UNITED STATES TAX COURT

156 T.C. No. 10

UNITED STATES TAX COURT

MYLAN, INC. & SUBSIDIARIES, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 26976-16, 26977-16,

26978-16.

Filed April 27, 2021.

P, a U.S. corporation, is a manufacturer of brand name and

generic pharmaceutical drugs. During 2012 to 2014 P incurred legal

fees in connection with applications submitted to the Food & Drug

Administration (FDA) for approval to market and sell generic

versions of brand name drugs. As part of the application process P

was required to provide a certification regarding the status of any

patents that had been listed by the FDA as covering the respective

brand name drug. On some applications P certified that listed patents

covering the brand name drugs were invalid or would not be infringed

by the manufacture of P’s generic drugs. When it made such a

certification, P was required to send notice letters to the brand name

drug manufacturer and any patentees stating that P had made such a

certification. Certification also constituted an act of patent

infringement giving the brand name manufacturer and patentees the

right to bring a patent infringement suit against P. At issue are the

legal expenses incurred to prepare notice letters and legal expenses

incurred in defending against these patent infringement suits.

Served 04/27/21

-2On its 2012, 2013, and 2014 returns, P deducted its legal

expenses as ordinary and necessary business expenditures. Upon

examination, R determined that these expenses were nondeductible

capital expenditures required to be capitalized and subsequently

disallowed P’s claimed deductions for the expenses at issue. R

thereafter issued a notice of deficiency for each of P’s 2012, 2013,

and 2014 taxable years determining deficiencies of $16,430,947,

$12,618,695, and $20,988,657, respectively.

Held: The legal expenses P incurred to prepare notice letters

are required to be capitalized because they were necessary to obtain

FDA approval of P’s generic drugs.

Held, further, the legal expenses P incurred to defend patent

infringement suits are deductible as ordinary and necessary business

expenses because the patent litigation was distinct from the FDA

approval process.

William F. Nelson and James G. Steele III, for petitioner.

Emily J. Giometti, Lisa M. Rodriguez, Mary Helen Weber, Kathryn

E. Kelly, and Nina P. Ching, for respondent.

URDA, Judge: Petitioner, Mylan, Inc. & Subsidiaries (Mylan), is a

manufacturer of brand name and generic pharmaceutical drugs. From 2012

through 2014 it incurred significant legal expenses in preparing notice letters and

defending patent infringement lawsuits related to its generic versions of certain

brand name drugs. On its 2012 through 2014 Federal income tax returns, Mylan

-3claimed deductions for the legal fees as ordinary and necessary business expenses

under section 162(a).1 The Internal Revenue Service (IRS) subsequently

disallowed these deductions, determining that the legal expenses were required to

be capitalized pursuant to section 263(a). We conclude that the legal expenses

Mylan incurred to prepare notice letters are required to be capitalized, while the

litigation expenses Mylan incurred to defend patent infringement suits are

deductible as ordinary and necessary business expenses.

Introduction

We begin by describing the highly reticulated statutory and regulatory

scheme under which Mylan’s legal expenses were incurred. Before a

pharmaceutical company can market or sell a brand name or generic drug in the

United States, it must first obtain approval from the Food & Drug Administration

(FDA), the Federal agency responsible for, inter alia, the safety and efficacy of

pharmaceuticals. See Federal Food, Drug, and Cosmetic Act, ch. 675, sec. 505, 52

Stat. at 1052 (1938) (codified as amended at 21 U.S.C. sec. 355 (2012)). Although

the first step in requesting approval is the same for both brand name and generic

1

Unless otherwise indicated, all section references are to the Internal

Revenue Code (26 U.S.C.), as amended, in effect for the years at issue. Rule

references are to the Tax Court Rules of Practice and Procedure. All amounts are

rounded to the nearest dollar.

-4drugs, i.e., by submitting to the FDA a Form FDA 356h, Application To Market a

New or Abbreviated New Drug or Biologic for Human Use, the roads diverge

thereafter.

A.

Brand Name Pharmaceuticals

1.

New Drug Application

For brand name pharmaceuticals, a drug’s manufacturer formally proposes

that the FDA approve the new drug for sale and marketing in the United States

through a new drug application (NDA). See, e.g., FTC v. Actavis, Inc., 570 U.S.

136, 142 (2013). The NDA must provide sufficient information for the FDA to

review the drug’s components, methods of manufacturing and testing, proposed

uses and labeling, and results of clinical trials demonstrating that it is safe and

effective. 21 U.S.C. sec. 355(b). The drug manufacturer then undergoes a “long,

comprehensive, and costly testing process, after which, if successful, the

manufacturer will receive marketing approval from the FDA.” Actavis, 570 U.S.

at 142; see also 21 U.S.C. sec. 355(d).

2.

The Orange Book

NDA holders are required to submit patent information for patents that

cover an FDA-approved brand name drug or an approved method of using that

drug. See 21 U.S.C. sec. 355(b)(1), (c)(2); see also aaiPharma Inc. v. Thompson,

-5296 F.3d 227, 230 (4th Cir. 2002). Patents so disclosed are listed in a register

maintained by the FDA, the Approved Drug Products with Therapeutic

Equivalence Evaluations (Orange Book). See Caraco Pharm. Labs., Ltd. v. Novo

Nordisk A/S, 566 U.S. 399, 405-406 (2012); aaiPharma, 296 F.3d at 231. The

FDA does not confirm the accuracy of the information provided with the Patent &

Trademark Office or the NDA applicant. See Am. Bioscience, Inc. v. Thompson,

269 F.3d 1077, 1080 (D.C. Cir. 2001); see also Caraco, 566 U.S. at 406-407;

Apotex, Inc. v. Thompson, 347 F.3d 1335, 1349 (Fed. Cir. 2003).

B.

Generic Pharmaceuticals

1.

Hatch-Waxman Act

Until 1984, manufacturers of generic pharmaceuticals, like their brand name

counterparts, were required to submit an NDA for FDA approval. See aaiPharma,

296 F.3d at 230-231. Congress altered course, however, in the Drug Price

Competition and Patent Term Restoration Act of 1984 (Hatch-Waxman Act or

Act), Pub. L. No. 98-417, 98 Stat. 1585. In the Act Congress sought “to strike a

balance between ‘two conflicting policy objectives: to induce name-brand

pharmaceutical firms to make the investments necessary to research and develop

new drug products, while simultaneously enabling competitors to bring cheaper,

generic copies of those drugs to market.’” aaiPharma, 296 F.3d at 230 (quoting

-6Abbott Labs. v. Young, 920 F.2d 984, 991 (D.C. Cir. 1990) (Edwards, J.,

dissenting on other grounds)); see also Eli Lilly & Co. v. Medtronic, Inc., 496 U.S.

661, 676 (1990); In re Lipitor Antitrust Litig., 868 F.3d 231, 240 (3d Cir. 2017).

2.

Abbreviated NDA

a.

FDA Submission

To implement the congressional purpose of bringing cheaper generic drugs

to market, the Hatch-Waxman Act established a shortcut to FDA approval for

manufacturers hoping to develop and market generic copies of brand name drugs

previously approved by the FDA. See Actavis, 570 U.S. at 142; In re Lipitor, 868

F.3d at 240. Under this expedited approach, a generic drug manufacturer may

submit an abbreviated new drug application (ANDA) that piggybacks on an

approved brand name drug’s NDA information by specifying that the generic has

the “same active ingredients as, and is biologically equivalent to,” the

already-approved brand name drug. Caraco, 566 U.S. at 404-405 (citing 21 U.S.C.

sec. 355(j)(2)(A)(ii), (iv)); see also Actavis, 570 U.S. at 142. Because the FDA

would have previously determined the brand name drug to be safe and effective,

the ANDA applicant can obtain approval while avoiding the “costly and

time-consuming studies” needed to obtain approval for a brand name drug. See

Eli Lilly, 496 U.S. at 676.

-7b.

Approval

The “FDA will approve an * * * [ANDA] and send the applicant an

approval letter if none of the reasons in § 314.127 for refusing to approve the * * *

[ANDA] applies.” 21 C.F.R. sec. 314.105(d) (2014); see also 21 U.S.C. sec.

355(j)(4). Title 21 C.F.R. sec. 314.127 (2014), in turn, enumerates a number of

technical reasons for the rejection of an ANDA including failure to show that the

generic has the same active ingredients as the brand name drug, failure to show

bioequivalence between the drugs, failure to establish that the production methods

would preserve the generic’s identity, strength, quality, and purity, and failure to

show proper labeling. See also 21 U.S.C. sec. 355(j)(4). None of the listed

grounds relates to patent issues. See id.; 21 C.F.R. sec. 314.127.

FDA approval of an ANDA, however, does not necessarily mean that a

generic drug may be sold and marketed. A generic drug, rather, “may be

introduced * * * into interstate commerce when approval of the * * * [ANDA] for

the drug product becomes effective.” 21 C.F.R. sec. 314.107(a) (2014); see also

21 U.S.C. sec. 355(a) (“No person shall introduce or deliver for introduction into

interstate commerce any new drug, unless an approval of an application filed

pursuant to subsection (b) or (j) of this section is effective with respect to such

drug.”). As a general matter, the “approval shall be made effective immediately”.

-821 U.S.C. sec. 355(j)(5)(B)(iii). In certain instances approval comes with a

delayed effective date. Such an approval is tentative and does not become final

until the effective date, id. cl. (iv)(II)(dd)(BB), which means that a new drug

product may not be introduced or delivered for introduction into interstate

commerce until approval of the ANDA is effective, id. subsec. (a).

3.

Patent Protections

In addition to endorsing a more simplified process for bringing generics to

market, the Hatch-Waxman Act “contains a complex set of provisions designed to

protect the intellectual property rights of * * * [brand name] drug companies and

others holding patents on brand name drugs.” aaiPharma, 296 F.3d at 231.

a.

Patent Litigation

The Hatch-Waxman Act created “special procedures” for identifying and

resolving patent disputes. See Actavis, 570 U.S. at 143; In re Lipitor, 868 F.3d

at 240; see also Apotex, 347 F.3d at 1338 (“The Act also sought to facilitate the

resolution of patent-related disputes over pharmaceutical drugs by creating a

streamlined mechanism for identifying and resolving patent issues related to the

proposed generic products.”). When filing an ANDA, a generic drug

manufacturer must make one of four “certifications” with respect to each drug for

which there is a patent listed in the Orange Book. 21 U.S.C. sec. 355(j)(2)(A)(vii).

-9Most relevant to these cases, a generic drug manufacturer may certify that any

patent “is invalid or will not be infringed by the manufacture, use, or sale” of the

generic version (paragraph IV certification). Id. subcl. (IV); see also Actavis, 570

U.S. at 143.

A paragraph IV certification “automatically counts as patent infringement,

see 35 U.S.C. § 271(e)(2)(A) (2006 ed., Supp. V), and often ‘means provoking

litigation’”. Actavis, 570 U.S. at 143 (quoting Caraco, 566 U.S. at 407); see also

Purepac Pharm. Co. v. Thompson, 354 F.3d 877, 879 (D.C. Cir. 2004) (“In

essence, applicants use paragraph IV certifications to challenge the validity of

brand-name manufacturers’ patents.”); Apotex, 347 F.3d at 1339. An ANDA

applicant making a paragraph IV certification is required to notify the patentees

and holder of the approved NDA implicated by its certification that it has made

such certification within 20 days of the ANDA’s filing. See 21 U.S.C.

sec. 355(j)(2)(B)(ii) and (iii). This notification letter, inter alia, must include a

detailed statement laying out the factual and legal bases for the applicant’s

conclusion that the patent is invalid or not infringed. See id. cl. (iv).

The patentees and the NDA holder are entitled to bring suit in Federal

District Court, with remedies including a court order that “the effective date of any

approval of the drug * * * is not earlier than the date of the expiration of the patent

- 10 which has been infringed” and injunctive relief precluding the ANDA applicant

from commercial manufacture. 35 U.S.C. sec. 271(e)(2)(A), (4)(A) (2012); see

also 28 U.S.C. sec. 1338(a) (2012) (providing that the Federal District Courts have

original jurisdiction over “any civil action arising under any Act of Congress

relating to patents”). “Notwithstanding th[e] defined act of infringement, a district

court’s inquiry in a suit brought under [35 U.S.C.] § 271(e)(2) is the same as it is

in any other infringement suit, viz., whether the patent in question is ‘invalid or

will not be infringed by the manufacture, use, or sale of the drug for which the

* * * [ANDA] is submitted.’” Glaxo, Inc. v. Novopharm, Ltd., 110 F.3d 1562,

1569 (Fed. Cir. 1997) (quoting 21 U.S.C. sec. 355(j)(2)(A)(vii)(IV)). “The only

difference in actions brought under [35 U.S.C.] § 271(e)(2) is that the allegedly

infringing drug has not yet been marketed and therefore the question of

infringement must focus on what the ANDA applicant will likely market if its

application is approved, an act that has not yet occurred.” Id.

b.

Effective FDA Approval

The date on which a 35 U.S.C. sec. 271(e)(2) (Section 271(e)(2)) suit is

initiated has consequences for the approval of the generic drug becoming

effective. If a suit is brought within 45 days of notice of an ANDA with a

paragraph IV certification, it triggers a 30-month stay during which the FDA is

- 11 prohibited from granting “effective” approval to the ANDA while the parties

litigate patent validity or infringement. See 21 U.S.C. sec. 355(j)(5)(B)(iii);

Actavis, 570 U.S. at 143.2

If the FDA approves the ANDA during the 30-month stay period, it will

issue a “tentative approval letter”. 21 C.F.R. sec. 314.107(b)(3)(v). “In order for

an approval to be made effective * * *, the applicant must receive an approval

letter from the agency indicating that the application has received final approval.”

Id. “Tentative approval of an application does not constitute ‘approval’ of an

application and cannot, absent a final approval letter from the agency, result in an

effective approval under paragraph (b)(3) of this section.” Id.

“If the courts decide the matter * * * [during the 30-month stay] period, the

FDA follows that determination; if they do not, the FDA may go forward and give

[effective] approval to market the generic product.” Actavis, 570 U.S. at 143; see

also 21 U.S.C. sec. 355(j)(5)(B)(iii) (explaining that approval “shall be made

effective upon the expiration of the thirty-month period” absent court action).3

2

Although a patent suit may be brought outside the 45-day window, the

filing of such a suit does not prohibit the FDA from making its approval effective.

3

Thus, if the court concludes that the patent was invalid or not infringed,

FDA approval becomes effective on the same date as entry of the judgment. See

21 U.S.C. sec. 355(j)(5)(B)(iii)(I) (2012); see also 21 C.F.R. sec. 314.107(b)(3)(ii)

(continued...)

- 12 “The generic manufacturer then has the option to launch ‘at risk,’ meaning that, if

the ongoing court proceeding ultimately determines that the patent was valid and

infringed, the generic manufacturer will be liable for the brand-name

manufacturer’s lost profits despite the FDA’s approval.” In re Lipitor, 868 F.3d

at 241.

c.

180-Day Exclusivity Period

Once approval of an ANDA becomes effective, the generic drug

manufacturer may begin commercially marketing the drug. See 21 U.S.C.

sec. 355(a); see also Eli Lilly, 496 U.S. at 677. “In order to encourage

paragraph IV challenges, thereby increasing the availability of low-cost generic

drugs, * * * [21 U.S.C. sec. 355(j)(5)(B)(iv)] provides that the first company to

win FDA approval of an ANDA containing a paragraph IV certification has the

right to sell its drug without competition for 180 days.” Purepac, 354 F.3d at 879;

see also Teva Pharms., USA, Inc. v. Leavitt, 548 F.3d 103, 104-105 (D.C. Cir.

2008). “Marketing exclusivity is valuable, designed to compensate manufacturers

for research and development costs as well as the risk of litigation from patent

3

(...continued)

(2014). If the court concludes that there has been infringement, effective FDA

approval waits for patent expiration. See 21 U.S.C. sec. 355(j)(5)(B)(iii)(II); see

also 21 C.F.R. sec. 314.107(b)(3)(iii).

- 13 holders.” Teva Pharms., USA, Inc., 548 F.3d at 104; see also Actavis, 570 U.S. at

144 (“Indeed, the Generic Pharmaceutical Association said * * * that the ‘vast

majority of potential profits for a generic drug manufacturer materialize during the

180-day exclusivity period.’”); In re Lipitor, 868 F.3d at 241.

FINDINGS OF FACT

Mylan is a group of affiliated corporations that join in the filing of

consolidated Federal income tax returns. Mylan, Inc., a Pennsylvania corporation

and the common parent of that group, maintained its principal place of business in

Canonsburg, Pennsylvania, when it timely filed the petitions in these consolidated

cases.

I.

Mylan’s Legal Expenses

Mylan manufactures both brand name and generic pharmaceuticals. During

the years relevant to these cases, Mylan regularly submitted ANDAs to obtain

FDA approval for generic versions of brand name drugs, including Celebrex,

Lunesta, and Nexium. As necessary to win FDA approval, Mylan set forth

detailed information to establish that the generic drug was bioequivalent to the

brand name drug, that the generic drug shared the same active components, and

that the manufacturing process would preserve the generic drug’s identity,

strength, and purity.

- 14 Each ANDA also included a certification as to any patent listed in the

Orange Book as covering the brand name drug. During the years relevant to these

cases, Mylan regularly included paragraph IV certifications, asserting that one or

more patents covering the respective brand name drug were invalid or would not

be infringed by Mylan’s generic version. Although Mylan understood that

paragraph IV certifications often resulted in litigation, it further recognized that

such certifications offered both the earliest opportunity to bring its generic

versions to market and the possibility (in some cases) of first-to-file exclusivity.

After filing ANDAs with paragraph IV certifications, Mylan prepared and

sent formal notice letters to the brand name drug manufacturers and patentees

implicated by the certifications. The letters set forth in detail Mylan’s

explanations as to the invalidity of the patents at issue or the reasons that the

manufacture, use, or sale of its generic version did not infringe such patents.

Mylan also informed the FDA when it sent these notice letters.

During 2012 through 2014, Mylan regularly defended itself against

Section 271(e)(2) suits brought in response to ANDAs with paragraph IV

certifications. The FDA was not a party to these suits. Mylan did notify the FDA

if a lawsuit was brought within 45 days of the issuance of the notice letter, in

- 15 consideration of the automatic 30-month stay mandated by 21 U.S.C.

sec. 355(j)(5)(B)(iii).

The FDA’s scientific and regulatory review of Mylan’s ANDAs with

paragraph IV certifications proceeded without regard to any Section 271(e)(2)

litigation. In some instances during the years at issue the 30-month stay expired

during the pendency of the litigation, and Mylan obtained FDA approval for the

generic drug at issue before the suit’s conclusion. When that occurred, Mylan

would continue defending the Section 271(e)(2) suit. On two occasions during the

relevant years, Mylan elected to launch an approved generic drug “at risk”, i.e.,

after the expiration of the 30-month stay but before the resolution of the litigation.

When Mylan won or lost a Section 271(e)(2) suit during the years at issue, it

notified the FDA and provided a copy of the final judgment or mandate. If Mylan

won, it was entitled to launch the generic drug at issue immediately upon approval

by the FDA without waiting for the expiration of the patents covering the brand

name drug. If Mylan lost, the FDA would deem Mylan to have converted its

paragraph IV certification (that the patents listed in the Orange Book were invalid

or were not infringed) into a paragraph III certification (that approval was sought

for a period beginning after the expiration of such patents). If Mylan lost the suit

- 16 after the ANDA had been approved, the FDA would convert the approval to a

tentative approval effective after the expiration of the relevant patents.

Mylan also informed the FDA of other court action during the years at issue.

Mylan apprised the FDA when it entered into settlements to resolve

Section 271(e)(2) suits, communicating the terms of the settlement agreement

including any license permitting Mylan to begin selling its generic drug before the

expiration of the patents covering the brand name drug. And Mylan informed the

FDA when the court issued or vacated preliminary injunctions prohibiting the

marketing or sale of its generic drugs before patent expiration.

Mylan incurred legal fees of $46,158,403, $38,211,911, and $38,618,993

during 2012, 2013, and 2014, respectively, to prepare notice letters and to litigate

the Section 271(e)(2) suits. During the years at issue Mylan reported legal

expenses with respect to approximately 120 suits involving ANDAs with

paragraph IV certifications and 15 additional ANDAs with paragraph IV

certifications for which suits had not yet been filed.

II.

IRS Examination and Tax Court Proceedings

Mylan timely filed a consolidated Form 1120, U.S. Corporation Income Tax

Return, for each of its 2012, 2013, and 2014 taxable years. On those returns

Mylan deducted $46,991,172, $39,684,483, and $44,060,180, respectively, for

- 17 legal fees and expenses it broadly attributed to the litigation of Section 271(e)(2)

suits during those years.

Mylan’s deductions for the years at issue broke down into the

following expense categories: (1) the legal fees described above that Mylan

incurred to prepare paragraph IV notice letters and defend Section 271(e)(2) suits

during 2012 through 2014; (2) legal fees of $832,769, $1,472,572, and

$3,669,397, respectively, which Mylan incurred with respect to generic drugs

(a) for which no Section 271(e)(2) suit was ever brought, (b) for which

Section 271(e)(2) suits were brought but disposed of before the respective year for

which the fees were claimed, and (c) for which Section 271(e)(2) suits were

brought (or joined by Mylan) following the respective year for which the fees were

claimed; and (3) legal fees of $1,771,790 which Mylan incurred in 2014 with

respect to drugs that had already been approved by the FDA and commercially

launched.

The IRS examined Mylan’s 2012 through 2014 returns and determined that,

with the exception of the third category of expense (i.e., the amounts incurred for

previously approved and launched copies), all of the foregoing legal expenses

were nondeductible capital expenditures required to be capitalized under

- 18 section 263(a) and subject to amortization under section 197. It consequently

disallowed Mylan’s claimed deductions, save for the $1,771,790 claimed for 2014.

The IRS thereafter issued notices of deficiency for each of Mylan’s 2012,

2013, and 2014 taxable years determining deficiencies of $16,430,947,

$12,618,695, and $20,988,657, respectively. Mylan filed timely petitions with this

Court for redetermination of the IRS’ determinations for its 2012 through 2014

taxable years. We consolidated the cases, and a trial was held in Washington,

D.C. At trial Mylan put on fact witnesses, and both parties presented expert

testimony regarding internal FDA processes writ large and, more specifically, the

typical course of dealing between an ANDA applicant and the FDA during the

submission process for an ANDA with a paragraph IV certification.4

OPINION

The Commissioner’s determinations in a notice of deficiency are presumed

correct, and the taxpayer bears the burden of proving them erroneous.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). “In exploring the

relationship between deductions and capital expenditures,” we are mindful of the

4

A total of six expert witnesses testified at trial, with each party offering

three experts. The Court admitted all the expert witness reports offered, including

the rebuttal reports. Although the expert witnesses testified extensively at trial,

their testimony is not necessary for the purposes of deciding these cases.

- 19 “familiar rule * * * that the burden of clearly showing the right to the claimed

deduction is on the taxpayer.” INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84

(1992) (quoting Interstate Transit Lines v. Commissioner, 319 U.S. 590, 593

(1943)).

I.

Deductibility Versus Capitalization

A.

General Principles

Section 162(a) allows a deduction for “all the ordinary and necessary

expenses paid or incurred during the taxable year in carrying on any trade or

business”.5 By contrast, section 263(a) provides that “[n]o deduction shall be

allowed” for a capital expenditure. Deductions are exceptions to the “norm” of

capitalization. See INDOPCO, Inc. v. Commissioner, 503 U.S. at 84. Where

section 162 and section 263 each apply to a given expenditure, the capitalization

requirement controls and functions to bar the deduction. See sec. 161; see also

Commissioner v. Idaho Power Co., 418 U.S. 1, 17-18 (1974).

The “primary effect” of a payment’s classification as a deductible business

expense or nondeductible capital expenditure is seen in the timing of the

5

An expense is “ordinary” if it is customary or usual within a particular

trade, business, or industry or relates to a common or frequent transaction in the

type of business involved. See Deputy v. du Pont, 308 U.S. 488, 495 (1940). An

expense is “necessary” if it is appropriate and helpful to the operation of the

taxpayer’s business. See Commissioner v. Tellier, 383 U.S. 687, 689 (1966).

- 20 taxpayer’s cost recovery. INDOPCO, Inc. v. Commissioner, 503 U.S. at 83.

Whereas a deduction for an ordinary and necessary business expenditure may be

taken in the current year and yields an immediate corresponding reduction in

taxable income, a capital expenditure typically results in recovery of a taxpayer’s

expenditure over a longer period through amortization and depreciation

deductions. See Ill. Tool Works, Inc. v. Commissioner, 355 F.3d 997, 1000 (7th

Cir. 2004), aff’g 117 T.C. 39 (2001); PNC Bancorp, Inc. v. Commissioner, 212

F.3d 822, 827 (3d Cir. 2000) (citing INDOPCO, Inc. v. Commissioner, 503 U.S.

at 83-84), rev’g 110 T.C. 349 (1998). Section 263(a) thus “prevent[s] a taxpayer

from utilizing currently a deduction properly attributable, through amortization, to

later tax years when the capital asset becomes income producing.” Commissioner

v. Idaho Power Co., 418 U.S. at 16.

Whether a given expenditure is deductible under section 162 or must instead

be capitalized under section 263(a) turns on the particular facts of each case. See

INDOPCO, Inc. v. Commissioner, 503 U.S. at 86; see also Santa Fe Pac. Gold Co.

& Subs. v. Commissioner, 132 T.C. 240, 262 (2009); FMR Corp. & Subs. v.

Commissioner, 110 T.C. 402, 415 (1998); Norwest Corp. & Subs. v.

Commissioner, 108 T.C. 265, 280 (1997). An expenditure, no matter its type, may

be deductible in one setting but nevertheless required to be capitalized in another.

- 21 See Lychuk v. Commissioner, 116 T.C. 374, 388 (2001); see also Am. Stores Co.

& Subs. v. Commissioner, 114 T.C. 458, 469 (2000) (“Simply because other cases

have allowed a current deduction for similar expenses in different contexts does

not require the same result * * * [in another case].”).

B.

Capitalization of Intangibles

An expenditure generally must be capitalized where it is determined that the

expenditure either: (1) creates or enhances a separate and distinct asset, or

(2) otherwise generates significant benefits for the taxpayer extending beyond the

current taxable year. Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 262;

see also INDOPCO, Inc. v. Commissioner, 503 U.S. at 87; Lincoln Sav. & Loan

Ass’n v. Commissioner, 403 U.S. 345, 354 (1971). In response to difficulties in

administering the significant future benefits standard in the context of intangible

assets, the IRS and the Department of the Treasury proposed regulations that

“defined the exclusive scope of the significant future benefit test through the

specific categories of intangible assets for which capitalization is required”. 67

Fed. Reg. 77702 (Dec. 19, 2002). As adopted, section 1.263(a)-4(b)(1), Income

Tax Regs., requires the capitalization of amounts paid, inter alia: (1) to acquire an

existing intangible; (2) to create certain types of intangibles identified in section

1.263(a)-4(d), Income Tax Regs.; (3) to create or enhance various “separate and

- 22 distinct” intangibles; and (4) to create or enhance a “future benefit” identified in

subsequent guidance published by the IRS.

1.

Relevant Intangibles

For its part, section 1.263(a)-4(d)(5), (7), and (9), Income Tax Regs.,

enumerates certain “created intangibles”, including “rights obtained from a

governmental agency”, contract termination fees, and amounts paid to another to

defend or perfect title to intangible property.6 With respect to rights obtained from

a governmental agency, section 1.263(a)-4(d)(5)(I), Income Tax Regs., specifies:

“A taxpayer must capitalize amounts paid 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 governmental

agency.” Whether an amount is paid to create an intangible under paragraph (d) is

determined on the basis of “all of the facts and circumstances, disregarding

6

A special 12-month rule applies to the created intangibles identified in

sec. 1.263(a)-4(d), Income Tax Regs. Pursuant to that rule, “a taxpayer is not

required to capitalize under this section amounts paid to create (or to facilitate the

creation of) any right or benefit for the taxpayer that does not extend beyond the

earlier of--(I) 12 months after the first date on which the taxpayer realizes the right

or benefit; or (ii) The end of the taxable year following the taxable year in which

the payment is made.” Id. para. (f)(1). The rule is subject to various exceptions,

including for “amounts paid to create (or facilitate the creation of) an intangible

that constitutes an amortizable section 197 intangible within the meaning of

section 197(c).” Id. subpara. (3).

- 23 distinctions between the labels used in this paragraph (d) to describe the intangible

and the labels used by the taxpayer and other parties to the transaction.” Id.

subpara. (1).

As also germane to these cases, section 1.263(a)-4(d)(9)(I), Income Tax

Regs., provides that a “taxpayer must capitalize amounts paid to another party to

defend or perfect title to intangible property if that other party challenges the

taxpayer’s title to the intangible property.” As described in the preamble to the

proposed regulations, “[t]his is consistent with existing regulations” and “is not

intended to require capitalization of amounts paid to protect the property against

infringement and to recover profits and damages as a result of infringement.” 67

Fed. Reg. 77705 (Dec. 19, 2002). “As under current law, these costs are generally

deductible.” Id. (citing Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954),

rev’g 20 T.C. 944 (1953)); see also T.D. 9107, 2004-1 C.B. 447, 450 (“The final

regulations retain the rule contained in the proposed regulations.”).

2.

Facilitative Costs

The direct costs of creating intangibles are not the only costs that must be

capitalized under section 1.263(a)-4, Income Tax Regs. Taxpayers are further

required to capitalize any amounts “paid to facilitate * * * an acquisition or

creation” of, among other things, an intangible described in paragraph (d). Id.

- 24 para. (b)(1)(v). This provision “recognizes that capitalization is required not only

for the cost of an asset itself, but for the ancillary expenditures incurred in

acquiring, creating, or enhancing the intangible asset.” 67 Fed. Reg. 77705 (citing

Woodward v. Commissioner, 397 U.S. 572 (1970)).

“[A]n amount is paid to facilitate the acquisition or creation of an intangible

(the transaction) if the amount is paid in the process of investigating or otherwise

pursuing the transaction.” Sec. 1.263(a)-4(e)(1)(I), Income Tax Regs. Whether an

amount is “paid in the process of investigating or otherwise pursuing” a given

transaction “is determined * * * [on the basis of] all of the facts and

circumstances.” Id. “[T]he fact that the amount would (or would not) have been

paid but for the transaction is relevant, but is not determinative.” Id. For purposes

of this inquiry, “the term transaction means all of the factual elements comprising

an acquisition or creation of an intangible and includes a series of steps carried out

as part of a single plan.” Id. subpara. (3).

C.

Litigation Expenses

The deductibility of a legal expense generally depends upon the origin and

character of the claim with respect to which the expense was incurred. See United

States v. Hilton Hotels Corp., 397 U.S. 580, 583 (1970); Woodward v.

Commissioner, 397 U.S. at 577-578; United States v. Gilmore, 372 U.S. 39, 48-49

- 25 (1963); see also Wellpoint, Inc. v. Commissioner, 599 F.3d 641, 647 (7th Cir.

2010), aff’g T.C. Memo. 2008-236; Newark Morning Ledger Co. v. United States,

539 F.2d 929, 935 (3d Cir. 1976). Under this “origin of the claim” test, “the

substance of the underlying claim or transaction out of which the expenditure in

controversy arose governs whether the item is a deductible expense or a capital

expenditure, regardless of the motives of the payor or the consequences that may

result from the failure to defeat the claim.” Santa Fe Pac. Gold Co. v.

Commissioner, 132 T.C. at 264-265; see also Woodward v. Commissioner, 397

U.S. at 578. “Thus, legal expenses directly connected with (or pertaining to) the

taxpayer’s trade or business are deductible under Section 162 as ordinary and

necessary business expenses”, while “expenses arising out of the acquisition,

improvement or ownership of property are capital expenditures under

Section 263(a) and are not currently deductible.” Meade Emory et al., “Legal

Expenses of Patent Defense Held Deductible”, 70 J. Tax’n 180 (1989); see also

Am. Stores Co. v. Commissioner, 114 T.C. at 468 (citing Commissioner v.

Heininger, 320 U.S. 467 (1943), Commissioner v. Tellier, 383 U.S. 687, 689-690

(1966), and INDOPCO, Inc., v. Commissioner, 503 U.S. at 83).

- 26 Patent law has long distinguished suits for the defense of title to intellectual

property from patent infringement litigation.7 The former involves the disposition

or acquisition of a capital asset, and expenses in litigating such a suit have been

treated as capital--even before the Supreme Court embraced the origin of the claim

test. See, e.g., Estate of Baier v. Commissioner, 533 F.2d 117, 120 (3d Cir. 1976)

(holding that litigation expenses incurred incident to a dispute over the terms of a

disposition are capital), aff’g 63 T.C. 513 (1975); Urquhart v. Commissioner, 215

F.2d at 19-20; Safety Tube Corp. v. Commissioner, 168 F.2d 787 (6th Cir. 1948)

(requiring legal fees to be capitalized where controversy involved title and

ownership of a patent), aff’g 8 T.C. 757 (1947).

Patent infringement litigation is a different creature altogether, sounding in

tort. See Schillinger v. United States, 155 U.S. 163, 169 (1894);

Giesecke+Devrient GmbH v. United States, 150 Fed. Cl. 330, 344 (2020). Such

“litigation is a far cry from removing a cloud of title, or defending ownership of

property.” Urquhart v. Commissioner, 215 F.2d at 20. Usually “what a patent

7

While recognizing the nonprecedential nature of most forms of IRS

administrative guidance, see sec. 6110(k)(3), we note that the IRS has recognized

this distinction as well, see, e.g., 67 Fed. Reg. 77705 (Dec. 19, 2002) (citing

Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954), rev’g 20 T.C. 944 (1953));

Priv. Ltr. Rul. 201536006 (Sept. 4, 2015); Field Serv. Advisory 199925012 (June

25, 1999) (“[A]n acceptance by the Service of Urquhart has developed.”); Tech.

Adv. Mem. 8831001 (Apr. 8, 1988).

- 27 owner loses from infringement is the acquisition of ‘a just and deserved gain’ from

the exploitation of the invention embodied in his patent.” Mathey v.

Commissioner, 177 F.2d 259, 263 (1st Cir. 1949) (quoting 3 Walker on Patents

(Deller’s Ed.) § 281), aff’g 10 T.C. 1099 (1948). Therefore, “an award of damages

in patent [infringement] litigation is ordinarily an award of compensation for gains

or profits lost by the patent owner and hence is taxable to him as income in the

year received.” Id.

As the U.S. Court of Appeals for the Third Circuit, to which an appeal in

these cases would lie absent a stipulation to the contrary, see sec. 7482(b)(1)(B),

has observed, litigation expenses for taxpayers “engaged in the business of

exploiting and licensing patents * * * are peculiarly normal” to their business,

Urquhart v. Commissioner, 215 F.2d at 19. “[F]or taxpayers engaged in the trade

or business of creating and licensing intangible assets, the costs incurred in

prosecuting an action for * * * infringement will most likely be deductible as a

business expense.” Phillip F. Postlewaite et al., Federal Income Taxation of

Intellectual Properties & Intangible Assets, para. 1.03 (2021), 1998 WL 1038665.

Moreover, costs incurred by a business to defend against tort claims

generally have been held deductible for the current taxable year. See, e.g.,

Kornhauser v. United States, 276 U.S. 145, 153 (1928). Both we and our

- 28 predecessor have permitted the deduction of costs incurred in defending patent

infringement suits. See F. Meyer & Bro. Co. v. Commissioner, 4 B.T.A. 481, 482

(1926) (holding that amount paid by defendant in patent infringement suit for an

accounting was an ordinary and necessary expense); Addressograph-Multigraph

Corp. v. Commissioner, a Memorandum Opinion of this Court dated Feb. 5, 1945,

4 T.C.M. (CCH) 147, 166 (1945) (upholding treatment of amounts incurred in

defending patent infringement suits as ordinary and necessary business expenses).

The deductibility of these expenses is consistent with the treatment of damages

paid in the wake of such litigation. Schnadig Corp. v. Gaines Mfg. Co., 620 F.2d

1166, 1169 (6th Cir. 1980) (“When an infringer is required to pay damages to a

design patentee, the amount so paid is deductible from his income tax.”).

II.

Analysis

In these cases, the parties dispute whether the legal fees at issue were

incurred to facilitate the acquisition of a right obtained from a Government

agency. We will begin by identifying the underlying transaction, i.e., the

acquisition of the right, before determining whether the respective fees were paid

in the process of investigating or otherwise pursuing that transaction.

- 29 A.

The Transaction

The parties before us both describe the relevant transaction as the

acquisition of an FDA-approved ANDA with a paragraph IV certification.

However, the parties ascribe very different meanings to this general formulation.

Mylan asserts that the acquisition of an FDA-approved ANDA with a

paragraph IV certification occurs when the FDA completes its scientific and

technical review and issues either a tentative or final approval letter. The

Commissioner asserts that the acquisition of an FDA-approved ANDA with a

paragraph IV certification refers to obtaining effective approval of an ANDA with

a paragraph IV certification.

The Commissioner’s interpretation is the more persuasive.

Section 1.263(a)-4(b)(i)(v), Income Tax Regs., requires capitalization of amounts

paid to facilitate the acquisition or creation of an intangible. As relevant here,

created intangibles include “certain rights obtained from a governmental agency”,

such as “rights under a trademark, trade name, copyright, license, permit,

franchise, or other similar right granted by that governmental agency.” Id.

para. (d)(5)(i).8

8

Neither party contends that FDA-approved ANDAs are subject to the

12-month rule of sec. 1.263(a)-4(f), Income Tax Regs. We therefore do not

(continued...)

- 30 Although the “FDA will approve an * * * [ANDA] and send the applicant

an approval letter” as long as it satisfies the scientific and technical requirements

set forth in 21 C.F.R. sec. 314.127, see 21 C.F.R. sec. 314.105(d); see also 21

U.S.C. sec. 355(j)(4), this approval does not confer any rights on an applicant until

it becomes “effective”, see 21 U.S.C. sec. 355(j)(5)(B); 21 C.F.R. sec. 314.107(a).

Only at that point does the right attach, which then allows for a generic drug to be

“introduced or delivered for introduction into interstate commerce”. 21 C.F.R.

sec. 314.107(a); see also 21 U.S.C. sec. 355(a) (“No person shall introduce or

deliver for introduction into interstate commerce any new drug, unless an approval

of an application filed pursuant to subsection (b) or (j) of this section is effective

with respect to such drug.”).

Mylan has not shown, and we have not found, any authority demonstrating

that approval before it becomes effective confers rights equivalent to “rights under

a trademark, trade name, copyright, license, permit, franchise, or other similar

right granted by that governmental agency.” Sec. 1.263(a)-4(d)(5)(i), Income Tax

Regs. We accordingly adopt the Commissioner’s interpretation of the transaction.

8

(...continued)

address the application vel non of that rule to these cases.

- 31 B.

Relevant Legal Fees

1.

Paragraph IV Notice Letters

We next consider the proper characterization of the legal fees Mylan

incurred during 2012 through 2014 to prepare notice letters relating to its filing of

ANDAs with paragraph IV certifications. An applicant for an ANDA with a

paragraph IV certification “shall give notice” to “each owner of the patent that is

the subject of the certification” and the holder of the NDA with respect to the

brand name drug covered by such patents. 21 U.S.C. sec. 355(j)(2)(B)(iii). The

notice is required to inform the recipients of the ANDA submission and to explain

in detail “the factual and legal basis of the opinion of the applicant that the patent

is invalid or will not be infringed.” Id. cl. (iv). After providing that notice, the

applicant is required to submit an amendment to its ANDA reflecting that the

notice had been given. See 21 C.F.R. sec. 314.95(b).

This notice requirement is also a part of the ANDA itself. Under 21 U.S.C.

sec. 355(j)(2)(B)(i), the applicant that makes a paragraph IV certification “shall

include” in its ANDA a statement that the applicant “will give notice” as outlined

in 21 U.S.C. sec. 355(j)(2)(B). And failure to provide such notice has tangible

consequences as “certifications become effective only upon notification.”

Purepac, 354 F.3d at 890.

- 32 The notice described above thus is a required step in securing an

FDA-approved ANDA for those applicants that make a paragraph IV certification.

Sec. 1.263(a)-4(e)(3), Income Tax Regs. Although Mylan argues that the notice

serves to facilitate patent litigation, Congress has made the notice a prerequisite

for ANDA approval. Consequently, 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, id. subpara. (1)(i), and must be capitalized, see also id. para. (l), Example

(1) (concluding that payments to outside counsel to prepare license application

facilitated the creation of an intangible).

2.

Section 271(e)(2) Litigation Expenses

We reach a different conclusion with respect to Mylan’s Section 271(e)(2)

litigation expenses incurred during the years at issue. In the Hatch-Waxman Act,

Congress sought to encourage the entry of low-cost generic drugs into the

marketplace while softening the risk to cost-intensive innovation by giving brand

name drug manufacturers the opportunity to avail themselves of patent law

protections before sustaining damages. Among other changes made to accomplish

these objectives, the Hatch-Waxman Act moved up the timeline of patent litigation

with respect to generic copies of brand name drugs subject to a patent listed in the

- 33 Orange Book. Although the filing of an ANDA with a paragraph IV certification

triggers the opportunity for patent litigation as well as the FDA review process,

this statutory design does not transform patent litigation into a step in the ANDA

approval process. The patent litigation expenses at issue accordingly are not

subject to capitalization.

a.

Hatch-Waxman Regime

We start by considering the ANDA approval process. The FDA reviews an

ANDA to ensure that certain safety standards are met and that the generic copy has

the same active ingredients as, and is “bioequivalent” to, the approved brand name

drug. See 21 U.S.C. sec. 355(j)(2)(A), (4); see also Actavis, 570 U.S. at 142;

Caraco, 566 U.S. at 404-405. According to 21 U.S.C. sec. 355(j)(4), the FDA

“shall approve” an ANDA unless it fails to satisfy certain technical requirements

enumerated in the statute and accompanying regulations, including failure to show

that the generic has the same active ingredients as the brand name drug, failure to

show bioequivalence between the drugs, failure to establish that the production

methods would preserve the generic’s identity, strength, quality, and purity, and

failure to show proper labeling. See also 21 C.F.R. secs. 314.105(d), 314.127.

The outcome of a Section 271(e)(2) suit has no bearing on the FDA’s safety

and bioequivalence review. The FDA continues its review process during the

- 34 pendency of the patent infringement suit and may issue a tentative or final

approval before the suit is resolved. The FDA does not analyze patent issues as

part of its review, and neither the statute nor regulations suggest that patent issues

might block approval of an ANDA. And winning a patent litigation suit does not

ensure that the generic drug manufacturer will receive approval, as the FDA can

disapprove an ANDA for not meeting safety and bioequivalence standards.

21 U.S.C. sec. 355(j)(4)(F).

A review of the patent litigation framework implemented by the

Hatch-Waxman Act likewise fails to suggest that such litigation is an element of

the approval process for ANDAs with paragraph IV certifications. “[T]o guard

against infringement of patents relating to * * * [brand name] drugs”, Eli Lilly,

496 U.S. at 676-677, Congress devised a system where a certification that a patent

covering the brand name drug is invalid or not infringed “automatically counts as

patent infringement”, Actavis, 570 U.S. at 143. The new cause of action

embodied in Section 271(e)(2) was a direct response to Congress’ decision to end

the prohibition on use of brand name pharmaceuticals for research and

development before the expiration of patents covering such pharmaceuticals. See

- 35 35 U.S.C. sec. 271(e)(1).9 The technical act of infringement provided an earlier

trigger for a patent suit “so that courts could promptly resolve infringement and

validity disputes before the ANDA applicant had engaged in the traditional

statutorily defined acts of infringement.” AstraZeneca Pharms. LP v. Apotex

Corp., 669 F.3d 1370, 1377 (Fed. Cir. 2012); see also Bristol-Myers Squibb Co. v.

Royce Labs., Inc., 69 F.3d 1130, 1135 (Fed. Cir. 1995) (holding that a

Section 271(e)(2) suit makes “it possible for a patent owner to have the court

determine whether, if a particular drug were put on the market, it would infringe

the relevant patent”).

Although the Hatch-Waxman Act moved up the timing of patent litigation,

its character remained unchanged. “Notwithstanding th[e] defined act of

infringement, a district court’s inquiry in a suit brought under § 271(e)(2) is the

same as it is in any other infringement suit, viz., whether the patent in question is

‘invalid or will not be infringed by the manufacture, use, or sale of the drug for

which the * * * [ANDA] is submitted.’” Glaxo, 110 F.3d at 1569 (quoting 21

9

“For those who consider legislative history relevant,” Warger v. Shauers,

574 U.S. 40, 48 (2014), in its report on the bill proposing what became the HatchWaxman Act, the House Energy & Commerce Committee stated that “[t]he

purpose of sections 271(e)(1) and (2) is to establish that experimentation with a

patented drug product, when the purpose is to prepare for commercial activity

which will begin after a valid patent expires, is not a patent infringement”, H.R.

Rept. No. 98-857 (Part 1), at 45 (1984), 1984 U.S.C.C.A.N. 2647, 2678.

- 36 U.S.C. sec. 355(j)(2)(A)(vii)(IV)); see also Alcon Research Ltd. v. Barr Labs.,

Inc., 745 F.3d 1180, 1186 (Fed. Cir. 2014); Abbott Labs. v. TorPharm, Inc., 300

F.3d 1367, 1373 (Fed. Cir. 2002).10 “The only difference in actions brought under

§ 271(e)(2) is that the allegedly infringing drug has not yet been marketed and

therefore the question of infringement must focus on what the ANDA applicant

will likely market if its application is approved, an act that has not yet occurred.”

Glaxo, 110 F.3d at 1569.

The Commissioner counters that a Section 271(e)(2) suit is a step in

obtaining effective approval of an ANDA with a paragraph IV certification. He

asserts that the Hatch-Waxman regime incentivized the filing of ANDAs with

paragraph IV certifications by the prospect of market entry before patent

expiration and lucrative first-to-file exclusivity and that Section 271(e)(2) suits

ineluctably followed. We are not persuaded. Although Congress erected a

framework that promotes the prompt resolution of patent issues, aaiPharma, 296

F.3d at 232, the Commissioner fails to demonstrate how encouraging early and

10

Again, for those who wish to consider legislative history, the House

Energy & Commerce Committee noted in its report that “[t]he provisions of this

bill relating to the litigation of disputes involving patent validity and infringement

are not intended to modify existing patent law with respect to the burden of proof

and the nature of the proof to be considered by the courts in determining whether a

patent is valid or infringed.” H.R. Rept. No. 98-857 (Part 1), supra at 28, 1984

U.S.C.C.A.N. at 2661.

- 37 expeditious patent litigation shows that such litigation is an element of acquiring

effective FDA approval of an ANDA with a paragraph IV certification.

The Commissioner also points to statutory provisions linking the effective

date of approval to the outcome of Section 271(e)(2) suits as supporting his view.

As an initial matter, we note that a Section 271(e)(2) suit is not required to obtain

effective approval of an ANDA with a paragraph IV certification, see 21 U.S.C.

sec. 355(j)(5)(B)(iii), and that a brand name drug manufacturer is under no

obligation to initiate such a suit in response to an ANDA with a paragraph IV

certification. Both of these points belie the idea that a Section 271(e)(2) suit is a

step in obtaining an effective FDA approval.

Title 21 sec. 355(j)(5)(B)(iii), on which the Commissioner relies, does not

suggest a different result. Where “the courts decide the matter within * * * [the

30-month stay] period, the FDA follows that determination; if they do not, the

FDA may go forward and give approval to market the generic product.” Actavis,

570 U.S. at 143. Title 21 sec. 355(j)(5)(B)(iii) thus ties the effective date to the

outcome of a Section 271(e)(2) suit.

Congress’ decision to coordinate effective FDA approval with the outcome

of a Section 271(e)(2) suit does not convert such litigation into a link in the

ANDA approval chain. To the contrary, a Section 271(e)(2) suit serves the same

- 38 function as a normal patent infringement suit under 35 U.S.C. sec. 271(a), namely,

allowing patent holders the opportunity to vindicate their intellectual property

rights. Moreover, the primary relief available in a Section 271(e)(2) suit, i.e.,

prohibiting introduction of the infringing product into the market until expiration

of the applicable patent, is the same relief available in a normal patent

infringement suit (through an injunction), only tailored for the unique context

where the infringing product has not yet been introduced into the market. See

35 U.S.C. sec. 271(e)(4)(A).11 The statutory coordination between the outcome of

Section 271(e)(2) litigation and FDA effective approval ensures that the FDA does

not run afoul of a District Court’s resolution of the intellectual property rights of

the parties when deciding whether to grant approval. See Caraco, 566 U.S. at 405

(“[T]he FDA cannot authorize a generic drug that would infringe a patent[.]”).

Section 271(e)(2) litigation is a vehicle built for the patent holder. It is the

patent holder that has the choice to bring litigation within 45 days of notice, with

the consequences described in 21 U.S.C. sec. 355(j)(5)(B)(iii). The legal expenses

11

We note that this point was made by Representative Henry Waxman

before the enactment of the Hatch-Waxman Act, for those who find such

statements worth considering. See 130 Cong. Rec. 24427 (1984) (statement of

Rep. Henry Waxman). Mr. Waxman observed that, under then-current patent law,

“if someone markets a competitive product, * * * [brand name drug manufactures]

can go to court and sue for an injunction, or they can sue for treble damages for

infringement of that patent.” Id.

- 39 incurred in defending such suits relate to determining the patent holders’

intellectual property rights with respect to brand name drugs. Absent the filing of

such a suit by a patent holder, the generic drug manufacturer is under no

obligation to demonstrate that a patent is invalid or not infringed to obtain FDA

approval. In other words, a patent on a brand name drug presents no impediment

to FDA approval of a generic version unless the patent holder decides to take

advantage of the mechanism Congress provided for an early adjudication of the

patent holder’s rights.12 We cannot conclude that such litigation--controlled by

and primarily benefiting patent holders--is a step in the FDA approval process for

the generic drug.

As a final matter, section 1.263(a)-4(e)(1)(i), Income Tax Regs., identifies

“the fact that the amount would (or would not) have been paid but for the

12

Our view on this point is consistent with that expressed by Representative

Waxman, again for those who consider such statements. In responding to an

objection to the 30-month stay, Mr. Waxman noted that “[t]he facts of life are that

a generic drug manufacturer will await, as a practical matter, until the decision of a

court on a patent challenge before that manufacturer markets a generic drug.” 130

Cong. Rec. 24427. He continued that “[t]he 30-month period is one that gave

further assurance to the brand-name drug manufacturer that the generic drug

manufacturer would not put his competitor on th[e] market until that court

decision came through.” Id. Mr. Waxman did not suggest either that the patent

litigation is connected with obtaining FDA approval, or that the 30-month stay

was more than reassurance to brand name drug manufacturers in the patent

context.

- 40 transaction” as a relevant, although not dispositive, factor in evaluating whether an

expense facilitates a transaction. On a surface level, this factor appears to weigh

in favor of the Commissioner’s position: absent the transaction to obtain FDA

approval, the generic drug manufacturer would not make a paragraph IV

certification, the patent holder would not initiate a Section 271(e)(2) suit, and the

generic drug manufacturer would not incur litigation expenses defending that suit.

Nonetheless “a district court’s inquiry in a suit brought under § 271(e)(2) is the

same as is in any other infringement suit”. Glaxo, 110 F.3d at 1569. Even absent

the transaction, the patent holder would doubtless seek to defend its intellectual

property against a potential infringer, and the generic manufacturer would incur

the same litigation costs in defending such suit. We are not persuaded that the

litigation expenses would not have been incurred but for the transaction.13

In summary, the Hatch-Waxman Act made coordinated changes to several

areas of law, including the FDA approval process and patent law, to serve its goals

of encouraging the entry of low-cost generic drugs into the marketplace while

affording patent protections to brand name drug manufacturers. See, e.g., In re

13

Again, for those who wish to consider Mr. Waxman’s views on this point,

he noted that under then-current patent law, “if someone markets a competitive

product, * * * [brand name drug manufacturers] can go to court and sue for an

injunction, or they can sue for treble damages for infringement of that patent.”

130 Cong. Rec. 24427.

- 41 Lipitor, 868 F.3d at 240; Am. Bioscience, 269 F.3d at 1079. Despite the

coordination devised by Congress, Section 271(e)(2) litigation is not a step in

obtaining effective FDA approval of an ANDA with a paragraph IV certification.

Accordingly, expenses Mylan incurred in defending Section 271(e)(2) suits were

not “paid to facilitate” the transaction and are not required to be capitalized.

b.

Origin of the Claim

The origin of the claim test likewise indicates that Section 271(e)(2)

litigation expenses should be treated as deductible ordinary and necessary business

expenses. Under this test, we inquire “whether the origin of the claim litigated is

in the process of acquisition”, enhancement, or other disposition of a capital asset.

Woodward v. Commissioner, 397 U.S. at 577; see also Santa Fe Pac. Gold Co. v.

Commissioner, 132 T.C. at 264-265.

The legal expenses at issue arose out of actions initiated by patent holders to

protect their intellectual property from infringement and exploitation. See, e.g.,

Glaxo, 110 F.3d at 1569 (“[A] district court’s inquiry in a suit brought under

§ 271(e)(2) is the same as it is in any other infringement suit, viz., whether the

patent in question is ‘invalid or will not be infringed by the manufacture, use, or

sale of the drug for which the * * * [ANDA] is submitted.’” (quoting 21 U.S.C.

sec. 355(j)(2)(A)(vii)(IV))). Patent infringement suits are creatures of tort,

- 42 Schillinger, 155 U.S. at 169; Giesecke+Devrient GmbH, 150 Fed. Cl. at 344, with

an aim of preventing and recovering damages to the patent holder’s business of

exploiting its patent, see Urquhart v. Commissioner, 215 F.2d at 20.

The U.S. Court of Appeals for the Third Circuit has previously explained

the proper treatment of expenses incurred in litigating an infringement suit. See

id. at 18-19. In that case the taxpayers attempted to deduct various legal expenses

associated with patent infringement litigation, and the IRS disallowed the

deductions on the ground that they were capital expenditures for the protection or

perfection of property rights. Id. We sustained the IRS’ determination. Urquhart

v. Commissioner, 20 T.C. 944. The Third Circuit disagreed, pointing out that

patent infringement “litigation is a far cry from removing a cloud of title, or

defending ownership of property.” Urquhart v. Commissioner, 215 F.2d at 20. It

reasoned that the litigation instead “arose out of and related directly to the

exploitation of the invention embodied in the patent” and thus held that the

litigation expenses were incurred not to defend or protect title but rather, “to

prevent (and recover) damage to their business, that is, to protect, conserve and

maintain their business profits.” Id.14 The Department of the Treasury explicitly

14

Although Urquhart preceded Woodward v. Commissioner, 397 U.S. 572

(1970), by nearly 20 years, we note that the Third Circuit’s analysis of the

(continued...)

- 43 endorsed the Third Circuit’s holding in Urquhart in the preamble to its proposed

regulations on the capitalization of intangible assets. See 67 Fed. Reg. 77705

(noting that the proposed regulation was consistent with “existing regulations” and

“current law” and “is not intended to require capitalization of amounts paid to

protect the property against infringement”).

The litigation expenses at issue here likewise arose out of patent

infringement claims. See Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C.

at 264-265 (“[T]he substance of the underlying claim or transaction out of which

the expenditure in controversy arose governs whether the item is a deductible

expense or a capital expenditure[.]” (Emphasis added.)). Under the reasoning of

Urquhart, the litigation expenses of the patent holders that initiated infringement

suits against Mylan seem clearly deductible.

We see no reason that Mylan should face different treatment. Expenses

incurred in defending patent infringement claims have been found deductible in

the past. See F. Meyer & Bro. Co. v. Commissioner, 4 B.T.A. at 482;

Addressograph-Multigraph Corp. v. Commissioner, 4 T.C.M. (CCH) at 166.

Although Section 271(e)(2) litigation usually occurs before marketing and sale of

14

(...continued)

litigation expenses perceptively anticipated the origin of the claim test that the

Supreme Court adopted.

- 44 the generic drug, the purpose of the suit remains to protect future business

profits.15 Cf. Urquhart, 215 F.2d at 20; Mathey v. Commissioner, 177 F.2d at 263.

We conclude that the litigation expenses that Mylan incurred in defending

Section 271(e)(2) suits arose out of the ordinary and necessary activities of its

generic drug business and accordingly are deductible. See Am. Stores Co. v.

Commissioner, 114 T.C. at 468.

In short, the Commissioner fails to convince us that the substance of the

underlying claim arises out of the acquisition, ownership, or improvement of

property as might support the capitalization of Mylan’s Section 271(e)(2)

litigation expenses. Indeed, we struggle to see the nature of the property right that

the Commissioner has in mind. Although a generic drug manufacturer must assert

in an ANDA with a paragraph IV certification that listed patents covering the

brand name drug are invalid or not infringed by the generic version, the

manufacturer is not required to undertake affirmative litigation to establish that

point as a condition of entering its generic on the market. It thus does not appear

15

Where a generic drug has been launched “at risk,” i.e., after the conclusion

of the 30-month stay but before the resolution of the litigation, the plaintiff in the

Section 271(e)(2) suit may seek damages as in a normal infringement suit. See 35

U.S.C. sec. 271(e)(4)(C). As explained, such infringement damages have been

treated as deductible business expenses of the infringing party. See Schnadig

Corp. v. Gaines Mfg. Co., 620 F.2d 1166, 1169 (6th Cir. 1980).

- 45 that Section 271(e)(2) litigation relates to the acquisition or enhancement of any

right of a generic drug manufacturer, such that the expenses incurred in that

litigation must be capitalized. This litigation instead gives the brand name drug

manufacturer a chance to protect its intellectual property. In this circumstance, the

origin of the claim test suggests that Mylan’s litigation expenses are deductible.

c.

Regulatory Examples

Certain examples set forth in sections 1.263(a)-4(e) and 1.263(a)-5(l),

Income Tax Regs., illustrating the scope of the term “facilitate” in

section 1.263(a)-4(e)(1)(i), Income Tax Regs., offer further support for our

conclusion. As an initial matter, the parties spar over whether we should consider

the regulations set forth in section 1.263(a)-5(l), Income Tax Regs., which address

the treatment of “[a]mounts paid or incurred to facilitate an acquisition of a trade

or business, a change in the capital structure of a business entity, and certain other

transactions”, given that the issue before us relates to section 1.263(a)-4(e),

Income Tax Regs., which bears on “[a]mounts paid to create or acquire

intangibles” as applies to our cases. Both provisions include a nearly identical

description of the term “facilitate”, and we will consider the regulatory examples

to the extent they illuminate the common term.

- 46 We believe that the most apposite example is section 1.263(a)-5(l), Example

(18)(i), Income Tax Regs. This example discusses the treatment of legal fees paid

in connection with bankruptcy proceedings implicating tort liability of the

taxpayer. It provides:

X corporation is the defendant in numerous lawsuits alleging tort

liability based on X’s role in manufacturing certain defective

products. X files a petition for reorganization under Chapter 11 of the

Bankruptcy Code in an effort to manage all of the lawsuits in a single

proceeding. X pays its outside counsel to prepare the petition and

plan of reorganization, to analyze adequate protection under the plan,

to attend hearings before the Bankruptcy Court concerning the plan,

and to defend against motions by creditors and tort claimants to strike

the taxpayer’s plan. [Id.]

The example concludes, in relevant part, that the legal expenses paid by X “to

prepare, analyze or obtain approval of the portion of X’s plan of reorganization

that resolves X’s tort liability do not facilitate the reorganization and are not

required to be capitalized, provided that such amounts would have been treated as

ordinary and necessary business expenses under section 162 had the bankruptcy

proceeding not been instituted.” Id. Example (18)(ii). We see a strong parallel

here, where patent litigation is connected with but distinct from the broader project

of obtaining effective FDA approval of ANDAs with paragraph IV certifications.

The conclusion reached by the example, i.e., that the separate litigation expenses

should not be capitalized, thus attaches here.

- 47 The Commissioner argues that section 1.263(a)-4(e)(5), Example (4),

Income Tax Regs., provides the more apt comparison. In that example U owns a

majority of the shares in T while M is a minority shareholder. See id. U and M

disagree over a perpetual extension of T’s charter, which, under State law, requires

U to buy out M. See id. A dispute over the proper value of M’s stock spawns

litigation and $25,000 in litigation expenses. See id. The example concludes that

the litigation expenses facilitate the acquisition of stock by helping to establish the

purchase price and thus must be capitalized. See id.

Despite the complicated backdrop, the principle illustrated by this example

is straightforward: litigation expenses incurred to establish a necessary element of

the transaction (i.e., the purchase price) facilitate it and are subject to

capitalization. We believe the instant case is not comparable. The patent

litigation expenses were not incurred in connection with a necessary element of

obtaining effective FDA approval but to resolve the question of patent rights. As

such, the example finds no purchase here.

C.

Conclusion

We hold that the disputed legal expenses that Mylan incurred during the

years at issue to prepare paragraph IV notice letters must be capitalized pursuant

to section 263(a), whereas expenses incurred to litigate Section 271(e)(2) suits are

- 48 currently deductible pursuant to section 162(a). The IRS’ determinations as set

forth in the notices of deficiency are accordingly sustained for amounts incurred to

prepare paragraph IV notice letters.

III.

Amortization of Mylan’s Legal Expenses

Lastly we turn briefly to the amortization (that is, the incremental recovery)

of Mylan’s expenses for the years at issue. Though Mylan has raised various

concerns regarding the equitable and policy implications of requiring generic drug

manufacturers to recover their legal expenses over a 15-year term, we understand

Mylan’s arguments to be geared toward advocating its general position that its

expenses are not capital expenditures.

When the IRS determined to disallow Mylan’s deductions, part of its

determination reflected that Mylan’s expenses were subject to amortization over a

15-year period pursuant to section 197. See sec. 197(a). In general, where

section 197 applies, no other method of depreciation or amortization is permitted.

Id. subsec. (b).

Mylan does not contest in its posttrial briefing the substance of the IRS’

determination that, assuming Mylan’s expenses were capital, section 197 provides

the method for amortization of those expenses. Mylan is therefore deemed to have

conceded the section 197 amortization issue. See Mendes v. Commissioner, 121

- 49 T.C. 308, 312-313 (2003); Leahy v. Commissioner, 87 T.C. 56, 73-74 (1986); see

also Ohde v. Commissioner, T.C. Memo. 2017-137, at *2 n.2. We accordingly

sustain the IRS’ determination that Mylan’s expenses fall within the bounds of

section 197.

IV.

Conclusion

In sum Mylan is liable for tax deficiencies as to amounts incurred to prepare

paragraph IV notice letters for its 2012, 2013, and 2014 taxable years.

To reflect the foregoing,

Decisions will be entered under

Rule 155.