In PLR 201802003, the Internal Revenue Service National Office (IRS) permitted a taxpayer claiming the credit under Section 45C (the orphan drug credit) to include in its credit calculation the clinical testing expenses it incurred as a result of the accelerated approval conditions imposed by the Food and Drug Administration (FDA).

Background

The taxpayer is a company that claims the credit under Section 45C for its qualified costs of developing an "orphan drug," i.e., the drug for which it was granted the orphan drug designation under Section 526 of the Federal Food, Drug and Cosmetic Act (FDCA) for the treatment of a rare disease or condition. Following the orphan drug designation, the taxpayer submitted a new drug application (NDA) to the FDA under Section 505(b)(1) of the FDCA to obtain marketing approval for its orphan drug.

The FDA approved the orphan drug under the accelerated approval program described in Section 506(c) of the FDCA, which authorizes the FDA to approve an application for a drug for a serious or life-threatening disease or condition, but allows the FDA to condition its approval on the taxpayer conducting post-approval studies to verify the clinical benefit of the drug. Depending on the outcome of the required studies, or if the sponsor fails to conduct the required studies, the FDA can withdraw the approval. Consistent with Section 506(c) of the FDCA, the FDA required post-approval studies of the taxpayer's orphan drug as outlined in its accelerated approval letter.

Law

Section 45C provides a credit in an amount equal to 50% of a taxpayer's qualified clinical testing expenses (QCTEs) for expenses incurred in tax years beginning before December 31, 2017. (The credit is retained after 2017, but the credit rate is reduced to 25%.) Section 45C(b)(1) defines QCTEs as amounts paid or incurred by a taxpayer that would be described in Section 41(b) (defining qualified research expenses, or QREs) if "clinical testing" was substituted for "qualified research" each place it appears in Section 41(b)(2) and (3).

Section 45C(b)(2)(A) defines the term "clinical testing" as any human clinical testing that is carried out under an exemption for a drug being tested for a rare disease or condition under Section 505(i) of the FDCA (or regulations issued under that section), which occurs: (i) after the drug is designated under Section 526 of the FDCA; and (ii) before the date on which an application for such drug is approved under Section 505(b) of the FDCA.

Legislative history

Section 45C(b)(2)(A) does not refer to accelerated approval, which was first formally established in the FDA's New Drug, Antibiotic, and Biological Drug Product Regulations; Accelerated Approval, 57 Fed. Reg. 58942 (Dec. 11, 1992) (the 1992 FDA Regulations). The preamble to the 1992 FDA Regulations states that "these new procedures are intended to provide expedited marketing of drugs for patients suffering from such illnesses when the drugs provide meaningful therapeutic benefit compared to existing treatment," and further provides that approval "under these procedures [depends] on compliance with certain additional requirements, such as timely completion of studies to document the expected clinical benefit."

In 2012, Congress wanted to expand the FDA's authority to approve drugs on an accelerated basis and, as part of the Food and Drug Administration Safety and Innovation Act (FDASIA), provided statutory rules in Section 506 of the FDCA that are largely consistent with the FDA rules for accelerated approval. The statutory rules for accelerated approval were not part of the FDCA in 1983, when the Orphan Drug Act was first enacted, establishing the tax credit and the type of clinical testing that would be eligible for the credit.

In Section 901(a)(1)(C) of the FDASIA, Congress provided that, in enacting Section 506 of the FDCA, it hoped to provide the FDA additional authority to grant approval for drugs in limited circumstances "without compromising or altering the high standards of the FDA for the approval of drugs." Section 506(e) provides that FDASIA amendments to the FDCA are "intended to encourage the Secretary to utilize innovative and flexible approaches to the assessment of products under accelerated approval for treatments for patients with serious or life-threatening diseases or conditions and unmet medical needs … [and that] [n]othing in this section shall be construed to alter the standards of evidence under subsection (c) or (d) of [S]ection 505."

IRS Ruling

The IRS concluded that post-approval studies required as a condition of approval for accelerated approval drugs are clinical testing within the meaning of Section 45C, and that accelerated approval is not a final approval as contemplated by the cross reference to Section 505(b) in Section 45C(b)(2)(A)(ii)(II). Therefore, the taxpayer's qualified clinical testing expenses, as defined in Section 45C(b)(1), may include expenses for clinical trials that: (1) occur after the date the FDA granted the orphan drug accelerated approval; and (2) are required as a condition of the accelerated approval of that NDA. The expenses must be incurred before the date the taxpayer receives FDA notification that the orphan drug's post-approval study requirements are no longer necessary, or the date the FDA determines that the required post-approval study verifies and describes the orphan drug's clinical benefit.

Implications

The IRS has taken a taxpayer-favorable position in this ruling by concluding that clinical testing expenses incurred under the accelerated approval requirements are eligible for the orphan drug credit. Clarity on the credit-eligibility of post-accelerated approval clinical testing expenses was much needed, as accelerated approvals are increasingly common for orphan drugs. Eligible taxpayers that have not historically included these expenses in QCTEs should consider including them in their credit computations going forward, or even filing amended credit claims, especially given the Tax Cuts and Jobs Act's reduction in the credit amount going forward (taking it from 50% to 25% for expenses incurred in tax years beginning in 2018).

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