Tax Court Examines Claim Origin and Legal Fees Doctrine | Freeman Law

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[author: John Reyna]

A recent Tax Court decision dealt with the deductibility of legal fees and the so-called “origin of the claim” theory. the Mylan The decision demonstrates that the deductibility of legal fees generally depends on the origin and character of the underlying claim or transaction from which the legal fees were incurred. An expense, such as legal fees, may be deductible in one setting, but must nonetheless be capitalized in another. Legal fees directly related to (or relating to) the trade or business of the taxpayer are deductible under section 162 of the IRC as ordinary and necessary business expenses, while expenses arising from the taxpayer The acquisition, improvement or ownership of property is a capital expenditure under section 263 of IRC (a) and is not currently deductible.

Mylan, Inc. and its subsidiaries v. Commissioner, 156 TC n ° 10 | April 27, 2021 | File n ° 26976-16 | Urda, J.

Short summary: Mylan, Inc. and its subsidiaries (“Mylan”) is a manufacturer of brand name and generic drugs. To gain approval from the Food & Drug Administration (“FDA”) for generic versions of brand name drugs, Mylan had to provide certification regarding the status of all patents that the FDA had listed as covering the respective brand name drug.

Mylan has certified that the listed patents covering the respective brand name drug are invalid or that the generic version of Mylan will infringe them. This type of certification automatically counts as patent infringement and often causes litigation under 35 USC Section 271 (e) (2). Mylan was to send notice letters to the brand name drug maker and all patent holders stating that Mylan had achieved this certification.

Mylan incurred legal fees in preparing letters of advice and defending herself against patent infringement lawsuits. In his 2012, 2013 and 2014 federal income tax returns, Mylan deducted his legal fees as ordinary and necessary business expenses.

Key questions:

  • What is the correct characterization of the legal costs incurred in preparing notification letters to be sent to the manufacturer of brand-name drugs and to any patentee?
  • What is the proper qualification of legal costs incurred in defending patent infringement lawsuits?

Primary holdings:

  • Mylan had to capitalize the legal costs incurred to prepare the notification letters because these expenses were necessary to obtain FDA approval of Mylan’s generic drugs.
  • Legal fees incurred in defending patent infringement lawsuits were deductible as ordinary and necessary business expenses, as patent litigation was separate from the FDA approval process.

Main points of law:

  • Section 162 (a) of IRC allows a deduction for “all ordinary and necessary expenses paid or incurred in the tax year in carrying on any trade or business”.
  • IRC section 263 (a) provides that no deduction will be allowed for a capital expenditure.
  • Where IRC Section 162 and IRC Section 263 each apply to a given expense, the funding requirement controls and operates to prevent the deduction. See RC Sec. 161.
  • Section 1.263 (a) -4 (b) (i) (v) of the Treasury Regulations requires the capitalization of amounts paid to facilitate the acquisition or establishment of a intangible, which includes “certain rights obtained from a government agency”, such as “rights in a trademark, trade name, copyright, license, permit, franchise or other similar right granted by that agency government. ”
  • Since Congress has made the notice a prerequisite for approval, the legal costs incurred in preparing, assembling and delivering the notice letters constitute amounts incurred “to investigate or prosecute” the creation transaction. FDA approved applications, and therefore amounts must be capitalized. See Reg. Section 1.263 (a) -4 (e) (1) (i).
  • It is the decision of the patent holder whether or not to initiate a dispute. If the patentee does not file a complaint, the manufacturer of the generic drug has no obligation to demonstrate that a patent is invalid or not infringed in order to gain FDA approval. Since the patentee controls litigation and is the primary beneficiary of litigation, litigation is not a step in the FDA approval process for the generic drug. Expenses incurred in defending the Section 271 (e) (2) lawsuits were not “paid to facilitate” the transaction and, therefore, the expenses should not be capitalized.
  • Under the origin of the complaint test, litigation costs incurred to defend legal claims under section 271 (e) (2) (e., patent infringement lawsuits arising in response to the generic drug manufacturer’s certification) arise out of the ordinary and necessary business activities of the taxpayer’s generic drug business and are therefore deductible.

Overview: the Mylan The decision demonstrates that the deductibility of legal fees generally depends on the origin and character of the underlying claim or transaction from which the legal fees were incurred. An expense, such as legal fees, may be deductible in one setting, but must nevertheless be capitalized in another. Legal fees directly related to (or relating to) the trade or business of the taxpayer are deductible under Article 162 of the IRC as ordinary and necessary business expenses, while expenses arising from the taxpayer The acquisition, improvement or ownership of property is a capital expenditure under IRC Section 263 (a) and is not currently deductible.

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