On April 27, 2021 the United States Tax Court issued its ruling in Mylan, Inc. & Subsidiaries v. Comm’r of Internal Revenue, 156 T.C. No. 10 (U.S. Tax Ct. 2021). This ruling clarified the tax implications of the legal costs associated with filing Abbreviated New Drug Applications (“ANDA”) for generic drugs under the Hatch-Waxman Act and defending patent infringement suits related to generic drugs.

Mylan sits at the crossroads of two complicated statutory frameworks—the ANDA process for getting approval of generic drugs and the tax distinction between deductible expenses and nondeductible capital expenditures.

During the ANDA process, the generic applicant must notify every person that has a patent registered with the FDA on the corresponding brand-name drug. This is known as the “paragraph IV” notice. In response, the patentees may then sue the applicant for infringement, despite the fact that no infringement has yet taken place. This stays ANDA approval. Legal costs are incurred in connection with both the preparing of the paragraph IV notice and during the subsequent infringement action. The question is whether any of those legal costs are deductible.

Taxpayers are allowed a deduction for ordinary and necessary business expenses. Id. at *7–8. By comparison, capital expenditures—which include those costs associated with the acquisition or creation of capital assets—are not deductible. Id. at *7–8. One class of capital assets explicitly contemplated by statute are governmental rights—e.g., an approved ANDA, which is a right to sell a generic drug. Id. at *8.

Background

Mylan deducted its legal fees associated with its ANDA filings as an ordinary and necessary business expenditure. In response, the IRS determined that the legal fees were nondeductible capital expenditures, and issued a notice of deficiency on that basis.

The court broke Mylan’s expenditures into two categories: expenditures related to the drafting and filing of the ANDA-required paragraph IV notifications, and expenditures related to the infringement litigation associated with the generic entry. It then analyzed whether either of those two sets of expenditures were deductible.

The Mylan Court’s holdings

In its opinion, the Mylan court had three major holdings:

1. The date of acquisition of an FDA-approved ANDA is the date of effective approval.
2. Legal costs incurred in connection with the drafting of a paragraph IV notice are nondeductible capital expenditures.
3. Litigation expenses incurred in defending infringement litigation triggered by the ANDA filing are deductible.

First, the court determined that the date of the acquisition of the ANDA right was the date on which the applicant gains the right to sell its generic. Id. at *10. Approval of an ANDA often proceeds in two stages. First the FDA performs its technical review and issues a tentative approval letter. Id. at *4. Then, at the conclusion of any pending litigation or the conclusion of the 30-month stay, the FDA issues a “final” approval, which makes the approval effective. Id. at *10. The court recognized that it is only after the approval is made effective that the ANDA applicant gains the right to sell its generic drug. Id. Thus, the Mylan court wrote, it is only then that the ANDA applicant acquires the FDA-approved ANDA. Id.

Second, the court determined that legal costs associated with the drafting paragraph IV notices are nondeductible capital expenditures. The court analyzed whether these legal fees were required to be capitalized under Treasury regulations providing that a taxpayer must capitalize an amount “paid to facilitate…an acquisition or creation” of rights obtained from a governmental agency. Treas. Reg. § 1.263(a)-4(b)(1)(v). The court wrote that, since the notices were “required” in securing the FDA-approved ANDA, the legal costs associated with drafting such notices are “incurred ‘investigating or otherwise pursuing’” the “FDA-approved ANDAs.” And, since costs associated with pursuing intangible assets “must be capitalized,” so must the legal fees incurred when drafting the paragraph IV notice. Id. (internal citations omitted). The court sustained the IRS’s determination that such legal fees are required to be amortized over a 15-year period that applies to certain intangible assets.

And finally, the court provided two reasons that legal costs associated with ANDA-induced infringement litigation are “ordinary and necessary business expenses,” and thus can be deducted: the litigation is not necessary for the acquisition of the FDA-approved ANDA, and infringement litigation costs are typically deductible.

First, the Mylan court explained that the infringement litigation is controlled by a third-party to the FDA approval. Filing an ANDA gives all parties who receive the paragraph IV notice an artificial patent infringement cause of action against the applicant. The purpose of this cause of action is to allow the parties to resolve any patent disputes before the applicant begins to sell their generic drug in the market. Unlike the paragraph IV notice, which is a statutory requirement, any litigation that occurs as a result of that notice comes at the patentee’s option. Id. at *13. Since the litigation is “controlled by and primarily benefiting patent holders,” the Mylan court held that it cannot be “a step in the FDA approval process for the generic drug.” Id. The court concluded that legal fees Mylan incurred in defending these patent infringement suits were not amounts “paid to facilitate” the transaction and thus they were not required to be capitalized under the regulations.

Second, the court concluded that the legal fees Mylan incurred in defending patent infringement suits were deductible under the “origin of the claim” test. That test provides that 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. In reaching this conclusion, the court pointed to the typical deductibility of patent infringement litigation costs. Id. at *14. The purpose of infringement suits is “to protect future business profits” and not to resolve a dispute of title. Id. The court reasoned that while infringement suits related to Hatch-Waxman might arise before sale, their purpose hasn’t changed. *15. Thus, defending against such suits is part of the “ordinary and necessary activities of its generic drug business and accordingly [is] deductible.” Id.

Conclusions

The Tax Court’s opinion in Mylan is significant in the precedent it establishes on the circumstances in which legal fees may be claimed as deductible expenses. Under the court’s holding, legal fees for defending patent infringement lawsuits may be deducted in the year paid or incurred, but legal fees for preparing notice letters must be recovered by amortization deductions over a 15-year period. Generic drug manufacturers should analyze how Mylan could apply to them, which would include reviewing procedures for separately accounting for legal fees incurred in preparing notice letters and legal fees incurred in defending patent infringement lawsuits. Finally, given that the Tax Court’s ruling was in part in Mylan’s favor and in part in the IRS’s favor, either Mylan or the IRS or both could file an appeal.

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