IRS outlines its position on the tax treatment of ANDA Paragraph IV litigation costs

Transcription

1 Tax Insights from WNTS Federal Tax Services, Pharmaceutical & Life Sciences IRS outlines its position on the tax treatment of ANDA Paragraph IV litigation costs December 2, 2014 In brief The Internal Revenue Service (IRS) National Office recently concluded in Generic Legal Advice Memorandum (GLAM) that when a generic company files an Abbreviated New Drug Application (ANDA) with a paragraph IV patent certification, the legal fees the generic company incurs to defend against a patent infringement lawsuit must be capitalized under Section 263(a) of the Internal Revenue Code as a cost that facilitates obtaining the ANDA. However, the IRS added that when a brand company holds a patent on a drug for which an ANDA with a paragraph IV patent certification is filed, the legal fees incurred by the brand company to try to establish that the manufacture, use, or sale of the drug subject to the ANDA would infringe the brand company s patent generally are not required to be capitalized as a cost to perfect title to the brand company s patent under Section 263(a). The GLAM, which presents the IRS Chief Counsel s view on this significant issue for pharmaceutical companies, is consistent with previous advice of IRS field attorneys with respect to the generic company s legal fees, but differs from previous advice regarding the brand company s legal fees (see Field Attorney Advice (FAA) F and FAA F). In detail In general, brand companies that intend to market and sell a pioneer brand drug within the United States must submit a new drug application (NDA) to the Food and Drug Administration (FDA) for approval. Similarly, generic companies seeking to market and sell generic equivalents of a brand drug must obtain FDA approval. Prior to 1984, the testing and approval process to establish that a generic drug was safe and effective for its proposed use was considered prohibitively expensive relative to the profits the generic company could anticipate earning from that drug. In addition, the threat of losing complex and uncertain patent infringement litigation was a significant deterrent for generic companies. To address these concerns, the Drug Price Competition and Patent Term Restoration Act, Pub. L. No (Hatch- Waxman),was enacted in 1984 to establish an abbreviated application process, known as an ANDA, for the review and ultimate approval of generic equivalents of previously approved branded drugs. An ANDA permits a generic pharmaceutical company to manufacture and market a generic drug that is the bioequivalent of a brand drug. A primary objective of Congress in enacting Hatch-Waxman was to increase competition and lower drug prices by encouraging the timely manufacturing and marketing of generic drugs. The generic drug applications are called abbreviated because they generally are not required to

2 include preclinical (animal) and clinical (human) data to establish safety and effectiveness. Instead, generic applicants must scientifically demonstrate that their product is bioequivalent (i.e., performs in the same manner as the brand drug). In addition to expediting the FDA review of the safety and bioequivalence of generic drugs, the ANDA process is designed to accelerate resolution of any patent infringement issues that may arise from the manufacture, use, or sale of a generic equivalent of a brand drug. Thus, an ANDA applicant must make one of four certifications with respect to the listed patents for the brand drug. With a paragraph I, II, or III certification, the generic company certifies there are no listed patents, the listed patents have expired, or the generic drug will not be sold before the listed patents expire. With a paragraph IV certification, the applicant asserts that the listed patent is invalid, unenforceable, or will not be infringed. An approved ANDA allows generic drugs to be sold prior to the expiration of the patent on the branded drug only if the generic company files an ANDA with a paragraph IV certification. The first applicant to file a paragraph IV ANDA for a particular generic drug is eligible for a 180-day exclusivity period during which the FDA may not grant approval to any competing generic drug. The act of filing a paragraph IV ANDA constitutes an act of patent infringement, providing courts with the jurisdiction to resolve patent issues before actual sale of the generic drug. As a result, when a paragraph IV ANDA is filed, the generic company must provide notice to all patentees of record, who then have 45 days to file a patent infringement lawsuit. If a lawsuit is filed, FDA final approval of the ANDA is delayed for 40 months (40-month stay), unless the patent is found to be invalid or not infringed upon prior to that time. After the 40- month stay, the FDA may approve the ANDA, subject to confirming bioequivalence, even if the infringement litigation is not resolved or is resolved in favor of the patent holder (in the latter case, final approval will take effect when the patent expires). However, FDA final approval may be withdrawn or altered if a patent infringement suit is filed after the 45-day period or a court later determines that the patent has been infringed. IRS analysis The IRS addressed two issues in the GLAM: Whether a drug manufacturer that files an ANDA with paragraph IV certification must capitalize under Section 263(a) and Treas. Reg. Sec (a)-4, the legal fees it incurs to defend against a patent infringement suit; and Whether a drug manufacturer that holds a patent on a drug for which an ANDA with paragraph IV certification is filed is required to capitalize, under Treas. Reg. Sec (a)- 4(d)(9), the legal fees incurred in trying to establish that the manufacture, use, or sale of the drug subject to the ANDA would infringe its patent. In the GLAM, the IRS relied on Sections 162(a) and 263(a) and the regulations thereunder. Section 162 generally allows a deduction for all ordinary and necessary expenses paid or incurred in carrying on a trade or business. However, Section 263(a) and the regulations thereunder require a taxpayer to capitalize certain intangibles, including a government-granted right. The regulations under Section 263(a) also require a taxpayer to capitalize an amount paid to defend or perfect title to intangible property if the other party challenges the taxpayer s title. In addition, a taxpayer is required to capitalize an amount that facilitates the acquisition or creation of a capitalizable intangible, such as a government-granted right or perfection of title. An amount facilitates the acquisition or creation of an intangible if the amount is paid in the process of investigating or otherwise pursuing the transaction. The generic company's patent infringement litigation costs In the GLAM, the IRS first addressed whether the costs of defending a patent infringement claim brought after a paragraph IV ANDA notice must be capitalized as part of the costs to obtain FDA approval to market and sell a generic drug. Initially, the IRS recognized that costs to defend against a claim of patent infringement generally are deductible on the theory that the taxpayer is protecting or maintaining its business. However, otherwise deductible PwC Page 2

3 costs must be capitalized if incurred in a capital transaction. With respect to the generic company, the IRS stated it was uncontested that direct costs incurred to obtain FDA approval to market and sell a generic drug are amounts paid for a government-granted right the ANDA that must be capitalized. The IRS then reasoned that the patent infringement defense costs incurred in the ANDA process would be capitalizable if they are transaction costs that facilitate the creation of that government-granted right. In considering this question, the IRS pointed out the facilitation standard under the Section 263(a) regulations is intentionally broad in scope (all costs paid in the process of investigating or otherwise pursuing the transaction), as is the definition of transaction (all of the factual elements comprising an acquisition ). According to the IRS, this conclusion is consistent with the underlying purpose of the capitalization rules, which attempt to match expenses with the income generated by those expenses. In filing an ANDA with paragraph IV patent certification, an applicant seeks to obtain the right to market and sell a generic drug in advance of actually manufacturing and selling that drug. All costs the generic drug maker incurs in the process of seeking FDA approval are better matched against the income derived from future sales of a generic drug sales that cannot commence until after FDA approval is received. In concluding that the amounts incurred by generic companies must be capitalized, the IRS reasoned that patent claims are an integral step in the process of pursuing FDA approval of a paragraph IV ANDA and the effective date of FDA approval is dependent on how the patent infringement litigation is resolved. According to the IRS, the infringement suit pursuant to a paragraph IV ANDA is so integral to the process by which a generic company obtains approval to market and sell a generic drug that the litigation costs to defend the suit are incurred in the process of pursuing such approval. The IRS concluded that patent defense litigation pursuant to a paragraph IV ANDA originates in a capital transaction, and thus the costs of such litigation must be capitalized. Observation: The conclusion reached in the GLAM with respect to the paragraph IV litigation costs incurred by generic companies is consistent with the holdings in FAAs F and F, in which the IRS field attorneys determined that legal fees incurred to research patents to make the necessary certifications and to defend against paragraph IV litigation must be capitalized under Section 263(a) as costs that facilitate creating a capitalizable intangible (the ANDA) and amortized over 15 years as a Section 197 intangible (specifically, a franchise). Generic companies typically deduct the cost of defending paragraph IV litigation as an ordinary and necessary cost of defending against patent infringement litigation. Many generic companies take the view that legal fees incurred to research patents and to defend against patent infringement could be considered ordinary and necessary costs of promoting and protecting the taxpayer s business, similar to any other deductible patent litigation. That is, a generic company could obtain FDA approval of an ANDA by filing a paragraph I, II, or III certification without incurring paragraph IV litigation fees, but those certifications only would allow the generic drugs to be sold after the related patents expire. Thus, the paragraph IV litigation costs arise because a generic company wants to sell its drug prior to expiration of patents that it believes are invalid or not infringed, similar to litigation costs arising in any other patent challenge. The costs therefore arguably have their origin in ordinary, deductible patent litigation. Similarly, the fact that a generic company cannot obtain final approval of a paragraph IV ANDA that allows it to sell a drug before the patent expires if the paragraph IV litigation is unsuccessful is the same outcome as for any other deductible patent litigation in which the defendant is unsuccessful. Under this alternative view, paragraph IV litigation costs would not be capitalized as amounts paid to facilitate the acquisition or creation of an intangible under Section 263(a), but would be deductible under Section 162 as ordinary and necessary business expenses. The brand company's patent infringement litigation costs PwC Page 3

4 The IRS then addressed whether the legal fees the brand company incurred to try to establish that the manufacture, use, or sale of the generic drug subject to the ANDA would infringe the brand company s patent are incurred to defend an existing intellectual property right or create a new intangible. Specifically, the IRS considered whether the brand company must capitalize the litigation costs because the litigation defended or perfected title to the brand company s patent. In its analysis, the IRS first explained that title is at issue when there is a question of ownership. In the context of patent infringement suits arising from a paragraph IV ANDA, the IRS reasoned that costs incurred to defend against a claim that the patent holder does not have proper ownership are likely to be rare. That is, paragraph IV certification does not challenge ownership of a patent, but rather provides that the patent for the listed drug is not valid or will not be infringed by the generic drug. Thus, the IRS concluded that the brand company that holds a patent on the drug for which a paragraph IV ANDA is filed generally is not required to capitalize legal fees incurred to try to establish that the manufacture, use, or sale of the generic drug subject to the ANDA would infringe the brand company s patent. The IRS noted that it would be highly unusual in the context of a patent infringement suit arising from an ANDA with paragraph IV patent certification for the ownership or title to the patent to be in question. However, if that were the case, Treas. Reg. Sec (a)-4(d)(9) may require capitalization of some portion of the drug manufacturer s legal fees. Observation: Like generic companies, brand companies typically deduct costs to prosecute paragraph IV litigation without regard to whether the litigation ultimately perfects or defends title to patents. In most cases, the paragraph IV litigation is merely protecting patents clearly owned by the brand company, and thus the litigation costs should be deductible according to the IRS. However, to the extent the paragraph IV litigation is defending or perfecting title (i.e., ownership) to the brand company s patents, the paragraph IV litigation costs must be capitalized as costs that facilitate creating the intangible (i.e., the patents) according to the IRS. The takeaway Both brand and generic companies typically deduct their litigation costs associated with paragraph IV litigation as ordinary and necessary costs of prosecuting or defending patent infringement. The IRS conclusion in this GLAM that legal fees incurred by a brand company in paragraph IV litigation are deductible is consistent with this historic treatment. However, the IRS conclusion that legal fees incurred by the generic drug company in the same lawsuit generally must be capitalized as a cost that facilitates obtaining an ANDA likely is not consistent with the generic company s historic treatment. As a result, generic companies should consider carefully the tax treatment of their paragraph IV patent infringement litigation costs. PwC Page 4

5 Tax Insights Let s talk For a deeper conversation of how this development might affect your business, please contact: Federal Tax Services Dennis Tingey Partner, Phoenix dennis.tingey@us.pwc.com Christine Turgeon Partner, New York christine.turgeon@us.pwc.com Monic Kechik Director, New York monic.kechik@us.pwc.com Pharmaceutical & Life Sciences Tax Leader Kathleen Michael Partner, Florham Park kathleen.michael@us.pwc.com 2014 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. SOLICITATION This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.