On April 27, 2021, the United States Tax Court held that legal fees incurred by generic drug manufacturers in connection with “Section 271(e)(2)” patent infringement suits are deductible as ordinary business expenses and need not be capitalized. The opinion contradicts longstanding IRS field advice, and has potential applicability to generic drug manufacturers and others who have capitalized legal fees in recent years.
Such Section 271(e)(2) suits are brought in response to a generic drug manufacturer’s filing of an abbreviated new drug application (ANDA). The ANDA is a shortcut to Federal Drug Administration (FDA) approval for generic drug manufacturers wishing to develop and market generic copies of brand name drugs that already have FDA approval.
The ANDA may be filed with a “paragraph IV” certification. This certification has the generic drug manufacturer make a statement certifying that a patent is “invalid or will not be infringed by the manufacture, use, or sale”[1] of the generic drug. Once the ANDA is filed with a “paragraph IV” certification, brand name manufacturers are provided a limited time to file patent infringement lawsuits against the generic drug manufacturer. The purpose of the ANDA process is to encourage potential patent infringement cases early in the process and expedite the entry of generic drugs to market with lesser concern for later infringement claims.
The IRS has taken the position, in LAFA 20114901F (Legal Field Advice Issued by Field Attorneys) dated December 9, 2011, that attorney fees incurred to defend actions for patent infringement under Section 271(e)(2) must be capitalized. The IRS concluded in its LAFA that because the attorney fees originated from the generic drug manufacturer’s actions to “obtain assets,” the character of the fees are capital in nature.
In Mylan, the Tax Court closely scrutinized the ANDA process. It agreed with the past IRS position that attorney fees incurred in preparing the NDA – in particular, notice letters sent to the brand name manufacturers informing them of the paragraph IV certification – must be capitalized as a cost of creating an asset.
However, most critically, the Tax Court viewed the patent infringement litigation expenses that arose as a result of the paragraph IV certification – those costs arising after the brand name manufacturers responded and filed suit – are not subject to capitalization. “[We] note that a Section 271(e)(2) suit is not required to obtain effective approval of an ANDA with a paragraph IV certification . . . and that a brand name drug manufacturer is under no obligation to initiate such suit in response to an ANDA with a paragraph IV certification.”[2] Further, “a Section 271(e)(2) suit serves the same 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.”[3]
Due to the reversal of a prior standing IRS policy on deductibility of legal fees in connection with Section 271(e)(2) suits, clients are encouraged to consult with their tax advisors or a member of the Husch Blackwell tax team to consider amendments and prospective tax positions based on this Tax Court case. In particular, manufacturers who have capitalized such expenses should consider filing claims for refund for any open years in light of the Tax Court’s ruling. The IRS will have 90 days to appeal the Tax Court opinion.
[1] 21 U.S.C. § 355(j)(2)(A)(vii)(IV).
[2] Mylan, Inc. & Subs. V. Comm’r, 156 T.C. 37 (April 27, 2021).
[3] Id. at 38.