Courts generally consider costs relating to patent infringement litigation to be tax deductible. However, until recently, it was unclear whether expenses arising from patent litigation under the Hatch-Waxman Act should be treated similarly. Patent litigation under the Hatch-Waxman Act plays a key role in allowing a generic pharmaceutical company to obtain FDA approval to market its generic version of a name brand drug. The Third Circuit considered this issue in Mylan Inc & Subsidiaries v Commissioner of Internal Revenue. However, it was not until this year that the US Court of Appeals for the Federal Circuit addressed this issue in Actavis Laboratories FL Inc v United States.
Actavis lies at the intersection of:
- the Hatch-Waxman Act;
- patent litigation; and
- Title 26 of the US Code (the tax code).
Actavis highlights notable differences between litigation arising from Hatch-Waxman and non-Hatch-Waxman cases, and the resulting tax implications. This article discusses the Federal Circuit's holding and reasoning, as well as potential implications for generic pharmaceutical companies.
Implications and significance
It should come as no surprise that Hatch-Waxman litigation is an expensive endeavor, with companies spending millions of dollars every year fighting over whether a generic version of a name brand pharmaceutical can enter the market. For example, Actavis had reported they spent over $12 million in Hatch-Waxman litigation fees in 2008 and 2009, and Mylan reported they had spent approximately $130 million between 2012 and 2014. Given the amount of money involved, whether these expenses are tax deductible can have significant implications on a company's tax liability—reported to be around $4.3 million for Actavis and $50 million for Mylan—and can result in significant interest and penalties if misapplied.
Actavis is an important case for generic pharmaceutical companies to be aware of as it solidifies the tax implications of expenses incurred during Hatch-Waxman litigation and serves as a roadmap for determining whether non-litigation expenses incurred as part of the Hatch-Waxman Act (expenses incurred in drafting a notice letter) should be categorised as an ordinary business expense.
Features of the Hatch-Waxman Act
As a primer for the uninitiated, the Hatch-Waxman Act attempts to balance two competing objectives: inducing "[branded] pharmaceutical firms to make the investments necessary to research and develop new drug products that are not biologics, while simultaneously enabling competitors to bring cheaper, generic copies of those drugs to market", explains the 1990 case Abbott Labs v Young. Key features of the Hatch-Waxman Act relevant to Actavis centre on the ability of generic manufacturers to receive expedited approval through an Abbreviated New Drug Application, or ANDA for short, while permitting brand companies to sue for infringement well before the US Food and Drug Administration has approved the ANDA and even to pause the administration's approval of the ANDA for 30 months.
At the heart of the Hatch-Waxman act is the Orange Book which the Food and Drug Administration maintains. In order for a brand company to take advantage of the benefits they must list the patents covering the new drug in the Orange Book, and when an ANDA applicant seeks to obtain approval to market a generic version prior to the listed patent's expiration date, the applicant must submit a "Paragraph IV certification" to the Food and Drug Administration that asserts the patent is invalid or not infringed.
After filing the Paragraph IV certification, the ANDA applicant must notify the patent holder of it via a "notice letter". This starts the clock for a patent holder to bring a suit for patent infringement against the ANDA applicant to stay the Food and Drug Administration approval. A promptly filed suit stays the approval of the ANDA application for up to 30 months pending resolution of the case. However, in the event the 30-month stay expires or the case resolves in the ANDA applicant's favor, the Food and Drug Administration can grant final approval of the ANDA if it is otherwise approvable.
The ANDA litigation process is distinct among patent litigation because there has yet to be any actual sale of a product. Patents are tested before sales of a competing product begin. As a result, there were questions whether the traditional tax treatment of patent litigation expenses applied to Hatch-Waxman litigation expenses.
The Actavis decision
In Actavis,the issue before the Federal Circuit was whether the litigation expenses incurred by an ANDA applicant defending against a Hatch-Waxman litigation are tax-deductible as ordinary business expenses. In its tax filings with the Internal Revenue Service, and consistent with the tax classification of non-ANDA litigation expenses, Actavis deducted its $12 million Hatch-Waxman litigation expenses as ordinary business expenses. The tax agency disagreed and took the position that because the expenses were incurred in pursuit of an intangible capital asset—specifically, Food and Drug Administration approval to market its generic drugs—they amounted to nondeductible capital expenditures. The US Court of Federal Claims granted summary judgment in favor of Actavis, and the government appealed.
While the appeal was pending, the US Court of Appeals for the Third Circuit considered a similar fact pattern and held that legal expenses incurred in defending against Hatch-Waxman litigation are deductible as ordinary business expenses.
In contemplating the Actavis issue, the Federal Circuit primarily focused on two competing tests advanced by the parties for how to categorise the patent litigation expenses. Actavis contended that the Federal Circuit should apply the "origin of the claim" test from a 1970 case, Woodward v Commissioner of Internal Revenue. The government, in contrast, insisted on the Federal Circuit applying Internal Revenue Service regulation C.F.R. § 1.263(a)-4, which implements the "significant future benefit" methodology.
The Federal Circuit found that both tests yielded the same result. It determined that Food and Drug Administration approval of the ANDA was either granted or withheld solely based on whether the agency regards the generic drug as a safe, effective and bioequivalent alternative to the branded version. Although the outcome of a Hatch-Waxman litigation drives the timing of when the government can grant final approval of an ANDA, the litigation and the ANDA approval proceed on separate timelines and they "do not depend on each other". As the Court of Federal Claims put it, the "generic drug company is not obligated to demonstrate patent invalidity or non-infringement to the FDA to obtain ANDA approval, nor is it obligated to show the technical acceptability of its ANDA application to the court during Hatch-Waxman litigation". Thus, the "origin of the claim" is not the ANDA applicant's pursuit of market approval for its drug, but the patent holder's decision to enforce its patent through litigation. Similarly, the Federal Circuit found that ANDA litigation does not facilitate the acquisition of ANDA approval as required by the Internal Revenue Service regulation.
Moreover, while the Federal Circuit did not directly address this question in terms of litigation arising under the related Biologics Price Competition and Innovation Act (BPCIA) governing biosimilars, it would appear to be a fair extension as the Food and Drug Administration's approval of a biosimilar is similarly independent of the results of any litigation under BPCIA.
Overall, Actavis sets the stage for ANDA applicants to pursue a tax benefit by deducting Hatch-Waxman litigation expenses as a business expense.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
