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August 30, 2022

Court of Federal Claims rules pharmaceutical company may treat patent litigation fees as deductible expenses

  • Litigation expenses incurred in defending a business in conjunction with a patent infringement suit are deductible under IRC Section 162(a).
  • Litigation expenses of this type are not capitalized under Treas. Reg. Section 1.263(a)-4 because they are not part of the acquisition of an abbreviated new drug application (ANDA), do not facilitate the creation or acquisition of an ANDA, and do not enhance the approved ANDA.

In Actavis Laboratories, FL, Inc. v. United States, the Court of Federal Claims granted a pharmaceutical company's motion for summary judgment, finding that the company may deduct under IRC Section 162 the legal expenses incurred in defending against patent infringement lawsuits that may arise after an abbreviated new drug application (ANDA) is filed.


Watson Pharmaceuticals, Inc. (Watson), a generic drug manufacturer, filed seven ANDAs and certifications that "any patent 'is invalid or will not be infringed by the manufacture, use, or sale' of the generic version," also known as paragraph IV certifications, with the FDA from 2008 to 2009. After the ANDA filings, the drug companies that made the brand name drugs sued Watson for patent infringement.

On its 2008 and 2009 tax returns, Watson deducted the patent litigation expenses, which were allowed until 2011, when the IRS issued a memorandum concluding that "expenses incurred defending patent litigation under [35 U.S.C. Section] 271(e)(2) must be capitalized under the origin of the claim test and Treasury [Reg. Section] 1.263(a)-4." Watson deducted litigation expenses of approximately $3.9 million and $8.5 million for 2008 and 2009, respectively.

In 2016, the IRS issued a notice of deficiency disallowing Watson's deductions for patent litigation expense. The IRS sought payment of the additional taxes owed and imposed interest and penalties for late payment.

Actavis Laboratories, FL, Inc. (Actavis) became Watson's substitute agent for the returns and Actavis's parent company paid the deficiency. Actavis filed amended returns for 2008 and 2009 and then filed suit in the Court of Federal Claims seeking "a refund of the taxes, interest, and penalties paid," for a total of approximately $2 million for 2008 and approximately $4 million for 2009.

In its motion for summary judgment, Actavis asserted that the patent litigation expenses were incurred in defending Watson's business practices and were ordinary and deductible expenses. The Government filed a cross-motion for partial summary judgment, arguing that patent infringement expenses incurred by Watson "facilitated the acquisition of FDA-approved ANDAs" and, therefore, must be capitalized.


In its holdings, the Court of Federal Claims relied on the recent United States Tax Court decision, Mylan, Inc. & Subsidiaries v. Commissioner, 156 T.C. 137 (2021) (pending appeal to the United States Court of Appeals for the Third Circuit). In Mylan, the Tax Court held that the litigation expenses incurred as a result of the infringement suits could be deducted under IRC Section 162(a) as ordinary and necessary business activities because the expenses Mylan incurred to defend the lawsuits "were not 'paid to facilitate' the transaction and are not required to be capitalized [under Treasury Reg. Section 1.263(a)-4]." (See Tax Alert 2021-0991.)

Treas. Reg. Section 1.263(a)-4(b) provides rules for applying the capitalization rules under IRC Section 263(a) to amounts paid to acquire or create intangibles. These rules require taxpayers to capitalize amounts paid to (i) acquire an intangible asset, (ii) facilitate the acquisition or creation of an intangible asset, and (iii) create or enhance a separate and distinct intangible asset. See Treas. Reg. Section 1.263(a)-4(b)(1)(i), (iii), (v).

Citing Mylan, the Court of Federal Claims held that no provision of Treas. Reg. Section 1.263(a)-4 requires Actavis to capitalize its litigation expenses, finding that even though Actavis and the Government agree that "an FDA-approved ANDA with a Paragraph IV certification is a qualifying intangible under [Treas. Reg. Section] 1.263(a)-4, defending … litigation is not a part of that transaction." The court also concluded that the litigation expenses "do not 'facilitate the acquisition or creation of' the approved ANDA" because those expenses are not paid to investigate or pursue the transaction under Treas. Reg. Section 1.263(a)-4(b) and (e)(1)(i). The court also observed "the expenses do not 'enhance' the approved ANDA; they only prevent its further diminishment."

Additionally, the court examined whether IRC Section 271(e)(2) litigation expenses must be capitalized under the "origin of the claim test." See, generally, United States v. Gilmore, 372 U.S. 39 (1963) (the deductibility of expenses turns, "not upon the consequences to [the taxpayer] … but upon the origin and nature of the claims themselves"). In determining that the litigation expenses incurred by Watson were not required to be capitalized under the origin of the claim test, the court held that the "substance of a [Section] 271(e)(2) claim is that of traditional patent infringement — a property trespass action sounding in tort … [T]he origin of the [Section] 271(e)(2) claims plaintiff litigated is not 'in the process of acquisition' of the ANDAs themselves … [r]ather, the origin of the [Section] 271(e)(2) claims is the branded drug companies' patent enforcement efforts to maintain their business profits and cease plaintiff's generic drug business activities."

Citing A.E. Staley Manufacturing Co. & Subsidiaries v. Commissioner, 119 F.3d 482, 487 (7th Cir. 1997) and Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954), rev'g 20 T.C. 944 (1953), the court held that litigation expenses incurred by Watson are deductible under IRC Section 162(a) as ordinary and necessary business expenses.


The Court of Federal Claims' ruling is consistent with longstanding, established case law, which holds that patent infringement litigation costs are deductible as ordinary and necessary business expenses. Following the Mylan case, this summary judgement is welcome affirmation that these patent litigation costs remain deductible when incurred in the ANDA context. It remains to be seen whether the IRS will continue to challenge the treatment of such costs in light of recent decisions that reject the Service's contrary interpretation as asserted over many years.


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