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Generic drug manufacturer may deduct patent litigation expenses

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May 2021

In brief

The Tax Court on April 27 held in Mylan, Inc. v. Commissioner, 156 T.C. No. 10, 2021 BL 154261, that Mylan, a generic drug manufacturer, may deduct as ordinary and necessary business expenses legal fees incurred to defend patent infringement lawsuits brought by branded drug companies, rejecting the IRS’s position that the legal fees must be capitalized. However, the court agreed with the IRS in holding that Mylan must capitalize legal expenses incurred to prepare, assemble, and transmit notice letters to branded drug companies as part of obtaining Food and Drug Administration (FDA) approval to manufacture and sell generic drugs. 

Action item: Generic drug manufacturers should consider (1) deducting legal fees incurred to defend such patent infringement lawsuits going forward and (2) determining whether this decision provides them with an opportunity to claim refunds for open tax years where such costs were capitalized.

In detail

Background

Drug companies requesting FDA approval to market or sell a generic version of an existing FDA-approved drug must file an abbreviated new drug application (ANDA) that leverages the approved branded drug’s application information. Mylan’s ANDA filing included a Paragraph IV certification that the branded drug’s patent was invalid or would not be infringed by the manufacture, use, or sale of Mylan’s generic version. Mylan also notified the branded drug patent holders of its ANDA filing within 20 days as required by the FDA. Certain branded drug patent holders filed patent infringement lawsuits against Mylan within 45 days of receiving notice.

An ANDA is a government-granted right and thus a capitalizable intangible under Section 263(a). Section 263(a) regulations require amounts paid to facilitate the acquisition or creation of an intangible to be capitalized. Mylan deducted the legal fees it incurred in preparing, assembling, and transmitting the notice letters sent to the branded drug patent holders as well as its legal fees to defend the patent infringement lawsuits brought by the branded drugs patent holders. The IRS took the position that the legal fees were not deductible as ordinary and necessary business expenses under Section 162 and must be capitalized under Section 263(a) because they were incurred as part of an ‘integral step’ in obtaining FDA approval of the ANDA.

Tax Court decision

The Tax Court agreed with the IRS’s position that Mylan’s legal fees for preparing, assembling, and transmitting the notices must be capitalized because the notification is a required step for obtaining FDA approval and the related costs constitute amounts incurred to facilitate the creation of an FDA-approved ANDA.  

However, the Tax Court determined that Mylan’s legal expenses incurred in defending the patent infringement suits were deductible as ordinary and necessary business expenses. The court reasoned that the litigation — which primarily benefited the branded drug patent holder in protecting its intellectual property rights and future business profits — was not a step in the FDA approval process. The court also found that, under the origin of the claim test, Mylan’s patent litigation expenses should be treated as ordinary and necessary business expenses and that the IRS failed to show that the substance of the underlying claim arose out of the acquisition, ownership, or improvement of property.

The takeaway

Although the Tax Court denied Mylan’s deduction of legal fees incurred in obtaining FDA approval, it found that its legal expenses incurred in defending the patent infringement suits were deductible as ordinary and necessary business expenses. Generic drug manufacturers should consider whether this decision provides them with an opportunity to claim refunds for open tax years where such costs were capitalized. Note that obtaining such a refund may require the consent of the IRS for the drug manufacturer to change its method of accounting. These manufacturers should track patent infringement legal fees separately from legal fees associated with the creation of an intangible asset.

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Michelle Lee

Health Industry & Pharma Life Science Tax Leader, PwC US

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