March 2, 2023 Cost of priority review vouchers must be capitalized but amortization and depreciation depend on pharmaceutical company's intent to keep or sell
In Chief Counsel Advice memorandum 202304009, the IRS concluded that a pharmaceutical company must capitalize the cost of acquiring priority review vouchers (PRVs) under IRC Section 263(a). Whether those costs may be recovered through amortization or deducted as a loss depends on if the company acquired the PRV to redeem it with the Federal Drug Administration (FDA) to expedite the new drug application (NDA) process or to hold it for resale. Pharmaceutical companies can amortize the cost of acquiring a PRV to use currently or in the future, but not for PRVs acquired for resale. Priority review vouchers The priority review voucher (PRV) program was created by Congress to incentivize pharmaceutical companies to develop new treatments for certain neglected and rare diseases. Companies that have developed these new treatments can then be awarded a PRV for expedited review (generally from 10 months down to 6 months) of a future NDA. A company can use its PRV to expedite review of a specific NDA, hold it for a future NDA, or sell it to an unrelated company. Because PRVs allow companies to bring drugs to market faster, they can have significant value, whether to the original holder or to another holder that purchases the PRV from the original holder. Analysis The proper tax treatment of a PRV's cost depends on the purpose of the company's acquisition. When analyzing capitalization and recovery of costs through amortization and depreciation, the question is whether the pharmaceutical company acquired the PRV to (1) redeem it with the FDA to expedite the NDA process, either presently or in the future, or (2) hold it for resale. PRV used for an expedited NDA The IRS reasoned that the costs of acquiring a PRV to use either presently or in the future must be capitalized under IRC Section 263(a) and added to the basis in the tax year that the costs are paid or incurred. Under the IRS rationale, the PRV constitutes a transaction cost of acquiring an NDA. Specifically, the NDA is a franchise described in Treas. Reg. Section 1.263(a)-4(d)(5)(i) (for payments to a governmental agency to obtain, renew, renegotiate, or upgrade its rights under a trademark, trade name, copyright, license, permit, franchise, or other similar right granted by that agency), and transaction costs incurred to create a franchise must be capitalized under Treas. Reg. Section 1.263(a)-4(e). In its analysis, the IRS cited Mylan, Inc. v. Commissioner, 156 T.C. 137 (2021), for the premise that the courts have required taxpayers to capitalize payments to a party other than the government for facilitating the creation of a right from a government agency as costs that facilitate the acquisition of that right under Treas. Reg. Sections 1.263(a)-4(b)(1) and 1.263(a)-4(e).1 The IRS further concluded that the cost to acquire a PRV is not depreciable or amortizable at the time a PRV is acquired under either IRC Section 197 or 167. The PRV is not an amortizable IRC Section 197 intangible because it is excluded under IRC Section 197(e)(4)(B) and Treas. Reg. Section 1.197-2(c)(6) as a right to receive services from the FDA. The PRV is not amortizable under IRC Section 167 because it has an unlimited useful life under Treas. Reg. Section 1.167(a)-3.2 Instead, if the pharmaceutical company uses the PRV to expedite the NDA process, and the NDA is approved, the PRV would be capitalized and amortizable over 15 years under IRC Sections 197(c)(1) and 197(d)(1)(F) because the PRV is considered a transaction cost of acquiring a franchise (i.e., the NDA) and is included in the basis of the franchise. If the NDA is not approved, the pharmaceutical company may recognize a loss under IRC Section 165 in the tax year that the NDA process is abandoned, subject to the loss disallowance rules under IRC Section 197(f)(1) and Treas. Reg. Section 1.197-2(g). PRV acquired for resale The cost of acquiring the PRV to hold for sale must be capitalized either under Treas. Reg. Section 1.263(a)-4(c), as an intangible acquired in a purchase or similar transaction, or under Treas. Reg. Section 1.263(a)-4(b)(3), as a separate and distinct intangible asset. A PRV acquired for resale is not depreciable or amortizable because IRC Section 197(e)(4)(B) and Treas. Reg. Section 1.197-2(c)(6) exclude it from treatment as an amortizable IRC Section 197 intangible (in this case, a right to receive a service from the government). Because PRVs do not expire, they are considered assets with unlimited useful lives and are not depreciable under IRC Section 167 and Treas. Reg. Section 167(a)-3.3 Thus, if the pharmaceutical company resells the PRV, it may not amortize the PRV costs under either IRC Section 167 or 197 but may recover its basis through the recognition of the applicable gain or loss at the time the PRV is sold. Implications This CCA is significant because it is the first time the IRS has analyzed the treatment of PRVs. Several aspects of the IRS's rationale may be surprising, however, to taxpayers and practitioners that have viewed PRVs as separate and distinct intangibles from the NDA, whether used in connection with the NDA process or held for resale. The IRS treatment of a PRV as a separate and indistinct intangible appears to depend on whether it is ultimately used in the NDA process or is held for resale.4 In the former, it is simply a transaction cost of acquiring the NDA; in the latter, it is a separate and distinct intangible with basis. Taxpayer's intent The IRS does not cite any authority in this memo for the position that a taxpayer's intent, when acquiring an intangible, controls whether it is a separate and distinct intangible. Separate and distinct intangible v. acquired intangible The IRS's analysis of how to treat a PRV held for resale seems to suggest that an intangible must first be a separate and distinct intangible described in Treas. Reg. Section 1.263(a)-4(b)(3) before it can be considered an acquired intangible under Treas. Reg. Section 1.263(a)-4(c) (the CCA states "a PRV is properly characterized as a separate and distinct intangible asset under [Treas. Reg. Section] 1.263(a)-4(b)(3) and, as such, the acquisition cost of the PRV must be capitalized under [IRC Section] 263(a) and [Treas. Reg. Section] 1.263(a)-4(c) in the taxable year such costs are paid or incurred."). This does not seem to comport with Treas. Reg. Section 1.263(a)-4(b)(1), under which costs incurred to enhance a separate and distinct intangible described in Treas. Reg. Section 1.263(a)-4(b)(3) and payments to acquire an intangible described in Treas. Reg. Section 1.263(a)-4(c) are separate rules that require capitalization and operate independently of each other. Government-granted right v. franchise It is not clear whether a PRV is an amortizable IRC Section 197 intangible. PRVs may be viewed either as (1) government-granted rights described in IRC Section 197(d)(1)(D) and Treas. Reg. Section 1.197-2(b)(8) or (2) franchises under IRC Section 197(d)(F) and Treas. Reg. Section 1.197-2(b)(10). As noted in the CCA, the definition of an amortizable IRC Section 197 intangible excludes rights to receive services from a governmental unit that are not connected with the acquisition of a trade or business. Taxpayers may have differing views as to whether a PRV constitutes a right to receive services from the FDA. As described in the CCA, a PRV entitles the holder to expedited review of an NDA, effectively allowing the holder to "cut the line." Simply being able to move to the front of the line, without more, may not clearly represent a service that the FDA provides. In addition, it is not clear whether this governmental-right exception applies under the IRS's rationale in the CCA, which posits that the PRV is a franchise described in IRC Section 197(d)(1)(F) and Treas. Reg. Section 1.197-2(b)(10). Under Treas. Reg. 1.197-2(e)(2)(i) acquiring a franchise is considered to be the acquisition of a trade or business. Thus, if the PRV is viewed as a franchise, the exception in Treas. Reg. 1.197-2(c)(6) would not apply because it does not apply to governmental rights acquired in connection with the acquisition of a trade or business. Recovery of basis The IRS's analysis on recovery of basis in the PRV may also surprise some taxpayers and practitioners that treat the PRV as a separate and distinct amortizable IRC Section 197 intangible. Specifically, an amortizable IRC Section 197 intangible is an IRC Section 197 intangible held in connection with the conduct of a trade or business. This does not require the PRV actually to be used, but only to be held in connection with a trade or business. Thus, if the holder of a PRV is in a trade or business to which a PRV would be relevant, it is arguably held in connection with a trade or business, and amortization can begin upon acquisition (see, Treas. Reg. Sections 1.197-2(d)(1) and 1.197-2(f)(1)). Under the IRS rationale in the CCA, the basis in the PRV is not recoverable until it is used in connection with the NDA process, or it is resold or otherwise disposed. Further, the CCA notes that the pharmaceutical company can claim an IRC Section 165 loss, subject to the loss disallowance rules under IRC Section 197(f)(1) and Treas. Reg. Section 1.197-2(g), if the PRV is used in the NDA process and the NDA is not approved. The statement that the IRC Section 197 loss disallowance rules may apply seems incongruous with the conclusion the PRV is not an amortizable IRC Section 197 intangible because the loss disallowance rules would only apply to the disposition of an amortizable IRC Section 197 intangible. Consistent with its analysis, the IRS did not address potential accounting method considerations in the CCA. The treatment of amortizable costs, once established through consistency, generally is a method of accounting under IRC Section 446. As applicable, consideration should be given to potential implications in this context. ———————————————
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor ____________________________ ENDNOTES 1 The Tax Court in Mylan held, in part, that a pharmaceutical company must capitalize, under IRC Section 263(a), legal fees paid for preparing and distributing notice letters as part of the approval process for the abbreviated new drug application (ANDA) as costs that facilitate the creation of the rights from the government. Because the notice requirement was a prerequisite to obtaining the FDA's approval, the court reasoned that the "legal expenses Mylan incurred to prepare, assemble, and transmit such notice letters constitute amounts incurred 'investigating or otherwise pursuing' the transaction of creating FDA-approved ANDAs … and must be capitalized" (see Tax Alert 2021-0991). 2 While not specifically addressed in the CCA, the 15-year safe harbor in Treas. Reg. Section 1.167(a)-3(b), which applies to certain intangibles with a useful life that cannot be estimated with reasonable accuracy, presumably did not apply. Based on the IRS's rationale, it is not entirely clear why this would be the case. Treas. Reg. Section 1.167(a)-3(b)(ii) excludes acquired intangibles described in Treas. Reg. Section 1.263(a)-4(c) from the 15-year safe harbor amortization. Under the facts in the CCA, the PRV was acquired by purchase. However, the IRS did not conclude that the costs to acquire the PRV had to be capitalized because the PRV was an acquired intangible under Treas. Reg. Section 1.263(a)-4(c). Instead, the IRS concluded that the PRV had to be capitalized as a transaction cost incurred to facilitate the creation of a franchise (i.e., the NDA) under Treas. Reg. Sections 1.263(a)-4(d)(5)(i) and 1.263(a)-4(e), which are not excluded from the 15-year safe harbor amortization. 3 Although the IRS did not refer to the 15-year safe harbor in Treas. Reg. Section 1.167(a)-3(b) for certain intangibles with an unascertainable useful life, that safe harbor presumably did not apply because the PRV was an intangible acquired by purchase under Treas. Reg. Section 1.263(a)-4(c), which is excluded from the safe harbor. 4 The IRS's analysis of the treatment of a PRV as not being a separate and distinct intangible seems to have inconsistencies, even in the scenario where it is used in the NDA process. For example, the IRS's conclusion that the exception in Treas. Reg. Section 1.197-2(c)(6) precludes the PRV from being an amortizable IRC Section 197 intangible suggests that the PRV, in the first instance, is a separate and distinct intangible under IRC Section 197, which is then excluded from IRC Section 197 under the exception in Treas. Reg. Section 1.197-2(c)(6). In other words, for this exception to be relevant, the intangible at issue must first be an intangible to which IRC Section 197 applies. | ||||||||||||||||||
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