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Drug Manufacturer Must Capitalize Certain Legal Expenses Incurred in Obtaining Patents

(Parker Tax Publishing April 2021)

The Tax Court held that legal expenses a generic drug manufacturer incurred in preparing notice letters to patentees are required to be capitalized because they are necessary to obtain Food and Drug Administration (FDA) approval of the manufacturer's generic drugs. However, the court concluded that the legal expenses the manufacturer 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. Mylan, Inc. & Subs. v. Comm'r, 156 T.C. No. 10 (2021).


Mylan, Inc. (Mylan), is a U.S. corporation and the parent of a group of affiliated corporations that file a consolidated federal income tax return. Mylan manufactures brand name and generic pharmaceutical drugs. To implement the congressional purpose of bringing cheaper generic drugs to market, the Hatch-Waxman Act established a shortcut to Food & Drug Administration (FDA) approval for manufacturers hoping to develop and market generic copies of brand name drugs previously approved by the FDA. 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 new drug application (NDA) information by specifying that the generic drug has the same active ingredients as, and is biologically equivalent to, the already-approved brand name drug. 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.

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. Under the Hatch-Waxman Act, special procedures were created for identifying and resolving patent disputes. 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 what is known as "the Orange Book." 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. This is known as a "paragraph IV certification."

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. This notification letter 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. 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 which has been infringed" and injunctive relief precluding the ANDA applicant from commercial manufacture. 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 prohibited from granting "effective" approval to the ANDA while the parties litigate patent validity or infringement. If the FDA approves the ANDA during the 30-month stay period, it will issue a "tentative approval letter."

During 2012 to 2014, Mylan incurred legal fees in connection with applications submitted to the FDA for approval to market and sell generic versions of brand name drugs. As part of the application process, Mylan 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, Mylan certified that listed patents covering the brand name drugs were invalid or would not be infringed by the manufacture of Mylan's generic drugs. When it made such a certification, Mylan was required to send notice letters to the brand name drug manufacturer and any patentees stating that Mylan 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 Mylan.

On its 2012, 2013, and 2014 returns, Mylan deducted the legal expenses incurred to prepare the notice letters and the legal expenses incurred in defending against the patent infringement suits as ordinary and necessary business expenditures. Upon auditing Mylan's tax returns, the IRS determined that these expenses were nondeductible capital expenditures required to be capitalized under Code Sec. 263(a) and subject to amortization under Code Sec. 197. The IRS issued notices for Mylan's 2012, 2013, and 2014 tax years determining deficiencies of $16.4 million, $12.6 million, and $21 million, respectively.

Mylan argued that the expenses it incurred to prepare the notices were deductible because the notices it prepared served to facilitate patent litigation and the legal expenses incurred in defending against the patent infringement suits were ordinary trade or business expenses.


The Tax Court held that the legal expenses Mylan incurred to prepare the notice letters were required to be capitalized because they were necessary to obtain FDA approval of Mylan's generic drugs. The court rejected Mylan's argument that the notices served to facilitate patent litigation. Congress, the court noted, had made the notice a prerequisite for ANDA approval. Consequently, the legal expenses Mylan incurred to prepare, assemble, and transmit such notice letters constituted amounts incurred "investigating or otherwise pursuing" the transaction of creating FDA-approved ANDAs and must be capitalized.

However, the court said, the legal expenses Mylan incurred to defend the patent infringement suits were deductible as ordinary and necessary business expenses because the patent litigation was distinct from the FDA approval process. Although the filing of an ANDA with a paragraph IV certification triggered the opportunity for patent litigation as well as the FDA review process, the court said, this statutory design did not transform patent litigation into a step in the ANDA approval process. In reaching its conclusion, the court cited the origin-of-claim test and an example in Reg. Sec. 1.263(a)-5(l), which discusses the treatment of legal fees paid in connection with bankruptcy proceedings implicating tort liability of the taxpayer. That example involves a corporation who was the defendant in numerous lawsuits alleging tort liability based on the corporation's role in manufacturing certain defective products. The example concludes, in relevant part, that the legal expenses paid by the corporation to prepare, analyze or obtain approval of the portion of the corporation's plan of reorganization that resolved the corporation's tort liability did not facilitate the reorganization and the legal expenses were thus not required to be capitalized, provided that such amounts would have been treated as ordinary and necessary business expenses under Code Sec. 162 had the bankruptcy proceeding not been instituted. The Tax Court saw a strong parallel with Mylan's situation, where the patent litigation was connected with, but distinct from, the broader project of obtaining effective FDA approval of ANDAs with paragraph IV certifications. According to the court, the conclusion reached by the example, i.e., that the separate litigation expenses should not be capitalized, thus attached to Mylan's situation.

For a discussion of the deductibility of legal expenses, see Parker Tax ¶90,150.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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