Mylan, Inc. & Subsidiaries

156 T.C. No. 10UNITED STATES TAX COURT
MYLAN, INC. & SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 26976-16, 26977-16, Filed April 27, 2021.
26978-16.
P, a U.S. corporation, is a manufacturer of brand name and
generic pharmaceutical drugs. During 2012 to 2014 P incurred legal
fees in connection with applications submitted to the Food & Drug
Administration (FDA) for approval to market and sell generic
versions of brand name drugs. As part of the application process P
was required to provide a certification regarding the status of any
patents that had been listed by the FDA as covering the respective
brand name drug. On some applications P certified that listed patents
covering the brand name drugs were invalid or would not be infringed
by the manufacture of P’s generic drugs. When it made such a
certification, P was required to send notice letters to the brand name
drug manufacturer and any patentees stating that P had made such a
certification. Certification also constituted an act of patent
infringement giving the brand name manufacturer and patentees the
right to bring a patent infringement suit against P. At issue are the
legal expenses incurred to prepare notice letters and legal expenses
incurred in defending against these patent infringement suits.
Served 04/27/21
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On its 2012, 2013, and 2014 returns, P deducted its legal
expenses as ordinary and necessary business expenditures. Upon
examination, R determined that these expenses were nondeductible
capital expenditures required to be capitalized and subsequently
disallowed P’s claimed deductions for the expenses at issue. R
thereafter issued a notice of deficiency for each of P’s 2012, 2013,
and 2014 taxable years determining deficiencies of $16,430,947,
$12,618,695, and $20,988,657, respectively.
Held: The legal expenses P incurred to prepare notice letters
are required to be capitalized because they were necessary to obtain
FDA approval of P’s generic drugs.
Held, further, the legal expenses P incurred to defend patent
infringement suits are deductible as ordinary and necessary business
expenses because the patent litigation was distinct from the FDA
approval process.
William F. Nelson and James G. Steele III, for petitioner.
Emily J. Giometti, Lisa M. Rodriguez, Mary Helen Weber, Kathryn
E. Kelly, and Nina P. Ching, for respondent.
URDA, Judge: Petitioner, Mylan, Inc. & Subsidiaries (Mylan), is a
manufacturer of brand name and generic pharmaceutical drugs. From 2012
through 2014 it incurred significant legal expenses in preparing notice letters and
defending patent infringement lawsuits related to its generic versions of certain
brand name drugs. On its 2012 through 2014 Federal income tax returns, Mylan
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claimed deductions for the legal fees as ordinary and necessary business expenses
under section 162(a).1 The Internal Revenue Service (IRS) subsequently
disallowed these deductions, determining that the legal expenses were required to
be capitalized pursuant to section 263(a). We conclude that the legal expenses
Mylan incurred to prepare notice letters are required to be capitalized, while the
litigation expenses Mylan incurred to defend patent infringement suits are
deductible as ordinary and necessary business expenses.
Introduction
We begin by describing the highly reticulated statutory and regulatory
scheme under which Mylan’s legal expenses were incurred. Before a
pharmaceutical company can market or sell a brand name or generic drug in the
United States, it must first obtain approval from the Food & Drug Administration
(FDA), the Federal agency responsible for, inter alia, the safety and efficacy of
pharmaceuticals. See Federal Food, Drug, and Cosmetic Act, ch. 675, sec. 505, 52
Stat. at 1052 (1938) (codified as amended at 21 U.S.C. sec. 355 (2012)). Although
the first step in requesting approval is the same for both brand name and generic
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code (26 U.S.C.), as amended, in effect for the years at issue. Rule
references are to the Tax Court Rules of Practice and Procedure. All amounts are
rounded to the nearest dollar.
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drugs, i.e., by submitting to the FDA a Form FDA 356h, Application To Market a
New or Abbreviated New Drug or Biologic for Human Use, the roads diverge
thereafter.
A. Brand Name Pharmaceuticals
1. New Drug Application
For brand name pharmaceuticals, a drug’s manufacturer formally proposes
that the FDA approve the new drug for sale and marketing in the United States
through a new drug application (NDA). See, e.g., FTC v. Actavis, Inc., 570 U.S.
136, 142 (2013). The NDA must provide sufficient information for the FDA to
review the drug’s components, methods of manufacturing and testing, proposed
uses and labeling, and results of clinical trials demonstrating that it is safe and
effective. 21 U.S.C. sec. 355(b). The drug manufacturer then undergoes a “long,
comprehensive, and costly testing process, after which, if successful, the
manufacturer will receive marketing approval from the FDA.” Actavis, 570 U.S.
at 142; see also 21 U.S.C. sec. 355(d).
2. The Orange Book
NDA holders are required to submit patent information for patents that
cover an FDA-approved brand name drug or an approved method of using that
drug. See 21 U.S.C. sec. 355(b)(1), (c)(2); see also aaiPharma Inc. v. Thompson,
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296 F.3d 227, 230 (4th Cir. 2002). Patents so disclosed are listed in a register
maintained by the FDA, the Approved Drug Products with Therapeutic
Equivalence Evaluations (Orange Book). See Caraco Pharm. Labs., Ltd. v. Novo
Nordisk A/S, 566 U.S. 399, 405-406 (2012); aaiPharma, 296 F.3d at 231. The
FDA does not confirm the accuracy of the information provided with the Patent &
Trademark Office or the NDA applicant. See Am. Bioscience, Inc. v. Thompson,
269 F.3d 1077, 1080 (D.C. Cir. 2001); see also Caraco, 566 U.S. at 406-407;
Apotex, Inc. v. Thompson, 347 F.3d 1335, 1349 (Fed. Cir. 2003).
B. Generic Pharmaceuticals
1. Hatch-Waxman Act
Until 1984, manufacturers of generic pharmaceuticals, like their brand name
counterparts, were required to submit an NDA for FDA approval. See aaiPharma,
296 F.3d at 230-231. Congress altered course, however, in the Drug Price
Competition and Patent Term Restoration Act of 1984 (Hatch-Waxman Act or
Act), Pub. L. No. 98-417, 98 Stat. 1585. In the Act Congress sought “to strike a
balance between ‘two conflicting policy objectives: to induce name-brand
pharmaceutical firms to make the investments necessary to research and develop
new drug products, while simultaneously enabling competitors to bring cheaper,
generic copies of those drugs to market.’” aaiPharma, 296 F.3d at 230 (quoting
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Abbott Labs. v. Young, 920 F.2d 984, 991 (D.C. Cir. 1990) (Edwards, J.,
dissenting on other grounds)); see also Eli Lilly & Co. v. Medtronic, Inc., 496 U.S.
661, 676 (1990); In re Lipitor Antitrust Litig., 868 F.3d 231, 240 (3d Cir. 2017).
2. Abbreviated NDA
a. FDA Submission
To implement the congressional purpose of bringing cheaper generic drugs
to market, the Hatch-Waxman Act established a shortcut to FDA approval for
manufacturers hoping to develop and market generic copies of brand name drugs
previously approved by the FDA. See Actavis, 570 U.S. at 142; In re Lipitor, 868
F.3d at 240. Under this expedited approach, a generic drug manufacturer may
submit an abbreviated new drug application (ANDA) that piggybacks on an
approved brand name drug’s NDA information by specifying that the generic has
the “same active ingredients as, and is biologically equivalent to,” the
already-approved brand name drug. Caraco, 566 U.S. at 404-405 (citing 21 U.S.C.
sec. 355(j)(2)(A)(ii), (iv)); see also Actavis, 570 U.S. at 142. Because the FDA
would have previously determined the brand name drug to be safe and effective,
the ANDA applicant can obtain approval while avoiding the “costly and
time-consuming studies” needed to obtain approval for a brand name drug. See
Eli Lilly, 496 U.S. at 676.
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b. Approval
The “FDA will approve an * * * [ANDA] and send the applicant an
approval letter if none of the reasons in § 314.127 for refusing to approve the * * *
[ANDA] applies.” 21 C.F.R. sec. 314.105(d) (2014); see also 21 U.S.C. sec.
355(j)(4). Title 21 C.F.R. sec. 314.127 (2014), in turn, enumerates a number of
technical reasons for the rejection of an ANDA including failure to show that the
generic has the same active ingredients as the brand name drug, failure to show
bioequivalence between the drugs, failure to establish that the production methods
would preserve the generic’s identity, strength, quality, and purity, and failure to
show proper labeling. See also 21 U.S.C. sec. 355(j)(4). None of the listed
grounds relates to patent issues. See id.; 21 C.F.R. sec. 314.127.
FDA approval of an ANDA, however, does not necessarily mean that a
generic drug may be sold and marketed. A generic drug, rather, “may be
introduced * * * into interstate commerce when approval of the * * * [ANDA] for
the drug product becomes effective.” 21 C.F.R. sec. 314.107(a) (2014); see also
21 U.S.C. sec. 355(a) (“No person shall introduce or deliver for introduction into
interstate commerce any new drug, unless an approval of an application filed
pursuant to subsection (b) or (j) of this section is effective with respect to such
drug.”). As a general matter, the “approval shall be made effective immediately”.
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21 U.S.C. sec. 355(j)(5)(B)(iii). In certain instances approval comes with a
delayed effective date. Such an approval is tentative and does not become final
until the effective date, id. cl. (iv)(II)(dd)(BB), which means that a new drug
product may not be introduced or delivered for introduction into interstate
commerce until approval of the ANDA is effective, id. subsec. (a).
3. Patent Protections
In addition to endorsing a more simplified process for bringing generics to
market, the Hatch-Waxman Act “contains a complex set of provisions designed to
protect the intellectual property rights of * * * [brand name] drug companies and
others holding patents on brand name drugs.” aaiPharma, 296 F.3d at 231.
a. Patent Litigation
The Hatch-Waxman Act created “special procedures” for identifying and
resolving patent disputes. See Actavis, 570 U.S. at 143; In re Lipitor, 868 F.3d
at 240; see also Apotex, 347 F.3d at 1338 (“The Act also sought to facilitate the
resolution of patent-related disputes over pharmaceutical drugs by creating a
streamlined mechanism for identifying and resolving patent issues related to the
proposed generic products.”). When filing an ANDA, a generic drug
manufacturer must make one of four “certifications” with respect to each drug for
which there is a patent listed in the Orange Book. 21 U.S.C. sec. 355(j)(2)(A)(vii).
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Most relevant to these cases, a generic drug manufacturer may certify that any
patent “is invalid or will not be infringed by the manufacture, use, or sale” of the
generic version (paragraph IV certification). Id. subcl. (IV); see also Actavis, 570
U.S. at 143.
A paragraph IV certification “automatically counts as patent infringement,
see 35 U.S.C. § 271(e)(2)(A) (2006 ed., Supp. V), and often ‘means provoking
litigation’”. Actavis, 570 U.S. at 143 (quoting Caraco, 566 U.S. at 407); see also
Purepac Pharm. Co. v. Thompson, 354 F.3d 877, 879 (D.C. Cir. 2004) (“In
essence, applicants use paragraph IV certifications to challenge the validity of
brand-name manufacturers’ patents.”); Apotex, 347 F.3d at 1339. An ANDA
applicant making a paragraph IV certification is required to notify the patentees
and holder of the approved NDA implicated by its certification that it has made
such certification within 20 days of the ANDA’s filing. See 21 U.S.C.
sec. 355(j)(2)(B)(ii) and (iii). This notification letter, inter alia, must include a
detailed statement laying out the factual and legal bases for the applicant’s
conclusion that the patent is invalid or not infringed. See id. cl. (iv).
The patentees and the NDA holder are entitled to bring suit in Federal
District Court, with remedies including a court order that “the effective date of any
approval of the drug * * * is not earlier than the date of the expiration of the patent
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which has been infringed” and injunctive relief precluding the ANDA applicant
from commercial manufacture. 35 U.S.C. sec. 271(e)(2)(A), (4)(A) (2012); see
also 28 U.S.C. sec. 1338(a) (2012) (providing that the Federal District Courts have
original jurisdiction over “any civil action arising under any Act of Congress
relating to patents”). “Notwithstanding th[e] defined act of infringement, a district
court’s inquiry in a suit brought under [35 U.S.C.] § 271(e)(2) is the same as it is
in any other infringement suit, viz., whether the patent in question is ‘invalid or
will not be infringed by the manufacture, use, or sale of the drug for which the
* * * [ANDA] is submitted.’” Glaxo, Inc. v. Novopharm, Ltd., 110 F.3d 1562,
1569 (Fed. Cir. 1997) (quoting 21 U.S.C. sec. 355(j)(2)(A)(vii)(IV)). “The only
difference in actions brought under [35 U.S.C.] § 271(e)(2) is that the allegedly
infringing drug has not yet been marketed and therefore the question of
infringement must focus on what the ANDA applicant will likely market if its
application is approved, an act that has not yet occurred.” Id.
b. Effective FDA Approval
The date on which a 35 U.S.C. sec. 271(e)(2) (Section 271(e)(2)) suit is
initiated has consequences for the approval of the generic drug becoming
effective. If a suit is brought within 45 days of notice of an ANDA with a
paragraph IV certification, it triggers a 30-month stay during which the FDA is
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prohibited from granting “effective” approval to the ANDA while the parties
litigate patent validity or infringement. See 21 U.S.C. sec. 355(j)(5)(B)(iii);
Actavis, 570 U.S. at 143.2
If the FDA approves the ANDA during the 30-month stay period, it will
issue a “tentative approval letter”. 21 C.F.R. sec. 314.107(b)(3)(v). “In order for
an approval to be made effective * * *, the applicant must receive an approval
letter from the agency indicating that the application has received final approval.”
Id. “Tentative approval of an application does not constitute ‘approval’ of an
application and cannot, absent a final approval letter from the agency, result in an
effective approval under paragraph (b)(3) of this section.” Id.“If the courts decide the matter * * * [during the 30-month stay] period, the
FDA follows that determination; if they do not, the FDA may go forward and give
[effective] approval to market the generic product.” Actavis, 570 U.S. at 143; see
also 21 U.S.C. sec. 355(j)(5)(B)(iii) (explaining that approval “shall be made
effective upon the expiration of the thirty-month period” absent court action).3
2
Although a patent suit may be brought outside the 45-day window, the
filing of such a suit does not prohibit the FDA from making its approval effective.
3
Thus, if the court concludes that the patent was invalid or not infringed,
FDA approval becomes effective on the same date as entry of the judgment. See
21 U.S.C. sec. 355(j)(5)(B)(iii)(I) (2012); see also 21 C.F.R. sec. 314.107(b)(3)(ii)
(continued...)
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“The generic manufacturer then has the option to launch ‘at risk,’ meaning that, if
the ongoing court proceeding ultimately determines that the patent was valid and
infringed, the generic manufacturer will be liable for the brand-name
manufacturer’s lost profits despite the FDA’s approval.” In re Lipitor, 868 F.3d
at 241.
c. 180-Day Exclusivity Period
Once approval of an ANDA becomes effective, the generic drug
manufacturer may begin commercially marketing the drug. See 21 U.S.C.
sec. 355(a); see also Eli Lilly, 496 U.S. at 677. “In order to encourage
paragraph IV challenges, thereby increasing the availability of low-cost generic
drugs, * * * [21 U.S.C. sec. 355(j)(5)(B)(iv)] provides that the first company to
win FDA approval of an ANDA containing a paragraph IV certification has the
right to sell its drug without competition for 180 days.” Purepac, 354 F.3d at 879;
see also Teva Pharms., USA, Inc. v. Leavitt, 548 F.3d 103, 104-105 (D.C. Cir.
2008). “Marketing exclusivity is valuable, designed to compensate manufacturers
for research and development costs as well as the risk of litigation from patent
3
(...continued)
(2014). If the court concludes that there has been infringement, effective FDA
approval waits for patent expiration. See 21 U.S.C. sec. 355(j)(5)(B)(iii)(II); see
also 21 C.F.R. sec. 314.107(b)(3)(iii).
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holders.” Teva Pharms., USA, Inc., 548 F.3d at 104; see also Actavis, 570 U.S. at
144 (“Indeed, the Generic Pharmaceutical Association said * * * that the ‘vast
majority of potential profits for a generic drug manufacturer materialize during the
180-day exclusivity period.’”); In re Lipitor, 868 F.3d at 241.
FINDINGS OF FACT
Mylan is a group of affiliated corporations that join in the filing of
consolidated Federal income tax returns. Mylan, Inc., a Pennsylvania corporation
and the common parent of that group, maintained its principal place of business in
Canonsburg, Pennsylvania, when it timely filed the petitions in these consolidated
cases.
I. Mylan’s Legal Expenses
Mylan manufactures both brand name and generic pharmaceuticals. During
the years relevant to these cases, Mylan regularly submitted ANDAs to obtain
FDA approval for generic versions of brand name drugs, including Celebrex,
Lunesta, and Nexium. As necessary to win FDA approval, Mylan set forth
detailed information to establish that the generic drug was bioequivalent to the
brand name drug, that the generic drug shared the same active components, and
that the manufacturing process would preserve the generic drug’s identity,
strength, and purity.
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Each ANDA also included a certification as to any patent listed in the
Orange Book as covering the brand name drug. During the years relevant to these
cases, Mylan regularly included paragraph IV certifications, asserting that one or
more patents covering the respective brand name drug were invalid or would not
be infringed by Mylan’s generic version. Although Mylan understood that
paragraph IV certifications often resulted in litigation, it further recognized that
such certifications offered both the earliest opportunity to bring its generic
versions to market and the possibility (in some cases) of first-to-file exclusivity.
After filing ANDAs with paragraph IV certifications, Mylan prepared and
sent formal notice letters to the brand name drug manufacturers and patentees
implicated by the certifications. The letters set forth in detail Mylan’s
explanations as to the invalidity of the patents at issue or the reasons that the
manufacture, use, or sale of its generic version did not infringe such patents.
Mylan also informed the FDA when it sent these notice letters.
During 2012 through 2014, Mylan regularly defended itself against
Section 271(e)(2) suits brought in response to ANDAs with paragraph IV
certifications. The FDA was not a party to these suits. Mylan did notify the FDA
if a lawsuit was brought within 45 days of the issuance of the notice letter, in
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consideration of the automatic 30-month stay mandated by 21 U.S.C.
sec. 355(j)(5)(B)(iii).
The FDA’s scientific and regulatory review of Mylan’s ANDAs with
paragraph IV certifications proceeded without regard to any Section 271(e)(2)
litigation. In some instances during the years at issue the 30-month stay expired
during the pendency of the litigation, and Mylan obtained FDA approval for the
generic drug at issue before the suit’s conclusion. When that occurred, Mylan
would continue defending the Section 271(e)(2) suit. On two occasions during the
relevant years, Mylan elected to launch an approved generic drug “at risk”, i.e.,
after the expiration of the 30-month stay but before the resolution of the litigation.
When Mylan won or lost a Section 271(e)(2) suit during the years at issue, it
notified the FDA and provided a copy of the final judgment or mandate. If Mylan
won, it was entitled to launch the generic drug at issue immediately upon approval
by the FDA without waiting for the expiration of the patents covering the brand
name drug. If Mylan lost, the FDA would deem Mylan to have converted its
paragraph IV certification (that the patents listed in the Orange Book were invalid
or were not infringed) into a paragraph III certification (that approval was sought
for a period beginning after the expiration of such patents). If Mylan lost the suit
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after the ANDA had been approved, the FDA would convert the approval to a
tentative approval effective after the expiration of the relevant patents.
Mylan also informed the FDA of other court action during the years at issue.
Mylan apprised the FDA when it entered into settlements to resolve
Section 271(e)(2) suits, communicating the terms of the settlement agreement
including any license permitting Mylan to begin selling its generic drug before the
expiration of the patents covering the brand name drug. And Mylan informed the
FDA when the court issued or vacated preliminary injunctions prohibiting the
marketing or sale of its generic drugs before patent expiration.
Mylan incurred legal fees of $46,158,403, $38,211,911, and $38,618,993
during 2012, 2013, and 2014, respectively, to prepare notice letters and to litigate
the Section 271(e)(2) suits. During the years at issue Mylan reported legal
expenses with respect to approximately 120 suits involving ANDAs with
paragraph IV certifications and 15 additional ANDAs with paragraph IV
certifications for which suits had not yet been filed.
II. IRS Examination and Tax Court Proceedings
Mylan timely filed a consolidated Form 1120, U.S. Corporation Income Tax
Return, for each of its 2012, 2013, and 2014 taxable years. On those returns
Mylan deducted $46,991,172, $39,684,483, and $44,060,180, respectively, for
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legal fees and expenses it broadly attributed to the litigation of Section 271(e)(2)
suits during those years.
Mylan’s deductions for the years at issue broke down into the
following expense categories: (1) the legal fees described above that Mylan
incurred to prepare paragraph IV notice letters and defend Section 271(e)(2) suits
during 2012 through 2014; (2) legal fees of $832,769, $1,472,572, and
$3,669,397, respectively, which Mylan incurred with respect to generic drugs
(a) for which no Section 271(e)(2) suit was ever brought, (b) for which
Section 271(e)(2) suits were brought but disposed of before the respective year for
which the fees were claimed, and (c) for which Section 271(e)(2) suits were
brought (or joined by Mylan) following the respective year for which the fees were
claimed; and (3) legal fees of $1,771,790 which Mylan incurred in 2014 with
respect to drugs that had already been approved by the FDA and commercially
launched.
The IRS examined Mylan’s 2012 through 2014 returns and determined that,
with the exception of the third category of expense (i.e., the amounts incurred for
previously approved and launched copies), all of the foregoing legal expenses
were nondeductible capital expenditures required to be capitalized under
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section 263(a) and subject to amortization under section 197. It consequently
disallowed Mylan’s claimed deductions, save for the $1,771,790 claimed for 2014.
The IRS thereafter issued notices of deficiency for each of Mylan’s 2012,
2013, and 2014 taxable years determining deficiencies of $16,430,947,
$12,618,695, and $20,988,657, respectively. Mylan filed timely petitions with this
Court for redetermination of the IRS’ determinations for its 2012 through 2014
taxable years. We consolidated the cases, and a trial was held in Washington,
D.C. At trial Mylan put on fact witnesses, and both parties presented expert
testimony regarding internal FDA processes writ large and, more specifically, the
typical course of dealing between an ANDA applicant and the FDA during the
submission process for an ANDA with a paragraph IV certification.4
OPINION
The Commissioner’s determinations in a notice of deficiency are presumed
correct, and the taxpayer bears the burden of proving them erroneous.
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). “In exploring the
relationship between deductions and capital expenditures,” we are mindful of the
4
A total of six expert witnesses testified at trial, with each party offering
three experts. The Court admitted all the expert witness reports offered, including
the rebuttal reports. Although the expert witnesses testified extensively at trial,
their testimony is not necessary for the purposes of deciding these cases.
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“familiar rule * * * that the burden of clearly showing the right to the claimed
deduction is on the taxpayer.” INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84
(1992) (quoting Interstate Transit Lines v. Commissioner, 319 U.S. 590, 593
(1943)).
I. Deductibility Versus Capitalization
A. General Principles
Section 162(a) allows a deduction for “all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or
business”.5 By contrast, section 263(a) provides that “[n]o deduction shall be
allowed” for a capital expenditure. Deductions are exceptions to the “norm” of
capitalization. See INDOPCO, Inc. v. Commissioner, 503 U.S. at 84. Where
section 162 and section 263 each apply to a given expenditure, the capitalization
requirement controls and functions to bar the deduction. See sec. 161; see also
Commissioner v. Idaho Power Co., 418 U.S. 1, 17-18 (1974).
The “primary effect” of a payment’s classification as a deductible business
expense or nondeductible capital expenditure is seen in the timing of the
5
An expense is “ordinary” if it is customary or usual within a particular
trade, business, or industry or relates to a common or frequent transaction in the
type of business involved. See Deputy v. du Pont, 308 U.S. 488, 495 (1940). An
expense is “necessary” if it is appropriate and helpful to the operation of the
taxpayer’s business. See Commissioner v. Tellier, 383 U.S. 687, 689 (1966).
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taxpayer’s cost recovery. INDOPCO, Inc. v. Commissioner, 503 U.S. at 83.
Whereas a deduction for an ordinary and necessary business expenditure may be
taken in the current year and yields an immediate corresponding reduction in
taxable income, a capital expenditure typically results in recovery of a taxpayer’s
expenditure over a longer period through amortization and depreciation
deductions. See Ill. Tool Works, Inc. v. Commissioner, 355 F.3d 997, 1000 (7th
Cir. 2004), aff’g 117 T.C. 39 (2001); PNC Bancorp, Inc. v. Commissioner, 212
F.3d 822, 827 (3d Cir. 2000) (citing INDOPCO, Inc. v. Commissioner, 503 U.S.
at 83-84), rev’g 110 T.C. 349 (1998). Section 263(a) thus “prevent[s] a taxpayer
from utilizing currently a deduction properly attributable, through amortization, to
later tax years when the capital asset becomes income producing.” Commissioner
v. Idaho Power Co., 418 U.S. at 16.
Whether a given expenditure is deductible under section 162 or must instead
be capitalized under section 263(a) turns on the particular facts of each case. See
INDOPCO, Inc. v. Commissioner, 503 U.S. at 86; see also Santa Fe Pac. Gold Co.
& Subs. v. Commissioner, 132 T.C. 240, 262 (2009); FMR Corp. & Subs. v.
Commissioner, 110 T.C. 402, 415 (1998); Norwest Corp. & Subs. v.
Commissioner, 108 T.C. 265, 280 (1997). An expenditure, no matter its type, may
be deductible in one setting but nevertheless required to be capitalized in another.
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See Lychuk v. Commissioner, 116 T.C. 374, 388 (2001); see also Am. Stores Co.
& Subs. v. Commissioner, 114 T.C. 458, 469 (2000) (“Simply because other cases
have allowed a current deduction for similar expenses in different contexts does
not require the same result * * * [in another case].”).
B. Capitalization of Intangibles
An expenditure generally must be capitalized where it is determined that the
expenditure either: (1) creates or enhances a separate and distinct asset, or
(2) otherwise generates significant benefits for the taxpayer extending beyond the
current taxable year. Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 262;
see also INDOPCO, Inc. v. Commissioner, 503 U.S. at 87; Lincoln Sav. & Loan
Ass’n v. Commissioner, 403 U.S. 345, 354 (1971). In response to difficulties in
administering the significant future benefits standard in the context of intangible
assets, the IRS and the Department of the Treasury proposed regulations that
“defined the exclusive scope of the significant future benefit test through the
specific categories of intangible assets for which capitalization is required”. 67
Fed. Reg. 77702 (Dec. 19, 2002). As adopted, section 1.263(a)-4(b)(1), Income
Tax Regs., requires the capitalization of amounts paid, inter alia: (1) to acquire an
existing intangible; (2) to create certain types of intangibles identified in section
1.263(a)-4(d), Income Tax Regs.; (3) to create or enhance various “separate and
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distinct” intangibles; and (4) to create or enhance a “future benefit” identified in
subsequent guidance published by the IRS.
1. Relevant Intangibles
For its part, section 1.263(a)-4(d)(5), (7), and (9), Income Tax Regs.,
enumerates certain “created intangibles”, including “rights obtained from a
governmental agency”, contract termination fees, and amounts paid to another to
defend or perfect title to intangible property.6 With respect to rights obtained from
a governmental agency, section 1.263(a)-4(d)(5)(I), Income Tax Regs., specifies:
“A taxpayer must capitalize amounts paid to a governmental agency to obtain,
renew, renegotiate, or upgrade its rights under a trademark, trade name, copyright,
license, permit, franchise, or other similar right granted by that governmental
agency.” Whether an amount is paid to create an intangible under paragraph (d) is
determined on the basis of “all of the facts and circumstances, disregarding
6
A special 12-month rule applies to the created intangibles identified in
sec. 1.263(a)-4(d), Income Tax Regs. Pursuant to that rule, “a taxpayer is not
required to capitalize under this section amounts paid to create (or to facilitate the
creation of) any right or benefit for the taxpayer that does not extend beyond the
earlier of--(I) 12 months after the first date on which the taxpayer realizes the right
or benefit; or (ii) The end of the taxable year following the taxable year in which
the payment is made.” Id. para. (f)(1). The rule is subject to various exceptions,
including for “amounts paid to create (or facilitate the creation of) an intangible
that constitutes an amortizable section 197 intangible within the meaning of
section 197(c).” Id. subpara. (3).
- 23 -
distinctions between the labels used in this paragraph (d) to describe the intangible
and the labels used by the taxpayer and other parties to the transaction.” Id.subpara. (1).
As also germane to these cases, section 1.263(a)-4(d)(9)(I), Income Tax
Regs., provides that a “taxpayer must capitalize amounts paid to another party to
defend or perfect title to intangible property if that other party challenges the
taxpayer’s title to the intangible property.” As described in the preamble to the
proposed regulations, “[t]his is consistent with existing regulations” and “is not
intended to require capitalization of amounts paid to protect the property against
infringement and to recover profits and damages as a result of infringement.” 67
Fed. Reg. 77705 (Dec. 19, 2002). “As under current law, these costs are generally
deductible.” Id. (citing Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954),
rev’g 20 T.C. 944 (1953)); see also T.D. 9107, 2004-1 C.B. 447, 450 (“The final
regulations retain the rule contained in the proposed regulations.”).
2. Facilitative Costs
The direct costs of creating intangibles are not the only costs that must be
capitalized under section 1.263(a)-4, Income Tax Regs. Taxpayers are further
required to capitalize any amounts “paid to facilitate * * * an acquisition or
creation” of, among other things, an intangible described in paragraph (d). Id.- 24 -
para. (b)(1)(v). This provision “recognizes that capitalization is required not only
for the cost of an asset itself, but for the ancillary expenditures incurred in
acquiring, creating, or enhancing the intangible asset.” 67 Fed. Reg. 77705 (citing
Woodward v. Commissioner, 397 U.S. 572 (1970)).
“[A]n amount is paid to facilitate the acquisition or creation of an intangible
(the transaction) if the amount is paid in the process of investigating or otherwise
pursuing the transaction.” Sec. 1.263(a)-4(e)(1)(I), Income Tax Regs. Whether an
amount is “paid in the process of investigating or otherwise pursuing” a given
transaction “is determined * * * [on the basis of] all of the facts and
circumstances.” Id. “[T]he fact that the amount would (or would not) have been
paid but for the transaction is relevant, but is not determinative.” Id. For purposes
of this inquiry, “the term transaction means all of the factual elements comprising
an acquisition or creation of an intangible and includes a series of steps carried out
as part of a single plan.” Id. subpara. (3).
C. Litigation Expenses
The deductibility of a legal expense generally depends upon the origin and
character of the claim with respect to which the expense was incurred. See United
States v. Hilton Hotels Corp., 397 U.S. 580, 583 (1970); Woodward v.
Commissioner, 397 U.S. at 577-578; United States v. Gilmore, 372 U.S. 39, 48-49
- 25 -
(1963); see also Wellpoint, Inc. v. Commissioner, 599 F.3d 641, 647 (7th Cir.
2010), aff’g T.C. Memo. 2008-236; Newark Morning Ledger Co. v. United States,
539 F.2d 929, 935 (3d Cir. 1976). Under this “origin of the claim” test, “the
substance of the underlying claim or transaction out of which the expenditure in
controversy arose governs whether the item is a deductible expense or a capital
expenditure, regardless of the motives of the payor or the consequences that may
result from the failure to defeat the claim.” Santa Fe Pac. Gold Co. v.
Commissioner, 132 T.C. at 264-265; see also Woodward v. Commissioner, 397
U.S. at 578. “Thus, legal expenses directly connected with (or pertaining to) the
taxpayer’s trade or business are deductible under Section 162 as ordinary and
necessary business expenses”, while “expenses arising out of the acquisition,
improvement or ownership of property are capital expenditures under
Section 263(a) and are not currently deductible.” Meade Emory et al., “Legal
Expenses of Patent Defense Held Deductible”, 70 J. Tax’n 180 (1989); see also
Am. Stores Co. v. Commissioner, 114 T.C. at 468 (citing Commissioner v.
Heininger, 320 U.S. 467 (1943), Commissioner v. Tellier, 383 U.S. 687, 689-690
(1966), and INDOPCO, Inc., v. Commissioner, 503 U.S. at 83).
- 26 -
Patent law has long distinguished suits for the defense of title to intellectual
property from patent infringement litigation.7 The former involves the disposition
or acquisition of a capital asset, and expenses in litigating such a suit have been
treated as capital--even before the Supreme Court embraced the origin of the claim
test. See, e.g., Estate of Baier v. Commissioner, 533 F.2d 117, 120 (3d Cir. 1976)
(holding that litigation expenses incurred incident to a dispute over the terms of a
disposition are capital), aff’g 63 T.C. 513 (1975); Urquhart v. Commissioner, 215
F.2d at 19-20; Safety Tube Corp. v. Commissioner, 168 F.2d 787 (6th Cir. 1948)
(requiring legal fees to be capitalized where controversy involved title and
ownership of a patent), aff’g 8 T.C. 757 (1947).
Patent infringement litigation is a different creature altogether, sounding in
tort. See Schillinger v. United States, 155 U.S. 163, 169 (1894);
Giesecke+Devrient GmbH v. United States, 150 Fed. Cl. 330, 344 (2020). Such
“litigation is a far cry from removing a cloud of title, or defending ownership of
property.” Urquhart v. Commissioner, 215 F.2d at 20. Usually “what a patent
7
While recognizing the nonprecedential nature of most forms of IRS
administrative guidance, see sec. 6110(k)(3), we note that the IRS has recognized
this distinction as well, see, e.g., 67 Fed. Reg. 77705 (Dec. 19, 2002) (citing
Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954), rev’g 20 T.C. 944 (1953));
Priv. Ltr. Rul. 201536006 (Sept. 4, 2015); Field Serv. Advisory 199925012 (June
25, 1999) (“[A]n acceptance by the Service of Urquhart has developed.”); Tech.
Adv. Mem. 8831001 (Apr. 8, 1988).
- 27 -
owner loses from infringement is the acquisition of ‘a just and deserved gain’ from
the exploitation of the invention embodied in his patent.” Mathey v.
Commissioner, 177 F.2d 259, 263 (1st Cir. 1949) (quoting 3 Walker on Patents
(Deller’s Ed.) § 281), aff’g 10 T.C. 1099 (1948). Therefore, “an award of damages
in patent [infringement] litigation is ordinarily an award of compensation for gains
or profits lost by the patent owner and hence is taxable to him as income in the
year received.” Id.As the U.S. Court of Appeals for the Third Circuit, to which an appeal in
these cases would lie absent a stipulation to the contrary, see sec. 7482(b)(1)(B),
has observed, litigation expenses for taxpayers “engaged in the business of
exploiting and licensing patents * * * are peculiarly normal” to their business,
Urquhart v. Commissioner, 215 F.2d at 19. “[F]or taxpayers engaged in the trade
or business of creating and licensing intangible assets, the costs incurred in
prosecuting an action for * * * infringement will most likely be deductible as a
business expense.” Phillip F. Postlewaite et al., Federal Income Taxation of
Intellectual Properties & Intangible Assets, para. 1.03 (2021), 1998 WL 1038665.
Moreover, costs incurred by a business to defend against tort claims
generally have been held deductible for the current taxable year. See, e.g.,
Kornhauser v. United States, 276 U.S. 145, 153 (1928). Both we and our
- 28 -
predecessor have permitted the deduction of costs incurred in defending patent
infringement suits. See F. Meyer & Bro. Co. v. Commissioner, 4 B.T.A. 481, 482
(1926) (holding that amount paid by defendant in patent infringement suit for an
accounting was an ordinary and necessary expense); Addressograph-Multigraph
Corp. v. Commissioner, a Memorandum Opinion of this Court dated Feb. 5, 1945,
4 T.C.M. (CCH) 147, 166 (1945) (upholding treatment of amounts incurred in
defending patent infringement suits as ordinary and necessary business expenses).
The deductibility of these expenses is consistent with the treatment of damages
paid in the wake of such litigation. Schnadig Corp. v. Gaines Mfg. Co., 620 F.2d
1166, 1169 (6th Cir. 1980) (“When an infringer is required to pay damages to a
design patentee, the amount so paid is deductible from his income tax.”).
II. Analysis
In these cases, the parties dispute whether the legal fees at issue were
incurred to facilitate the acquisition of a right obtained from a Government
agency. We will begin by identifying the underlying transaction, i.e., the
acquisition of the right, before determining whether the respective fees were paid
in the process of investigating or otherwise pursuing that transaction.
- 29 -
A. The Transaction
The parties before us both describe the relevant transaction as the
acquisition of an FDA-approved ANDA with a paragraph IV certification.
However, the parties ascribe very different meanings to this general formulation.
Mylan asserts that the acquisition of an FDA-approved ANDA with a
paragraph IV certification occurs when the FDA completes its scientific and
technical review and issues either a tentative or final approval letter. The
Commissioner asserts that the acquisition of an FDA-approved ANDA with a
paragraph IV certification refers to obtaining effective approval of an ANDA with
a paragraph IV certification.
The Commissioner’s interpretation is the more persuasive.
Section 1.263(a)-4(b)(i)(v), Income Tax Regs., requires capitalization of amounts
paid to facilitate the acquisition or creation of an intangible. As relevant here,
created intangibles include “certain rights obtained from a governmental agency”,
such as “rights under a trademark, trade name, copyright, license, permit,
franchise, or other similar right granted by that governmental agency.” Id.para. (d)(5)(i).8
8
Neither party contends that FDA-approved ANDAs are subject to the
12-month rule of sec. 1.263(a)-4(f), Income Tax Regs. We therefore do not
(continued...)
- 30 -
Although the “FDA will approve an * * * [ANDA] and send the applicant
an approval letter” as long as it satisfies the scientific and technical requirements
set forth in 21 C.F.R. sec. 314.127, see 21 C.F.R. sec. 314.105(d); see also 21
U.S.C. sec. 355(j)(4), this approval does not confer any rights on an applicant until
it becomes “effective”, see 21 U.S.C. sec. 355(j)(5)(B); 21 C.F.R. sec. 314.107(a).
Only at that point does the right attach, which then allows for a generic drug to be
“introduced or delivered for introduction into interstate commerce”. 21 C.F.R.
sec. 314.107(a); see also 21 U.S.C. sec. 355(a) (“No person shall introduce or
deliver for introduction into interstate commerce any new drug, unless an approval
of an application filed pursuant to subsection (b) or (j) of this section is effective
with respect to such drug.”).
Mylan has not shown, and we have not found, any authority demonstrating
that approval before it becomes effective confers rights equivalent to “rights under
a trademark, trade name, copyright, license, permit, franchise, or other similar
right granted by that governmental agency.” Sec. 1.263(a)-4(d)(5)(i), Income Tax
Regs. We accordingly adopt the Commissioner’s interpretation of the transaction.
8
(...continued)
address the application vel non of that rule to these cases.
- 31 -
B. Relevant Legal Fees
1. Paragraph IV Notice Letters
We next consider the proper characterization of the legal fees Mylan
incurred during 2012 through 2014 to prepare notice letters relating to its filing of
ANDAs with paragraph IV certifications. An applicant for an ANDA with a
paragraph IV certification “shall give notice” to “each owner of the patent that is
the subject of the certification” and the holder of the NDA with respect to the
brand name drug covered by such patents. 21 U.S.C. sec. 355(j)(2)(B)(iii). The
notice is required to inform the recipients of the ANDA submission and to explain
in detail “the factual and legal basis of the opinion of the applicant that the patent
is invalid or will not be infringed.” Id. cl. (iv). After providing that notice, the
applicant is required to submit an amendment to its ANDA reflecting that the
notice had been given. See 21 C.F.R. sec. 314.95(b).
This notice requirement is also a part of the ANDA itself. Under 21 U.S.C.
sec. 355(j)(2)(B)(i), the applicant that makes a paragraph IV certification “shall
include” in its ANDA a statement that the applicant “will give notice” as outlined
in 21 U.S.C. sec. 355(j)(2)(B). And failure to provide such notice has tangible
consequences as “certifications become effective only upon notification.”
Purepac, 354 F.3d at 890.
- 32 -
The notice described above thus is a required step in securing an
FDA-approved ANDA for those applicants that make a paragraph IV certification.
Sec. 1.263(a)-4(e)(3), Income Tax Regs. Although Mylan argues that the notice
serves to facilitate patent litigation, Congress has made the notice a prerequisite
for ANDA approval. Consequently, the legal expenses Mylan incurred to prepare,
assemble, and transmit such notice letters constitute amounts incurred
“investigating or otherwise pursuing” the transaction of creating FDA-approved
ANDAs, id. subpara. (1)(i), and must be capitalized, see also id. para. (l), Example
(1) (concluding that payments to outside counsel to prepare license application
facilitated the creation of an intangible).
2. Section 271(e)(2) Litigation Expenses
We reach a different conclusion with respect to Mylan’s Section 271(e)(2)
litigation expenses incurred during the years at issue. In the Hatch-Waxman Act,
Congress sought to encourage the entry of low-cost generic drugs into the
marketplace while softening the risk to cost-intensive innovation by giving brand
name drug manufacturers the opportunity to avail themselves of patent law
protections before sustaining damages. Among other changes made to accomplish
these objectives, the Hatch-Waxman Act moved up the timeline of patent litigation
with respect to generic copies of brand name drugs subject to a patent listed in the
- 33 -
Orange Book. Although the filing of an ANDA with a paragraph IV certification
triggers the opportunity for patent litigation as well as the FDA review process,
this statutory design does not transform patent litigation into a step in the ANDA
approval process. The patent litigation expenses at issue accordingly are not
subject to capitalization.
a. Hatch-Waxman Regime
We start by considering the ANDA approval process. The FDA reviews an
ANDA to ensure that certain safety standards are met and that the generic copy has
the same active ingredients as, and is “bioequivalent” to, the approved brand name
drug. See 21 U.S.C. sec. 355(j)(2)(A), (4); see also Actavis, 570 U.S. at 142;
Caraco, 566 U.S. at 404-405. According to 21 U.S.C. sec. 355(j)(4), the FDA
“shall approve” an ANDA unless it fails to satisfy certain technical requirements
enumerated in the statute and accompanying regulations, including failure to show
that the generic has the same active ingredients as the brand name drug, failure to
show bioequivalence between the drugs, failure to establish that the production
methods would preserve the generic’s identity, strength, quality, and purity, and
failure to show proper labeling. See also 21 C.F.R. secs. 314.105(d), 314.127.
The outcome of a Section 271(e)(2) suit has no bearing on the FDA’s safety
and bioequivalence review. The FDA continues its review process during the
- 34 -
pendency of the patent infringement suit and may issue a tentative or final
approval before the suit is resolved. The FDA does not analyze patent issues as
part of its review, and neither the statute nor regulations suggest that patent issues
might block approval of an ANDA. And winning a patent litigation suit does not
ensure that the generic drug manufacturer will receive approval, as the FDA can
disapprove an ANDA for not meeting safety and bioequivalence standards.
21 U.S.C. sec. 355(j)(4)(F).
A review of the patent litigation framework implemented by the
Hatch-Waxman Act likewise fails to suggest that such litigation is an element of
the approval process for ANDAs with paragraph IV certifications. “[T]o guard
against infringement of patents relating to * * * [brand name] drugs”, Eli Lilly,
496 U.S. at 676-677, Congress devised a system where a certification that a patent
covering the brand name drug is invalid or not infringed “automatically counts as
patent infringement”, Actavis, 570 U.S. at 143. The new cause of action
embodied in Section 271(e)(2) was a direct response to Congress’ decision to end
the prohibition on use of brand name pharmaceuticals for research and
development before the expiration of patents covering such pharmaceuticals. See
- 35 -
35 U.S.C. sec. 271(e)(1).9 The technical act of infringement provided an earlier
trigger for a patent suit “so that courts could promptly resolve infringement and
validity disputes before the ANDA applicant had engaged in the traditional
statutorily defined acts of infringement.” AstraZeneca Pharms. LP v. Apotex
Corp., 669 F.3d 1370, 1377 (Fed. Cir. 2012); see also Bristol-Myers Squibb Co. v.
Royce Labs., Inc., 69 F.3d 1130, 1135 (Fed. Cir. 1995) (holding that a
Section 271(e)(2) suit makes “it possible for a patent owner to have the court
determine whether, if a particular drug were put on the market, it would infringe
the relevant patent”).
Although the Hatch-Waxman Act moved up the timing of patent litigation,
its character remained unchanged. “Notwithstanding th[e] defined act of
infringement, a district court’s inquiry in a suit brought under § 271(e)(2) is the
same as it is in any other infringement suit, viz., whether the patent in question is
‘invalid or will not be infringed by the manufacture, use, or sale of the drug for
which the * * * [ANDA] is submitted.’” Glaxo, 110 F.3d at 1569 (quoting 21
9
“For those who consider legislative history relevant,” Warger v. Shauers,
574 U.S. 40, 48 (2014), in its report on the bill proposing what became the Hatch-
Waxman Act, the House Energy & Commerce Committee stated that “[t]he
purpose of sections 271(e)(1) and (2) is to establish that experimentation with a
patented drug product, when the purpose is to prepare for commercial activity
which will begin after a valid patent expires, is not a patent infringement”, H.R.
Rept. No. 98-857 (Part 1), at 45 (1984), 1984 U.S.C.C.A.N. 2647, 2678.
- 36 -
U.S.C. sec. 355(j)(2)(A)(vii)(IV)); see also Alcon Research Ltd. v. Barr Labs.,
Inc., 745 F.3d 1180, 1186 (Fed. Cir. 2014); Abbott Labs. v. TorPharm, Inc., 300
F.3d 1367, 1373 (Fed. Cir. 2002).10 “The only difference in actions brought under
§ 271(e)(2) is that the allegedly infringing drug has not yet been marketed and
therefore the question of infringement must focus on what the ANDA applicant
will likely market if its application is approved, an act that has not yet occurred.”
Glaxo, 110 F.3d at 1569.
The Commissioner counters that a Section 271(e)(2) suit is a step in
obtaining effective approval of an ANDA with a paragraph IV certification. He
asserts that the Hatch-Waxman regime incentivized the filing of ANDAs with
paragraph IV certifications by the prospect of market entry before patent
expiration and lucrative first-to-file exclusivity and that Section 271(e)(2) suits
ineluctably followed. We are not persuaded. Although Congress erected a
framework that promotes the prompt resolution of patent issues, aaiPharma, 296
F.3d at 232, the Commissioner fails to demonstrate how encouraging early and
10
Again, for those who wish to consider legislative history, the House
Energy & Commerce Committee noted in its report that “[t]he provisions of this
bill relating to the litigation of disputes involving patent validity and infringement
are not intended to modify existing patent law with respect to the burden of proof
and the nature of the proof to be considered by the courts in determining whether a
patent is valid or infringed.” H.R. Rept. No. 98-857 (Part 1), supra at 28, 1984
U.S.C.C.A.N. at 2661.
- 37 -
expeditious patent litigation shows that such litigation is an element of acquiring
effective FDA approval of an ANDA with a paragraph IV certification.
The Commissioner also points to statutory provisions linking the effective
date of approval to the outcome of Section 271(e)(2) suits as supporting his view.
As an initial matter, we note that a Section 271(e)(2) suit is not required to obtain
effective approval of an ANDA with a paragraph IV certification, see 21 U.S.C.
sec. 355(j)(5)(B)(iii), and that a brand name drug manufacturer is under no
obligation to initiate such a suit in response to an ANDA with a paragraph IV
certification. Both of these points belie the idea that a Section 271(e)(2) suit is a
step in obtaining an effective FDA approval.
Title 21 sec. 355(j)(5)(B)(iii), on which the Commissioner relies, does not
suggest a different result. Where “the courts decide the matter within * * * [the
30-month stay] period, the FDA follows that determination; if they do not, the
FDA may go forward and give approval to market the generic product.” Actavis,
570 U.S. at 143. Title 21 sec. 355(j)(5)(B)(iii) thus ties the effective date to the
outcome of a Section 271(e)(2) suit.
Congress’ decision to coordinate effective FDA approval with the outcome
of a Section 271(e)(2) suit does not convert such litigation into a link in the
ANDA approval chain. To the contrary, a Section 271(e)(2) suit serves the same
- 38 -
function as a normal patent infringement suit under 35 U.S.C. sec. 271(a), namely,
allowing patent holders the opportunity to vindicate their intellectual property
rights. Moreover, the primary relief available in a Section 271(e)(2) suit, i.e.,
prohibiting introduction of the infringing product into the market until expiration
of the applicable patent, is the same relief available in a normal patent
infringement suit (through an injunction), only tailored for the unique context
where the infringing product has not yet been introduced into the market. See
35 U.S.C. sec. 271(e)(4)(A).11 The statutory coordination between the outcome of
Section 271(e)(2) litigation and FDA effective approval ensures that the FDA does
not run afoul of a District Court’s resolution of the intellectual property rights of
the parties when deciding whether to grant approval. See Caraco, 566 U.S. at 405
(“[T]he FDA cannot authorize a generic drug that would infringe a patent[.]”).
Section 271(e)(2) litigation is a vehicle built for the patent holder. It is the
patent holder that has the choice to bring litigation within 45 days of notice, with
the consequences described in 21 U.S.C. sec. 355(j)(5)(B)(iii). The legal expenses
11
We note that this point was made by Representative Henry Waxman
before the enactment of the Hatch-Waxman Act, for those who find such
statements worth considering. See 130 Cong. Rec. 24427 (1984) (statement of
Rep. Henry Waxman). Mr. Waxman observed that, under then-current patent law,
“if someone markets a competitive product, * * * [brand name drug manufactures]
can go to court and sue for an injunction, or they can sue for treble damages for
infringement of that patent.” Id.- 39 -
incurred in defending such suits relate to determining the patent holders’
intellectual property rights with respect to brand name drugs. Absent the filing of
such a suit by a patent holder, the generic drug manufacturer is under no
obligation to demonstrate that a patent is invalid or not infringed to obtain FDA
approval. In other words, a patent on a brand name drug presents no impediment
to FDA approval of a generic version unless the patent holder decides to take
advantage of the mechanism Congress provided for an early adjudication of the
patent holder’s rights.12 We cannot conclude that such litigation--controlled by
and primarily benefiting patent holders--is a step in the FDA approval process for
the generic drug.
As a final matter, section 1.263(a)-4(e)(1)(i), Income Tax Regs., identifies
“the fact that the amount would (or would not) have been paid but for the
12
Our view on this point is consistent with that expressed by Representative
Waxman, again for those who consider such statements. In responding to an
objection to the 30-month stay, Mr. Waxman noted that “[t]he facts of life are that
a generic drug manufacturer will await, as a practical matter, until the decision of a
court on a patent challenge before that manufacturer markets a generic drug.” 130
Cong. Rec. 24427. He continued that “[t]he 30-month period is one that gave
further assurance to the brand-name drug manufacturer that the generic drug
manufacturer would not put his competitor on th[e] market until that court
decision came through.” Id. Mr. Waxman did not suggest either that the patent
litigation is connected with obtaining FDA approval, or that the 30-month stay
was more than reassurance to brand name drug manufacturers in the patent
context.
- 40 -
transaction” as a relevant, although not dispositive, factor in evaluating whether an
expense facilitates a transaction. On a surface level, this factor appears to weigh
in favor of the Commissioner’s position: absent the transaction to obtain FDA
approval, the generic drug manufacturer would not make a paragraph IV
certification, the patent holder would not initiate a Section 271(e)(2) suit, and the
generic drug manufacturer would not incur litigation expenses defending that suit.
Nonetheless “a district court’s inquiry in a suit brought under § 271(e)(2) is the
same as is in any other infringement suit”. Glaxo, 110 F.3d at 1569. Even absent
the transaction, the patent holder would doubtless seek to defend its intellectual
property against a potential infringer, and the generic manufacturer would incur
the same litigation costs in defending such suit. We are not persuaded that the
litigation expenses would not have been incurred but for the transaction.13
In summary, the Hatch-Waxman Act made coordinated changes to several
areas of law, including the FDA approval process and patent law, to serve its goals
of encouraging the entry of low-cost generic drugs into the marketplace while
affording patent protections to brand name drug manufacturers. See, e.g., In re
13
Again, for those who wish to consider Mr. Waxman’s views on this point,
he noted that under then-current patent law, “if someone markets a competitive
product, * * * [brand name drug manufacturers] can go to court and sue for an
injunction, or they can sue for treble damages for infringement of that patent.”
130 Cong. Rec. 24427.
- 41 -
Lipitor, 868 F.3d at 240; Am. Bioscience, 269 F.3d at 1079. Despite the
coordination devised by Congress, Section 271(e)(2) litigation is not a step in
obtaining effective FDA approval of an ANDA with a paragraph IV certification.
Accordingly, expenses Mylan incurred in defending Section 271(e)(2) suits were
not “paid to facilitate” the transaction and are not required to be capitalized.
b. Origin of the Claim
The origin of the claim test likewise indicates that Section 271(e)(2)
litigation expenses should be treated as deductible ordinary and necessary business
expenses. Under this test, we inquire “whether the origin of the claim litigated is
in the process of acquisition”, enhancement, or other disposition of a capital asset.
Woodward v. Commissioner, 397 U.S. at 577; see also Santa Fe Pac. Gold Co. v.
Commissioner, 132 T.C. at 264-265.
The legal expenses at issue arose out of actions initiated by patent holders to
protect their intellectual property from infringement and exploitation. See, e.g.,
Glaxo, 110 F.3d at 1569 (“[A] district court’s inquiry in a suit brought under
§ 271(e)(2) is the same as it is in any other infringement suit, viz., whether the
patent in question is ‘invalid or will not be infringed by the manufacture, use, or
sale of the drug for which the * * * [ANDA] is submitted.’” (quoting 21 U.S.C.
sec. 355(j)(2)(A)(vii)(IV))). Patent infringement suits are creatures of tort,
- 42 -
Schillinger, 155 U.S. at 169; Giesecke+Devrient GmbH, 150 Fed. Cl. at 344, with
an aim of preventing and recovering damages to the patent holder’s business of
exploiting its patent, see Urquhart v. Commissioner, 215 F.2d at 20.
The U.S. Court of Appeals for the Third Circuit has previously explained
the proper treatment of expenses incurred in litigating an infringement suit. See
id. at 18-19. In that case the taxpayers attempted to deduct various legal expenses
associated with patent infringement litigation, and the IRS disallowed the
deductions on the ground that they were capital expenditures for the protection or
perfection of property rights. Id. We sustained the IRS’ determination. Urquhart
v. Commissioner, 20 T.C. 944. The Third Circuit disagreed, pointing out that
patent infringement “litigation is a far cry from removing a cloud of title, or
defending ownership of property.” Urquhart v. Commissioner, 215 F.2d at 20. It
reasoned that the litigation instead “arose out of and related directly to the
exploitation of the invention embodied in the patent” and thus held that the
litigation expenses were incurred not to defend or protect title but rather, “to
prevent (and recover) damage to their business, that is, to protect, conserve and
maintain their business profits.” Id.14 The Department of the Treasury explicitly
14
Although Urquhart preceded Woodward v. Commissioner, 397 U.S. 572(1970), by nearly 20 years, we note that the Third Circuit’s analysis of the
(continued...)
- 43 -
endorsed the Third Circuit’s holding in Urquhart in the preamble to its proposed
regulations on the capitalization of intangible assets. See 67 Fed. Reg. 77705(noting that the proposed regulation was consistent with “existing regulations” and
“current law” and “is not intended to require capitalization of amounts paid to
protect the property against infringement”).
The litigation expenses at issue here likewise arose out of patent
infringement claims. See Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C.
at 264-265 (“[T]he substance of the underlying claim or transaction out of which
the expenditure in controversy arose governs whether the item is a deductible
expense or a capital expenditure[.]” (Emphasis added.)). Under the reasoning of
Urquhart, the litigation expenses of the patent holders that initiated infringement
suits against Mylan seem clearly deductible.
We see no reason that Mylan should face different treatment. Expenses
incurred in defending patent infringement claims have been found deductible in
the past. See F. Meyer & Bro. Co. v. Commissioner, 4 B.T.A. at 482;
Addressograph-Multigraph Corp. v. Commissioner, 4 T.C.M. (CCH) at 166.
Although Section 271(e)(2) litigation usually occurs before marketing and sale of
14
(...continued)
litigation expenses perceptively anticipated the origin of the claim test that the
Supreme Court adopted.
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the generic drug, the purpose of the suit remains to protect future business
profits.15 Cf. Urquhart, 215 F.2d at 20; Mathey v. Commissioner, 177 F.2d at 263.
We conclude that the litigation expenses that Mylan incurred in defending
Section 271(e)(2) suits arose out of the ordinary and necessary activities of its
generic drug business and accordingly are deductible. See Am. Stores Co. v.
Commissioner, 114 T.C. at 468.
In short, the Commissioner fails to convince us that the substance of the
underlying claim arises out of the acquisition, ownership, or improvement of
property as might support the capitalization of Mylan’s Section 271(e)(2)
litigation expenses. Indeed, we struggle to see the nature of the property right that
the Commissioner has in mind. Although a generic drug manufacturer must assert
in an ANDA with a paragraph IV certification that listed patents covering the
brand name drug are invalid or not infringed by the generic version, the
manufacturer is not required to undertake affirmative litigation to establish that
point as a condition of entering its generic on the market. It thus does not appear
15
Where a generic drug has been launched “at risk,” i.e., after the conclusion
of the 30-month stay but before the resolution of the litigation, the plaintiff in the
Section 271(e)(2) suit may seek damages as in a normal infringement suit. See 35
U.S.C. sec. 271(e)(4)(C). As explained, such infringement damages have been
treated as deductible business expenses of the infringing party. See Schnadig
Corp. v. Gaines Mfg. Co., 620 F.2d 1166, 1169 (6th Cir. 1980).
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that Section 271(e)(2) litigation relates to the acquisition or enhancement of any
right of a generic drug manufacturer, such that the expenses incurred in that
litigation must be capitalized. This litigation instead gives the brand name drug
manufacturer a chance to protect its intellectual property. In this circumstance, the
origin of the claim test suggests that Mylan’s litigation expenses are deductible.
c. Regulatory Examples
Certain examples set forth in sections 1.263(a)-4(e) and 1.263(a)-5(l),
Income Tax Regs., illustrating the scope of the term “facilitate” in
section 1.263(a)-4(e)(1)(i), Income Tax Regs., offer further support for our
conclusion. As an initial matter, the parties spar over whether we should consider
the regulations set forth in section 1.263(a)-5(l), Income Tax Regs., which address
the treatment of “[a]mounts paid or incurred to facilitate an acquisition of a trade
or business, a change in the capital structure of a business entity, and certain other
transactions”, given that the issue before us relates to section 1.263(a)-4(e),
Income Tax Regs., which bears on “[a]mounts paid to create or acquire
intangibles” as applies to our cases. Both provisions include a nearly identical
description of the term “facilitate”, and we will consider the regulatory examples
to the extent they illuminate the common term.
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We believe that the most apposite example is section 1.263(a)-5(l), Example
(18)(i), Income Tax Regs. This example discusses the treatment of legal fees paid
in connection with bankruptcy proceedings implicating tort liability of the
taxpayer. It provides:
X corporation is the defendant in numerous lawsuits alleging tort
liability based on X’s role in manufacturing certain defective
products. X files a petition for reorganization under Chapter 11 of the
Bankruptcy Code in an effort to manage all of the lawsuits in a single
proceeding. X pays its outside counsel to prepare the petition and
plan of reorganization, to analyze adequate protection under the plan,
to attend hearings before the Bankruptcy Court concerning the plan,
and to defend against motions by creditors and tort claimants to strike
the taxpayer’s plan. [Id.]
The example concludes, in relevant part, that the legal expenses paid by X “to
prepare, analyze or obtain approval of the portion of X’s plan of reorganization
that resolves X’s tort liability do not facilitate the reorganization and are not
required to be capitalized, provided that such amounts would have been treated as
ordinary and necessary business expenses under section 162 had the bankruptcy
proceeding not been instituted.” Id. Example (18)(ii). We see a strong parallel
here, where patent litigation is connected with but distinct from the broader project
of obtaining effective FDA approval of ANDAs with paragraph IV certifications.
The conclusion reached by the example, i.e., that the separate litigation expenses
should not be capitalized, thus attaches here.
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The Commissioner argues that section 1.263(a)-4(e)(5), Example (4),
Income Tax Regs., provides the more apt comparison. In that example U owns a
majority of the shares in T while M is a minority shareholder. See id. U and M
disagree over a perpetual extension of T’s charter, which, under State law, requires
U to buy out M. See id. A dispute over the proper value of M’s stock spawns
litigation and $25,000 in litigation expenses. See id. The example concludes that
the litigation expenses facilitate the acquisition of stock by helping to establish the
purchase price and thus must be capitalized. See id.Despite the complicated backdrop, the principle illustrated by this example
is straightforward: litigation expenses incurred to establish a necessary element of
the transaction (i.e., the purchase price) facilitate it and are subject to
capitalization. We believe the instant case is not comparable. The patent
litigation expenses were not incurred in connection with a necessary element of
obtaining effective FDA approval but to resolve the question of patent rights. As
such, the example finds no purchase here.
C. Conclusion
We hold that the disputed legal expenses that Mylan incurred during the
years at issue to prepare paragraph IV notice letters must be capitalized pursuant
to section 263(a), whereas expenses incurred to litigate Section 271(e)(2) suits are
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currently deductible pursuant to section 162(a). The IRS’ determinations as set
forth in the notices of deficiency are accordingly sustained for amounts incurred to
prepare paragraph IV notice letters.
III. Amortization of Mylan’s Legal Expenses
Lastly we turn briefly to the amortization (that is, the incremental recovery)
of Mylan’s expenses for the years at issue. Though Mylan has raised various
concerns regarding the equitable and policy implications of requiring generic drug
manufacturers to recover their legal expenses over a 15-year term, we understand
Mylan’s arguments to be geared toward advocating its general position that its
expenses are not capital expenditures.
When the IRS determined to disallow Mylan’s deductions, part of its
determination reflected that Mylan’s expenses were subject to amortization over a
15-year period pursuant to section 197. See sec. 197(a). In general, where
section 197 applies, no other method of depreciation or amortization is permitted.
Id. subsec. (b).
Mylan does not contest in its posttrial briefing the substance of the IRS’
determination that, assuming Mylan’s expenses were capital, section 197 provides
the method for amortization of those expenses. Mylan is therefore deemed to have
conceded the section 197 amortization issue. See Mendes v. Commissioner, 121
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T.C. 308, 312-313 (2003); Leahy v. Commissioner, 87 T.C. 56, 73-74 (1986); see
also Ohde v. Commissioner, T.C. Memo. 2017-137, at *2 n.2. We accordingly
sustain the IRS’ determination that Mylan’s expenses fall within the bounds of
section 197.
IV. Conclusion
In sum Mylan is liable for tax deficiencies as to amounts incurred to prepare
paragraph IV notice letters for its 2012, 2013, and 2014 taxable years.
To reflect the foregoing,
Decisions will be entered under
Rule 155.