We are all familiar with Form 8275, Disclosure Statement, and its sibling, Form 8275R, collectively known as the “Please Audit Me” forms. Today, Judge Patrick J. (“Scholar Pat”) Urda encounters the “paragraph IV certification,” also known as Please Sue Me.

Per the Waxman-Hatch Act, Pub. L. No. 98-417, 98 Stat. 1585 (1984), which intended to speed up generic drug approvals, manufacturers of generics could get fast-track pre-approvals from FDA if they certified the generics were equal to the brand-names, and the generic crowd could get exclusive marketing rights. But they also had to certify that the brand-name patents were expired or invalid, and let the patentees know.

Mylan Inc. and Subsidiaries, 156 T. C. 10, filed 4/27/21, ran up some hefty legal bills during the years at issue, between preparing notices to patentees that would satisfy FDA and fighting off the patentees before FDA final approval; like about $123 million in legal fees.

Mylan expensed the lot. IRS, surprise, surprise, wants the whole deal capitalized. IRS claims this is part of the cost of producing and marketing the generics, except for maybe $1.7 million for defending drugs already fully approved. And Judge Scholar Pat goes through the entire process in granular detail, having listened to the various experts presented by both sides.

The issue is whether the expenditure is a one-year consumable (expense), or a gift that keeps on giving through the years (capital). The Section 263 regulations set out the rules for “… 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. 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 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).” 156 T. C. 10, at pp. 22-23. (Footnotes omitted).

And the Reg Section takes in amounts paid to another party if that party challenges the claim to the intangible.

Expenses for acquiring, creating or enhancing the intangible must be capitalized.

 But the preamble to the Regs states that expenses of defending against infringement and collecting damages from infringement are deductible.

Expenses of litigating infringement are materially different from expenses of acquiring, creating or enhancing that which was infringed. Litigating infringement seeks getting the gain that inures to the owner of the intangible. And defense of one’s intangible is protecting said gain. Both are deductible.

So when does Mylan get the rights from the governmental agency? The convoluted FDA approval is only effective, that is, only allows the genericist to sell, after they have drafted, gotten approval of, and sent out the paragraph IV “sue-me” letter.

Mylan claims the sue-me is part of litigation, but Judge Scholar Pat says it’s part of getting the effective 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 [the FDA effective approval]… and must be capitalized….” 156 T. C. 10, at p. 32. It’s really part of the application process.

But once the torpedoes have been launched, it’s another story. The expenses and outcomes of the various litigations brought by the patentees are defending Mylan’s right to sell the generics.

“The outcome of a [patent] suit has no bearing on the FDA’s safety and bioequivalence review. The FDA continues its review process during the 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 [application]. And winning a patent litigation suit does not ensure that the generic drug manufacturer will receive approval, as the FDA can disapprove [an application] for not meeting safety and bioequivalence standards.” 156 T. C. 10, at pp. 33-34.

The aim of the statute was to prevent patentees from treating any experimentation with their patented drug pre-expiry as an infringement.   

Once the experimenter goes forward, then the patentee can sue, but it’s a straight infringement suit. IRS claims that the suits are a prerequisite to approval. Except effective approvals can issue without a final judgment in an infringement case, and the brand name manufacturer isn’t obliged to sue.

 And the familiar origin of the claim test shows the origin of the claimed litigation expenses is a patent infringement case, not obtaining FDA approval. It’s to obtain profits, not protect title.

So the legal fees for preparing the sue-me letters are not currently deductible.