believe that these products will be available to 
wholesalers and retailers in all States with no interruption and no 
discernable taste differences.
    Coors commented that the 0.5% standard ``is also fair because it 
does not prohibit any current product. Just because many of the current 
`flavored

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malt beverages' may need to be reclassified as distilled spirits does 
not mean that the TTB proposed regulation will `kill the category,' as 
some might claim.'' Coors suggested that under the proposed rule, 
products containing 0.5% or more alcohol from the distilled spirits 
components of added flavors could continue to be produced, but would be 
regulated as distilled spirits products.
2. Comments Supporting the 51/49 Standard
    While the major brewers claimed that product reformulation under 
the 0.5% standard would not be a problem, as previously noted in this 
preamble, other FMB producers suggested that this would have a 
significant impact on their businesses, resulting in higher costs for 
research and development, new equipment, and marketing, and the 
possibility of reduced sales due to consumer rejection of reformulated 
products.
    Furthermore, several members of Congress expressed concerns about 
the costs of reformulation and the possible risks posed by such 
reformulations to the FMB industry. For example, one U.S. Senator 
stated:

    If the new formulation standards increase the costs of producing 
FMBs, and alter their taste such that consumers are reluctant to 
purchase them, the FMB market will decline. This decline in 
profitability will surely drive some FMB manufacturers out of the 
market, and reduce competition in the marketplace.

    This Senator urged adoption of the 51/49 standard. Another Senator 
suggested that the proposed standard ``would likely change the taste 
and character of FMBs--products which have attained broad consumer 
loyalty. There is no doubt that this outcome would provide FMB's rivals 
with a distinct competitive advantage.''
    Numerous State lawmakers opposed to the 0.5% standard commented 
that if TTB establishes the 0.5% standard, it would force FMB brewers 
to make costly changes to their current production processes. They 
indicated that TTB's adoption of the 0.5% standard would force FMB 
brewers to increase the amount of malted barley and other traditional 
ingredients used in an FMB, probably resulting in very differently 
tasting products.
    As indicated earlier in this comment discussion, the Flavor and 
Extract Manufacturers Association of the United States (FEMA) urged TTB 
to reconsider the proposed 0.5% standard because it would significantly 
restrict the amount of alcohol contributed to the finished product from 
flavors, thus making it impossible for flavor chemists to satisfy the 
consumer desire for the distinctive FMBs currently sold.
    FEMA noted that flavors contain ethyl alcohol because it is a safe, 
economical, and effective extraction medium for fruits, nuts, and 
botanicals, as well as a diluent for polar and non-polar flavor 
chemicals. FEMA also stated that fruit essences and distillates, which 
are used extensively in the creation of natural fruit flavors, contain 
an appreciable amount (up to 20-25%) of naturally occurring ethyl 
alcohol.
    FEMA stated that, because of their composition, alcohol beverages 
require higher flavor loads to deliver pleasing characterizing flavors. 
It stated that while many non-alcoholic beverages use emulsions to 
deliver flavor systems, this is not possible in alcohol beverages 
because the destabilizing effect of the ethyl alcohol will produce 
precipitation and oil separation in the final beverage. According to 
FEMA, this means that the higher flavor level and the dependence on 
ethyl alcohol as the only reliable solvent makes it necessary to exceed 
the 0.5% limitation to manufacture acceptable and stable products.
    FEMA noted that the ATF study referenced in Notice No. 4 found that 
most FMBs formulated their products in accordance with ATF Ruling 96-1. 
FEMA stated this has resulted in the evolution of beverages that 
deliver to the consumer a clean, pleasant flavor and that have a 
reasonable shelf life. FEMA further stated that producers have used 
various treatments to reduce the inherent bitterness and off-flavor 
characteristics associated with fermented malt beverages. FEMA 
suggested that if TTB limits the contribution of alcohol from flavors 
to less than 0.5%, that restriction would negatively impact the taste 
of FMBs and limit the shelf life of these products.
    FEMA noted that malt-based beverages require a higher percentage of 
flavor addition than other alcohol beverages due to the more pronounced 
organoleptic properties of the malt base itself. Malt-based products 
have an aftertaste that is difficult to overcome. The aftertaste and 
malty off-characters tend to accentuate with increased exposure to 
heat. Limiting the amount of alcohol derived from flavor severely 
limits the opportunity to use vanilla, cocoa, coffee, and other 
botanical extracts that often require usage levels of 3% or higher in 
the finished products.
    In conclusion, FEMA stated that limiting the contribution of 
alcohol content by flavors to less than 0.5% would change the overall 
taste profile of these products, and the consumer will ultimately 
receive a different tasting, less acceptable beverage. The change in 
flavor will be caused by a combination of increased malt base 
percentages and off-flavor contributed by the malt. FEMA stated that 
limiting either the ingredients that may be used in flavors or the 
alcohol contributions from flavors would make it impossible for 
manufacturers to continue producing many of the malt beverages being 
sold today and would severely limit the flavor industry's opportunity 
for new product development.
3. Neutral Comment
    Finally, Gallo stated that it had conducted a study involving the 
aging of reformulated products under normal conditions to determine the 
impact of the proposed changes to the alcohol source standards on FMBs. 
Gallo studied two of its 13 FMB products, comparing their current 
formulation with both standards aired in Notice No. 4. Due to the 
limited time available, Gallo noted that it was only able to evaluate 
these products as they would age under normal shipping and storage 
conditions 3\1/2\ months after production.
    After evaluating the results, Gallo determined that the study was 
inconclusive. According to Gallo, it appeared that the change in malt 
percentage impacted each product differently. Gallo concluded that 
``[t]he indication is that all of our products must be studied 
individually to understand the full impact of the proposed change. 
There was no time to explore this issue in time for these comments.'' 
Gallo stated that, in light of the inconclusive results from the study, 
it took no position on the proposed definitions for beer and malt 
beverages.
    Gallo did indicate that it plans to continue to produce and market 
FMBs under either of the standards aired for comment in Notice No. 4. 
However, it pointed out that either new standard would require Gallo to 
invest in new equipment to produce additional volumes of malt base. 
Either standard would also force Gallo to develop new malt fermentation 
techniques and production techniques to provide a malt base that 
results in products with a flavor and taste profile that meets current 
consumer expectations. This, Gallo noted, might require development of 
new technology and different equipment.

C. Effect on Competition

1. Comments in Support of the 0.5% Standard
    Many small craft brewers expressed support for the 0.5% standard 
based on their view that the arrival of FMBs in

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the marketplace has had a negative effect on sales of traditional malt 
beverage products. Some commenters suggested that TTB should adopt the 
0.5% standard for added alcohol because this action would benefit small 
brewers who generally do not produce FMBs.
    Many small brewers and their employees expressed their concern that 
the arrival of FMBs during the past years has weakened the brewing 
industry. They explained that over the past 25 years there has been a 
major revitalization of the brewing industry, with smaller brewers and 
brewpubs now found in every State and metropolitan area and in many 
small towns. They indicated that the number of microbreweries closing 
since the arrival of the newer FMBs has exceeded the number of 
microbreweries opening--reversing the trend and weakening the industry.
    One small brewer stated that he expects to compete with other 
quality small brewers in the region, but would not like to see huge 
corporations with unlimited legal and marketing funds compete against 
him with products that are not real beer. Another small brewer 
commented that if he can make a wonderful tasting product with this 
standard, then the larger competitors could do it also. A third brewer 
indicated that the manner of FMB production explained in Notice No. 4 
avoids many of the costs associated with the volume demands of beer 
production and storage. He indicated that he believes this results in 
an unfair competitive advantage over traditional and craft brewers.
2. Comments in Support of the 51/49 Standard
    Many opponents of the 0.5% standard suggested that adoption of the 
standard would have an anti-competitive effect. For example, the FMBC 
suggested that support for the 0.5% standard appeared to come from the 
many industry members who, for competitive reasons, would benefit from 
the complete demise of the FMB category or would derive a competitive 
advantage from a 0.5% rule. The FMBC stated that the 0.5% standard, if 
adopted, would give a competitive advantage to some FMB producers at 
the expense of others. In support of this claim, the FMBC pointed out 
that America's largest brewer claimed that it could already produce 
FMBs meeting the 0.5% standard without compromising product taste or 
availability. The FMBC stated that this illustrates that, if adopted, 
the standard would adversely affect competition by forcing competitors 
to acquire technologies and capabilities similar to those apparently 
possessed today by the largest brewers. The FMBC added that the 
marketplace, not the Government, should determine the industry's 
winners and losers. The FMBC urged TTB to avoid crafting a rule that 
hands a competitive advantage to some FMB producers at the expense of 
others.
    Mark Anthony Brands (MAB) stated that:

    [F]ederal policies favoring competition demand that TTB consider 
anticipated anti-competitive effects in choosing between policy 
alternatives and seek to adopt that alternative which promotes 
competitive outcomes. The 0.5% standard would favor larger 
companies, particularly America's (and the world's) largest brewers, 
and would therefore decrease competition in the FMB market segment. 
MAB accordingly urges TTB to reject the proposed 0.5% standard in 
favor of one that allows FMB producers to compete on a level playing 
field and supports future competition.

    MAB suggested that Federal policy strongly favors marketplace 
competition and discourages the unhealthy concentration of market power 
in the hands of a few dominant players. MAB also argued that ensuring 
competition in the alcohol beverage industry played an important role 
in motivating Congress to enact the FAA Act, and it cited a provision 
of the legislative history of the FAA Act, which indicated that its 
promoters wanted to ``enable small units to get into the liquor 
industry.'' MAB also noted that the burdens of regulation fall 
disproportionately on small companies, citing a provision of the 
legislative history of the Regulatory Flexibility Act which recognized 
that even if actual regulatory costs are equal between competing large 
and small firms, small firms have fewer units of output over which to 
spread such costs and are thus unable to take advantage of the 
economies of scale.
    As noted earlier in this comment discussion, MAB argued that TTB 
should abandon the 0.5% proposal in favor of the majority standard. MAB 
stated that the past two decades have seen the concentration of brewing 
capacity in the United States into a very small number of hands and 
that while America is home to over 1,400 breweries, the three largest 
brewers own the facilities responsible for producing over 90% of 
domestic beer and malt beverages. Noting that most other brewers are 
small ``micro'' and ``regional specialty'' operations that produce 
their own products, the commenter argued that these small brewers would 
not have the capacity to produce a successful new brand. MAB suggested 
that because of the costs of a new brewery, combined with the high 
failure rate of new products, production capacity presents a formidable 
barrier to entry to the U.S. beer market.
    Accordingly, MAB stated that the ``few remaining `old regional' 
brewers today represent the only realistic way to quickly access 
significant production capacity in the U.S.'' MAB argued that the 
demise of America's ``second-tier'' brewers over the past 10 years has 
taken vast amounts of brewing capacity off-line, and that a few old 
regional breweries, which currently co-pack FMB products for MAB and 
others, own the remaining excess U.S. brewing capacity. MAB concluded 
that a decline in FMB sales would ``likely'' cause these brewers to 
close their doors altogether and that this resulting loss of production 
capacity in the United States would add costs and drive jobs overseas.
    MAB also suggested that the 0.5% standard represented a ``win-win'' 
scenario for the largest brewers if they indeed possess the technology 
to produce FMBs under that standard that achieve the same taste profile 
as existing products. MAB stated that this technology would allow them 
to dominate the FMB category with their products. On the other hand, if 
consumers reject FMBs produced under the 0.5% standard, MAB stated that 
``the largest brewers will benefit because the elimination of the FMB 
category will protect their extensive investments in the production and 
distribution of traditional beer and malt beverage products.''
    Several members of Congress indicated that the 0.5% standard seems 
designed to distort the existing market by providing an artificial 
competitive advantage for companies that currently dominate the 
domestic beer industry but that have introduced under-performing and 
less popular FMB products.
    We also received a comment from the British Embassy suggesting that 
the proposed rule would place an unfair competitive disadvantage on 
companies based in the United Kingdom (U.K.), including the U.S. market 
leader, threatening jobs in the U.K. and the United States, as well as 
thousands of dollars in investment.

D. Effect on the Retail Licensing System and Overall Marketplace

1. Comments in Support of the 0.5% Standard
    Many commenters stated that the 0.5% standard would ensure product 
integrity, preserve long standing distinctions imposed on beer, wine, 
and spirits, and provide a uniform and

[[Page 208]]

consistent classification system on which States, wholesalers, 
retailers, and consumers can rely. They stated that, if adopted, the 
standard would help to maintain an orderly marketplace, meet consumer 
expectations for consistent products, and help sustain the long-term 
development of the FMB category.
    According to several commenters, implementation of the 0.5% 
standard would avoid costly and confusing disruptions in State 
licensing, taxation, and distribution policies. Several retailers and 
wholesalers feared that any other standard could have significant 
consequences for the industry and for thousands of alcohol beverage 
licensees, most of which are small businesses. Without a clear 
standard, some commenters believed that the States would take action 
and may ultimately classify these products as distilled spirits. Such 
reclassification would negatively affect beer wholesalers and retailers 
because in certain States they would no longer be able to sell these 
products.
2. Comments in Support of the 51/49 Standard
    In opposition to the 0.5% standard, several FMB wholesalers 
expressed concern that the standard would cause TTB to reclassify 
existing FMBs as distilled spirits. Some commenters expressed a fear 
that if TTB reclassifies these products, certain States will no longer 
permit beer wholesalers to distribute them. Some commenters pointed out 
that this reclassification would also affect retailers because in many 
States only State-operated stores can sell distilled spirits.
    Many commenters, chiefly wholesalers and their employees, as well 
as employees of FMB producers, expressed the fear that they will lose 
their jobs if TTB approves the 0.5% standard. One industry association 
cautioned that approval of this standard would cost jobs in production 
facilities all across the country. Another commenter pointed out that 
thousands of businesses rely on sales of FMBs for revenue, from the 
product itself and from secondary sales. The commenter indicated that, 
if implemented, Notice No. 4 would threaten sales and put further 
pressure on small businesses already pushed to the brink.
    Diageo explained that its products have generated numerous jobs 
throughout the country. Diageo noted that it not only employs numerous 
production and sales employees, but also generates work for numerous 
suppliers in areas such as glassware and packaging materials. Diageo 
stated that two of its facilities are involved in the production of 
FMBs and contract production has occurred at five non-Diageo facilities 
during the past three years.
    A U.S. Senator commented that FMB bottling facilities provide jobs 
and millions in dollars to local economies through wages, taxes, 
services purchased, and other means. He stated that any regulation that 
threatens the market position of these products puts those jobs at 
risk. Other U.S. Senators commented that this proposal could have a 
profound and devastating impact on employees in their States and across 
the nation. Two U.S. Senators indicated that FMBs constitute a booming 
industry that has brought a direct benefit to their State, and they do 
not wish to see its growth and associated jobs curtailed in such an 
unnecessary fashion.
    A wholesaler expressed concern over some small brewers' claims that 
the 0.5% standard will not harm America's small brewers. This commenter 
asserted that these small brewers have never produced an FMB product 
and have no intention of competing in the FMB category in the future. 
Since these small brewers have no stake in the outcome of this proposed 
rulemaking, their claims should not be considered as authoritative. 
Other commenters pointed out that it is not the job of TTB to favor one 
industry over another.

E. TTB Response

1. Regulatory Burdens and Costs Imposed by the Proposed Rule
    When we issued Notice No. 4, we certified that the proposed rule 
would not have a significant impact on a substantial number of 
entities. We stated our belief that 10 or fewer qualified small 
breweries manufacture FMBs subject to the rule. We asked any small 
brewery that believed it would be significantly affected by this rule 
to let us know and tell us how it would affect them. We also certified 
that the proposed rule was not a significant regulatory action, as 
defined by Executive Order 12866, because it would not have an annual 
effect of $100 million or more on the United States economy.
    After reviewing the comments, we have not changed our position on 
these matters. We do not believe that the proposed rule would have had 
a significant economic impact on small businesses, within the meaning 
of the Regulatory Flexibility Act. While we received many comments 
suggesting that there would be numerous indirect effects on wholesalers 
and retailers of FMBs, we received only a few comments from brewers 
that identified themselves as small businesses producing FMBs that 
would be adversely impacted by the proposed 0.5% standard.
    Nor do we believe that the proposed rule would have been a 
significant regulatory action within the meaning of Executive Order 
12866, notwithstanding the suggestion to the contrary in the ECS Study. 
The primary data for the analysis in that study comes from FMBC 
members. Because much of the economic data submitted by FMBC members is 
proprietary and confidential, TTB cannot verify the accuracy of the 
figures.
    Furthermore, we are concerned that certain parameter assumptions 
and calculations in the ECS study are questionable and could lead to an 
overstatement of loss. For example, since the study separately included 
estimates of declines in Federal corporate tax revenue, it should have 
presented its estimates of declines in profits net of taxes. Under the 
0.5% standard, ECS calculated that Federal corporate tax revenue would 
decline by $94 million in present value due to reduced profits for FMBC 
firms over the period 2004-2007. Accordingly, the expected after-tax 
decline in profits for FMBC firms would be $247 million rather than the 
$341 million decline in profits listed in the study. The study's use of 
discount rates of 20 and 30 percent to account for the increased 
uncertainty of future income appears to assume a large risk-premium. 
The treatment of capital expenditures is unclear, and the measurement 
of capital stock and capital losses is questionable.
    Furthermore, there is a methodological flaw in deriving private and 
public loss totals because the ECS study looked at FMB operations in 
isolation, without accounting for the potential for increased sales of 
other types of alcohol beverages. For example, we do not agree that 
either the proposed 0.5% standard or the 51/49 standard would result in 
significant losses of Federal tax revenues as a result of lowered sales 
of FMBs. Even if the reformulation of popular FMB products results in 
lowered sales for these products, it does not necessarily follow that 
the Federal Government would lose tax revenues as a result. Because of 
changes in consumer preference and other factors, the relative market 
share of specific products often fluctuates. However, it is logical to 
assume that most of the FMB consumers who might abandon their favorite 
products as a result of changes in taste profile would substitute other 
alcohol beverages for them.

[[Page 209]]

    Thus, it is unlikely that any changes in the relative market share 
of FMB products would result in a significant net loss of the Federal 
excise taxes collected on alcohol beverages. Furthermore, because many 
FMB producers also manufacture other types of alcohol beverages, losses 
in sales of FMB products may be offset by increased sales of other 
types of alcohol beverages.
    Finally, we do not believe that the economic impact on FMBC members 
can necessarily be extrapolated to the rest of the FMB industry based 
simply on market share. In fact, the FMBC, as well as other commenters 
opposed to the proposed 0.5% standard, have argued in this rulemaking 
proceeding that the 0.5% standard would benefit America's largest 
brewers at the expense of their competitors. The comments show that the 
expected costs of compliance vary from producer to producer. For 
example, as previously noted, Anheuser-Busch commented that it expected 
the total cost impact to be minimal and did not anticipate the ``slight 
change in cost'' to impact FMB prices for wholesalers, retailers, or 
consumers. Opponents of the 0.5% standard cannot argue with any 
consistency that the standard would unfairly benefit their competitors, 
while still maintaining that those competitors would suffer the same 
costs and losses as they would.
    Nonetheless, after carefully considering all of the comments on 
this issue, TTB is persuaded that implementation of the proposed 0.5% 
standard might impose economic burdens on a sector of the FMB industry 
and adversely affect the viability of some small brewers who produce 
FMBs, as well as their ability to compete within the beer industry.
    The comments indicated that while some brewers would be able to 
reformulate without incurring significant costs, many producers of FMBs 
believe that reformulation of their products to comply with a 0.5% 
standard would result in significant costs. The FMB producers that 
commented on this issue indicated that they would reformulate their 
products as FMBs rather than produce them as distilled spirits 
products. Accordingly, the costs associated with the 0.5% standard are 
not connected with the higher Federal excise tax imposed on distilled 
spirits products. Instead, these costs are brought about by the need to 
conduct research and development, and to invest in new equipment and 
technology necessary to produce FMBs that meet the 0.5% standard. Many 
FMB producers indicated that the costs of complying with a 51/49 
standard would be significantly lower. Those FMB producers that 
commented in favor of the 0.5% standard did not specifically address 
the relative costs of the two standards, although one brewer noted that 
either standard would impose some costs.
    In addition to the costs associated with producing new FMBs that 
met the new standards, many FMB producers expressed concerns that they 
would not be able to achieve the same taste profile under the proposed 
0.5% standard, and that the 51/49 standard would afford them more 
flexibility in meeting the expectations of consumers in this area. 
These producers are concerned that if they attempt to reformulate their 
products in accordance with the 0.5% standard, consumers will not 
accept the reformulated products and product sales will go down, 
possibly resulting in the disappearance of some current FMB products 
from the marketplace.
    A comment from FEMA supported this concern, noting that the 0.5% 
standard would make it impossible for manufacturers to continue 
producing many of the malt beverages being sold today and would 
severely limit the flavor industry's opportunity for new product 
development. We also find persuasive the comment from Gallo, which did 
not take a position on the 0.5% or 51/49 standard, but which noted the 
difficulty of predicting the impact of either standard on the taste 
profile and shelf life of FMB products.
    Although the number of small brewers affected by this rule is not 
large, we note that several commenters indicated that there are fewer 
regional brewers with excess production capacity in the United States 
today than in the past. Many commenters indicated that the proposed 
0.5% standard could have a significant impact on those regional brewers 
that co-pack FMBs for other companies. In particular, we are concerned 
that the economic impact of the proposed rule may be disproportionately 
borne by those small brewers who lack the economies of scale possessed 
by their larger competitors, and who would be less able to absorb the 
costs associated with reformulation of products in accordance with the 
more stringent 0.5% standard.
    As a related matter, TTB is concerned that the proposed 0.5% rule 
might affect the ability of some small brewers to compete within the 
brewing industry. It should be noted that we do not agree with those 
comments that suggested that one of the purposes of the proposed rule 
was to protect either large or small brewers from competition with 
producers of FMBs. It is not TTB's intention in this rulemaking action 
to favor any one segment of the FMB or beer industry over another, to 
remove competition in the marketplace, or to destroy a particular 
category of malt beverages simply because it is preferred by many 
consumers over more traditional brewery products. Our statutory mission 
under the FAA Act is to promote fair competition within the malt 
beverage industry, not to favor one segment of the industry over 
another. Accordingly, the purpose of the final rule is to treat all 
segments of the beer and FMB industries in a fair and even fashion.
2. Options To Reduce Regulatory Burdens and Costs
    Even if a rule is not a significant regulatory action, Executive 
Order 12866 requires us to design the regulation in the most cost-
effective manner to achieve the regulatory objective.
    We have considered several options to reduce the regulatory burdens 
and economic costs imposed by the proposed rule. One of those options 
is to exempt small businesses from the requirements of the rule. 
However, this option is not viable for several reasons. First, one of 
the primary purposes of the rule is to enhance consumer protection; 
this purpose would be defeated by an exemption for small businesses. 
Furthermore, some small brewers who produce FMBs do so under contract 
with larger companies, and allowing an exemption for these companies 
would raise significant fairness issues. Finally, and most important, 
since the IRC does not authorize such a difference in tax treatment for 
small producers of FMBs, we do not believe we have statutory authority 
to implement such an exemption by regulation.
    A second option we considered was the delay of the effective date 
of the final rule in order to provide adequate time for the industry to 
make the necessary changes to product formulation. As discussed in more 
detail later in this document, we have delayed the implementation of 
the final rule for one year. We believe this one-year delayed effective 
date will provide ample time for the FMB industry to conform to the 
requirements of the final rule.
    The final option we considered was adoption of the 51/49 standard 
instead of the 0.5% standard. Based on the information in the 
rulemaking record, we have concluded that compliance with the 51/49 
standard will be significantly less burdensome and costly than 
compliance with the 0.5% standard. Furthermore, based on the

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comments, it appears that adoption of the 51/49 standard would not 
adversely affect the ability of small brewers to compete in the FMB 
marketplace and would reduce the impact of the changes needed to 
reformulate existing products to comply with the final rule.
    As we considered the comments and weighed the relative merits of 
the 0.5% standard and the 51/49 standard, we also considered the issues 
of costs and other regulatory burdens. As shown in the remainder of 
this document, we have tried to address these issues at each step, so 
that our final rule will achieve the goals of this rulemaking process--
protecting the revenue, ensuring that FMB labels provide the consumer 
with adequate information about the identity of the product and do not 
mislead consumers, and setting a Federal standard for the use of added 
alcohol flavors in malt beverage products--while minimizing unnecessary 
costs and other regulatory burdens on the affected industry.
    For these and other reasons set forth later in this document, we 
have concluded that we should adopt the 51/49 standard for beers under 
the IRC and for malt beverages under the FAA Act. TTB believes that by 
allowing FMBs to comply with the less stringent 51/49 standard rather 
than the proposed 0.5% standard, we meet the goals of this rulemaking 
proceeding and, at the same time, lessen the potential economic costs 
and other regulatory burdens imposed on members of the FMB industry. 
The other reasons for adopting the 51/49 standard are set forth 
elsewhere in this preamble.

VIII. The 0.5% Standard vs. the 51/49 Standard--Other Issues

A. Comments in Favor of the 0.5% Standard

1. Consistency With the IRC and the FAA Act
    Many commenters found support for the proposed 0.5% standard in the 
IRC provisions establishing 0.5% as a dividing point between products 
subject to tax under the IRC and those that are not subject to tax. For 
example, the Beer Institute noted that the IRC ``clearly provides the 
Secretary with broad authority to issue and enforce regulations, to 
classify products for tax purposes, and to establish a workable 
administrative system to collect taxes.'' The Beer Institute stated 
that classifying intoxicating liquors based on the 0.5% cutoff has a 
long history, dating back to 1902 and continuing through Prohibition. 
Miller commented that the ``use of what could be characterized as a de 
minimis threshold such as 0.5% is a common sense approach to the 
regulation of alcohol beverages considering that small amounts of 
alcohol are present in many other beverage products such as juice, soft 
drinks, soda, and non-alcoholic beers made by brewers.''
    Several commenters noted that the IRC and FAA Act definitions of 
``beer'' and ``malt beverage,'' respectively, contemplate that the 
alcohol content in those products must be derived from fermentation, 
not from added distilled spirits. Coors argued that while some may 
argue that there is a difference between combining distilled spirits 
``directly'' with a malt base and doing so ``indirectly'' through the 
addition of flavors, it believed that ``this is a distinction without a 
difference. Congress clearly intended to classify any alcoholic 
beverage that contains a mixture or dilution of distilled spirits as 
`distilled spirits.' ''
    Several brewers commented that neither law nor good policy 
supported the 51/49 standard. Coors suggested that while the proposed 
0.5% standard allowed the addition of a de minimis amount of flavors, a 
51/49 rule went beyond the allowance of a de minimis quantity of 
flavors. Anheuser-Busch stated that neither the FAA Act nor the IRC 
provided a basis for TTB to adopt the 51/49 standard, arguing that 
``[t]he difference of only a couple of drops between a product that is 
`mostly' a beer versus `mostly' a distilled spirit would make a mockery 
of the law, public policy and the many years of distinction between 
malt beverages and distilled spirits.''
2. Consumer Deception or Confusion
    Many commenters supported the proposed 0.5% standard based on the 
premise that it would reduce consumer confusion. These commenters 
included consumers, State senators and representatives, beer 
distributors, merchandisers, Members of Congress, State governors, 
State ABC commissions, breweries, national associations, State 
licensing and taxing authorities, State coalitions, and industry 
members.
    As indicated in the comment overview, several thousand commenters 
stated that the establishment of a 0.5 percent standard would eliminate 
consumer confusion, preserve the integrity of the beer category, or 
provide beer consumers with a clear understanding of the product. Many 
commenters suggested that it was important to define the difference 
between beer and other alcohol beverages, such as distilled spirits. 
For example, we received thousands of comments suggesting that the 
proposed 0.5% standard was the best way to maintain ``clear 
distinctions between beer and liquor.''
    Many commenters agreed that TTB has a responsibility to protect 
consumers through accurate labeling, to ensure that products labeled as 
``flavored malt beverages'' are truly products that have alcohol 
obtained by the fermentation of malt. Others believed the proposed rule 
would promote consistency in consumer expectations, clarify Federal 
public policy, and end any confusion that may linger from the past or 
that may arise from alternative proposals.
    Several commenters suggested that, in the absence of a national 
standard, States would enact differing standards under which the same 
product may be sold as a ``beer'' in one State and as a ``distilled 
spirits'' product in another State. The commenters suggested that these 
inconsistent standards would confuse consumers.
    Many commenters focused on industry and consumer understanding of 
the terms ``beer'' and ``malt beverage.'' For example, the Brewers' 
Association of America (BAA), a 62-year-old trade association 
representing the interests of more than 1,400 small American breweries, 
submitted a comment in support of the 0.5% standard. The BAA stated:

    The perception of the general public is that beer is a beverage 
with malt flavor and hop bitterness, flavor and aroma. Many small 
brewers currently produce flavored malt beverages that have these 
characteristics. The products currently classified as FMBs and 
recently analyzed by TTB display none of these characteristics, and 
should not be considered or taxed as beer.

    Many commenters stated that many FMBs do not meet the traditional 
definition of beer or ale and thus blur the line between spirits-based 
beverages and traditional beers and ales. Others argued that the 
consumer does not expect beer to contain added distilled alcohol from 
outside sources. Some suggested that it was deceptive to characterize 
FMBs as malt beverages since many FMBs do not resemble or taste like 
beer.
3. Preserving the Integrity of Beer
    Many commenters stated that beer and malt beverages are unique 
beverages with a unique history. We received thousands of comments from 
the beer industry urging TTB to maintain this distinction by adopting 
the 0.5% standard. These commenters noted that Federal and State 
governments have historically regulated and taxed beer and malt 
beverages differently from

[[Page 211]]

distilled spirits. These commenters suggested that the 0.5% standard 
was the only way to maintain the integrity of beer and the brewing 
process.
    Many commenters were of the opinion that the 0.5 percent standard 
will ensure that FMBs are produced as traditional malt beverages using 
traditional brewing methods and processes. A large number of commenters 
stated that the classification of FMBs as beer threatens beer culture 
in the United States. In this regard, they pointed out that beer has 
unique attributes as a beverage--including malt-flavor, hop-bitterness, 
and aroma. Many of these commenters argued that the integrity of beer 
and the brewing process must be preserved.
    Some commenters suggested that beer and FMBs are produced 
differently and should be categorized separately in the alcohol 
beverage market. Many commenters pointed to the history of alcohol 
beverages in the United States as evidence of the longstanding 
distinction between malt beverages and distilled spirits. They stated 
that these differences are well defined by the taxation structures at 
the State and Federal levels and these differences should be 
maintained.

B. Comments in Favor of the 51/49 Standard

1. TTB's Statutory Authority Under the IRC and the FAA Act
    Several FMB producers suggested that TTB lacks statutory authority 
to impose a 0.5% limit on the use of alcohol derived from flavoring 
materials in the production of FMBs. It should be noted that while 
these commenters also believe TTB lacks authority to impose any limits 
on the use of alcohol derived from flavoring materials in the 
production of malt beverages, they nonetheless supported the 51/49 
option as a matter of policy.
    Authority Under the IRC. Several commenters stated that the current 
definition of the term ``beer'' in the IRC, at 26 U.S.C. 5052, gives 
brewers substantial discretion in formulating their products and places 
no limits on the use of nonbeverage flavors in products taxed as beer. 
They noted that prior IRC provisions included restrictions on producing 
a beverage from nonbeverage articles such as flavors, and they 
suggested that the current IRC's silence on the issue represents a 
deliberate choice by Congress not to restrict flavor use in the 
production of beer. Furthermore, the comments noted that the statutory 
definitions of beer and malt beverages do not specify any minimum 
amount of alcohol to be derived from fermentation. The FMBC suggested 
that the IRC places a practical limit on the use of flavors because of 
the unpleasant taste of nonbeverage flavors. The FMBC and Diageo both 
argued that IRC section 5001(a)(2) does not apply to products 
containing nonbeverage drawback flavors, and that it instead only 
applies to products containing distilled spirits on which tax has not 
been paid or determined.
    Authority Under the FAA Act. Many commenters also noted that the 
FAA Act does not place limits on the use of flavors in a malt beverage 
but instead explicitly authorizes the use of ``wholesome food 
products'' in malt beverage production (see 27 U.S.C. 211(a)(7)). 
Furthermore, the comments suggested that since the Volstead Act 
explicitly restricted the use of nonbeverage flavors to make a 
beverage, the silence of the FAA Act indicates a deliberate choice by 
Congress to allow the unlimited use of flavoring materials in malt 
beverage production.
2. Standard Best Supported by Law
    Many commenters suggested that if TTB has statutory authority to 
impose a limit under the IRC or the FAA Act, the 0.5% standard has no 
basis in Federal law; rather, the 51/49 standard is the proper 
standard. These commenters pointed out that in Notice No. 4, TTB 
indicated that IRC section 5052 also would support the issuance of a 
regulation requiring that a beer or malt beverage must directly derive 
a majority of its alcohol content from fermentation. The commenters 
argued that since both the FAA Act and the IRC would support such a 
standard, TTB did not provide sufficient reasons why it proposed the 
much stricter 0.5% standard.
3. IRC Regulatory Policy
    Many commenters suggested that the 51/49 standard would actually 
protect the revenue by placing a meaningful limit on the addition of 
alcohol flavorings to FMBs in a manner consistent with TTB's regulatory 
policy. For example, one commenter argued that the 0.5% standard is 
punitive and has no basis in recent TTB policy. This commenter 
suggested that ATF Ruling 96-1 actually weakened the case for the 0.5% 
standard since the ruling permits the addition of up to 1.5% alc/vol 
derived from flavors in beer and malt beverages over 6.0% alc/vol. The 
commenter stated that in view of this ruling, TTB has failed to present 
evidence why a far stricter standard, 0.5%, should be used for the 
definitions of beer and malt beverages.
    Some commenters stated that the proposed 0.5% standard would 
arbitrarily impose a more rigorous standard on FMBs and beer than TTB 
imposes on other alcohol beverages. The commenters allege, as examples 
of this disparity in treatment:
     There is no regulatory restriction on the amount of 
alcohol flavorings used in wine specialty products;
     Fortified wine has less stringent standards for the 
addition of distilled spirits to the wine base than the proposed 0.5% 
standard;
     Distilled spirits products may contain up to 50% wine on a 
proof gallon basis;
     Certain wines may be labeled with a varietal designation 
if 51% of the grapes are of the labeled grape variety; and
     A TTB regulation, 27 CFR 5.22(b), requires bourbon whiskey 
to be produced from a fermented mash of not less than 51 percent corn. 
The other 49 percent may come from any other grain.
    Additionally, a number of commenters argued that TTB's general 
policy on beer ingredients, allowing as little as 25% of the 
fermentable ingredients to be from malted barley, is significantly more 
lenient than the proposed 0.5% standard. Some commenters further noted 
that to label a product ``beer,'' 50 percent of the fermentable base 
must be a grain. Accordingly, these commenters argued that the 51/49 
standard was more consistent with TTB's regulatory policies than the 
0.5% standard.
4. Burden of Establishing Consumer Deception
    In support of their position against the proposed 0.5% standard, 
FMBC, as well as several FMB producers, argued that TTB failed to meet 
its burden of establishing that consumer deception or confusion results 
from use of the term ``malt beverage'' on the label of a product that 
derives most of its alcohol from added flavors. These commenters 
suggested that TTB must first produce evidence to back up its assertion 
that use of the term ``malt beverage'' on a label leads consumers to 
believe that a significant portion of the product's alcohol derives 
from fermentation of barley malt and other ingredients at the brewery, 
and must secondly demonstrate that the consumer confusion it asserts is 
material in that it actually affects consumers' purchasing decisions.
    FMBC suggested that TTB had not met either of those burdens in 
Notice No. 4. This commenter argued that the notice contained no 
evidence of consumer confusion, cited to no

[[Page 212]]

consumer survey, and did not point to a single consumer complaint about 
the alcohol source in FMBs. FMBC suggested that a final rule could not 
cure this deficiency as the APA requires TTB to provide the public an 
opportunity to comment on the basis of new regulations. FMBC also 
stated that Federal courts today virtually require survey evidence to 
back up a claim of consumer confusion; mere assertions of 
administrative expertise, without more, would not carry TTB's 
evidentiary burden.
    Finally, FMBC suggested that TTB bears an even heavier evidentiary 
burden since Notice No. 4's assertion of confusion directly contradicts 
its predecessor's pronouncements on the same subject. FMBC pointed out 
that when TTB's predecessor agency, ATF, decided not to pursue further 
rulemaking on the use of cocktail names on labels of malt beverage 
coolers, it concluded, in a letter dated November 17, 1997, as follows:

    Evidence introduced indicates that flavored malt beverages are 
viewed by consumers as coolers or low alcohol refreshers, and not as 
a distilled spirits product. Evidence introduced also indicates that 
the presence of distilled spirits or any similarity of these 
products to a distilled spirits drink is not a criteria in their 
selection by consumers.

    Accordingly, FMBC, like many other commenters, suggested that TTB's 
statement in the preamble to Notice No. 4 was inconsistent with the 
conclusion of its predecessor agency, reached just 6 years before, that 
consumers did not care about the alcohol source of malt beverage 
products. The commenters noted that ATF had reached this conclusion 
after soliciting public comments on the use of cocktail names in the 
labeling of malt beverages, and that its conclusion was consistent with 
consumer surveys submitted by malt beverage producers in that 
rulemaking proceeding.
5. Consumer Survey Conducted by the Luntz Research Companies
    MAB retained the Luntz Research Companies (``Luntz'') to survey 
consumer beliefs about the alcohol source in FMBs, and to ascertain 
whether any of these beliefs were material to FMB purchasing decisions. 
Luntz conducted 600 face-to-face interviews of FMB consumers in 3 
metropolitan areas--Baltimore, Chicago, and San Diego. The purpose of 
the survey was to determine if the term ``malt beverage'' led consumers 
to believe erroneously that the alcohol in an FMB comes from a 
fermentation process and whether consumer beliefs about the source of 
alcohol in FMBs were likely to influence the purchasing decisions of 
consumers.
    To determine if the term ``malt beverage'' confused consumers, the 
research group provided respondents with a bottle of the FMB ``Mike's 
Hard Lemonade.'' The term ``malt beverage'' appeared prominently on the 
front label. The survey asked the respondents to look at the bottle and 
to state if they believed the alcohol came from a distillation or 
fermentation process, or if they had no belief about the product's 
alcohol source. The results were as follows:

                              [In percent]
------------------------------------------------------------------------
 
------------------------------------------------------------------------
No belief about the source of alcohol............................     80
Alcohol comes from a distillation process........................     11
Alcohol comes from a fermentation process........................      9
------------------------------------------------------------------------

    As noted in the table, the Luntz survey found that four out of five 
FMB consumers had no belief about the alcohol source in an FMB product 
after examining a bottle of a well-known FMB product prominently 
labeled as a ``malt beverage.'' Consumers who had a belief about the 
alcohol source roughly split into those who believed that it contained 
alcohol from fermentation and those who believed that it contained 
alcohol from distillation. Of the 9% of the respondents (54 out of 600) 
who believed the product derived its alcohol from fermentation, 
approximately 2% (14 out of 600) based this belief on the product's 
labeling as a malt beverage. MAB asserted that the case law requires a 
level of confusion far greater than 2% in order to find the existence 
of consumer confusion in the marketplace.
    To determine whether the source of alcohol in FMBs affected 
purchasing decisions, the survey asked respondents to name the top two 
most important reasons why they drink FMBs. The results were as 
follows:

                              [In percent]
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Taste/Flavor.....................................................     52
New/Different/Not Beer...........................................     28
Convenience/Availability.........................................     13
Refreshing/Thirst Quenching......................................     12
Easy to Drink/No Alcohol Taste...................................     12
Females Like Them................................................      9
Effect of Alcohol................................................      6
Friends/Family Drink It..........................................      7
Given to Me/Bought For Me........................................      5
------------------------------------------------------------------------

    The survey noted that not one of the 600 respondents stated that 
the source of alcohol was an important reason for choosing an FMB.
    The survey then provided the respondents with a list of nine 
reasons why someone would choose an FMB, providing as one of the 
reasons whether the alcohol comes from the fermentation or distillation 
process. The respondents were asked to choose their top three reasons. 
The results were as follows:

                              [In percent]
------------------------------------------------------------------------
 
------------------------------------------------------------------------
The Taste.......................................................    81
Alcohol Strength................................................    47
Convenience.....................................................    42
Cost............................................................    32
What My Friends/Family/Co-Workers are Drinking..................    32
Advertising and Marketing.......................................    21
The Design of the Packaging and Bottle..........................     9
The Image I Want to Portray to People...........................     8
Whether the Alcohol Comes from a Fermentation or Distillation        0.2
 Process........................................................
------------------------------------------------------------------------

    MAB suggested that the Luntz survey demonstrates that alcohol 
source is totally immaterial to the purchasing decisions of FMB 
consumers. When asked for their top two reasons for choosing an FMB, 
not a single respondent gave alcohol source as a reason. Indeed, taste-
related responses topped consumers' criteria for selection, followed by 
the FMB's difference from beer and its convenience. Even when presented 
with a list of 9 reasons for selecting an FMB that included alcohol 
source, just one respondent chose alcohol source as a reason for 
selecting an FMB. MAB suggested that this evidence conclusively 
demonstrates that alcohol source is not material to consumers' 
purchasing decisions, and that to label an FMB as a ``malt beverage'' 
is not misleading as a matter of law.
6. Standard That Best Prevents Consumer Deception
    Some commenters suggested that adoption of the 51/49 standard would 
better prevent consumer deception than implementation of the proposed 
0.5% standard. The FMBC suggested that if TTB was concerned about 
consumer confusion, it had failed to bear its burden of establishing 
why the 0.5% standard prevents consumer deception better than a 
majority or 51/49% standard. As noted earlier in the comment overview, 
the National Consumers League (NCL) made a similar comment, noting that 
requiring that the product derive a majority of its alcohol content 
from malt fermentation would assure that an FMB actually contains a 
significant concentration of malt. The NCL also questioned whether 
source of alcohol was in any way material to consumer choice, and urged 
more complete labeling information on alcohol beverage containers.

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    As noted earlier in this comment discussion, several commenters 
pointed out that TTB and its predecessor agency had adopted 
``majority'' or ``predominance'' standards for other products. These 
commenters noted that wine can constitute up to 50% of a distilled 
spirits product; thus, nonbeverage flavors should be able to contribute 
up to half (or 49%) of the alcohol content of a malt beverage product.
7. Preserving the Integrity of Beer
    The FMBC noted that several supporters of the 0.5% standard cast 
themselves as defenders of ``traditional'' and ``age-old'' production 
techniques, but suggested that the brewing industry ``long ago departed 
from the brewing methods employed at the time current federal and state 
alcohol control laws were enacted.'' The FMBC suggested that several 
techniques currently used by brewers are not specifically authorized by 
law such as the use of high-tech enzymes to enhance fermentation, the 
use of ``high-gravity'' brewing to produce a high-alcohol product to 
which water is added just before packaging to make beer, new 
fermentation techniques that have pushed the upper strength limit of 
beer to 25% alcohol by volume, and the thousands of adjuncts authorized 
by the ARM.
    The FMBC argued that ``tradition'' arguments play upon the real 
differences in taste and appearance between conventional beers and 
FMBs. However, the FMBC asserted that Federal policy long ago abandoned 
any taste, aroma, or color criterion for products classified as beer or 
malt beverages. Finally, the FMBC noted that supporters of the 0.5% 
standard claim that brewers can produce, under the 0.5% standard, FMBs 
that look and taste exactly like FMBs on the market today. Thus, 
claimed the FMBC, ``in a wonderfully ironic twist, supporters of the 
0.5% standards wrap themselves in the banner of brewing tradition while 
championing a rule that will accelerate the development and deployment 
of high-technology processes necessary to produce an FMB under the 
Notice 4 standard.''

C. TTB Response

1. Statutory Authority
    In the preamble to Notice No. 4, TTB set forth, in great detail, 
its authority to engage in rulemaking to place limits on the use of 
alcohol derived from flavoring materials in the production of malt 
beverages. After carefully considering the comments to the contrary, we 
have concluded that we have authority, under both the IRC and the FAA 
Act, to issue regulations that establish those limits.
    Statutory Definitions. Fermentation is the process by which yeast 
converts sugar into alcohol and carbon dioxide. Both the definition of 
``beer'' under IRC section 5052 and the definition of ``malt beverage'' 
under the FAA Act focus on fermentation as the source of the alcohol in 
these products.
    The study conducted by ATF in 2002 established that for many FMB 
products, the major source of alcohol was distilled alcohol rather than 
fermented alcohol. The results of this study raised the question: 
Should a product that derives the majority (in some cases up to 99%) of 
its alcohol from the distilled spirits components of added flavors 
qualify as a ``beer'' under the IRC, and as a ``malt beverage'' under 
the FAA Act? TTB concluded that Congress never intended to allow such 
products to qualify as beers or malt beverages. At the same time, 
neither statutory definition explicitly excludes beverages that contain 
alcohol in addition to that produced during their fermentation. 
Accordingly, we proposed a regulation that would allow only less than 
0.5% alcohol by volume derived from flavors, and we also sought 
comments on an alternative proposal that would require that at least 
51% of the alcohol in a beer or malt beverage must be derived from 
fermentation at the brewery.
    After carefully considering the comments on this issue, as well as 
the statutes that provide us with authority to issue regulations on 
standards for beer and malt beverages, we have concluded that we have 
statutory authority to limit the alcohol that may be added to ``beers'' 
under the IRC, and to ``malt beverages'' under the FAA Act, and to 
ensure that they derive most of their alcohol from fermentation at a 
brewery rather than from the distilled spirits components of added 
flavors.
    Authority Under the IRC. TTB does not agree with those commenters 
who suggested that malt beverages may contain unlimited quantities of 
distilled alcohol from added flavors without falling under the 
statutory definition of a distilled spirit. One commenter argued that 
the provisions of IRC section 5001(a)(2) apply only to products 
containing distilled spirits on which the tax has not been paid. 
Because the distilled spirits used in nonbeverage drawback products are 
tax determined or taxpaid, the commenter argued that this section does 
not apply to products containing flavors.
    TTB does not agree with this interpretation of the IRC. Section 
5001(a)(2) provides as follows:

    (2) Products containing distilled spirits. All products of 
distillation, by whatever name known, which contain distilled 
spirits, on which the tax imposed by law has not been paid, and any 
alcoholic ingredient added to such products, shall be considered and 
taxed as distilled spirits.

    The commenter misreads this section by suggesting that the critical 
issue is whether the distilled spirits contained in the product have 
been taxpaid. Instead, the statute clearly imposes a tax on all 
products of distillation that contain distilled spirits, as long as the 
tax imposed by law on the finished product has not been paid.
    This provision of the IRC must be read in conjunction with other 
IRC requirements. Subject to certain exceptions not relevant here, a 
person who manufactures, mixes, or otherwise processes distilled 
spirits is a processor within the meaning of IRC section 5002(a)(5). 
The definition of a ``processor'' does not revolve around whether the 
distilled spirits in question are taxpaid or not, and neither does the 
imposition of tax under section 5001(a)(2). The critical issue is not 
whether the original distilled spirits used in the product were 
taxpaid; instead, the issue is whether the final product has been 
taxpaid as a distilled spirits product.
    Furthermore, IRC section 5002(a)(8) defines the term ``distilled 
spirits'' to mean ``that substance known as ethyl alcohol, ethanol, or 
spirits of wine in any form (including all dilutions and mixtures 
thereof from whatever source or by whatever process produced).'' The 
application of this definition does not depend upon whether the spirits 
are taxpaid or not.
    TTB also believes that those commenters who questioned TTB's 
authority under the IRC are overlooking our broad authority over the 
production of flavoring materials under the nonbeverage drawback 
provisions of the IRC. This authority includes the ability to ensure 
that nonbeverage flavors are not being misused as the primary source of 
alcohol in beverage products such as malt beverages.
    Pursuant to section 5132 of the IRC (26 U.S.C. 5132), the Secretary 
has authority to issue ``rules and regulations * * * to secure the 
Treasury against frauds.'' This authority is not new, and it has been 
used in the past to issue regulations placing a 2\1/2\ percent limit on 
the quantity of nonbeverage drawback flavors used in the production of 
distilled spirits products. (See T.D. 5573.) Congress recognized this

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regulatory limit when it enacted section 5010 of the IRC in 1980, 
limiting the quantity of flavors eligible for a tax credit in distilled 
spirits products to 2\1/2\ percent. Our broad authority to limit the 
use of drawback flavors in the production of alcoholic beverages also 
allows us to place limits on the use of such flavors in the production 
of beer.
    Authority Under the FAA Act. The FAA Act also gives the Secretary 
of the Treasury authority to issue regulations to prevent deception in 
the labeling and advertising of malt beverages and to ensure that 
labels provide consumers with adequate information about the identity 
and quality of malt beverages. (See 27 U.S.C. 205(e).) One of the 
questions raised by this rulemaking process is whether the term ``malt 
beverage'' is an accurate description of a product that derives up to 
99% of its alcohol from the distilled spirits components of added 
flavors. Our authority under the FAA Act requires us to issue 
regulations setting forth standards for terms such as ``malt beverage'' 
to ensure that use of this designation on alcohol beverage labels does 
not mislead consumers but instead provides consumers with adequate 
information about the identity and quality of the product.
    Accordingly, TTB has concluded that it has authority, under both 
the IRC and the FAA Act, to set limits on the quantity of non-fermented 
alcohol, derived from added flavors, that is used in the production of 
flavored malt beverages.
2. Which Standard Is Better Supported Under the IRC?
    In Notice No. 4, we stated that we believed that the IRC would 
support either the proposed 0.5% standard or the alternate 51/49 
standard. After carefully examining the comments, we have concluded 
that valid arguments may be made in favor of both standards.
    The primary argument in favor of the 0.5% standard is that it 
establishes a de minimis standard for the addition to beer of flavors 
containing alcohol. Essentially, the use of this a standard treats 
beers in the same way that soft drinks and other non-alcoholic products 
are treated; they may contain less than 0.5% added alcohol from 
flavors.
    The arguments against the 0.5% standard are both practical and 
statutory. We are not starting from a blank slate; instead, we are 
facing a marketplace in which many of the most popular FMB products 
derive the vast majority of their alcohol content from added flavors. 
The policies of TTB and its predecessor agencies have allowed this 
practice for years. We have allowed the use of non-beverage flavors in 
the production of beer, wine, and distilled spirits. The IRC does not 
require us to adopt a 0.5% standard. Accordingly, companies that have 
invested millions of dollars in reliance on the existing policy argued 
that if TTB has discretion to implement either standard, the Bureau 
should choose the standard that imposes the least burden on FMB 
producers.
    After carefully considering the comments, we agree with those 
commenters who stated that TTB has some discretion in this area. Beers 
subject to taxation under the IRC are not nonalcoholic beverages like 
soft drinks; thus, the 0.5% limit on added alcohol in nonalcoholic 
products does not apply to beers, which are already being taxed under 
the IRC. However, our authority under the IRC includes the authority to 
set standards for the production of beer and for the use of nonbeverage 
flavors in beer production, to ensure that the revenue is adequately 
protected.
3. Which Interpretation Is Consistent With Our Regulatory Policy and 
Practice?
    After careful consideration of the comments, we have concluded that 
it is necessary, for purposes of implementing the relevant statutes, to 
adopt a limit on the use of alcohol derived from flavoring materials in 
the production of beer. As explained below, we believe that the 51/49 
standard interprets the statutes as issue in a way most consistent with 
our regulatory policy on revenue classification issues.
    The unlimited use of flavors containing alcohol in the production 
of FMBs poses a threat to the revenue. Once FMBs start deriving 51%, or 
75%, or even 99% of their alcohol content from the distilled spirits 
components of added flavors, it can be argued that these products are 
properly classified as distilled spirits rather than as beers. As 
previously noted, the IRC definitions of these terms make it clear that 
beers are products of fermentation, and distilled spirits are generally 
products of distillation. The tax rate on beer is significantly lower 
than the tax rate on distilled spirits. Accordingly, allowing such 
products to be produced at a brewery and taxpaid as beers rather than 
distilled spirits renders meaningless the distinction between distilled 
spirits products and beers.
    Clearly, a standard must be established in order to avoid the 
current situation whereby a product deriving as much as 99% of its 
alcohol content from the distilled alcohol component in added flavors 
is classified, and taxpaid, as a beer. Furthermore, if we do not adopt 
a limit on the use of added flavors containing alcohol, it is very 
possible that producers will find new ways to take advantage of this 
policy, by producing at breweries more and more products that used to 
be produced at distilled spirits plants. Accordingly, we believe that, 
at a minimum, the alcohol derived from added flavors and other 
nonbeverage ingredients must be restricted to less than half the 
alcohol content of the finished FMB product.
    We are persuaded by the comments that suggested that the proposed 
0.5% limit was not the appropriate standard, notwithstanding its 
historical use to distinguish alcohol beverages from non-alcoholic 
beverage products, because we are dealing here with a taxable 
commodity--beer--not a nonalcoholic beverage such as a soda or juice. 
In other words, when we use the 0.5% limitation to limit the use of 
alcohol from flavorings in nonalcoholic beverages, we are drawing a 
line between products that are subject to tax under Chapter 51 of the 
IRC and those that are not. However, FMBs are clearly subject to tax 
under Chapter 51; the only question is whether they are appropriately 
taxed as beers or distilled spirits.
    While either the proposed 0.5% standard or the 51/49 standard would 
be consistent with the statutory language, we have concluded that the 
51/49 limit is more consistent with TTB regulatory policy and practice. 
As previously noted, the revenue issue posed is how to ensure that we 
maintain a meaningful distinction between beer and distilled spirits 
under the IRC. Because the statute does not provide us with specific 
guidance on this issue, we are guided by our regulatory policy on 
similar classification issues.
    With regard to those commenters who argued that the proposed limits 
on the use of alcoholic flavorings in the production of beer are 
inconsistent with our treatment of wines under the IRC, and who 
suggested that the regulations do not place limits on the use of 
flavors containing alcohol in the production of wine, we believe that 
these statements are not entirely accurate. In the first place, it 
should be noted that the statutes and regulations governing the 
production of wine under the IRC differ significantly from the statutes 
and regulations governing the production of beer under the IRC. While 
the IRC does not specifically authorize the direct addition of 
distilled spirits to beer, it does specifically authorize the addition 
of wine spirits to wines. (See 26 U.S.C. 5373.) Thus, many wines 
contain distilled alcohol from wine spirits.

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    Secondly, the IRC regulations governing the production of wine do 
place limits on the use of essences containing spirits. In particular, 
the regulations provide that where an essence contains spirits, use of 
the essence may not increase the volume of the wine more than 10 
percent nor its alcohol content more than four percent by volume. (See 
27 CFR 24.85.) Thus, the regulations do place limitations on the use of 
essences containing spirits in the production of wine. As previously 
noted, there is a 2\1/2\% limit on the use of drawback flavors eligible 
for credit in the production of distilled spirits products under 26 
U.S.C. 5010.
    TTB believes that because of the different statutory provisions, 
our treatment of the use of flavors in wines and distilled spirits does 
not provide clear guidance as to how to limit the use of alcohol 
derived from flavors in beer production. However, we believe that a 
more analogous regulatory provision concerns the use of wine in 
distilled spirits products. Regulations issued under both the FAA Act 
and the IRC define the term ``distilled spirits'' to exclude mixtures 
of distilled spirits and wine, bottled at 48 degrees proof or less, if 
the mixture contains more than 50 percent wine on a proof gallon basis. 
(See 27 CFR 5.11 and 19.11.) This longstanding distinction signifies 
the intent to distinguish between two categories of taxable alcohol 
beverages, wine and distilled spirits, based on a predominance 
standard.
4. Reasons for Adoption of the 51/49 Standard Under the IRC Regulations
    After carefully considering the record, TTB has concluded that the 
51/49 standard is most consistent with our regulatory policy on revenue 
classification issues. Accordingly, we are adopting the 51/49 standard 
in the regulations setting forth the standards, under the IRC, for 
addition of flavoring materials that contain alcohol to beer.
    As noted previously, TTB has determined that the adoption of the 
0.5% standard for all beers under the IRC would impose additional 
economic costs and regulatory burdens on the beer industry. Since we 
have concluded, after careful analysis of the record, that either 
interpretation is allowed under the relevant statutes, we are adopting 
the alternative that is less costly to the industry, and imposes fewer 
regulatory burdens.
    It should be emphasized that adoption of this standard reflects a 
decision on a tax classification issue, and will in no way reduce the 
tax liability of brewers that utilize the maximum amount of flavors in 
the FMBs that they produce. Brewers will pay the same tax rate on beer 
regardless of whether the beer derives 10% or 49% of its alcohol 
content from added flavors. Because beer is taxed on a volume basis, a 
brewer derives no tax advantage by increasing the flavors content of 
the product to the maximum allowed by the regulations. Thus, the 51/49 
standard will accord maximum flexibility to the industry in formulating 
their products according to the taste preferences of their consumers, 
without jeopardizing the revenue.
    Accordingly, TTB is amending the proposed regulation in 27 CFR 
25.15 to provide that flavors and other nonbeverage ingredients 
containing alcohol may contribute no more than 49% of the overall 
alcohol content of the finished beer.
5. FAA Act, Consumer Deception
    After carefully considering all the comments on this issue, TTB has 
concluded that current FMB labels do not provide consumers with 
adequate information about the product. For this reason, we have 
decided to set new standards for use of the designation ``malt 
beverage'' on labels.
    TTB concludes that the term ``malt beverage'' does not accurately 
describe a product that derives up to 99% of its alcohol content from 
the distilled spirits components of nonbeverage flavoring materials. 
However, it is important to stress that this in no way means that 
producers of FMBs currently on the market have intentionally misled 
consumers by using this term on labels. Instead, these producers have 
relied on the policies of TTB and our predecessor agency. Accordingly, 
the focus of TTB is on which standard for FMBs will best achieve our 
statutory mandate of ensuring that malt beverage labels adequately 
inform consumers about the identity of the product.
    Consistency With 1997 Decision on Cocktail Names. We do not believe 
that our predecessor agency's 1997 decision not to pursue further 
rulemaking on the use of cocktail names in the labeling or advertising 
of malt beverages precludes us from making this decision. In the first 
place, we recognize that we are changing longstanding policy with 
regard to the labeling of FMB products; that is why we engaged in 
notice and comment rulemaking before implementing this change. 
Secondly, the proposed and final rules are consistent in many respects 
with ATF's 1997 decision about cocktail names. As set forth later in 
this document, the regulations in this final rule continue to allow the 
use of a cocktail name as a brand name or fanciful name of a malt 
beverage, provided that the overall label does not present a misleading 
impression about the identity of the product.
    Consumer Survey Conducted by the Luntz Companies. We have carefully 
reviewed the results of the consumer study conducted by Luntz. The 
commenter that submitted this study argues that it establishes two 
essential points: alcohol source is immaterial to consumers, and 
consumers are not confused about the source of alcohol in an FMB 
product. We disagree.
    First, we will address the materiality issue. Other commenters have 
raised this issue as well, noting that in 1997 our predecessor agency 
concluded that there was evidence indicating that similarity to 
distilled spirits products was not a major factor in consumers' 
purchasing decisions with regard to FMB products. A major producer of 
FMB products has submitted new consumer evidence, the Luntz survey, 
which purports to establish that the source of alcohol in an FMB is not 
a material factor in a consumer's decision to purchase the product. 
Accordingly, several commenters have argued that TTB can justify action 
based on consumer deception only if consumers are being misled in a 
material fashion.
    TTB does not agree that the Luntz survey conclusively establishes 
that consumers do not care whether the product is a result of 
fermentation or distillation. Furthermore, we do not agree that we are 
required to conduct consumer surveys to find out if alcohol source is a 
material issue to consumers before setting standards that distinguish 
malt beverages from distilled spirits products.
    Since the enactment of the FAA Act in 1935, we and our predecessor 
agencies have issued regulations setting class and type designations or 
standards of identity for wines, distilled spirits, and malt beverages. 
These standards of identity are largely based on industry and consumer 
understanding of the meaning of certain terms. The FAA Act provides us 
with authority to issue labeling regulations that will prevent consumer 
deception and provide the consumers with adequate information about the 
identity and quality of the product. (See 27 U.S.C. 205(e).)
    The FAA Act provides for three broad categories of alcohol 
beverages: distilled spirits, wines, and malt beverages. The 
classification of a product within one of these categories is the most 
fundamental decision that must be made before the product can be 
properly labeled or advertised under the Act. To say that consumers do 
not care whether the alcohol in a product comes from

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fermentation or distillation is equivalent to saying that consumers do 
not care whether the product is a distilled spirits product or a malt 
beverage. Yet, our most basic responsibility under the FAA Act labeling 
provisions is to provide the consumer with adequate information about 
the identity of the product. There can be no question that the starting 
point of this responsibility is informing the consumer whether the 
beverage is a wine, malt beverage, or distilled spirits product.
    In Federal Security Administrator v. Quaker Oats Co., 318 U.S. 218 
(1943), the Supreme Court upheld revised standards of identity for 
``farina'' and ``enriched farina'' under the Federal Food, Drug and 
Cosmetic Act. A manufacturer had challenged these standards, alleging 
that under the revised standards, its product, previously marketed as 
farina enriched with Vitamin D, would qualify as neither farina nor 
enriched farina. The Court of Appeals found that the Administrator's 
findings as to probable consumer confusion in the absence of prescribed 
standards of identity were speculative and conjectural, in the absence 
of evidence that the respondent's product had in fact confused or 
misled anyone. The Supreme Court overturned this decision, stressing 
the deferential nature of its review of the Administrator's decision. 
The Supreme Court rejected the argument that the Administrator relied 
on speculative and conjectural testimony as to whether the marketing of 
products that do not conform to standards of identity would tend to 
confuse and mislead consumers, finding that:

    The exercise of the administrative rule-making power necessarily 
looks to the future. The statute requires the Administrator to adopt 
standards of identity [which], in his judgment, ``will'' promote 
honesty and fair dealing in the interest of consumers. Acting within 
his statutory authority he is required to establish standards which 
will guard against the probable future effects of present trends. 
(See 318 U.S. at 228.)

Similarly, our authority under the FAA Act requires us to prescribe 
labeling regulations that will ensure that consumers are adequately 
informed as to the identity and quality of alcohol beverages.

    Although the Quaker Oats case deals with the Federal Food, Drug and 
Cosmetic Act (FD&C Act), rather than the FAA Act, many of the Court's 
observations about the FD&C Act are equally applicable to the FAA Act. 
For example, the Court noted that ``the text and the legislative 
history of the present statute plainly show that its purpose was not 
confined to a requirement of truthful and informative labeling.'' (See 
318 U.S. at 230.) The Court held that ``provisions for standards of 
identity thus reflect a recognition by Congress of the inability of 
consumers in some cases to determine, solely on the basis of 
informative labeling, the relative merits of a variety of products 
superficially resembling each other.'' (See 318 U.S. at 230-231.) In 
the same way, regardless of whether we have consumer surveys 
establishing that consumers care whether a product derives its alcohol 
from distilled spirits or beer, it is our responsibility to ensure that 
the label truthfully and adequately describes the contents of the 
product. In order to do this, we must establish basic standards for use 
of the terms ``distilled spirits'' and ``malt beverage'' on alcohol 
beverage labels.
    The second issue addressed by the Luntz survey is whether current 
labels mislead consumers, and whether they provide adequate information 
about the identity of the product. MAB argues that consumers are not 
confused about the source of alcohol based on the fact that of the 20 
percent of consumers that had a belief about the source of alcohol, 
less than half believed that the alcohol came from fermentation, and 
slightly more than half believed that it came from distillation. TTB 
draws very different conclusions from this survey.
    The survey was conducted for a ``hard lemonade'' product labeled as 
a ``flavored malt beverage.'' Yet 80% of the respondents, after reading 
the label, had no belief whatsoever as to whether the product was 
derived from fermented alcohol or distilled alcohol. This would seem to 
indicate that the vast majority of the respondents were very confused 
as to the classification of this FMB product.
    Because the vast majority--80%--of the respondents had no belief on 
this issue whatsoever, and the remaining respondents were almost evenly 
divided on the question, the survey clearly does not establish that 
current FMB labels provide consumers with adequate information about 
the identity of the product. Indeed, the only thing that is clear from 
the results of the survey is that, of the 600 FMB consumers that 
participated in the survey, only a very small percentage (11%) 
recognized that the alcohol in the product might come from distillation 
rather than fermentation. Thus, to the extent that the survey's results 
establish anything at all, they would appear to resoundingly support 
the conclusion that there is significant confusion among FMB consumers 
about the identity of these products.
    As previously noted, TTB does not agree that it needs to conduct a 
consumer survey to establish standards for the use of labeling terms 
based on consumer and industry understanding of the terms. As the U.S. 
Court of Appeals for the D.C. Circuit has recognized, ``while consumer 
surveys conducted by independent experts may arguably constitute the 
best way to establish consumer understanding and preference * * * such 
surveys are not the exclusive form of probative evidence of public 
perception.'' (See FTC v. Brown & Williamson Tobacco Corp., 778 F.2d 
35, 41 (D.C. Cir. 1985).) Our conclusion in this matter is bolstered by 
comments from beer and malt beverage industry members urging us to 
preserve the integrity of the beer and malt beverage classifications by 
establishing limits on the use of flavors containing alcohol.
    Based on the above analysis, TTB concludes that current FMB labels 
may mislead or confuse consumers by labeling as ``malt beverages'' 
products that derive up to 99% of their alcohol content from added 
flavors rather than from fermentation at the brewery. We believe that 
our statutory mandate to prevent consumer deception, and to ensure that 
alcohol beverage labels provide consumers with adequate information 
about the identity of the product, support an amendment to the 
regulations that would limit the quantity of alcohol derived from 
flavors in a malt beverage product.
6. Reasons for Adopting the 51/49 Standard for FMBs
    After careful consideration of the record, we have decided to adopt 
the 51/49 standard for malt beverages under the FAA Act. We agree with 
those commenters who suggested that the 51/49 standard is consistent 
with certain other limits in our FAA Act labeling regulations. See, for 
example, 27 CFR 5.11 (the definition of the term ``distilled spirits'' 
excludes mixtures containing wine, bottled at 48[deg] proof or less, if 
the mixture contains more than 50 percent wine on a proof gallon basis) 
and 27 CFR 5.22(b)(1)(i) (the standard of identity for ``bourbon 
whisky'' provides, among other things, that it must be produced from a 
mash of not less than 51 percent corn). We believe the 51/49 standard 
will adequately inform consumers about the identity of the product. 
Furthermore, as noted previously, adoption of the 51/49 standard for 
FMBs will minimize economic costs and regulatory burdens placed on 
members of the FMB industry.

[[Page 217]]

IX. State Concerns

    As noted in the preamble to Notice No. 4, one of our concerns in 
this rulemaking process has been to provide a Federal standard for the 
guidance of State regulatory agencies. Several State regulatory and 
taxation agencies expressed concerns to TTB about FMBs and requested 
that TTB take action to clarify their status as either malt beverages 
or distilled spirits. Many States have urged us to define FMBs and 
establish regulatory limits on the addition of alcohol to beer and malt 
beverages through the use of flavors. In the absence of such a Federal 
definition and regulation, several States have said that they will 
develop their own definitions for FMBs.
    TTB received more than 650 comments addressing the creation of a 
Federal standard for beer or malt beverages or addressing Federal-State 
relationship issues. Thirty-one State liquor control boards, revenue 
departments, or other State agencies having jurisdiction over alcohol 
beverages, as well as one county liquor commission, submitted comments. 
Twenty-four of these comments supported the proposed rule. Of the 
remaining 8 comments, 6 supported the concept of a uniform standard for 
flavored malt beverages and 2 provided information about State laws 
without expressing an opinion on the TTB proposals.
    We also received comments in support of the proposed rule from 
three Governors, one Lieutenant Governor, and many State legislators. A 
smaller number of State legislators commented in favor of the 51/49 
standard.

A. Comments by State Regulatory Agencies

1. Federal Leadership Role
    Several State regulatory agencies commented that it was only in the 
last year that they became aware of the actual composition of flavored 
malt beverages and that is up to TTB to establish a national standard. 
Some stated that a Federal definition for beer and malt beverages would 
ease the burden on State regulators by providing a uniform definition.
    Several of these agencies also commented that individual State 
governments do not have the time or resources necessary to establish 
definitions of beer or malt beverages, or to properly identify new 
alcohol beverages. They suggested that the Federal Government has these 
resources. For example, the Delaware Alcoholic Beverage Control 
Commissioner noted that ``[i]f a national standard for these beverages 
is established, state legislatures and administrators can make an 
informed decision as to whether it is in the state's interest to comply 
with or deviate from the national standard.'' The Washington State 
Liquor Control Board commented that ``[a]ddressing these issues at the 
federal level will ensure consistency and preclude the various states 
from having to create separate regulations.''
2. Need for Expeditious Action
    Many States urged TTB to resolve the issue expeditiously. For 
example, the Superintendent of the Idaho Liquor Dispensary did not 
express support for either the 0.5% standard or the 51/49 standard, but 
urged TTB ``to take action to reach a decision on a standard.'' The 
Director of Minnesota's Alcohol and Gambling Enforcement Division also 
did not express a preference for either standard but noted that the 
introduction of FMBs into the marketplace ``has been a complicated and 
confusing situation for regulators as well as the consuming public'' 
and stated that the Federal efforts to establish a uniform national 
standard were of great importance to the State. The Director of 
Oklahoma's Alcoholic Beverage Laws Enforcement Commission expressed his 
appreciation of Federal efforts to clarify issues concerning FMBs.
3. Importance of Consistent Federal Standard
    Many States noted the importance of a consistent Federal standard. 
For example, the Director of the Montana Department of Revenue 
supported the proposed 0.5% standard, noting that Montana, ``like many 
other states, believe[s] it could be detrimental to both regulatory 
agencies and the industry if there are inconsistent classifications of 
these products in different states.''
4. States That Follow the Federal Standard
    Many commenters stated that State governments have traditionally 
followed Federal policy in the taxation, licensing, and distribution of 
alcohol beverages. For example, the Kentucky Alcoholic Beverage Control 
Board stated that the ``Board has long felt that this standard should 
be set by the Federal Regulatory Authorities, not the individual 
states. Such Policy consistency is important because while states enjoy 
regulatory power over alcohol, most follow federal regulatory 
guidelines.''
    Some comments from States indicated that they would follow the 
Federal standard regardless of what decision is reached by TTB. For 
example, a comment from the California Department of Alcoholic Beverage 
Control indicated that California had ``always deferred to your 
agency's professional expertise concerning the classification of 
alcoholic beverages into one of three primary categories: beer, wine, 
or distilled spirits'' and it intended to continue deferring to TTB's 
classification of FMBs. A comment from the Comptroller of Maryland and 
its Alcohol and Tobacco Tax Division supported the proposed 0.5% 
standard but stated that Maryland ``adopts federal standards with 
respect to labeling and content of alcoholic beverages'' and thus was 
``prepared to apply whatever standards your agency ultimately 
determines to be most appropriate.''
5. Possibility of Unilateral State Actions To Classify FMBs
    Several State agencies commented that without prompt action by TTB, 
it would be necessary for them to undertake this regulatory activity on 
their own. For example, Maine's Department of Public Safety Liquor 
Licensing Division commented that if TTB delays or fails to adopt the 
proposed 0.5% standard, many States ``will find the need to act under 
their independent authority to determine the alcohol beverage category, 
label disclosures, tax, necessary wholesale and retail license 
requirements in order to continue the selling of these products in 
their state.''
    Some States have already begun regulatory proceedings on this 
issue. The Nebraska Liquor Control Commission commented that it has 
already determined that FMBs containing more than 0.5% alcohol derived 
from distillation should be classified as distilled spirits, and has 
set a deadline for industry compliance with this standard. The 
Tennessee Alcoholic Beverage Commission commented that it had already 
conducted administrative proceedings on the classification issue and 
that it believed that TTB's proposed 0.5% standard would be consistent 
with the position taken at its hearing. The issuance of an order in 
this matter is awaiting the TTB final rule.
    Other States commented that they would defer action pending 
completion of the TTB rulemaking proceedings. A comment from the 
Virginia Department of Alcoholic Beverage Control noted that while 
Virginia had accepted Federal classification of products in the past, 
under State law a product containing alcohol from spirits and beer is 
classified as a distilled spirits product, even if the majority of the 
alcohol is contributed by beer. The commenter suggested that TTB's 
recent study revealed that most FMBs were

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incorrectly classified in Virginia, and stated that the Department was 
delaying action pending the outcome of the TTB rulemaking.
    A comment from the Massachusetts Alcoholic Beverages Control 
Commission expressed support for the proposed 0.5% standard, stating 
that the Commission ``in the past has substantially deferred to federal 
standards concerning the identity of a specific product, but the 
information that has come to light recently during the review and 
discussion of FMB is troubling to the Commission.'' This commenter 
indicated that Massachusetts is deferring taking any action pending 
completion of the TTB rulemaking process.
6. Tax Issues
    Some State agencies focused on the taxation aspects of the proposed 
0.5% standard, suggesting that taxing FMBs as distilled spirits would 
have positive revenue effects. For example, a comment from the Maryland 
Comptroller and Alcohol and Tobacco Tax Division suggested that it 
seemed ``inherently unfair to tax a product as a `malt beverage' when 
the majority of the alcohol by volume contained in the product is from 
distilled spirits (flavoring or otherwise).'' Delaware's Office of 
Alcoholic Beverage Control Commissioner commented in support of the 
proposed regulation and stated that its concerns were not with 
distribution, but with ``the tax issue and the substantial reduction in 
the rate paid for beer * * * versus the rate paid for `low spirits' * * 
*. Obviously, the amount of money in controversy is large for the 
State, the industry, and the consumers.''
7. Consumer Deception
    Several State agencies focused on the issue of consumer confusion 
or deception. For example, a comment from Florida's Division of 
Alcoholic Beverages and Tobacco supported the 0.5% standard as a 
``positive step toward providing consumer information and avoiding 
confusion.'' A comment from Kentucky's Alcoholic Beverage Control Board 
stated that the proposed 0.5% standard ``maintains the clear 
distinction between malt beverages and distilled spirits that were 
becoming blurred in the minds of many regulators, including Kentucky.'' 
The Oregon Liquor Control Commission stated that while FMBs were made 
in breweries, distributed through beer distribution channels, and taxed 
as beer, they discovered that ``their alcohol is mainly or completely 
from distilled spirits sources, and their appearance and taste usually 
do not resemble beer. Customers, along with regulators, have been 
unsure what this hybrid product really is.''
8. State Law Issues
    In Notice No. 4, TTB solicited comments on whether States would 
have to enact new legislation if TTB amended its regulations to 
establish either the 0.5% standard or the 51/49 standard. Some States 
advised that the proposed 0.5% standard would not require amendments to 
State law, but they did not address the issue of whether a different 
standard would be inconsistent with State law. For example, the 
Oklahoma Alcoholic Beverage Laws Enforcement Commission advised that 
under Oklahoma's constitution, alcohol beverages were taxed and 
regulated based on whether the alcohol content of the product exceeds 
3.2%, regardless of whether the alcohol content is derived from brewing 
or distilling.
    A comment from the Georgia Department of Revenue advised that the 
proposed 0.5% standard would most likely cause the State to enact new 
legislation, because Georgia's alcoholic beverage code did not 
anticipate such products. However, this comment noted that, regardless 
of the standard, it might be necessary for the State to enact 
legislation in order to bring clarity to the issues of taxation and 
distribution.
    Only a few States indicated that adoption of a standard other than 
the 0.5% standard would be inconsistent with State law. A comment from 
the Virginia Department of Alcoholic Beverage Control stated that while 
adoption of the proposed 0.5% standard would be consistent with State 
law, any standard allowing a higher percentage of alcohol from a source 
other than the brewing process would create a potential conflict with 
current State law, which classifies products containing mixtures of 
beer and distilled spirits as distilled spirits products, regardless of 
whether the majority of the alcohol is contributed by the beer. The 
Arkansas Alcoholic Beverage Control Division indicated that if TTB 
allowed the use of distilled spirits products as a flavoring agent, 
legislative changes would be required in Arkansas if this product was 
to be sold by beer-only permittees.

B. Other Comments in Support of the 0.5% Standard

    Hundreds of brewery employees submitted comments stating that 
without the proposed 0.5% standard, brewers, wholesalers and retailers 
may face a patchwork of individual State laws and regulations, where 
the same product may ultimately be sold as ``beer'' in one State and as 
``hard liquor'' in another. These comments suggested that this was 
already happening in Nebraska and will almost certainly happen in other 
States as well. Other commenters pointed out that such different 
standards could result in subjecting a product to two entirely 
different sets of laws and regulations regarding production, 
distribution, place of sales, labeling, and advertising. Many 
commenters stated that this discrepancy would jeopardize nationwide 
marketing and distribution efforts by industry members.
    A State lawmaker commented that clear definitions of alcohol 
beverages are important for the State legislative process. Without 
definitions, the State legislatures cannot study and act on beverage 
alcohol issues in an educated and professional manner.
    Several members of the beer industry supported the 0.5% standard as 
being most likely to resolve the concerns of State administrators. For 
example, the Beer Institute commented that the 0.5% standard is the 
best option to maintain consistency among existing Federal and State 
statutes and regulations. While noting that State officials must 
utilize their respective definitions of alcohol beverages, the Beer 
Institute suggested that almost all of the States that have reviewed 
the issue can reconcile their statutes and regulations with the TTB 
proposal, but that this is not true of alternative standards.
    The Beer Institute suggested that implementation of an alternative 
standard would:

unravel the consensus and relative stability that have been achieved 
to date with respect to state statutes and regulations. The 
alternative discussed in Notice No. 4, a standard permitting a 51-
49% blend of malt beverage and distilled alcohol would require many 
changes in existing state tax and regulatory systems or even worse, 
a return to state-federal conflicts and inconsistent regulation.

    Anheuser-Busch predicted that:

there will be complete disorder in the nationwide marketplace if 
FMBs are permitted to contain 49 percent distilled spirits alcohol 
under federal law, yet most states would only permit 0.5% spirit 
alcohol. A patchwork of states regulating identical products as 
distilled spirits in most states, and as beer in others, would cause 
havoc and tremendous consumer confusion.

As one example of the confusion that could be caused by differing State 
classifications of the same product, the brewer noted that television 
advertisements regularly cross State lines.
    Anheuser-Busch also suggested that while the 51/49 standard is 
nowhere to

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be found in State laws, many State laws incorporate a 0.5% alcohol by 
volume threshold in their definitions of malt beverages and distilled 
spirits; accordingly, adoption of the alternative 51/49 standard by TTB 
would be disruptive to the system of State laws. The brewer suggested 
there is no basis to support the alternative standard in existing State 
laws, and that such action would create a conflict between Federal and 
State law. Additionally, Anheuser-Busch stated that such Federal action 
would trigger disruptive State action since many States would no longer 
follow TTB guidance, but would instead have to develop and/or enforce 
their own 0.5% standard, ``effectively ending federal leadership on the 
most important alcohol regulation issues.''
    Coors commented that the 0.5% proposal is consistent with TTB's 
role under the 21st Amendment and noted that it is the only approach or 
proposal consistent with the vast majority of the different State laws. 
Accordingly, Coors suggested that the 0.5% proposal ``thus fulfills 
TTB's role as a leader of the states' regulatory and tax collecting 
organizations.'' Coors acknowledged that ``[e]xamples of differences in 
the regulation of malt beverages at the state level do exist,'' but 
suggested that ``only the TTB proposed regulation provides comity to 
the states and a marketplace free from disruption * * *.'' Miller 
suggested that, given the support of the States for the proposed 0.5% 
standard and the reality of the FAA Act's penultimate provision, 
``considering other standards would be detrimental to the creation of a 
uniform standard.''

C. Other Comments in Support of the 51/49 Standard

    Supporters of the 51/49 standard challenged those comments that 
suggested that only the proposed 0.5% standard would meet the needs of 
the States and result in a uniform Federal standard. These commenters 
argued that while a national standard would be beneficial, TTB has 
provided no evidence in Notice No. 4 as to why the proposed 0.5% 
standard is the only way to accomplish this goal. Several commenters 
stated there is no reason to assume the proposed 0.5% standard for 
added alcohol is the only standard supported by the various State 
authorities.
    The FMBC noted that Federal law remains independent of State law 
and that the views of State officials are not binding on TTB. The FMBC 
stated that while it commended TTB for seeking to craft a national 
standard to respond to State concerns, TTB should not regulate to the 
``least common denominator'' and elevate the opinions of a few State 
regulators above other considerations it must weigh.
    The FMBC further stated that all States today classify FMBs as 
``beer,'' ``malt beverages,'' or an equivalent statutory term. The FMBC 
suggested that while definitions vary from State to State, many 
resemble in material respects one of the two Federal definitions. Like 
these Federal statutes, State statutes are silent on the issue of how 
much alcohol nonbeverage flavors can contribute to a malt beverage or 
beer. Accordingly, the FMBC argued that even assuming that this silence 
could support the imposition of limits on the use of flavors, it would 
allow State regulators to adopt either a majority standard, a 0.5% 
standard, or some other standard.
    The FMBC also challenged the characterization by other commenters 
of State laws on this issue. The FMBC noted that some supporters of the 
0.5% standard suggest that the presence of a 0.5% alcohol by volume 
threshold in many State statutes requires those states to limit the 
alcohol contribution of flavors to that de minimis amount. However, the 
FMBC pointed out that these thresholds do not address the formulation 
of products but instead constitute a threshold that divides taxable 
alcohol beverages from products containing alcohol that are not subject 
to taxation. The FMBC stated that it was aware of no State statute that 
sets 0.5%--or any other figure--as the mandatory limit on the amount of 
alcohol that flavors or other alcohol sources can contribute to a malt 
beverage. The FMBC also noted that if such an interpretation prevailed, 
many States would have to reclassify wines that derive alcohol from 
flavors or spirits.
    The FMBC argued that while some States have expressed support for 
Notice No. 4, none to date had indicated that they could not accept a 
majority standard. Finally, the FMBC stated that in 2002, the Joint 
Committee of the States (a body that represents the interest of alcohol 
regulators from both the ``control'' and ``open'' States) voted to 
recommend that States support a position that more than 50% of the 
volume of a finished FMB come from the product's beer/malt beverage 
base. The FMBC suggested that such a standard would be more lenient 
than the majority standard that FMBC can accept.

D. TTB Response

    We agree with those commenters who suggested that the originally 
proposed 0.5% standard would give States guidance in classifying FMBs. 
However, we have concluded that the 51/49 standard would achieve the 
same goal, with less cost to the industry, as discussed earlier in this 
document. We agree with those commenters who suggested that the 51/49 
standard will achieve our regulatory goal of establishing a uniform 
standard that provides a meaningful distinction between FMBs and 
distilled spirits products.
    It is noteworthy that, while most of the comments from State 
regulatory agencies supported the proposed rule, only a few of these 
comments specifically opposed the majority standard. Several State 
regulatory agencies did not specifically support either standard, but 
simply supported TTB's action in trying to resolve this difficult issue 
by setting a uniform standard.
    Furthermore, while a few States suggested that any standard other 
than 0.5% would be inconsistent with their State laws or regulations, 
none of these comments pointed to laws that specifically restricted the 
use of alcohol derived from nonbeverage flavors in FMB production. Like 
Federal law, many State laws use 0.5% alcohol by volume as the dividing 
point between products subject to tax and other regulations, and those 
that are not. Similarly, some State laws classify mixtures of beer and 
distilled spirits as distilled spirits products. However, we are not 
aware of any current State statutes that specifically regulate flavor 
use in FMB production, although at least two States have apparently 
initiated administrative procedures to establish such a policy.
    Several States have indicated that they will not follow TTB's lead 
if we adopt an alternative to the 0.5% standard. Other States have 
indicated that they will follow the Federal standard, regardless of 
what it is. TTB's role is to provide Federal leadership on this issue. 
However, it is up to the States to decide whether they want to follow 
Federal standards or not.
    Clearly, many brewers are concerned over facing a multitude of 
different State laws and regulations. Pursuant to the 21st Amendment, 
States have significant authority to regulate the sale and distribution 
of alcohol beverages within their borders. Under the penultimate clause 
of the FAA Act, Federal labeling and advertising regulations apply to 
malt beverages only to the extent that the State has adopted similar 
requirements for malt beverages sold within the State. Accordingly, 
brewers, wholesalers and retailers must

[[Page 220]]

follow State laws on these issues, regardless of what standard TTB 
adopts.
    We recognize that our adoption of the 51/49 standard may mean that 
some States will adopt a standard that differs from the Federal 
standard. However, as many commenters noted, State requirements on 
alcohol beverage classification issues already vary from State to 
State. We do not believe that the adoption of a different standard by 
some States will cause major problems to the beer industry; in any 
case, it is beyond TTB's authority to control what the States choose to 
do on this issue. We would note, however, that although TTB is adopting 
the 51/49 standard for FMBs, brewers are free to adopt the stricter 
0.5% standard for their own FMB products, thus ensuring compliance with 
those State laws and regulations that are amended to incorporate this 
standard. Finally, by adopting a one-year effective date provision for 
this final rule, we hope to provide States with an adequate period of 
time in which to decide whether they wish to follow the Federal rule or 
not, and to make any corresponding changes in their own laws or 
policies.

X. Mandatory Alcohol Content Labeling for FMBs

    TTB received 31 comments expressing opinions about the proposed 
mandatory alcohol content labeling for flavored malt beverages. Five 
commenters were brewers, six were from State licensing or regulatory 
agencies, seven were from interest groups, six were from individuals, 
and smaller numbers were from other sources. Although we received 
thousands of form letters supporting the Notice No. 4 proposals, none 
of these letters specifically addressed alcohol content labeling.

A. Comments Supporting the Proposal

    Miller supported the proposed alcohol content labeling requirement 
for FMBs and other malt beverages that derive any alcohol from added 
ingredients. Miller's comment stated that it would oppose a requirement 
to label all malt beverages with an alcohol content statement. Miller 
also commented that the regulations should provide flexibility by 
allowing the alcohol statement on any label rather than on the brand 
label (front label) as proposed. Miller commented that allowing the 
alcohol content statement on any label is consistent with other 
mandatory labeling requirements such as the Government warning label, 
and that the proposed placement on the brand label is unnecessary since 
there is no empirical evidence concerning consumer confusion over the 
alcohol content of FMBs.
    Two State liquor authorities supported the Notice No. 4 proposal to 
require alcohol content labeling on FMBs and other malt beverages that 
derive alcohol content from sources other than the brewing process. 
They agreed that this alcohol content labeling is necessary because of 
the similarity of some FMB labels to distilled spirits labels and 
because of the need to distinguish FMBs from non-alcohol products. Both 
States cited the importance to consumers of having alcohol content 
information available on malt beverage labels.

B. Other Comments

    Several commenters opined that the proposed alcohol labeling 
requirement should not be restricted to FMBs and other products 
containing added alcohol but should apply to all malt beverages. These 
commenters generally stated that there was no reason to single out FMBs 
for mandatory alcohol content labeling. Diageo commented that Notice 
No. 4 provides no basis for requiring alcohol content statements only 
on the labels of malt beverages that derive alcohol from added flavors 
or other ingredients. Diageo stated that the intended alcohol content 
labeling bears no relationship to its cited justification in Notice No. 
4, where TTB stated that consumers may believe either that spirits-
branded malt beverages contain the same high alcohol content as 
distilled spirits or that other FMBs may contain no alcohol due to 
their unconventional appearance. As an example of the contradictory 
policy this requirement would cause, Diageo asserted that the 
regulations would not require alcohol content labeling on a product 
with a distilled spirits brand name such as ``Jack Daniels Pilsner'' 
but would require alcohol content labeling on a traditional malt 
beverage product made with alcohol flavoring materials like 
``Strawberry Blonde Ale.'' Diageo further stated that they have placed 
alcohol content on labels of their FMBs since 2000.
    Brown-Forman also commented that TTB has no basis for treating FMBs 
differently from other malt beverages. Brown-Forman argued that alcohol 
content labeling is important consumer information that should be 
required for all malt beverages. Gallo also supported extending alcohol 
content labeling to all malt beverages but requested that it be 
optional because of labeling prohibitions in Oklahoma and New York 
State.
    The FMBC commented that alcohol content is important consumer 
information and that all of their member companies place that labeling 
on their FMBs. This trade association noted that although nearly all 
FMBs fall within a 5.0 to 5.5 percent alcohol by volume range, so-
called traditional malt beverages contain between 4% and 25% alcohol by 
volume, a much wider range, making alcohol content labeling more 
meaningful for so-called traditional malt beverages than for FMBs. 
Since most malt beverage labels do not contain alcohol content 
information, the FMBC claims that consumers are less informed and more 
confused about the alcohol content of other malt beverages. The FMBC 
therefore urged TTB to require alcohol content labeling on all malt 
beverages.
    CSPI similarly urged TTB to adopt alcohol content labeling for all 
malt beverages, stating that there is no reason to require such 
labeling only for FMBs and other malternative-type products, but not 
for all malt beverages. Another consumer organization, the NCL, also 
supported mandatory alcohol labeling for all malt beverages. The NCL 
stated, ``Mandatory labeling will provide consumers with the 
information they need to make better, more informed choices about 
alcoholic beverage consumption.''
    Anheuser-Busch opposed the proposal to require alcohol content 
labeling on FMBs and other malt beverages containing alcohol from added 
ingredients. Anheuser-Busch stated that consumers do not assume malt 
beverages with distilled spirits brand names are higher in alcohol 
content, noting also that most FMBs already have alcohol content 
labeling. Anheuser-Busch further stated that any alcohol content 
labeling should be at the discretion of the brewer and should not be 
applied to only one kind of malt beverage.

C. TTB Response

    The intent of TTB's proposal for alcohol content labeling was to 
provide this important information to consumers who may not be familiar 
with FMBs, or who may be misled by distilled spirits brand labels into 
believing that their alcohol content is higher than of other malt 
beverages. For the reasons outlined in the preamble to Notice No. 4, 
TTB is adopting the amendment to Sec.  7.22(a) to require alcohol 
content labeling on the brand labels of malt beverages that derive any 
amount of alcohol from flavors or other ingredients containing alcohol. 
TTB believes this requirement will provide consumers with better 
information about these malt beverage products and will help prevent 
consumer confusion over their identity. Moreover, this requirement 
applies to

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the addition of flavors or other nonbeverage materials containing 
alcohol at any step in the production process. At the same time, we are 
modifying the new Sec.  7.22(a)(5) text to exclude from this 
requirement the use of hop extract that contains alcohol since hops are 
an essential ingredient in the production of malt beverages. It should 
be noted, however, that TTB will count any alcohol contained in added 
hop extract toward the 49% limitation under the 51/49 standard.
    TTB notes that the final rule text, like the proposed rule text, 
does not separate FMBs that derive a substantial portion (up to 49%) of 
their alcohol content from added flavors from those traditional malt 
beverages that contain small amounts of added alcohol from flavors. 
Thus, this alcohol content labeling requirement applies to flavored 
beers, flavored ales, and so forth that are produced using alcohol 
flavorings.
    While many comments supported alcohol content labeling for all malt 
beverages, TTB is unable to issue such a broad regulation at this time. 
In Notice No. 4, we specifically stated that we were not proposing to 
require alcohol content statements on all malt beverage containers at 
that time. Thus, we have not aired this issue for comment. We also 
believe that such a requirement represents a significant departure from 
past labeling requirements that, until the addition of Sec.  7.71 in 
1993, actually prohibited the placement of alcohol content statements 
on malt beverage labels (unless required by State law), due to the 
prohibition within the FAA Act (this prohibition was found to be 
unconstitutional in Rubin v. Coors Brewing Co., 514 U.S. 476 (1995)). 
Thus, while we are not unsympathetic to the comments suggesting 
mandatory alcohol content labeling for all malt beverages, we are not 
in a position to implement such a rule without notice and public 
comment. We also note that we have received several petitions from 
various consumer and public interest groups for additional labeling 
information on alcohol beverage containers, including alcohol content 
labeling. TTB intends to pursue these labeling issues in future 
rulemaking.
    TTB acknowledges Gallo's comment regarding two States' prohibition 
of alcohol content statements on malt beverage labels. Pursuant to the 
penultimate paragraph of the FAA Act, the labeling requirements of the 
FAA Act apply only to the extent that State law imposes similar 
requirements on malt beverages sold within the State. Thus, brewers 
have to comply with the labeling laws of the State in which the malt 
beverages are being sold.
    We recognize that brewers may be required to print different labels 
for malt beverages intended for sale in those States in which alcohol 
content statements on malt beverage labels are prohibited. However, TTB 
does not believe this is a sufficient reason not to adopt mandatory 
alcohol content labeling statements for malt beverages that derive 
alcohol from flavors or other ingredients. Brewers have always been 
required to conform labels to State requirements when those 
requirements conflict with part 7 requirements under the FAA Act.
    With regard to the requirement that the alcohol content statement 
appear on the brand label, we have concluded that consumers are more 
likely to notice the statement if it appears on the brand label. 
Furthermore, this requirement is consistent with the regulations 
applicable to the mandatory alcohol content statements for wine (see 27 
CFR 4.32(a)(3) and distilled spirits (see 27 CFR 5.32(a)(3)).

XI. Use of Distilled Spirits Terms on Labels and in Advertisements

A. Comments Received

    TTB received 10 comments addressing the proposed limitations on the 
use of distilled spirits terms in malt beverage labeling and 
advertising. Three of these comments came from brewers, two were from 
State licensing and regulatory agencies, and the rest were from other 
sources. The majority of the comments favored limiting the use of 
distilled spirits terms on FMBs.
    Several brewers requested assurances that the policy in ATF Ruling 
2002-2, allowing the use of distilled spirits brand names on FMBs, will 
continue. They commented that industry members have made large 
investments in the labeling and advertising of these distilled spirits 
brand names based on existing government policies.
    Several commenters believed the proposed language of Sec. Sec.  
7.29 and 7.54 is vague, and they requested clearer language that 
directly addresses TTB's stated purpose. The Washington Legal 
Foundation, a nonprofit public interest law and policy center, 
submitted a comment in opposition to the proposed language, asserting 
that the regulation would not accommodate the First Amendment rights of 
malt beverage industry members to make truthful statements about their 
products.
    One commenter pointed out that the use of certain non-misleading 
statements would be prohibited by the proposed limitations on the use 
of distilled spirits terms on FMBs. This commenter cites a statement of 
``having the color of dark rum'' as a truthful statement that describes 
the color of an FMB product but which would be prohibited. Another 
commenter cited the example of ``Beer aged in Bourbon Barrels'' as a 
truthful, informative statement that would similarly be prohibited by 
the proposed regulations.

B. TTB Response

    We are incorporating the general holdings of ATF Ruling 2002-2 into 
Sec. Sec.  7.29 and 7.54. However, in response to the comments received 
on this issue, we are modifying the language of the regulation to 
clarify that the regulation prohibits only those labeling and 
advertising representations that tend to create a false or misleading 
impression that the malt beverage contains distilled spirits or is a 
distilled spirits product. In addition, we are keeping ``safe harbor'' 
provisions in Sec. Sec.  7.29 and 7.54 that incorporate the specific 
practices that we do not consider misleading.
    The proposed language in Sec. Sec.  7.29 and 7.54 was patterned 
after the existing language in 27 CFR part 4, Labeling and Advertising 
of Wine. In response to the issues raised by the commenters, we are 
revising these sections to clarify that we are not banning truthful and 
non-misleading speech about malt beverage products. Instead, we are 
incorporating the holdings of ATF Ruling 2002-2, which were intended to 
ensure that labeling and advertising statements comparing FMBs to 
distilled spirits products do not mislead consumers.
    ATF Ruling 2002-2 noted the existence of a recent trend in the 
marketing of FMBs. Brewers and importers had begun to associate FMBs 
with well-known brands of distilled spirits, by using distilled spirits 
brand names as the brand names for FMB products; by using labeling and 
packaging that resemble the labeling and packaging of well-known 
distilled spirits brands; and by the use of specific distilled spirits 
terms in describing flavorings added to malt beverages. The ruling 
noted that these products were drawing media attention, in part because 
of the impression given that these FMBs are made with distilled spirits 
or contain distilled spirits. Certain FMBs were using labels that used 
distilled spirits brand names or distilled spirits class and type 
designations to describe a flavor element as part of the statement of 
composition on the label. For example, these labels used a distilled 
spirits brand name, and then stated ``Flavored malt beverage made with 
natural flavors containing vodka'' or ``Flavored malt beverage with 
natural flavors containing

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genuine [Distilled Spirits Brand Name].''
    The ruling held that such statements were misleading. The labels 
create the misleading impression that the product is made with, or 
contains, distilled spirits. In fact, however, distilled spirits used 
to manufacture flavors lose their class and type when blended with 
other ingredients to make a flavor extract. Thus, it is misleading to 
represent that the malt beverage contains a particular class or type of 
distilled spirits, such as vodka, rum or tequila. Furthermore, this 
kind of labeling created the misleading impression that the product 
contained distilled spirits, or in fact was a distilled spirits 
product.
    Accordingly, the purpose of the ruling was to set forth specific 
labeling and advertising statements that would be considered 
misleading. The ruling held that the use of a brand name of a distilled 
spirits product as the brand name of a malt beverage was not in itself 
misleading. However, the use of a distilled spirits term found in the 
standards of identity in 27 CFR part 5 (such as whisky, rum, vodka, 
brandy, gin, and so forth) as the brand name for a malt beverage or as 
part of the statement of composition or as the fanciful name of a malt 
beverage, is misleading. The use of a cocktail term as the fanciful 
name of a malt beverage would not be considered misleading if the 
overall labeling and advertising does not create a misleading 
impression about the identity of the product.
    TTB still takes the view that the use of a distilled spirits brand 
name as the brand name of an FMB is not inherently misleading. 
Furthermore, we do not believe that the use of a cocktail name as part 
of a fanciful name of an FMB is always misleading, as long as the 
remaining labeling and advertising of the product do not create a 
misleading impression as to the identity of the product. We are not 
changing our position with respect to these issues.
    In response to the concerns voiced by the commenters, we are 
changing the wording of the amendments to Sec. Sec.  7.29 and 7.54 
contained in the proposed rule. Instead of the specific prohibitions 
proposed in those sections, we are adding the following to the 
prohibited statements with respect to labeling and advertising of malt 
beverages:

    Any statement, design, device, or representation that tends to 
create a false or misleading impression that the malt beverage 
contains distilled spirits or is a distilled spirits product.

    Because this language prohibits only labeling and advertising 
statements that are false and misleading, it does not infringe upon the 
First Amendment rights of producers and importers of FMBs. Information 
on alcohol beverage labels is considered commercial speech. (See Rubin 
v. Coors Brewing Co., 514 U.S. 476, 481 (1995).) The First Amendment 
protects commercial speech only if that speech concerns lawful activity 
and is not false or misleading. (See Central Hudson Gas & Electric 
Corp. v. Public Serv. Comm'n, 447 U.S. 557, 563-564 (1980).) Similarly, 
our statutory authority under the FAA Act is to ensure that labels 
provide consumers with adequate information as to the quality and 
identity of malt beverages, and to ensure that labels and 
advertisements for such products do not tend to mislead consumers. (See 
27 U.S.C. 205(e) and (f).) It is not TTB's intention to prohibit any 
labeling or advertising statements that are truthful and non-
misleading.
    The final rule regulatory texts incorporate the proposal to 
prohibit the types of references to distilled spirits brand names and 
class and type designations in FMB statements of compositions that were 
addressed in ATF Ruling 2002-2. However, those texts will allow 
truthful non-misleading statements that may draw similarities between 
the taste or character of a malt beverage and the taste or character of 
a distilled spirits product, but that do not imply in a false or 
misleading fashion that the product contains distilled spirits or is a 
distilled spirits product. Moreover, this general prohibition will not 
prohibit truthful and non-misleading statements such as ``beer aged in 
whiskey barrels'', provided that such a statement is not in the context 
of implying that the FMB contains whisky as the result of the aging 
process. Finally, this standard will not prohibit the use of cocktail 
terms as a brand name or fanciful name on malt beverage labels or in 
advertising provided the use of those terms does not draw a misleading 
comparison between the two types of alcohol beverages. To the extent 
that labeling or advertising comparisons between malt beverages and 
distilled spirits are false or misleading in a manner that is not 
covered by these new regulations, they would fall under the general 
prohibition on the use of false or misleading statements in the 
labeling or advertising of malt beverages. (See 27 CFR 7.29(a)(1) and 
7.54(a)(1).)
    ATF Ruling 2002-2 held that certain labeling and advertising 
practices by themselves are not misleading if their use does not give a 
misleading impression about the malt beverage. The ruling specifically 
held that the use of a brand name of a distilled spirits product as the 
brand name of a malt beverage is not in itself misleading. The ruling 
further held that the use of a cocktail term as the brand name or 
fanciful name of a malt beverage is not misleading if there is no 
misleading impression about the identity of the product, based on the 
overall labeling and advertising of the product.
    Consistent with the proposed rule, and in response to the comments 
that specifically request affirmation that the use of distilled spirits 
brand names will be permitted, we are incorporating these ``safe 
harbor'' provisions from the ruling into Sec. Sec.  7.29 and 7.54. We 
are reconfiguring the text as three subparagraphs in Sec.  7.29(a)(7) 
and Sec.  7.54(a)(8). Subparagraph (i) permits the truthful statement 
of alcohol content in labeling and advertising in conformity with 
existing requirements in Sec.  7.71. Subparagraph (ii) in each case 
permits the use of a distilled spirits brand name as the brand name of 
a malt beverage provided the overall label or advertisement does not 
present a misleading impression about the identity of the product. 
Similarly, subparagraph (iii) permits the use of a cocktail name as the 
brand name or fanciful name of a malt beverage, with the same proviso.

XII. New Formula Requirements

    TTB received a small number of comments from brewers and brewery 
trade associations on the proposed new formula filing requirements that 
would replace the existing statement of process. These commenters 
generally favored the new formula filing requirements, but they 
expressed concerns regarding certain aspects of the proposal and 
requested that TTB clarify some of the proposed formula requirements.

A. Fermented Products Requiring Formulas Under Sec.  25.55

1. Comments Received
    Several brewers and brewing industry trade associations commented 
on the proposed requirements that would trigger the filing of a formula 
by a brewer. These commenters requested that we more clearly 
communicate which fermented products require filing formulas.
    One brewer stated that because of the wording of the proposal, it 
appears that most fermented products would require a formula. A brewery 
trade association argued that the requirement to file formulas showing 
special processing is so broad that the proposal would require brewers 
to file formulas for most products. This association noted that many 
traditional malt beverages contain

[[Page 223]]

fruits, herbs, spices, or honey and that the proposed requirement to 
file a formula for fermented products containing any of these 
ingredients would greatly increase the number of products for which a 
formula is required. The association further alleged that products 
containing some of these types of ingredients are considered 
traditional malt beverages or beer and that, therefore, filing formulas 
for them would simply increase the number of formulas filed without 
assisting TTB in classifying them for tax purposes. One brewer and one 
trade association suggested adding a paragraph to the formula 
requirements in Sec.  25.55 to state that a formula is not required 
when processes or ingredients are used in the production of traditional 
beers.
    One brewer commented that proposed Sec.  25.55 requires a formula 
when honey is used but does not specifically require a formula when 
maple syrup is added to beer. Further, this brewer commented that TTB 
should rewrite Sec.  25.55 in the final rule to require formulas only 
for beer made with the use of processes or ingredients that the TTB 
Administrator has not declared as standard brewing processes or 
ingredients. TTB would then implement this regulation by periodically 
publishing a list of processes or ingredients declared to be 
traditional and therefore not requiring the filing of a formula for 
their use in beer production.
2. TTB Response
    The formula requirement proposed in Sec.  25.55 would replace the 
statement of process now required by Sec.  25.67. The existing section 
currently requires brewers to file a statement of process whenever they 
propose to produce a fermented product not marketed as ``beer,'' 
``ale,'' ``porter,'' ``stout,'' ``lager,'' or ``malt liquor.'' As 
several commenters noted, some traditional malt beverage products are 
made with added flavors but are marketed under those traditional 
designations and not as flavored or specialty products. Because of the 
present wording in Sec.  25.67, which uses the marketing designation as 
the filing criterion, some brewers may not file a statement of process 
for some fermented products that contain flavors or other materials. 
While these fermented products do not require a statement of process 
under Sec.  25.67, the proposed regulation would require a formula and 
perhaps additional labeling for these traditional fermented products.
    The intent of this proposal was not to require a statement of 
process or formula for additional kinds of fermented products. Rather, 
it was intended to clarify which fermented products require the filing 
of a formula. Thus, in this final rule document, we have changed Sec.  
25.55 in order to state more clearly when a brewer must file and 
receive approval of a formula in order to produce a fermented product. 
We have added a provision to this section that allows a brewer to 
request information on whether a formula is required in specific 
instances. Additionally we have amended this section to make it clear 
that TTB approval of a formula is required prior to using it to produce 
a fermented product.
    Paragraph (a) of Sec.  25.55 lists processes, materials, or 
specific types of fermented products that will require a brewer to file 
a formula. Paragraph (a)(1) contains the general rule to file a formula 
for a fermented product that is produced using certain processes. Based 
on the comments to Notice No. 4, which indicated that the term 
``special processing'' is so broad that formulas would be required for 
most fermented products, we have changed the criteria in Sec.  
25.55(a)(1) that trigger filing a formula. Section 25.55(a)(1) now 
requires filing a formula for the use of any process, filtration, or 
other method of manufacture that is not generally recognized as a 
traditional process in the production of a fermented beverage 
designated as ``beer,'' ``ale,'' ``porter,'' ``stout,'' ``lager,'' or 
``malt liquor.'' We have also removed the language from this proposed 
section that would have used a change in the character of beer or the 
removal of material from beer as a criterion for the filing of a 
formula since it is impossible to quantify these standards. Thus, under 
Sec.  25.55(a)(1), the sole criterion for filing a formula for a 
process depends on whether or not the process is traditionally used in 
producing fermented products designated as beer, ale, and so forth.
    Non-traditional processes such as ion exchange treatment, reverse 
osmosis, concentration of beer, separation of beer into different 
components, and filtration to substantially change the color, flavor, 
or character of beer are processes that require the filing of a 
formula. These processes are those specifically included in proposed 
Sec.  25.55(a)(1) as requiring filing a formula. We note that these are 
only examples, and the exclusion of a process from this listing does 
not mean that its use in making a fermented product would not require 
the filing of a formula.
    Conversely, processes such as pasteurization, filtration prior to 
bottling, filtration in lieu of pasteurization, centrifuging for 
clarity, lagering, carbonation, blending, and so forth are clearly 
traditional and their use does not require a formula. Subparagraph, 
(a)(1)(ii) of Sec.  25.55 lists examples of these processes. These 
processes were listed in the preamble to Notice No. 4 as examples of 
traditional processes not requiring a formula. Other processes exist 
that are considered traditional and will not require filing a formula.
    Subparagraph (a)(1)(iii) of Sec.  25.55 provides that brewers may 
request a determination from us as to whether a particular process used 
in producing beer will require a formula. Procedures for requesting 
this determination are contained in new paragraph (f) of Sec.  25.55.
    Paragraphs 25.55(a)(2) through (a)(5) list the other instances when 
a formula is required to produce a fermented product. These correspond 
to those formula requirements in proposed Sec.  25.55(a).
    Paragraph (a)(3) requires brewers to file formulas when they use 
coloring or natural or artificial flavors in producing a fermented 
product. Paragraph (a)(4) requires brewers to file a formula for any 
fermented product to which fruit, fruit juice, fruit concentrate, 
herbs, spices, honey, maple syrup, or other food materials are added. 
In response to the above comments regarding the production of 
traditional brewery products to which certain flavors or other material 
are added without filing a statement of process, we have added a 
reference to Sec.  25.55(f). This section permits brewers to request a 
determination from us as to whether a particular ingredient used in 
producing beer will require a formula.
3. New Procedural Requirements
    New paragraph (f)(1) of Sec.  25.55 authorizes TTB to determine 
whether the use of a particular process or a particular ingredient will 
require the filing of a formula. Under Sec.  25.55(f)(2), a brewer may 
request a determination on whether the use of a proposed process or a 
proposed ingredient will require the filing of a formula. Paragraph 
(f)(2)(i) sets forth the information that a brewer must submit to TTB 
in order to request a determination as to whether a formula is required 
when using a particular process. For use of a proposed process, the 
brewer must submit a full description of the process, evidence of 
whether the process is generally recognized as a traditional process in 
the production of fermented beverages designated as beer, ale, and so 
forth, and an explanation of the intended effect of the process.
    Similarly, a brewer may request an exemption from the formula 
filing

[[Page 224]]

requirement under Sec.  25.55(a)(3) and (a)(4) when certain flavors or 
other ingredients are used in a fermented product. Under Sec.  
25.55(f)(2)(ii), a brewer must submit information about the proposed 
ingredient, including a description of the ingredient, evidence 
establishing that the proposed ingredient is generally recognized as a 
traditional ingredient in the production of a fermented beverage 
designated as beer, ale, and so forth, and what effect the use of the 
proposed ingredient has on the fermented product. However, there is no 
exemption from the formula requirement in Sec.  25.55(a)(2) with 
respect to the use of flavors and other ingredients containing alcohol, 
because this information is essential for purposes of administering the 
51/49 standard.
    As suggested by the comments, there may be many fermented beverages 
produced and marketed under the traditional designations of ``beer,'' 
``ale,'' and so forth that contain flavors or other ingredients and 
which are produced without statements of process. The information 
submitted by brewers under paragraph (f) will allow us to evaluate 
whether or not these fermented products made with flavors or other 
ingredients should be subject to the formula approval and possible 
additional labeling provisions. TTB will give consideration to the past 
usage of those flavors or other ingredients and to whether the 
fermented products are considered to be traditional products that are 
entitled to be marketed as ``beer,'' ``ale,'' and so forth without 
formula approval and without additional labeling information. As part 
of our evaluation, we will take into consideration the class and type 
regulations in Sec.  7.24(a) that require that statements of class and 
type conform to the designation of the product as known to the trade. 
Additionally, Sec.  7.24(e) requires products designated as ``ale,'' 
``porter''' or ``stout'' to be produced without the use of coloring or 
flavoring materials (other than those recognized in standard brewing 
practices). We will consider these criteria when evaluating a request 
for a determination on the use of flavors or other materials in 
producing fermented products without obtaining a formula approval.
    With respect to the use of processes, we recognize that the 
listings in Sec.  25.55(a)(1)(i) are not complete and that brewers may 
propose to use new processes in the production of fermented beverages. 
Thus, a request to TTB under paragraph (f) of Sec.  25.55 will permit 
us to determine, for example, whether a process may constitute 
distillation, and whether a proposed process is appropriate for the 
production of a fermented beverage that is to be sold under a 
traditional designation such as ``beer'' or ``ale''.
    We will maintain on the TTB Web site a list of new processes and 
ingredients determined by TTB under Sec.  25.55(f) to require, or not 
to require, the filing of a formula.

B. Standards for Formula Approval

1. Comments Received
    The FMBC and one FMB producer commented that proposed Sec.  
25.15(a) gives brewers a wide variety of ingredients for producing 
beer. The FMBC agreed that the statutory definition of beer permits the 
use of a wide range of fermentable materials at the brewery and that 
this listing of ingredients reflects existing TTB policy. However, both 
commenters stated that the proposed formula regulations provide no 
standard for using these materials in producing beer. The FMBC 
commented that proposed Sec.  25.15(a) appears to blur the distinction 
between beer and wine since TTB taxes as wine products made primarily 
from honey, fruit, fruit juice, and fruit concentrate, which are all 
materials listed in proposed Sec.  25.15(a). These commenters requested 
that TTB provide to the industry regulatory standards to as to when the 
use of honey, fruit, and other materials would result in classification 
of a product as a wine. As an example of a suggested standard, these 
commenters cited TTB's unofficial policy that half of the fermentable 
material in a beer must be derived from barley malt and other 
fermentable grains. These commenters suggested that incorporating this 
policy of ingredient use in the regulations would provide brewers with 
necessary guidance in determining what fermented products qualify as a 
beer, especially when other fermentable ingredients such as honey or 
fruit are used.
    The FMBC further commented that although Notice No. 4 stated that 
one use of the formula submission is for TTB to evaluate whether a 
certain process constitutes distillation, the actual proposed formula 
regulations do not contain any standards that could be used for this 
purpose. The FMBC stated that without such regulatory guidelines, 
producers would be uncertain whether a proposed process constitutes 
distillation and, further, that this lack of a standard will lead to 
arbitrary and uneven decision-making. The FMBC therefore requested that 
TTB seek comments on proposed regulations containing both criteria for 
distillation and criteria that TTB will use in evaluating beer produced 
by special processes.
2. TTB Response
    TTB has not incorporated in this final rule its informal 
administrative policy regarding the percentage of fermentable materials 
in a beer that must be grain-based because we did not air this issue 
for comment in Notice No. 4. However, we agree with the FMBC that the 
proposed regulatory text did not adequately distinguish between 
fermentable materials and fermentable adjuncts. The term ``beer'' is 
defined in section 5052(a) of the IRC as:

beer, ale, porter, stout, and other similar fermented beverages 
(including sak[eacute] or similar products) of any name or 
description containing one-half of 1 percent or more of alcohol by 
volume, brewed or produced from malt, wholly or in part, or from any 
substitute therefor.

    In 1889, the Commissioner of Internal Revenue stated that the term 
``substitute for malt'' included rice, grain of any kind other than 
malt, sugar, bran, glucose, and molasses.
    The comment from the FMBC rightly pointed out that the proposed 
language of new Sec.  25.15(a) seemed to authorize unlimited use of 
materials such as honey and fruit as substitutes for malt. This was not 
our intention. Accordingly, we have revised the language in paragraph 
(a) of proposed Sec.  25.15. The first and second sentences of 
paragraph (a) address the basic brewing materials, and we have revised 
this list to conform the substitutes for malt to those specifically 
listed in the Internal Revenue Commissioner's letter in 1889. 
Accordingly, Sec.  25.15(a) lists the following materials as the only 
permissible substitutes for malt: rice, grain of any kind, bran, 
glucose, sugar, and molasses. We note the term ``grain of any kind'' 
includes both malted and unmalted grains.
    The third sentence of paragraph (a) lists other materials that may 
be used in brewing but that are not considered basic brewing 
ingredients as contemplated by the IRC. Extensive use of those other 
materials in fermentation could yield a fermented product that might be 
considered wine rather than beer; thus, the revised text distinguishes 
between those materials that we categorize as ``adjuncts'' and the 
basic brewing materials covered by the first two sentences of Sec.  
25.15(a).
    In the absence of a regulatory standard, TTB will continue to rely 
on its current administrative guideline, which requires at least 50% of 
the fermentable material in an IRC ``beer'' to be one or more of the 
following: barley

[[Page 225]]

malt, other malted grains, unmalted grains, rice, bran, sugars, or 
molasses. Brewers may use the other materials listed in the third 
sentence of Sec.  25.15(a) as fermentable adjuncts in the production of 
a beer at a brewery. We will consider the comments summarized above as 
suggestions for future amendments of the part 25 regulations, and we 
may address this issue in the near future in connection with the 
planned revision of the part 25 brewery regulations.
    With regard to the FMBC comment requesting regulatory standards for 
distillation and for the evaluation of other processes in producing 
beer, TTB notes that Notice No. 4 did not propose to adopt either of 
those standards. Moreover, determinations of whether distillation has 
occurred are highly technical matters. The determination often depends 
on laboratory examination of the process and the materials produced. 
Therefore, we believe that it is preferable to continue to examine 
processes on a case-by-case basis. However, we will consider these 
comments as suggestions for future regulatory amendments.

C. Alcohol Information in Formulas

1. Comment Received
    One brewer commented that since Notice No. 4 proposed limits on the 
amount of alcohol that can be added to fermented beverages through the 
use of flavors and other ingredients containing alcohol, it was 
unnecessary to require detailed information about those ingredients in 
formula submissions. This commenter stated that since the proposal 
would limit the amount of added alcohol, the detailed information in 
proposed Sec.  25.57 is not needed and should not be required.
    Another brewer expressed its concern about the requirement to state 
maximum volumes of flavoring materials in formulas. This brewer 
commented that they need significant flexibility in the amounts and 
types of flavorings to accommodate price changes or acceptability of 
ingredients in foreign countries. Furthermore, they may use two or more 
flavors alternatively in a formulation. Although, on examination, the 
use of the maximum amounts of each flavor listed would appear to exceed 
overall added alcohol limitations, this brewer stated this is not the 
intention of using or listing alternative flavors in a formula. Thus, 
this brewer requested that TTB add a provision in Sec.  25.57 
specifying that the amount of alcohol contributed by all of the 
flavoring material in a formulation will not exceed the overall limit 
established by Sec.  25.15.
    This brewer also commented that the requirement to state the 
alcohol content of the fermented product at each step in production is 
overly restrictive. This requirement, according to the commenter, would 
eliminate streamlining of operations, forcing production by batches 
rather than in-line blending and other methods. The commenter therefore 
suggested requiring a single statement for alcohol content at the final 
stage of production.
2. TTB Response
    TTB will continue to require information about individual flavors 
and other ingredients in fermented beverages, not only for tax 
classification purposes under the IRC, but also for labeling purposes 
under the FAA Act. Thus, we are retaining the requirement in Sec.  
25.57 to provide information about separate flavors and other 
ingredients. Additionally, we need to know at what stage in production 
flavorings are added since this information impacts the classification 
and labeling of the fermented product. Thus, we have amended Sec.  
25.57(a)(2) to require brewers to state the point of production'during, 
before, or after fermentation'that flavors are added.
    We do agree that brewers need flexibility to use alternate 
ingredients in producing fermented beverages and that brewers should 
not be required to file new or amended formulas every time they make 
slight changes in the use of flavors or in the ratio of certain flavors 
used in a product. Nevertheless, we again emphasize that the proposed 
formula requirements are intended to clarify existing statement of 
process requirements and are not intended to impose new requirements on 
brewers.
    It is our intention to permit the use of alternate or optional 
flavors in producing fermented products, and, to this end, we have 
added the following sentence at the end of proposed Sec.  25.57(a)(1): 
``You may include optional ingredients in a formula if they do not 
impact the labeling or identity of the finished product.'' We have also 
clarified our position on alcohol content contributed by alternative 
flavors and other nonbeverage ingredients containing alcohol in a 
formula by adding the following sentences at the end of Sec.  
25.57(a)(3)(iv): ``You are not required to list the alcohol 
contribution of individual flavors and other nonbeverage ingredients 
containing alcohol. You may state the total alcohol contribution from 
these ingredients to the finished product.'' We believe the addition of 
these sentences to Sec.  25.57 will make it clear that the use of 
alternative ingredients is permitted and that it is not necessary to 
list the alcohol contribution of each individual ingredient in the 
formula.
    We also have removed the proposed requirement in Sec.  25.57(c) for 
listing in a formula the alcohol content of a fermented beverage at 
every step in production. We agree with the commenter that this 
requirement is burdensome and not useful in evaluating a formula. This 
paragraph now requires listing only the alcohol content of the 
fermented product after fermentation and the alcohol content of the 
finished product.

D. Reasonable Range of Ingredients

1. Comment Received
    Only one commenter addressed TTB's request for comments on how to 
define a ``reasonable range'' of ingredients used in formulas in Sec.  
25.57(a)(1). This commenter, Diageo, recommended that TTB prescribe 
specific ranges for various ingredients. For ``major ingredients'' or 
those composing more than 3% of a product's total weight or volume, 
Diageo recommended that the range should vary by no more than 30% over 
or under the actual amount used in production. For ``minor'' 
ingredients that represent less than 3% of the product's weight or 
volume, this comment recommended the reasonable range could vary by up 
to 200% of the actual quantity used.
2. TTB Response
    TTB is still seeking broad industry input on what constitutes a 
``reasonable range'' of ingredients in a formula. Since only one 
commenter responded to this question, we do not believe we have enough 
information to take final rule action on its meaning. Thus, we are not 
defining ``reasonable range'' of ingredients for purposes of Sec.  
25.57(a)(1), and have removed the word ``reasonable'' from this 
provision.
    TTB will continue to permit brewers who submit formulas to indicate 
a range of ingredients. A range of ingredients may not be so large as 
to change the tax classification of a fermented beverage or to change 
the designation of the fermented beverage. For example, a formula for a 
``wheat beer'' cannot indicate a range of fermentable ingredients of 5 
to 95% wheat malt since a minimum of 25% wheat malt is required for a 
beer to have this designation. We will evaluate formulas submitted by 
brewers, and make a case-by-case determination whether the range of 
ingredients indicated in a formula is appropriate. We note that,

[[Page 226]]

under Sec.  25.57(e), we will have authority to request additional 
information from brewers when we evaluate a formula.
    We intend to revisit the question of what constitutes a 
``reasonable'' range in the future through rulemaking or other 
appropriate procedure.

E. Formula Confidentiality

1. Comments Received
    One brewer expressed a strong concern regarding the need for 
formula confidentiality. Another commenter stated that formula 
protection from public disclosure is a very important issue in the 
competitive market. Another brewer commented that the confidentiality 
issue for formulas should be resolved in the final rule as a separate 
regulation.
2. TTB Response
    TTB agrees that formulas filed by brewers, like statements of 
process, are confidential and are not generally subject to public 
disclosure. To the extent that formulas are filed under the 
requirements of part 25, they are classified as ``return information'' 
subject to the disclosure restrictions of 26 U.S.C. 6103. Furthermore, 
formulas filed under either part 7 or part 25 are treated as 
confidential business information under the Freedom of Information Act, 
5 U.S.C. 552(b)(4), and are thus exempt from that statute's mandatory 
disclosure provisions. Finally, TTB has always treated statements of 
process and formulas as trade secrets subject to the disclosure 
restrictions of 18 U.S.C. 1905.
    At this time, TTB is not adopting the suggestion of the commenter 
who advocated placement of confidentiality provisions in the formula 
regulations in part 25 and part 7. At present, we believe that the 
existing TTB and Treasury disclosure regulations adequately address the 
protection of this type of data. Furthermore, it would not be an 
efficient use of government resources to address this issue for beer 
formulas, without addressing the similar issues presented by formulas 
for wine and distilled spirits products. Finally, before adopting such 
regulations, it would be preferable to specifically air the proposal 
for comments from the public and affected industry members. Notice No. 
4 did not contain any such proposal.
    Accordingly, TTB will consider these comments as suggestions for 
future rulemaking actions. In the interim, submitters of formulas 
required under parts 7 and 25 should accept our assurances that TTB 
will comply with all applicable statutory and regulatory restrictions 
on the disclosure of that proprietary information.

F. Standard Form for Formulas

1. Comments Received
    Three commenters suggested that TTB should develop a standardized 
form for formulas and that industry members should be able to provide 
input on the development of the form. One brewer commented that TTB 
should develop a formula form for FMBs that is similar to the form used 
for flavored wine products. Another brewer requested that TTB develop a 
unique formula form that is unlike the formula form for wine.
2. TTB Response
    At this time, TTB declines to adopt a standard formula form for 
part 25 purposes, but we will consider developing a standardized form 
for formulas in the future. We may consider combining a formula form 
for beer with the form used for wine in order to achieve 
standardization, and we will consider comments or suggestions from 
industry members and the public in developing any form for beer 
formulas. In the meantime, brewers may continue to prepare their 
formulas for fermented products on their own letterhead stationary.

G. Formula Proceedings

1. Comments Received
    A brewer commented on the statement in Sec.  25.55 that a formula 
remains in effect until surrendered or superseded by a new formula or 
until TTB cancels or revokes it. This commenter noted that no formal or 
informal procedure is given in the regulation that would apply to the 
cancellation or revocation of a formula. This commenter stated that any 
attempt to revoke a formula without proper procedures would raise 
serious due process issues. The commenter requested inclusion of those 
procedural safeguards and that they be at least similar to the 
procedural safeguards afforded certificate of label approval 
revocations.
2. TTB Response
    In 1999, ATF issued regulations setting forth procedures for the 
revocation of approved labels in 27 CFR part 13, Labeling Proceedings. 
Although we have not prescribed specific procedures for the revocation 
of formulas in the regulations, it has been our policy to afford 
formula holders due process by giving them advance notice, and an 
opportunity to respond, before revoking the formula. An exception, of 
course, applies to the extent that the revocation is by operation of 
law or regulation. In those cases, it is the new law or regulation that 
requires the revocation of the formula, and TTB has no choice but to 
comply with the requirements of the law or regulation.
    This issue was not specifically aired for comment in Notice No. 4. 
Accordingly, we are treating the single comment that we did receive on 
the issue as a suggestion for future rulemaking. Pending the issuance 
of regulations specifically addressing this issue, we will continue to 
provide due process to formula holders by applying procedures similar 
to those set forth in part 13 to any cancellation or revocation of an 
approved formula.

H. Placement in the CFR

1. Comments Received
    One brewer noted that the proposed formula requirements appear in 
part 25, which applies to domestic beers, but not in part 7, which 
applies to all malt beverages. This brewer stated that the formula 
requirement should apply equally to domestic and imported products and 
should therefore be placed in part 7.
2. TTB Response
    Placement of the formula requirement in part 25 is deliberate. This 
action implements TTB's existing statutory authority permitting it to 
request certain information from domestic brewers. Many domestic 
brewers do not operate in interstate commerce and do not obtain 
certificates of label approval for their products because they are not 
packaged but rather are sold from tanks at the tavern on brewery 
premises. The formula provisions must apply to these brewers as well as 
brewers who obtain certificates of label approval since the same 
requirements exist regarding the classification of fermented products 
and the appropriate use of ingredients. Thus, we must include the 
formula requirements in part 25 in order to apply them to all brewers, 
regardless of their size or the method of distribution of their 
products.
    TTB has no statutory authority to require foreign producers to 
submit formulas. In the case of imported malt beverages, our authority 
to require formula information applies to U.S importers rather than to 
foreign brewers. Thus, this final rule document adopts the proposal to 
add a new paragraph to Sec.  7.31 to reflect this authority. This 
provision recognizes TTB's authority to request formula or sample 
information from an importer in conjunction with the filing of a 
certificate of label approval for a malt beverage. We believe

[[Page 227]]

we can obtain adequate information about an imported malt beverage 
under this new provision to determine the class and type of an imported 
malt beverage and to resolve any ingredient or labeling issues that may 
arise during a certificate of label approval submission.

XIII. Other Issues Raised by Commenters

    A number of commenters raised issues regarding FMBs that were not 
directly addressed in Notice No. 4, and thus are outside the scope of 
this rulemaking document. However, TTB wishes to comment on some of 
these issues and may consider some of them to be appropriate for future 
rulemaking on beer or malt beverages.

A. Information Quality Act

1. Comment Received
    A law firm representing a major FMB producer filed a request under 
the Information Quality Act (IQA) for correction of TTB's statement in 
Notice No. 4 that existing FMB labels may confuse and mislead consumers 
as to both the source and amount of alcohol in these beverages, arguing 
that Notice No. 4 did not provide any supporting data for these 
assertions. In response to this request, TTB stated that it would treat 
the letter as a comment to the proposed rule.
2. TTB Response
    Section 515 of the Treasury and General Government Appropriations 
Act for Fiscal Year 2001, Public Law 106-554, directed the Office of 
Management and Budget (OMB) to issue, by September 30, 2001, 
government-wide guidelines that ``provide policy and procedural 
guidance to Federal agencies for ensuring and maximizing the quality, 
objectivity, utility and integrity of information (including 
statistical information) disseminated by Federal agencies.'' On 
September 28, 2001, OMB issued guidelines; revised final guidelines 
were published on February 22, 2002. (See 67 FR 8452.)
    The law also requires Federal agencies to issue their own 
implementing guidelines, including administrative mechanisms that allow 
affected persons to seek and obtain correction of information 
maintained and disseminated by the agency, where such information does 
not comply with the OMB Guidelines. Finally, the law requires agencies 
to report periodically to OMB on the number and nature of complaints 
received by the agency, and how such complaints were handled.
    In compliance with these requirements, both the Department of the 
Treasury and our predecessor agency, ATF, published guidelines on 
information quality. (See ``Subdivision of Treasury Information 
Technology (IT) Manual,'' Ch. 14: Information Quality (``Treasury 
Guidelines''), and ``Process for Requesting Correction of Information 
Disseminated by the Bureau of Alcohol, Tobacco and Firearms' (``ATF 
Guidelines'').) Both the Treasury and ATF Guidelines stress that the 
guidelines are not legally enforceable, and do not affect any otherwise 
available judicial review of agency action. Pursuant to the provisions 
of the Homeland Security Act of 2002, and Treasury Order No. 120-01 
(Revised), published on January 24, 2003, ATF's orders still apply to 
TTB until superseded or revised. Accordingly, TTB continues to rely 
upon the published procedures of ATF, as well as the published 
procedures of the Department of the Treasury, in responding to requests 
for correction of information under the IQA.
    Section 14.5.3(C) of the Treasury guidelines provides that in most 
cases, absent unusual circumstances, requests for correction of 
information contained in a notice of proposed rulemaking should be 
addressed through the rulemaking process. TTB found that there were no 
unusual circumstances in this case, and there was no evidence that the 
requester had a reasonable likelihood of suffering actual harm if the 
issue was not resolved before the issuance of the final rule on FMBs. 
Accordingly, we advised the requester that we would treat the letter as 
a comment on the proposed rule, and that the final rule would address 
the issues raised in the letter.
    The issues raised by this comment are addressed elsewhere in this 
preamble. As we stated, TTB remains of the opinion that it is 
inherently misleading to label as FMBs products that derive up to 99% 
of their alcohol content from the distilled spirits components of added 
flavors and other nonbeverage products. As stated earlier in this 
preamble, we have determined that both the FAA Act and the IRC provide 
us with authority to define the terms ``malt beverage'' and ``beer'' in 
order to set limits on the use of alcohol from added flavors and in 
order to ensure that the majority of the alcohol is derived from 
fermentation at the brewery.
    As already pointed out in this preamble, we have also concluded 
that we are not required to conduct consumer surveys every time we 
define a labeling term applicable to alcohol beverages. In this 
rulemaking proceeding, we have considered all the data presented by the 
commenters, including the consumer surveys previously conducted on this 
issue, as well as a new consumer survey submitted by another FMB 
producer. It is our conclusion that the evidence establishes that 
current labels may mislead consumers and that they do not provide 
adequate information about the identity of these products. As we 
specifically stated in this document, we are not concluding that FMB 
producers intentionally misled consumers; instead, these producers 
appear to have relied on the policies of TTB and its predecessor 
agencies in labeling and classifying these products.
    However, we have also concluded that the term ``malt beverage'' may 
tend to mislead consumers when applied to a product deriving the 
majority of its alcohol content from the spirits components of added 
flavors and other nonbeverage ingredients. We have also concluded that 
such a term does not provide adequate information to consumers about 
the identity of such a product. Accordingly, the final rule limits use 
of the labeling term ``malt beverage'' to products that derive at least 
51% of their alcohol content from fermentation at the brewery. We are 
confident that the data in support of the final rule comply with the 
requirements of the IQA.

B. ``Alcohol is Alcohol''

1. Comment Received
    In its comment, the National Consumer League (NCL) stated, 
``alcohol is alcohol, regardless of source.'' The NCL suggested that, 
from a consumer standpoint, only the actual alcohol content in a 
product matters and not the source of that alcohol. This commenter 
stated that most single servings of alcohol beverages contain roughly 
an equal amount of alcohol, a fact of which many consumers are unaware. 
Further, this commenter cited experts who agree that all types of 
alcohol beverages are functionally equivalent on a serving-to-serving 
basis and that no differences exist between hard liquor and beer.
    Because of the ``alcohol is alcohol'' argument, NCL opposed the 
proposed rule because it perpetuates the differences between different 
types of alcohol beverages and would continue to accord alcohol 
beverages different regulatory status based on their source of alcohol. 
This commenter suggested there is no scientific or public policy to 
support these distinctions. As previously noted, NCL did state that 
there was greater merit to the majority standard, as it ``may reduce 
the

[[Page 228]]

potential for consumers to be misled or confused,'' and that compliance 
with the majority standard ``will assure that consumers are not 
deceived as to product content.''
2. TTB Response
    TTB acknowledges that, depending on the alcohol content of the 
product, single servings of different types of alcohol beverages may 
contain roughly the same amount of ethyl alcohol and that the ethyl 
alcohol found in these is chemically the same substance. However, 
longstanding Federal and State laws recognize very significant 
differences between distilled spirits, wine, and beer or malt beverages 
for production, tax, labeling, advertising, and distribution purposes. 
Thus, to the extent that the NCL comment suggests that Federal law 
should ignore these distinctions, it lies outside the scope of the 
proposals made in Notice No. 4 and would require significant statutory 
changes.

C. Marketing of FMBs to Underage Drinkers

1. Comments Received
    A number of commenters, including many individuals and several 
public interest organizations, commented that FMBs should be treated as 
distilled spirits. These commenters claimed that FMBs are designed for 
the youth market due to their taste and the way in which they are 
marketed. Further, these commenters stated that the introduction of 
FMBs has substantially increased distilled spirits brand awareness and 
loyalty among young people. Some commenters claimed this is a 
deliberate strategy on the part of producers.
    One commenter suggested that TTB should take action against 
producers and collect distilled spirits taxes on products marketed as 
malt beverages. CSPI requested that TTB classify FMBs as distilled 
spirits in order to reduce youth access to them by limiting the range 
of outlets where they can be sold. An individual commenter suggested 
that TTB undertake any action that would make FMBs more expensive in 
order to reduce their availability to underage youth.
    CSPI further commented that its own data found that both teens and 
adults think that so-called ``alcopop'' products such as FMBs, which 
have the brand names of distilled spirits products, are more like 
liquor than beer or wine. Some commenters suggested that these products 
are particularly appealing to underage consumers and noted that these 
products are marketed on television and are widely available in 
convenience and grocery stores. Several commenters argued that 
convenience and grocery stores are more conducive to underage sales 
than are State-licensed retailers selling distilled spirits, and they 
supported classifying FMBs as distilled spirits products so that their 
distribution would be more strictly regulated in most States. Other 
commenters expressed various concerns about the public health 
consequences of alcohol abuse.
    On the other hand, some commenters pointed to the recent study 
conducted by the Federal Trade Commission (FTC). (See ``Alcohol 
Marketing and Advertising: A Report to Congress,'' Sept. 2003.) The 
FTC's report noted that it had previously reviewed this issue in 
response to a complaint by CSPI, and it had found no evidence of intent 
to target minors with the FMB products, packaging, or advertising. 
Furthermore, after reviewing the consumer survey evidence submitted by 
CSPI in support of the proposition that FMBs were predominantly popular 
with minors, the FTC concluded that flaws in the survey's methodology 
limited the ability to draw conclusions from the survey data.
    The FTC reviewed this issue again in response to a request by 
Congress to study the impact on underage consumers of the significant 
expansion of ads for flavored malt beverages. The FTC's investigation 
again found no evidence of targeting underage consumers in the 
marketing of FMBs. However, the report recognized that ad content that 
appeals to new legal drinkers, as well as the sweet taste of FMBs, may 
be attractive to minors, and the FTC urged the industry to exercise 
significant caution when introducing new alcohol beverage products, to 
ensure that they are not marketed to an underage audience. (See 
``Alcohol Marketing and Advertising: A Report to Congress,'' September 
2003, p.22.)
2. TTB Response
    As stated in Notice No. 4, we do not believe that the use of 
distilled spirits brand names or cocktail names on FMB labels is 
inherently misleading. We recognize that many commenters believe that 
these names confuse consumers as to the identity of the products. 
However, if a product is clearly labeled with a designation such as 
``malt beverage with natural flavors,'' we believe that the use of a 
distilled spirits brand name on the label does not mislead consumers. 
Accordingly, we are not adopting the suggestion that we prohibit the 
use of distilled spirits brand names or cocktail names in the labeling 
or advertising of FMBs. However, we will continue to consider labels 
and advertisements on a case-by-case basis, to determine if the overall 
presentation misleads consumers as to the identity of the product.
    We note that not a single FMB producer indicated an intention to 
produce FMBs that would be classified as distilled spirits products 
under either the proposed 0.5% standard or the 51/49 standard we are 
adopting. Thus, under either standard, FMBs would continue to be 
produced as malt beverages rather than distilled spirits.
    We recognize the concerns of many commenters that FMBs may be 
particularly attractive to young drinkers. The public health issue 
posed by underage consumption of alcohol beverages is significant. In 
September of 2003, the National Research Council and Institute of 
Medicine of the National Academies released a report to Congress on 
underage drinking, in which it found that the societal cost of underage 
drinking has been estimated at $53 billion, including $19 billion from 
traffic crashes and $29 billion from violent crime. (See ``Reducing 
Underage Drinking: A Collective Responsibility.'') The report calls for 
a comprehensive prevention strategy to create and sustain a broad 
societal commitment to reduce underage drinking.
    TTB appreciates the importance of these prevention efforts. 
However, many of the issues that are of concern to the commenters in 
this regard are beyond the scope of our authority. For example, the FAA 
Act does not prohibit the advertisement of distilled spirits products 
on television; voluntary industry codes in the broadcasting and 
distilled spirits industries govern this matter. Furthermore, it is the 
States that decide whether products such as FMBs are sold in liquor 
stores or grocery stores. As previously noted, the rulemaking record 
indicates that producers of FMBs will reformulate their products so 
that they will continue to be classified as malt beverages under 
Federal law, regardless of whether we adopt the 0.5% standard or the 
51/49 standard. Thus, we do not conclude that adoption of the 0.5% 
standard would result in the reclassification, under Federal law, of 
FMBs as distilled spirits products.
    Our mandate is to ensure the proper classification of FMBs under 
the IRC and the FAA Act, and to ensure that these alcohol beverages are 
labeled and advertised in a manner that does not mislead consumers. We 
do not believe that the concerns of those commenters who wish to reduce 
underage alcohol consumption, important as they are, are directly 
addressed by this rulemaking.

[[Page 229]]

D. More Explicit Labeling of FMBs

1. Comments Received
    Several commenters requested that TTB implement more specific 
labeling for FMBs, including label items such as calories, serving 
size, ingredients, alcohol content, and so forth. These commenters 
claimed this action would provide essential information to consumers 
regarding these products.
2. TTB Response
    TTB believes that these comments are outside the scope of the 
current rulemaking, as we did not specifically solicit comments on 
these issues in Notice No. 4. However, the CSPI, the NCL, and other 
public interest groups have recently petitioned TTB to require 
additional labeling of all alcohol beverages. TTB will separately study 
the petition in order to determine whether to propose such labeling for 
alcohol beverages. Therefore, TTB is not considering this request for 
additional labeling of flavored malt beverages as part of this 
rulemaking.

E. Establishing Another Category of Alcohol Beverages

1. Comments Received
    Some commenters suggested that, instead of attempting to classify 
FMBs as either beer or distilled spirits, TTB should seek an amendment 
to Federal law to define a new class of alcohol beverages. These 
commenters suggested that with a new category of alcohol beverages, TTB 
could better address taxation, labeling, and other issues that apply to 
FMBs. This suggestion would establish a unique category of alcohol 
beverages unlike distilled spirits or traditional beer.
2. TTB Response
    This comment is beyond the scope of the current rulemaking 
procedure, as its implementation would require amendments to Federal 
law.

F. Other Comments

    One commenter suggested that TTB require identification and 
labeling of the source of alcohol in FMBs in order to inform consumers 
of their composition.
    TTB believes that this comment is outside the scope of the 
proposals contained in Notice No. 4. Accordingly, we are not addressing 
this subject in the final rule.

XIV. Implementation Dates

    TTB received 20 comments expressing opinions about implementation 
dates, and related tax issues, for adoption of either the 0.5 percent 
standard or the majority standard for flavored malt beverages. Among 
these comments, 6 were from brewers, 3 were from Members of Congress, 2 
were from State licensing agencies, 3 were from national brewery trade 
associations, and the rest were from individuals.

A. Effective Date for Compliance With the New Added Alcohol Standard

1. Comments Received
    Comments concerning implementation, or a regulatory effective date, 
varied from a minimum of ``as short a period as is reasonable'' to a 
maximum of two years after publication of the final rule containing an 
added alcohol standard for FMBs.
    All brewers that commented on this issue expressed concerns 
regarding the time needed for reformulating products, and for the 
purchase, installation, and testing of new equipment. Among the reasons 
presented for establishing a longer effective date were: the need to 
develop the correct taste profile in a reformulated product; the need 
to invest and install new equipment to produce reformulated FMBs; the 
time needed to gear up for mass production of reformulated products; 
the time required to invest in co-packers equipment; and the need to 
test new formulations of FMBs. One brewer stated that reformulation of 
their products would require them to produce as much as 8 times the 
amount of fermented malt base and that they would require significant 
time to procure the necessary equipment. Another brewer commented that 
they would be able to comply with a 0.5% alcohol standard, as proposed, 
within 3 months time, and requested, at most, a 6-month delayed 
effective date. Six brewers requested effective dates of 6 months, 6 to 
9 months, 1 year (two comments), 18 months, and 2 years.
    Three trade associations commented on this issue. One brewery trade 
association commented that 3 months was an adequate amount of time to 
comply with the new standard. Another commented that 18 months would be 
required. The third, a wholesaler association, requested that TTB 
establish a reasonable amount of time for brewers to comply with the 
new standard.
    One State regulatory authority requested swift action to re-
classify FMBs to the 0.5 percent standard, specifying that a TTB delay 
will force them to initiate a more restrictive regulation for alcohol 
beverages. Another State believed it would not need new State 
legislation for the 0.5 percent standard, and urged TTB to adopt this 
standard in the minimum period needed to assure industry compliance.
2. TTB Response
    TTB is sensitive to the time needs and excise tax concerns of the 
FMB industry during this period of transition. We realize that adoption 
of any added alcohol standard will impact production methods, 
ingredients, suppliers, costs, and other facets of the business. 
Moreover, we recognize that considerable time is needed to develop new 
products that not only conform to an added alcohol standard, but which 
taste the same or are similar to existing non-conforming FMBs.
    Based on the submitted comments and the considerations noted above, 
we are prescribing a one-year delayed effective date for the regulatory 
changes adopted in this final rule document. We believe this will allow 
ample time to develop new products and to acquire the necessary 
equipment to place them into production. We believe the three-month and 
six-month periods requested by two commenters are too short for some 
industry members to make the necessary transition to the new rules. We 
also believe that industry members will be able to comply with the new 
rules in considerably less time than the 2-year period requested by one 
commenter, especially since we are adopting the less stringent 51/49 
standard for FMB products.
    In adopting a one-year delayed effective date, we also note that, 
due to the complex nature of this rulemaking, more than one year has 
already passed since the publication of the proposed rule. Thus, 
brewers have already had a substantial period of time to focus on the 
research and development necessary to bring their products into 
compliance with a new standard.
    Accordingly, we provide a one-year period of time from publication 
of this final rule in the Federal Register for brewers and importers to 
comply with the 51/49 standard as well as other new regulatory 
requirements. As of the effective date of this final rule, products 
that do not comply with the new 51/49 standard may not be produced at a 
brewery, bottled at a brewery, removed from a brewery with or without 
the payment of tax, removed from customs custody for consumption, or 
(in the case of products not destined for exportation) transferred to a 
second customs bonded warehouse.

[[Page 230]]

B. Effect on Products in the Marketplace

1. Comments Received
    Three brewers and two trade associations commented about FMBs that 
are in the marketplace at the time of the effective date of a new 
standard. These commenters sought reassurance that these FMBs would not 
be subject to a floor stocks tax at the higher distilled spirits excise 
tax rate, and that these products would not be subject to destruction 
or recall from the market since they might be considered distilled 
spirits at that time. One brewer requested a six-month delay from the 
final rule's effective date so that wholesalers could deplete their 
inventories of FMBs not in conformity with new alcohol standards.
2. TTB Response
    As noted above, the effective date for implementation of the 
alcohol standard impacts only the production and removal from a 
brewery, or the importation and removal from customs custody of malt 
beverage or beer products. Thus, TTB will continue to treat as beer or 
malt beverages those products made according to previously existing 
standards and removed from the brewery or from customs custody before 
the effective date. TTB will not assess a distilled spirits tax on them 
or require their recall or destruction. Wholesalers and retailers 
holding these products on or after the effective date may continue to 
market them in the same manner as prior to the effective date, until 
their supplies in the marketplace are exhausted.
    Notwithstanding the above, it is incumbent on wholesalers and 
retailers who hold these products to ensure compliance with the 
requirements of the States in which the products are held or introduced 
for sale. Many States have requested that TTB provide a Federal FMB 
definition and added alcohol percent standard that can serve as a guide 
for State classification of alcohol beverages. In adopting a 51/49 
standard for malt beverages containing no more than 6% alcohol by 
volume, and by adding to the regulations a 1.5% standard for malt 
beverages with an alcohol content in excess of 6% as explained later in 
this preamble, TTB is furnishing guidelines to the various States 
concerning the classification of flavored malt beverages. As already 
noted in this preamble, while most States look to Federal guidance in 
this area and rely on Federal classification of alcohol beverages, 
there is certainly no requirement for them to do so. Thus, individual 
States may take a different view of the classification and taxable 
status of these products, and may reclassify FMBs as distilled spirits 
products, perhaps even before the effective date of this final rule.

C. Additional TTB Comment on the Effective Date

    We are using a single effective date for the new alcohol percent 
standards for FMBs. This date will permit affected industry members to 
transition their product lines according to their own needs. Until the 
effective date of this final rule, industry members may continue to 
produce and remove, at the beer tax rate, FMBs that do not meet the new 
alcohol percent standards.
    Producers who cannot comply with the new 51/49 standard as of the 
effective date of the final rule must stop producing those FMB products 
at a brewery. As of the effective date of the final rule, products 
deriving more than 49% of their alcohol content from the distilled 
spirits components of added flavors may only be produced at distilled 
spirits plants. Such products would of course be subject to tax at the 
appropriate distilled spirits excise tax rate.
    Until the effective date of the final rule, TTB's Advertising, 
Labeling and Formulation Division (ALFD) will continue to approve 
statements of process and certificates of label approval (COLAs) for 
FMBs that may not comply with the new added alcohol standards. During 
this interim period, ALFD will qualify these statements of process and 
COLA approvals with reference to this final rule's effective date. 
However, whether qualified or not, statements of process for FMBs not 
in compliance (including those permitting you to make a product not in 
compliance with the 51/49 standard) will become obsolete as of the 
effective date of this final rule and will be revoked by operation of 
the regulation. This means that no individual proceedings are necessary 
in order to revoke those formulas. Similarly, whether qualified or not, 
COLAs for these products that do not comply with the 51/49 standard as 
of the effective date will also be considered revoked by operation of 
regulation unless the underlying statement of process is superseded by 
a new formula that is in compliance with the 51/49 standard.
    Because this final rule incorporates, in large part, the holdings 
of ATF Rulings 96-1 and 2002-2, while establishing new standards for 
added alcohol from flavors and other nonbeverage products, these 
rulings will become obsolete as of the effective date of the final 
rule.

XV. Comments on the Proposed Regulatory Text; Regulatory Text Changes

    Several commenters suggested changes to the proposed regulatory 
text amendments contained in Notice No. 4. These comments are not 
directed to the policy behind the proposed regulatory amendments, but 
rather to their wording, clarity, or organization. In addition, TTB has 
independently reviewed the texts of the proposed amendments and has 
made a number of changes as a result of that review. The comments 
submitted and the changes made that are not of a minor editorial nature 
are discussed below.

A. Reference to Malt Beverage Standards, Sec. Sec.  7.10 and 7.11

1. Comment Received
    The FMBC commented that creating a new section to include standards 
for malt beverages is unnecessary because persons seeking information 
on this topic would look at the definition of a malt beverage in Sec.  
7.10. The FMBC suggested incorporating the standards proposed in Sec.  
7.11 into the definition of malt beverage appearing in Sec.  7.10.
2. TTB Response
    TTB does not agree with the comment and suggested text change. The 
statutory definition of a malt beverage is not affected by this final 
rule; that definition cannot change without legislative action. 
Standards applying to production or composition of a malt beverage are 
more technical and may change from time to time. We wish to separate 
the relatively simple statutory definition from the more technical 
production requirements that we are adopting in this final rule. 
Further, we note that Sec.  7.10 would become unnecessarily long and 
technical if we were to place malt beverage standards in that section. 
Therefore, we have decided to place the standards applying to 
production and composition of malt beverages in Sec.  7.11.
    We have provided a cross reference in Sec.  7.10 to the standards 
for malt beverages appearing in Sec.  7.11 in order to alert readers 
that additional conditions may apply to the production or composition 
of malt beverages. We also have changed proposed Sec.  7.10 by 
including a reference to ``processes'' as well as standards for flavors 
in order to alert the reader to the fact that malt beverages may 
undergo certain processing specified in Sec.  7.11.
    TTB has changed the heading of Sec.  7.11 to read ``Use of 
ingredients containing alcohol in malt beverages; processing of malt 
beverages.'' We

[[Page 231]]

believe this title more accurately reflects the provisions of this 
section, which permit the use of certain processes and authorize the 
use of certain ingredients containing alcohol in malt beverages.

B. Comments on Alcohol Flavoring Material Reference, Sec. Sec.  7.11 
and 25.15

1. Comments Received
    The FMBC commented on the wording in proposed Sec.  7.11, 
specifically the phrase ``alcohol flavoring materials and other 
ingredients containing alcohol.'' The FMBC supported this wording, and 
suggested that this language recognized that brewers may add other 
ingredients containing alcohol, such as taxpaid distilled spirits and 
wine, to malt beverages. This commenter suggested that the final rule 
further clarify this policy by authorizing the use of ``alcohol 
flavors, taxpaid wine, taxpaid distilled spirits, or any other 
ingredient containing alcohol'' in both Sec.  7.11 and Sec.  25.15.
2. TTB Response
    TTB used the wording ``alcohol flavoring materials and other 
ingredients containing alcohol'' in proposed Sec.  7.11 to describe the 
kinds of materials that might contribute alcohol to a finished malt 
beverage. We do not agree with this commenter's suggestion that this 
language includes, or should be extended to include, the use of taxpaid 
distilled spirits or taxpaid wine.
    The provision allowing the addition of flavors and other 
ingredients containing alcohol to malt beverages was specifically 
designed to permit the addition of alcohol flavors to malt beverages 
and to allow the addition of certain other materials such as blenders 
containing alcohol to malt beverages. TTB in Notice No. 4 did not 
intend to authorize the direct addition of distilled spirits to malt 
beverages. TTB reaffirms its long-held position that the IRC does not 
explicitly authorize the direct addition of distilled spirits to malt 
beverages. Thus, this final rule will not authorize the addition of 
distilled spirits to malt beverages.
    TTB did include a reference to taxpaid wine in proposed Sec.  
25.15(b) and in proposed Sec.  25.55(a)(2). However, this final rule 
does not authorize that use of taxpaid wine.
    Like distilled spirits, taxpaid wine is a beverage product. Neither 
the IRC nor the FAA Act specifically authorizes the use of taxpaid wine 
in the production of malt beverages. TTB will not allow taxpaid wine to 
make up to 49% of the alcohol content of a malt beverage. Thus, this 
final rule does not authorize the use of taxpaid wine in any malt 
beverage.
    Accordingly, in this final rule we have clarified our intent 
regarding the use of ingredients containing alcohol by using the phrase 
``flavors and other nonbeverage ingredients containing alcohol'' in 
Sec. Sec.  7.11 and 25.15. Use of this modified language makes it very 
clear that flavoring materials may contain alcohol and that other 
nonbeverage ingredients such as blenders may contain alcohol. It does 
not authorize the use of taxpaid distilled spirits or taxpaid wine in 
the production of malt beverages.
    TTB notes that the FMBC also supported the Notice No. 4 recognition 
that various processes and treatments may be used on malt beverages to 
remove color, aroma, bitterness or other characteristics derived from 
fermentation. This provision remains unchanged in Sec.  7.11.

C. Malt Beverages Above 6.0% Alc/Vol; Status of ATF Ruling 96-1

1. Comments Received
    The FMBC commented that ATF Ruling 96-1 limits the contribution of 
added alcohol in malt beverages over 6.0% alc/vol to not more than 1.5% 
of the total volume. This commenter stated that Notice No. 4 neither 
incorporated nor addressed this limitation and requested that TTB 
clarify the status of the limit in the ruling on alcohol addition for 
malt beverages over 6.0% alc/vol.
    Coors commented that the practical effect of the proposed 0.5% 
added alcohol limitation is to establish a natural limitation on the 
[upper] alcohol content of malt beverages. This commenter noted that 
the TTB alternative 51/49 percent proposal would permit a brewer to 
produce a 35% alc/vol malt beverage by combining a high alcohol 
fermented malt beverage of 18% alc/vol with an additional 17% alc/vol 
through alcohol flavor and blender use. Coors stated that ATF Ruling 
96-1 clearly presented TTB's intention that alcohol in malt beverages 
should be derived from fermentation and not from fortification.
2. TTB Response
    Notice No. 4 proposed to limit the addition of alcohol to all malt 
beverages from flavors and other materials containing alcohol to less 
than 0.5% alc/vol. This proposal would have included malt beverages 
with an alcohol content exceeding 6% alcohol by volume. Thus, there was 
no need to separately address these malt beverages in the proposed 
regulations.
    As stated above, we have decided to adopt the more liberal 51/49 
standard instead of the proposed 0.5% standard. However, Coors has 
accurately pointed out one hazard of extending the 51/49% majority rule 
to malt beverages of any alcohol strength including those over 6% alc/
vol. To do so would facilitate the production of extremely high 
strength malt beverages at breweries.
    Prior to issuing ATF Ruling 96-1, our predecessor agency reviewed 
FMBs on the market and determined that, based on approved statements of 
process, the only FMBs containing a significant amount of alcohol 
derived from flavors were for products that contained 6% or less 
alcohol by volume in the finished product. Although ATF had approved 
statements of process under Sec.  25.67 for FMBs containing in excess 
of 6% alcohol by volume, in no instance had the quantitative amount of 
alcoholic flavoring materials used in such products contributed more 
than 1.5% alc/vol to the finished product. Accordingly, to preserve the 
status quo pending rulemaking on this issue, ATF ruled that FMBs 
containing in excess of 6% alcohol by volume may derive no more than 
1.5% alcohol by volume from added alcoholic flavoring materials.
    Based on the rulemaking record, there is no need to liberalize the 
added alcohol standard for FMBs with an alcohol content in excess of 
6%. TTB believes that any such liberalization would raise serious 
questions as to whether the finished product was appropriately 
classified as a malt beverage or as a distilled spirits product.
    Accordingly, this final rule incorporates the terms of ATF Ruling 
96-1 with respect to malt beverages with an alcohol content of more 
than 6% alc/vol, by restricting the addition of alcohol to malt 
beverages above 6.0% alc/vol to not more than 1.5% of the volume of the 
finished product. We have incorporated this policy in the regulatory 
texts by adding a new paragraph (a)(2) to Sec.  7.11 and by modifying 
Sec.  25.15(b) to include the same 1.5% added alcohol qualification for 
malt beverages and beer over 6% alc/vol.

D. Changes to Sec.  7.31

    Although there is no substantive change in the proposed amendment 
to Sec.  7.31, we have reversed the order of existing paragraph (d) and 
proposed new paragraph (e), so that paragraph (d) contains the new 
provision for submitting a formula or sample of a malt beverage to TTB 
in conjunction with the filing of an application for a certificate of 
label approval. We have also changed the term ``you'' to ``importer'' 
to clarify

[[Page 232]]

the person required to comply with the regulation.

E. Reference to Standards for Beer, Sec. Sec.  25.11 and 25.15

1. Comment Received
    The FMBC commented that creating a new Sec.  25.15 to include 
standards for beer production is unnecessary because persons seeking 
this information would look at the definition of beer in Sec.  25.11. 
The FMBC therefore suggested incorporating the proposed Sec.  25.15 
standards into the existing definition of beer in Sec.  25.11.
2. TTB Response
    TTB is not adopting this suggestion for the reasons previously set 
forth in this comment discussion. We wish to separate the relatively 
simple statutory definition of beer from the more technical production 
requirements that we are adopting in this final rule. Further, we note 
that Sec.  25.11 would become unnecessarily long and technical if we 
were to include standards for beer in that section. Therefore, we have 
retained the proposed standards applying to the production and 
composition of beer in new Sec.  25.15.
    We believe that the inclusion of a cross reference at the end of 
the Sec.  25.11 beer definition to the standards for beer appearing in 
Sec.  25.15 is sufficient to alert readers that additional conditions 
may apply to the production and composition of beer.

F. Other Sec.  25.15 Issues

    We have changed the title of Sec.  25.15 to read, `` Materials for 
the production of beer.'' This change better reflects the content since 
this section specifies materials that may be used in producing beer at 
a brewery, and does not refer to the tax on beer.

G. Comments on Formula Proposals, Sec. Sec.  25.55-25.58

    We have conformed the language throughout Sec. Sec.  25.55-25.58 to 
the use of the phrase ``flavors and other nonbeverage ingredients 
containing alcohol'' in referring to the materials containing alcohol 
that may be used in producing beer. We have also removed the term 
``taxpaid wine'' that appeared in proposed Sec. Sec.  25.55(a)(2) and 
25.57(a)(3)(ii). As noted earlier in this comment discussion, these 
formula regulations do not authorize the use of taxpaid wine or taxpaid 
distilled spirits in the production of beer. We also added exception 
language regarding hop extract in Sec.  25.55(a)(2) to clarify that the 
use of hop extract containing alcohol does not require the filing of a 
formula.
    It has been TTB's policy to authorize the use of a formula covering 
production of a beer base that the brewer does not intend to market, 
but will use in the eventual production of a product such as an FMB. 
For example, a brewer might choose to file a formula for a beer base 
that the brewer has produced and removed character from through a 
variety of processes. At a later stage, the brewer could produce 
several distinct fermented products by adding different flavors to this 
base. We have added a new paragraph (b)(2) to Sec.  25.55 to reflect 
this practice.
    If a brewer adds flavors to a beer base or otherwise treats it to 
produce a fermented beverage that the brewer intends to market, any 
approved beer base formula should be referenced in the formula 
information specified in Sec.  25.57. We have added a new paragraph (d) 
to Sec.  25.57 to clarify this point.
    Although we did not receive comments directed to Sec.  25.58, we 
have reorganized and revised this section in order to clarify the 
distinction between a new formula and a superseding formula. We have 
not changed the substantive requirements in proposed Sec.  25.58.
    Paragraph (a) sets forth conditions that trigger the filing of a 
new formula, and these conditions are the same as those in paragraphs 
(a)(1) through (a)(6) of proposed Sec.  25.58. The revised introductory 
text of paragraph (a) merely incorporates the terms of proposed 
paragraph (c) regarding giving each new formula a new formula number.
    Paragraph (b) of Sec.  25.58 combines proposed paragraphs (b) and 
(d). The introductory text of revised paragraph (b) clarifies when a 
brewer may file a superseding formula in lieu of filing an entirely new 
formula. Under this text, a brewer may file a superseding formula when 
the brewer makes a change to an existing approved formula that is not 
of a type that would require a holder of a certificate of label 
approval to file a new application for label approval on TTB Form 
5100.31, regardless of whether the formula is for a product covered by 
a certificate of label approval. Thus, when a brewer replaces one 
ingredient with a similar ingredient, and this replacement is not of a 
type that would require a new certificate of label approval for the 
product, the brewer may file a superseding formula rather than a new 
formula.
    Paragraph (b)(1) specifies that superseding formulas must be 
approved by TTB before they may be used, and that TTB will cancel the 
original formula upon approval of the superseding formula. Under Sec.  
25.58(b)(2), a superseding formula retains the original formula number 
but it must be annotated to show it is a superseding formula. If an 
existing certificate of label approval covers the product, the brewer 
may continue to use that certificate.
    We have changed the section headings in Sec. Sec.  25.15 and 25.53 
through 25.58 by changing the question-style headings to declarative 
statement headings. We believe the latter approach is more effective 
than question-style headings in helping the reader to find regulatory 
information. Additionally, we note that part 25 does not contain other 
question-style headings at this time.

XVI. Regulatory Analysis and Notices

A. Executive Order 12866

    As noted in the comment discussion in this final rule, several 
commenters suggested that the proposed 0.5% standard would impose 
significant regulatory burdens and economic costs on the FMB industry. 
One comment in particular, from the FMBC, suggested that the costs of 
the proposed 0.5% standard, when extrapolated to the entire FMB 
industry, would exceed $600 million over the next 4 years. In addition, 
this commenter suggested that the proposed 0.5% standard would have a 
negative impact on revenue collections by the Federal government due to 
reductions in sales of FMBs.
    TTB believes that the FMBC comment may have overstated the 
regulatory burdens and economic costs that would be imposed by the 
proposed rule. However, as already pointed out in this document, we are 
persuaded by this and other comments that imposition of a 0.5% standard 
for all FMBs would impose greater regulatory burdens and economic costs 
than the 51/49 standard.
    In response to these comments, TTB evaluated several options to 
minimize the regulatory burdens and economic costs imposed by the rule. 
In particular, we adopted an option that we believe will meet the 
important regulatory goals of this rulemaking project, while reducing 
in a meaningful fashion the regulatory burdens and costs imposed by the 
rule. In other words, we adopted the more lenient alternative advocated 
by the FMBC and others who opposed the 0.5% rule; thus, the final rule 
allows products labeled as FMBs to derive up to 49% of their alcohol 
content from the distilled spirits components of added flavors and 
other nonbeverage products.
    In response to concerns raised by the comments, TTB also adopted a 
one-year delayed effective date for the final rule,

[[Page 233]]

to allow affected producers adequate time to reformulate their 
products, if necessary. We believe that this delayed effective date 
also serves to address the concerns of affected industry members.
    Accordingly, for the reasons set forth above, we have determined 
that the final rule, as modified in response to the comments, is not a 
significant regulatory action as defined in E.O. 12866. Therefore, a 
regulatory assessment is not required.

B. Regulatory Flexibility Act

    The Regulatory Flexibility Act generally requires an agency to 
conduct a regulatory flexibility analysis of any rule subject to notice 
and comment rulemaking requirements unless the agency certifies that 
the rule will not have a significant economic impact on a substantial 
number of small entities. Small entities include small businesses, 
small not-for-profit enterprises, and small governmental jurisdictions.
    We have determined that this final rule will not have a significant 
economic impact on a substantial number of small entities. Accordingly, 
a regulatory flexibility analysis is not required.
    In Notice No. 4, we stated our belief that 10 or fewer qualified 
small breweries actually manufacture flavored malt beverages subject to 
this rule. We specifically solicited comments on the number of small 
breweries that may be affected by this rule and on the impact of this 
rule on those breweries. We asked small breweries that believe they 
would be significantly affected by this rule to let us know and to tell 
us how the rule would affect them.
    In response to Notice No. 4, we received only a few comments from 
brewers that identified themselves as small brewers that would be 
affected by the rule. These comments, as well as other comments 
submitted by FMB producers, suggested that the proposed 0.5% standard 
would unfairly burden small brewers, and could result in putting these 
companies out of business. The comments indicated that the small 
brewers would be able to comply with the 51/49 standard without such 
significant adverse consequences.
    In response to these comments and others, we have modified the 
regulatory texts contained in this final rule to reduce the potential 
economic impact of the rule on small businesses that produce FMBs. As 
indicated earlier in the preamble to this document, we considered 
several options to reduce the economic impact on small businesses.
    For various reasons, most importantly because the pertinent 
statutes would not authorize such an option, we rejected the option of 
exempting small businesses from compliance with the requirements of the 
final rule. However, for a number of reasons explained in detail 
earlier in the preamble to this document, we have adopted the more 
liberal 51/49 standard for products labeled as FMBs. We have also 
adopted a one-year delayed effective date for the provisions of this 
final rule, to allow adequate time for those FMB producers that wish to 
reformulate their products or otherwise conform to the requirements of 
the final rule regulatory texts. Accordingly, we believe that we have 
responded to the concerns raised by small businesses and have 
meaningfully reduced the costs and regulatory burdens imposed by the 
rule.
    It should be noted that several small wholesalers and retailers 
commented that the proposed rule would have an adverse impact on them, 
because State law might not allow them to sell FMB products that are 
reclassified as distilled spirits products. We believe that the 
modifications discussed above address their concerns. Furthermore, the 
FMB producers that commented on this issue all indicated an intention 
to reformulate their products within the requirements of the final 
rule, rather than produce beverages that would be classified as 
distilled spirits products under Federal law. Finally, we would note 
that the Regulatory Flexibility Act does not require us to consider 
indirect effects on businesses that are not directly subject to the 
requirements of the final rule; instead, the relevant economic impact 
is ``the impact of compliance with the proposed rule on regulated small 
entities.'' Mid-Tex Electric Cooperative, Inc. v. FERC, 773 F.2d 327, 
342 (D.C. Cir. 1985). Wholesalers and retailers of FMBs are not 
directly subject to the requirements of the final rule.
    Finally, a comment from the FMBC suggested that the alcohol content 
labeling requirement would have a significant economic impact on a 
substantial number of small entities, including many small brewers that 
produce beers and ales that contain only a small quantity of flavors. 
The FMBC comment conceded that it did not know how many brewers might 
be impacted by this requirement but suggested that many small brewers 
would be affected. The FMBC stated that its members already label their 
FMB products with alcohol content statements.
    TTB did not receive any comments from small brewers who produce 
traditional flavored beers and ales suggesting that the requirement for 
an alcohol content statement would impose a significant economic 
burden. The Brewer's Association of America, a trade association 
representing more than 1,400 small brewers, supported the proposed rule 
without mentioning the alcohol content statement requirement. 
Furthermore, we note that brewers are already required to keep records 
of alcohol content under the IRC regulations set forth in 27 CFR 
25.293. We have no information indicating that the requirement to 
disclose alcohol content on brand labels for malt beverages deriving 
alcohol from added flavors or other nonbeverage ingredients would 
impose a significant economic burden on a substantial number of small 
entities. Accordingly, the record does not support such a finding.
    Pursuant to section 7805(f) of the Internal Revenue Code of 1986, 
we submitted the notice of proposed rulemaking preceding this final 
rule to the Chief Counsel for Advocacy of the Small Business 
Administration (SBA) for comment on its impact on small businesses. We 
received no comment from the SBA in response to that submission.

C. Paperwork Reduction Act

    In Notice No. 4, TTB stated that the provisions of the Paperwork 
Reduction Act of 1995, 44 U.S.C. chapter 35, and its implementing 
regulations, 5 CFR part 1320, did not apply to the notice of proposed 
rulemaking, because we were not proposing any new or revised 
recordkeeping requirements. After review of the comments on this issue, 
TTB has determined that the final rule includes a new reporting 
requirement and a revision of an existing reporting requirement. The 
new reporting requirement involves the specific detail that must be 
included in the formulas for certain fermented products produced at a 
brewery. The revision involves the mandatory alcohol content statement 
for malt beverages that derive alcohol from added flavors or other 
ingredients. Because the final rule does not take effect for one year 
from publication of this document in the Federal Register, there is 
time to air these requirements for public comment prior to the 
effective date of the rule.
    These collections of information have been reviewed and, pending 
receipt and evaluation of public comments, approved by the Office of 
Management and Budget (OMB) under 44 U.S.C. 3507(j) and assigned 
control numbers 1513-0118 and 1513-0087. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a valid control number assigned by OMB.
    The collection of information in this regulation covered by OMB 
control

[[Page 234]]

number 1513-0118 is found in Sec. Sec.  25.55-25.58. This collection is 
necessary to ensure that producers of certain beers provide enough 
information to TTB to ensure the proper tax classification of the 
products. The likely respondents are businesses.
     Estimated total annual reporting and/or recordkeeping 
burden: 500 hours.
     Estimated average annual burden hours per respondent and/
or recordkeeper: 5 hours.
     Estimated number of respondents and/or recordkeepers: 100.
     Estimated annual frequency of responses: 5.
    The collection of information in this regulation covered by OMB 
control number 1513-0087 is in Sec.  7.22, which imposes a requirement 
for an alcohol content statement on labels of malt beverages deriving 
any alcohol from added flavors or other nonbeverage ingredients. This 
information is required to ensure that consumers are not misled as to 
the alcohol content of malt beverages that derive alcohol from sources 
other than fermentation at a brewery. The likely respondents are 
businesses. This information constitutes one element of the labeling 
information on alcohol beverages required under authority of the 
Federal Alcohol Administration Act (FAA Act), and it relates to only 
one sector of the alcohol beverage industry. The policy of TTB and its 
predecessor agency has been to treat all labeling requirements under 
the FAA Act as resulting in one burden hour per respondent. 
Accordingly, because the producers of malt beverages already know the 
alcohol content of their products and displaying that content on the 
label constitutes only a small portion of the existing labeling 
requirements, the burden estimate associated with this alcohol content 
labeling requirement is minimal.
    Comments concerning each collection of information should be 
directed to the Office of Management and Budget, Attention: Desk 
Officer for the Department of the Treasury, Office of Information and 
Regulatory Affairs, Washington, DC 20503. A copy should also be sent to 
the Chief, Regulations and Procedures Division, Alcohol and Tobacco Tax 
and Trade Bureau, 1310 G Street, NW., Washington, DC 20220. Any such 
comments should be submitted not later than March 4, 2005. Comments are 
invited on:
     Whether the collection of information is necessary for the 
proper performance of the functions of the agency, including whether 
the information will have practical utility;
     The accuracy of the agency's estimate of the information 
collection burden;
     Ways to enhance the quality, utility, and clarity of the 
information to be collected;
     Ways to minimize the information collection burden on 
respondents, including through the use of automated collection 
techniques or other forms of information technology; and
     Estimates of capital or start up costs and costs of 
operations, maintenance, and purchase of services to provide 
information.

XVII. Drafting Information

    This principal author of this document is Charles N. Bacon. Other 
personnel in the Alcohol and Tobacco Tax and Trade Bureau and in the 
Department of the Treasury participated in the drafting of the 
document.

List of Subjects

27 CFR Part 7

    Advertising, Authority delegations, Beer, Consumer protection, 
Customs duties and inspection, Imports, Labeling, Packaging and 
containers, Reporting and recordkeeping requirements.

27 CFR Part 25

    Beer, Claims, Electronic fund transfers, Excise taxes, Exports, 
Labeling, Liquors, Packaging and containers, Reporting and 
recordkeeping requirements, Research, Surety bonds.

Amendment to the Regulations

0
For the reasons discussed in the preamble, TTB amends 27 CFR parts 7 
and 25 as follows:

PART 7--LABELING AND ADVERTISING OF MALT BEVERAGES

0
1. The authority citation for 27 CFR part 7 continues to read as 
follows:

    Authority: 27 U.S.C. 205.


0
2. We amend Sec.  7.10 by revising the definition of ``malt beverage'' 
to read as follows:


Sec.  7.10  Meaning of terms.

* * * * *
    Malt beverage. A beverage made by the alcoholic fermentation of an 
infusion or decoction, or combination of both, in potable brewing 
water, of malted barley with hops, or their parts, or their products, 
and with or without other malted cereals, and with or without the 
addition of unmalted or prepared cereals, other carbohydrates or 
products prepared therefrom, and with or without the addition of carbon 
dioxide, and with or without other wholesome products suitable for 
human food consumption. Standards applying to the use of processing 
methods and flavors in malt beverage production appear in Sec.  7.11.
* * * * *

0
3. We amend subpart B by adding a new Sec.  7.11 to read as follows:


Sec.  7.11  Use of ingredients containing alcohol in malt beverages; 
processing of malt beverages.

    (a) Use of flavors and other nonbeverage ingredients containing 
alcohol--
    (1) General. Flavors and other nonbeverage ingredients containing 
alcohol may be used in producing a malt beverage. Except as provided in 
paragraph (a)(2) of this section, no more than 49% of the overall 
alcohol content of the finished product may be derived from the 
addition of flavors and other nonbeverage ingredients containing 
alcohol. For example, a finished malt beverage that contains 5.0% 
alcohol by volume must derive a minimum of 2.55% alcohol by volume from 
the fermentation of barley malt and other materials and may derive not 
more than 2.45% alcohol by volume from the addition of flavors and 
other nonbeverage ingredients containing alcohol.
    (2) In the case of malt beverages with an alcohol content of more 
than 6% by volume, no more than 1.5% of the volume of the malt beverage 
may consist of alcohol derived from added flavors and other nonbeverage 
ingredients containing alcohol.
    (b) Processing. Malt beverages may be filtered or otherwise 
processed in order to remove color, taste, aroma, bitterness, or other 
characteristics derived from fermentation.

0
4. We amend Sec.  7.22 by adding a new paragraph (a)(5) to read as 
follows:


Sec.  7.22  Mandatory label information.

* * * * *
    (a) * * *
    (5) Alcohol content in accordance with Sec.  7.71, for malt 
beverages that contain any alcohol derived from added flavors or other 
added nonbeverage ingredients (other than hops extract) containing 
alcohol.
* * * * *

0
5. We amend Sec.  7.29 by revising the introductory text of paragraph 
(a) and by adding a new paragraph (a)(7) to read as follows:


Sec.  7.29  Prohibited practices.

    (a) Statements on labels. Containers of malt beverages, or any 
labels on such

[[Page 235]]

containers, or any carton, case, or individual covering of such 
containers, used for sale at retail, or any written, printed, graphic, 
or other material accompanying such containers to the consumer, must 
not contain:
* * * * *
    (7) Any statement, design, device, or representation that tends to 
create a false or misleading impression that the malt beverage contains 
distilled spirits or is a distilled spirits product. This paragraph 
does not prohibit the following on malt beverage labels:
    (i) A truthful and accurate statement of alcohol content, in 
conformity with Sec.  7.71;
    (ii) The use of a brand name of a distilled spirits product as a 
malt beverage brand name, provided that the overall label does not 
present a misleading impression about the identity of the product; or
    (iii) The use of a cocktail name as a brand name or fanciful name 
of a malt beverage, provided that the overall label does not present a 
misleading impression about the identity of the product.
* * * * *

0
6. We amend Sec.  7.31 by redesignating paragraph (d) as paragraph (e) 
and by adding a new paragraph (d) to read as follows:


Sec.  7.31  Label approval and release.

* * * * *
    (d) Formula and samples. The appropriate TTB officer may require an 
importer to submit a formula for a malt beverage, or a sample of any 
malt beverage or ingredients used in producing a malt beverage, prior 
to or in conjunction with the filing of a certificate of label approval 
on TTB Form 5100.31.
* * * * *

0
7. We amend Sec.  7.54 by revising the introductory text of paragraph 
(a) and by adding a new paragraph (a)(8) to read as follows:


Sec.  7.54.  Prohibited statements.

    (a) General prohibition. An advertisement of malt beverages must 
not contain:
* * * * *
    (8) Any statement, design, device, or representation that tends to 
create a false or misleading impression that the malt beverage contains 
distilled spirits or is a distilled spirits product. This paragraph 
does not prohibit the following in advertisements for malt beverages:
    (i) A truthful and accurate statement of alcohol content, in 
conformity with Sec.  7.71;
    (ii) The use of a brand name of a distilled spirits product as a 
malt beverage brand name, provided that the overall advertisement does 
not present a misleading impression about the identity of the product; 
or
    (iii) The use of a cocktail name as a brand name or fanciful name 
of a malt beverage, provided that the overall advertisement does not 
present a misleading impression about the identity of the product.
* * * * *

PART 25--BEER

0
8. The authority citation for part 25 continues to read as follows:

    Authority: 19 U.S.C. 81c; 26 U.S.C. 5002, 5051-5054, 5056, 5061, 
5091, 5111, 5113, 5142, 5143, 5146, 5222, 5401-5403, 5411-5417, 
5551, 5552, 5555, 5556, 5671, 5673, 5684, 6011, 6061, 6065, 6091, 
6109, 6151, 6301, 6302, 6311, 6313, 6402, 6651, 6656, 6676, 6806, 
7011, 7342, 7606, 7805; 31 U.S.C. 9301, 9303-9308.


0
9. We amend Sec.  25.11 by revising the definition of ``beer'' to read 
as follows:


Sec.  25.11  Meaning of terms.

* * * * *
    Beer. Beer, ale, porter, stout, and other similar fermented 
beverages (including sak[eacute] and similar products) of any name or 
description containing one-half of one percent or more of alcohol by 
volume, brewed or produced from malt, wholly or in part, or from any 
substitute for malt. Standards for the production of beer appear in 
Sec.  25.15.
* * * * *

0
10. We amend subpart B by adding an undesignated center heading and a 
new Sec.  25.15 to read as follows:

Standards for Beer


Sec.  25.15  Materials for the production of beer.

    (a) Beer must be brewed from malt or from substitutes for malt. 
Only rice, grain of any kind, bran, glucose, sugar, and molasses are 
substitutes for malt. In addition, you may also use the following 
materials as adjuncts in fermenting beer: honey, fruit, fruit juice, 
fruit concentrate, herbs, spices, and other food materials.
    (b) You may use flavors and other nonbeverage ingredients 
containing alcohol in producing beer. Flavors and other nonbeverage 
ingredients containing alcohol may contribute no more than 49% of the 
overall alcohol content of the finished beer. For example, a finished 
beer that contains 5.0% alcohol by volume must derive a minimum of 
2.55% alcohol by volume from the fermentation of ingredients at the 
brewery and may derive not more than 2.45% alcohol by volume from the 
addition of flavors and other nonbeverage ingredients containing 
alcohol. In the case of beer with an alcohol content of more than 6% by 
volume, no more than 1.5% of the volume of the beer may consist of 
alcohol derived from added flavors and other nonbeverage ingredients 
containing alcohol.

0
11. We amend subpart F by adding two undesignated center headings, and 
by adding new Sec. Sec.  25.53 and 25.55 through 25.58, to read as 
follows:

Samples


Sec.  25.53  Submissions of samples of fermented products.

    The appropriate TTB officer may, at any time, require you to submit 
samples of:
    (a) Cereal beverage, sak[eacute], or any fermented product produced 
at the brewery,
    (b) Materials used in the production of cereal beverage, 
sak[eacute], or any fermented product; and
    (c) Cereal beverage, sak[eacute], or any fermented product, in 
conjunction with the filing of a formula.


(26 U.S.C. 5415, 5555, 7805(a))

Formulas


Sec.  25.55  Formulas for fermented products.

    (a) For what fermented products must a formula be filed? You must 
file a formula for approval by TTB if you intend to produce:
    (1) Any fermented product that will be treated by any processing, 
filtration, or other method of manufacture that is not generally 
recognized as a traditional process in the production of a fermented 
beverage designated as ``beer,'' ``ale,'' ``porter,'' ``stout,'' 
``lager,'' or ``malt liquor.'' For purposes of this paragraph:
    (i) Removal of any volume of water from beer, filtration of beer to 
substantially change the color, flavor, or character, separation of 
beer into different components, reverse osmosis, concentration of beer, 
and ion exchange treatments are examples of non-traditional processes 
for which you must file a formula.
    (ii) Pasteurization, filtration prior to bottling, filtration in 
lieu of pasteurization, centrifuging for clarity, lagering, 
carbonation, and blending are examples of traditional processes for 
which you do not need to file a formula.
    (iii) If you have questions about whether or not use of a 
particular process not listed in this section requires the filing of a 
formula, you may request a determination from TTB in

[[Page 236]]

accordance with paragraph (f) of this section.
    (2) Any fermented product to which flavors or other nonbeverage 
ingredients (other than hop extract) containing alcohol will be added.
    (3) Subject to paragraph (f) of this section, any fermented product 
to which coloring or natural or artificial flavors will be added.
    (4) Subject to paragraph (f) of this section, any fermented product 
to which fruit, fruit juice, fruit concentrate, herbs, spices, honey, 
maple syrup, or other food materials will be added.
    (5) Sak[eacute], including flavored sak[eacute] and sparkling 
sak[eacute].
    (b) Are separate formulas required for different products?
    (1) You must file a separate formula for approval for each 
different fermented product for which a formula is required.
    (2) You may file a formula for a beer base to be used in the 
production of one or more other fermented products. The beer base must 
conform to the standards set forth in Sec.  25.15.
    (c) When must I file a formula?
    (1) Except as provided in paragraph (c)(2) of this section, you may 
not produce a fermented product for which a formula is required until 
you have filed and received approval of a formula for that product.
    (2) You may, for research and development purposes (including 
consumer taste testing), produce a fermented product without an 
approved formula, but you may not sell or market this product until you 
receive approval of the formula for it.
    (d) How long is my formula approval valid? Your formula approved 
under this section remains in effect until: you supersede it with a new 
formula; you voluntarily surrender the formula; TTB cancels or revokes 
the formula; or the formula is revoked by operation of law or 
regulation.
    (e) Are my previously approved statements of process valid? Your 
statements of process approved before January 3, 2006 are considered 
approved formulas under this section, provided that any finished 
product that could be made under the statement of process would be in 
compliance with the provisions of this part. You do not need to submit 
a formula for approval if a statement of process that remains valid 
covers the product.
    (f) Determinations by TTB regarding specific processes and 
ingredients.
    (1) The appropriate TTB officer may determine whether or not use of 
a process not listed in paragraph (a)(1) of this section requires you 
to file a formula for approval. The appropriate TTB officer may also 
exempt the use of a particular coloring, flavoring, or food material 
from the formula filing requirement of paragraph (a)(3) or paragraph 
(a)(4) of this section upon a finding that the coloring, flavoring, or 
food material in question is generally recognized as a traditional 
ingredient in the production of a fermented beverage designated as 
``beer,'' ``ale,'' ``porter,'' ``stout,'' ``lager,'' or ``malt 
liquor.''
    (2) You may request a determination from TTB on whether or not the 
use of a process not listed in paragraph (a)(1) of this section will 
require the filing of a formula or whether the use of a particular 
coloring, flavoring or food material may be exempted from the formula 
filing requirement of paragraph (a)(3) or paragraph (a)(4) of this 
section. You should mail your request to the Assistant Chief, 
Advertising, Labeling and Formulation Division, Alcohol and Tobacco Tax 
and Trade Bureau, 1310 G Street, NW., Washington, DC 20220.
    (i) When requesting a determination as to whether a process is 
subject to the formula filing and approval requirement, the request 
must include:
    (A) A detailed description of the proposed process;
    (B) Evidence establishing that the proposed process is generally 
recognized as a traditional process in the production of a fermented 
beverage designated as ``beer,'' ``ale,'' ``porter,'' ``stout,'' 
``lager,'' or ``malt liquor''; and
    (C) An explanation of the effect of the proposed process on the 
production of a fermented product.
    (ii) When requesting an exemption from the formula filing 
requirement in paragraph (a)(3) or paragraph (a)(4) of this section 
regarding coloring, flavoring, or food material ingredients, the 
request must include the following information:
    (A) A description of the proposed ingredient;
    (B) Evidence establishing that the proposed ingredient is generally 
recognized as a traditional ingredient in the production of a fermented 
beverage designated as ``beer,'' ``ale,'' ``porter,'' ``stout,'' 
``lager,'' or ``malt liquor''; and
    (C) An explanation of the effect of the proposed ingredient in the 
production of a fermented product.


Sec.  25.56  Filing of formulas.

    (a) What are the general requirements for filing a formula? (1) You 
must file your formula in writing. Your formula must identify each 
brewery where the formula applies by including each brewery name, 
address, and registry number.
    (2) You must serially number each formula, commencing with ``1'' 
and continuing in numerical sequence.
    (3) You must date and sign each formula.
    (4) You must file two copies of each formula with TTB.
    (b) Where do I file a formula? File your formula with the Assistant 
Chief, Advertising, Labeling and Formulation Division, Alcohol and 
Tobacco Tax and Trade Bureau, 1310 G Street, NW., Washington, DC 20220.


(26 U.S.C. 5401, 7805)


Sec.  25.57  Formula information.

    (a) Ingredient information. (1) For each formula you must list each 
separate ingredient and the specific quantity used, or a range of 
quantities used. You may include optional ingredients in a formula if 
they do not impact the labeling or identity of the finished product.
    (2) For fermented products containing flavorings you must list for 
each formula: The name of the flavor; the product number or TTB 
drawback number and approval date of the flavor; the name and location 
(city and State) of the flavor manufacturer; the alcohol content of the 
flavor; and the point of production at which the flavor was added (that 
is, before, during, or after fermentation).
    (3) For formulas that include the use of flavors and other 
nonbeverage ingredients containing alcohol, you must explicitly 
indicate:
    (i) The volume and alcohol content of the beer base;
    (ii) The maximum volumes of the flavors and other nonbeverage 
ingredients containing alcohol to be used;
    (iii) The alcoholic strength of the flavors and other nonbeverage 
ingredients containing alcohol;
    (iv) The overall alcohol contribution to the finished product 
provided by the addition of any flavors or other nonbeverage 
ingredients containing alcohol. You are not required to list the 
alcohol contribution of individual flavors and other nonbeverage 
ingredients containing alcohol. You may state the total alcohol 
contribution from these ingredients to the finished product; and
    (v) The final volume and alcohol content of the finished product.
    (b) Process information. For each formula you must describe in 
detail each process used to produce a fermented beverage.
    (c) Alcohol content. For each formula you must state the alcohol 
content of the fermented product after fermentation

[[Page 237]]

and the alcohol content of the finished product.
    (d) Beer base formulas. You must refer in your formula to any 
approved formula number that covers the production of any beer base 
used in producing the formula product. If the beer base was produced by 
another brewery of the same ownership, you must also provide the name 
and address or name and registry number of that brewery.
    (e) Additional information. The appropriate TTB officer may at any 
time require you to file additional information concerning a fermented 
product, ingredients, or processes, in order to determine whether a 
formula should be approved or disapproved or whether the approval of a 
formula should be continued.
    (26 U.S.C. 5415, 5555, 7805(a))


Sec.  25.58  New and superseding formulas.

    (a) New formulas. Except as otherwise provided in paragraph (b) of 
this section, you must file a new formula (with a new formula number) 
for approval by TTB if you--
    (1) Create an entirely new fermented product that requires a 
formula;
    (2) Add new ingredients to an existing formulation;
    (3) Delete ingredients from an existing formulation;
    (4) Change the quantity of an ingredient used from the quantity or 
range of usage in an approved formula;
    (5) Change an approved processing, filtration, or other special 
method of manufacture that requires the filing of a formula; or
    (6) Change the contribution of alcohol from flavors or ingredients 
that contain alcohol.
    (b) Superseding formulas. You may file a superseding formula, 
instead of a new formula, if you have made any change listed in 
paragraphs (a)(2) through (a)(6) of this section and that change is not 
of a type that would require a holder of a certificate of label 
approval to file a new application for label approval on TTB Form 
5100.31.
    (1) A superseding formula replaces an existing formula, and you 
should file one only if you do not intend to use the existing formula 
any more. A superseding formula must be filed with TTB for approval. 
When TTB approves a superseding formula, TTB will cancel your previous 
formula.
    (2) You may use the same formula number for a superseding formula 
that you used for the formula the superseding formula replaces, but you 
must annotate the formula number to indicate it is a superseding 
formula number. (For example, ``Formula 2, superseding.'')
    (c) When you file a new or superseding formula with TTB, you must 
follow the procedures and other requirements of Sec. Sec.  25.56 and 
25.57.


Sec.  25.62  [Amended]

0
12. We amend Sec.  25.62 by removing and reserving paragraph (a)(7).


Sec.  25.67  [Removed and Reserved]

0
13. We amend Subpart G by removing and reserving Sec.  25.67.


Sec.  25.76  [Removed and Reserved]

0
14. We amend Subpart G by removing and reserving Sec.  25.76.

    Signed: August 6, 2004.
Arthur J. Libertucci,
Administrator.
    Approved: December 22, 2004.
Timothy E. Skud,
Deputy Assistant Secretary (Tax, Trade, and Tariff Policy).
[FR Doc. 04-28460 Filed 12-29-04; 8:45 am]
BILLING CODE 4810-31-P