Government Seeks Reversal of Tax Court Decision in Mylan Inc. Case

MYLAN INC. & SUBSIDIARIES,
Petitioner-Appellee
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant

IN THE UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT

ON APPEAL FROM THE DECISIONS OF
THE UNITED STATES TAX COURT

OPENING BRIEF FOR THE APPELLANT

DAVID A. HUBBERT
Deputy Assistant Attorney General

ARTHUR T. CATTERALL
(202) 514-2937
CLINT A. CARPENTER
(202) 514-4346
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

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TABLE OF CONTENTS

Table of contents

Table of authorities

Statement of jurisdiction

Statement of the issue

Statement of related cases and proceedings

Statement of the case

A. Statutory and regulatory overview

1. Capitalization versus deduction under the Internal Revenue Code and regulations

2. FDA approval of generic drugs under the Hatch-Waxman Act

B. Mylan's claimed deductions of legal fees

C. The Tax Court proceedings

Summary of argument

Argument:

Mylan's litigation expenses must be capitalized because Mylan incurred them to facilitate its acquisition of intangible assets

Standard of review

A. As the Tax Court recognized, the regulation requires capitalization of expenses that Mylan incurred “in the process of . . . pursuing” — or to otherwise “facilitate” obtaining — effective FDA approvals of its paragraph IV ANDAs 

B. Mylan's litigation expenses facilitated its acquisition of effective FDA approvals of its paragraph IV ANDAs because Mylan incurred them in the process of pursuing those transactions

1. Section 271(e)(2) litigation is part of the statutory process that Congress prescribed for pursuing FDA approval to market and sell a generic before the brand-name patents expire

2. Section 271(e)(2) litigation expenses are incurred in the process of pursuing effective FDA approval of paragraph IV ANDAs whether or not such litigation is a “step” in the approval process

3. The tax treatment of patent-litigation expenses incurred outside the context of acquiring an intangible is irrelevant

C. The regulatory examples support the Commissioner's position

D. Requiring Mylan to capitalize its litigation expenses is consistent with the purpose of I.R.C. § 263

Conclusion

Certificate of bar membership

Certificate of compliance

Statutory and regulatory addendum

TABLE OF AUTHORITIES

Cases:

aaiPharma Inc. v. Thompson, 296 F.3d 227 (4th Cir. 2002)

Addressograph-Multigraph Corp. v. Commissioner, 4 T.C.M. (CCH) 147 (1945)

Am. Stores Co. & Subs. v. Commissioner, 114 T.C. 458 (2000)

Anderson v. Commissioner, 698 F.3d 160 (3d Cir. 2012)

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

Cap. Blue Cross v. Commissioner, 431 F.3d 117 (3d Cir. 2005)

Caraco Pharm. Labs., Ltd. v. Novo Nordisk A/S, 566 U.S. 399 (2012)

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

Conn. Gen. Life Ins. Co. v. Commissioner, 177 F.3d 136 (3d Cir. 1999)

F. Meyer & Bro. Co. v. Commissioner, 4 B.T.A. 481 (1926)

FTC v. Actavis, Inc., 570 U.S. 136 (2013)

Grand Ent. Grp., Ltd. v. Star Media Sales, Inc., 988 F.2d 476 (3d Cir. 1993)

Hosp. Corp. of Am. & Subs. v. Commissioner, 348 F.3d 136 (6th Cir. 2003)

INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992)

Lychuk v. Commissioner, 116 T.C. 374 (2001)

Metro Leasing Dev. Corp. v. Commissioner, 376 F.3d 1015 (9th Cir. 2004)

Mylan Labs., Inc. v. Thompson, 389 F.3d 1272 (Fed. Cir. 2004)

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

Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954)

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

Statutes:

21 U.S.C.:

§ 355(a)

§ 355(d)

§ 355(j)(2)(A)(ii)

§ 355(j)(2)(A)(iv)

§ 355(j)(2)(A)(vii)(III)

§ 355(j)(2)(A)(vii)(IV)

§ 355(j)(2)(B)

§ 355(j)(4)

§ 355(j)(5)(A)

§ 355(j)(5)(B)

§ 355(j)(5)(B)(iii)

§ 355(j)(5)(B)(iv)

35 U.S.C.:

§ 271(e)(1)

§ 271(e)(2)

Internal Revenue Code (26 U.S.C.):

§ 161

§ 162

§ 162(a)

§ 167

§ 197

§ 263

§ 263(a)

§ 1001(a)

§ 6212

§ 6213(a)

§ 6214

§ 7442

§ 7482

§ 7483

Drug Price Competition and Patent Term Restoration (Hatch-Waxman) Act of 1984, Pub. L. No. 98-417, 98 Stat. 1585

Other Authorities:

5 Bittker & Lokken, Federal Taxation of Income, Estates & Gifts ¶ 106.1.2 (3d ed. 2012)

21 C.F.R.:

§ 314.107(a)

§ 314.107(g)

Advance Notice of Proposed Rulemaking, 67 Fed. Reg. 3461 (Jan. 24, 2002)

Federal Rule of Appellate Procedure 13(a)(1)(A)

Rev. Rul. 77-204, 1977-1 C.B. 40

T.D. 9107, 2004-1 C.B. 447, 69 Fed. Reg. 436 (Jan. 5, 2004)

Treasury Regulations (26 C.F.R.):

§ 1.263(a)-4

§ 1.263(a)-4(b)(1)

§ 1.263(a)-4(b)(1)(ii)

§ 1.263(a)-4(b)(1)(v)

§ 1.263(a)-4(b)(v)

§ 1.263(a)-4(d)(1)

§ 1.263(a)-4(d)(5)

§ 1.263(a)-4(d)(5)(i)

§ 1.263(a)-4(e)(1)

§ 1.263(a)-4(e)(1)(i)

§ 1.263(a)-4(e)(3)

§ 1.263(a)-4(e)(4)(iii)

§ 1.263(a)-4(e)(5), Example 4

§ 1.263(a)-4(e)(5), Example 7

§ 1.263(a)-5

§ 1.263(a)-5(a)

§ 1.263(a)-5(b)(1)

§ 1.263(a)-5(c)(4)

§ 1.263(a)-5(l), Example 10

§ 1.263(a)-5(l), Example 18

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ON APPEAL FROM THE DECISIONS OF
THE UNITED STATES TAX COURT

OPENING BRIEF FOR THE APPELLANT

STATEMENT OF JURISDICTION

The Commissioner of Internal Revenue mailed notices of deficiency under § 6212 of the Internal Revenue Code (26 U.S.C.) (I.R.C.) to Mylan Inc. & Subsidiaries (collectively, “Mylan”) for the years 2012-2013 and 2014 on September 23, 2016 and November 17, 2016, respectively. (A18.)¹ On December 19, 2016, Mylan timely filed petitions for redetermination of the deficiencies in the United States Tax Court. (A13, A18, A69, A87, A105); see I.R.C. § 6213(a). The Tax Court had jurisdiction under I.R.C. §§ 6213(a), 6214, and 7442.

On November 2, 2021, the Tax Court entered final decisions that disposed of all parties' claims. (A50-55.) On January 28, 2022, within 90 days after entry of the decisions, see I.R.C. § 7483; Fed. R. App. P. 13(a)(1)(A), the Commissioner timely filed notices of appeal. (A56-67.) This Court has jurisdiction under I.R.C. § 7482.

STATEMENT OF THE ISSUE

Under federal tax law, drug manufacturers must capitalize the expenses they incur in the process of pursuing, or to otherwise facilitate obtaining, FDA approvals. Congress has created a process for obtaining FDA approval to market and sell new generic drugs before the brand-name drug patents expire, but only if, as part of that process, the generic manufacturer invites the patentholders to sue it for infringement and contests any suits that are brought. The issue presented is whether the litigation expenses that Mylan incurred in defending against such infringement suits must be capitalized. (A28-30, A32-48.)

STATEMENT OF RELATED CASES AND PROCEEDINGS

This case has not previously been before this Court. Counsel for the Commissioner are aware of the following cases pending in other courts that involve an issue substantially the same, similar, or related to the issue in this appeal:

Actavis LLC v. Commissioner, No. 18732-19 (T.C.)

Actavis Labs., FL, Inc. v. United States, No. 1:19-cv-798 (Fed. Cl.)

Actavis Labs. FL, Inc. v. Commissioner, No. 2254-20 (T.C.)

Perrigo Co. v. United States, No. 1:17-cv-737 (W.D. Mich.)

TEVA Pharms. USA, Inc. v. Commissioner, No. 17680-19 (T.C.)

STATEMENT OF THE CASE

This case concerns not whether, but when Mylan is entitled to deduct certain litigation expenses that it incurred as part of a congressionally prescribed process for obtaining FDA approval to market and sell generic versions of brand-name drugs before the patents on the brand-name drugs expire. During the years 2012-2014, Mylan pursued a number of such approvals, which required Mylan to certify to the FDA that the patents for the brand-name drug were either invalid or would not be infringed by Mylan's generic version and to then give notice of that certification to the patentholders. The patentholders were then entitled by statute to sue Mylan for infringement and thereby trigger a statutory period of 30 months in which any subsequent FDA approval of Mylan's generic would be ineffective (and the patentholders' monopoly would thus be maintained) while the suit was litigated.

Mylan incurred substantial legal fees in preparing the required notice letters and defending itself against the infringement suits that followed, all of which Mylan deducted (as ordinary and necessary business expenses) on its income tax returns for the years in which the fees were incurred. But after an audit, the Commissioner disallowed those deductions, determining that Mylan's legal fees were incurred to facilitate the creation of intangible assets (i.e., the FDA approvals) and were therefore capital expenditures, which must be capitalized and deducted ratably over a multi-year (in this case, 15-year) amortization period. As a result, the Commissioner determined that Mylan owed deficiencies in tax for the years 2012-2014 totaling $50 million.

Mylan petitioned the Tax Court for a redetermination of the deficiencies, and after a trial, the court sustained the Commissioner's determinations only in part. The court agreed with the Commissioner that the fees for the notice letters must be capitalized because Mylan incurred them to facilitate its acquisition of the sought-for drug approvals. But the court concluded that the infringement litigation was distinct from the FDA approval process, and that the fees Mylan incurred in that litigation — which far exceeded the notice-letter fees — were therefore not capital expenditures, but rather ordinary and necessary business expenses that Mylan had properly deducted in the years incurred. As a result, the Tax Court entered decisions holding Mylan liable for deficiencies totaling less than $2 million. The Commissioner now appeals from those decisions. Mylan did not cross-appeal.

A. Statutory and regulatory overview

Because these appeals turn on the interplay of complicated tax rules and the even more complicated process for approval of generic drugs, we begin with a brief summary of the applicable law.

1. Capitalization versus deduction under the Internal Revenue Code and regulations

Section 162(a) of the Internal Revenue Code (26 U.S.C.) authorizes a deduction for “ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Section 263(a), however, prohibits such deductions for capital expenditures. And to the extent a given capital expenditure may also be considered an “ordinary and necessary” business expense, § 263(a) takes precedence over § 162(a) and bars the deduction. See I.R.C. § 161; see also Commissioner v. Idaho Power Co., 418 U.S. 1, 17-18 (1974). Thus, deduction of expenses in the year incurred is the “exception[ ] to the norm of capitalization.” INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).

The hallmark of a capital expenditure is the expectation that it will produce significant economic benefits beyond the year in which it is paid or incurred. See id. at 86-87. Capital expenditures usually result in — or are incurred in connection with — the acquisition, creation, or enhancement of a separate identifiable asset. See id. And in that circumstance, the amount of the expenditure is included in the tax basis of the corresponding asset, to be recovered later through depreciation or amortization deductions, see I.R.C. §§ 167, 197, or as an offset to the amount realized upon a taxable disposition of the asset, see I.R.C. § 1001(a).² Thus, the “primary effect” of classifying an expenditure as either a business expense or a capital expenditure goes only to the timing, not the availability, of cost recovery. INDOPCO, 503 U.S. at 83. Section 263(a) simply “prevent[s] a taxpayer from utilizing currently a deduction properly attributable, through amortization, to later tax years when the capital asset becomes income producing,” Idaho Power, 418 U.S. at 16; see Advance Notice of Proposed Rulemaking, 67 Fed. Reg. 3461, 3462 (Jan. 24, 2002) (“A fundamental purpose of section 263(a) is to prevent the distortion of taxable income [that would result from] current deduction of expenditures relating to the production of income in future years.”).

In the case of intangible capital assets, the application of I.R.C. § 263(a) is governed by § 1.263(a)-4 of the Treasury Regulations (26 C.F.R.), which was issued in 2004. As relevant here, the regulation treats as a capital expenditure — and therefore requires taxpayers to capitalize — any “amount paid to facilitate (within the meaning of paragraph (e)(1) of this section) an acquisition or creation of an intangible described in . . . this section.” Treas. Reg. § 1.263(a)-4(b)(1)(v). And paragraph (e)(1) defines the “[s]cope of facilitate” generally as follows:

[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. Whether an amount is paid in the process of investigating or otherwise pursuing the transaction is determined based on all of the facts and circumstances. In determining whether an amount is paid to facilitate a transaction, the fact that the amount would (or would not) have been paid but for the transaction is relevant, but is not determinative. An amount paid to determine the value or price of an intangible is an amount paid in the process of investigating or otherwise pursuing the transaction.

Treas. Reg. § 1.263(a)-4(e)(1)(i).³ As for the “described” intangibles to which these rules apply, Treas. Reg. § 1.263(a)-4(b)(1)(v), they include, most notably, “rights” that a taxpayer “obtain[s]” from “a governmental agency . . . under a trademark, trade name, copyright, license, permit, franchise, or other similar [agency-granted] right.” Treas. Reg. § 1.263(a)-4(d)(5)(i); see Treas. Reg. § 1.263(a)-4(b)(1)(ii), (d)(1).

2. FDA approval of generic drugs under the Hatch-Waxman Act

In the Drug Price Competition and Patent Term Restoration Act of 1984, commonly called the Hatch-Waxman Act, Pub. L. No. 98-417, 98 Stat. 1585, Congress established a new, expedited process for obtaining FDA approval to market and sell generic copies of previously approved brand-name pharmaceuticals. Manufacturers of generic drugs had previously been subject to the same FDA approval procedure as their brand-name counterparts, which entails a “long, comprehensive, and costly testing process.” FTC v. Actavis, Inc., 570 U.S. 136, 142 (2013); see 21 U.S.C. § 355(d). But to implement Congress's purpose of bringing cheaper generic drugs to market, the Hatch-Waxman Act's expedited approach allows generic drug manufacturers to obtain FDA approval without the “costly and time-consuming studies” by submitting an Abbreviated New Drug Application (ANDA) “specifying that the generic has the 'same active ingredients as,' and is 'biologically equivalent' to, the already-approved brand-name drug.” Actavis, 570 U.S. at 142 (quoting Caraco Pharm. Labs., Ltd. v. Novo Nordisk A/S, 566 U.S. 399, 405 (2012)); see 21 U.S.C. § 355(j)(2)(A)(ii), (iv).

At the same time, Congress sought to “strike a balance between” its objective of “'enabling competitors to bring cheaper, generic copies . . . to market'” and the competing objective of “'induc[ing] name-brand pharmaceutical firms to make the investments necessary to research and develop new drug products.'” aaiPharma Inc. v. Thompson, 296 F.3d 227, 230 (4th Cir. 2002) (citation omitted). So while generally requiring the FDA to approve or disapprove an ANDA within 180 days, 21 U.S.C. § 355(j)(5)(A), the Hatch-Waxman Act also tied the date on which an approval becomes effective to a new “streamlined mechanism for identifying and resolving patent issues related to the proposed generic products.” Apotex, Inc. v. Thompson, 347 F.3d 1335, 1349 (Fed. Cir. 2003); see 21 U.S.C. § 355(j)(5)(B). Under these “special procedures,” a generic-drug manufacturer must identify any patents covering the brand-name drug (as listed in the FDA's “Orange Book”) and, if any of the patents are unexpired, submit with its ANDA one of two certifications. Actavis, 570 U.S. at 143. The first option is a “paragraph III” certification requesting that the FDA make any approval to market the generic drug effective only upon the expiration of the patent. See 21 U.S.C. § 355(j)(2)(A)(vii)(III).

More relevant here, however, is the alternative: a “paragraph IV” certification that the unexpired patent “is invalid or will not be infringed by the manufacture, use, or sale of the new [generic] drug for which the [ANDA] is submitted.” 21 U.S.C. § 355(j)(2)(A)(vii)(IV); see Actavis, 570 U.S. at 143. A paragraph IV certification triggers yet another special process under the Hatch-Waxman Act, which enables upfront resolution of patent disputes while also having direct consequences for the timing of the FDA's approval to market the generic drug, including the potential for any such approval to become effective before the brand-name patent expires. The Act does that by (i) deeming a paragraph IV certification an act of patent infringement, 35 U.S.C. § 271(e)(2); (ii) requiring an applicant that makes a paragraph IV certification (a “paragraph IV applicant”) to send a notification letter within 20 days to the brand-name drug patentee explaining in detail the factual and legal bases of the applicant's determination that the patent is invalid or will not be infringed, 21 U.S.C. § 355(j)(2)(B); and (iii) entitling the patentee to prevent any FDA approval of the generic from becoming effective for up to 30 months — and potentially until the patent expires — by suing the applicant for infringement (a “Section 271(e)(2) suit”) within 45 days of receiving the applicant's notification letter, 21 U.S.C. § 355(j)(5)(B)(iii). See Actavis, 570 U.S. at 143 (discussing this process and noting that making a paragraph IV certification “often 'means provoking litigation'”).

If the patentee prevails in such litigation within 30 months after receiving the notification letter, then any FDA approval of the ANDA will not become effective until the patent expires. But otherwise, approval will become effective before the patent expires, either (i) upon resolution of the litigation in the applicant's favor, if such resolution occurs prior to the expiration of the 30-month period; (ii) upon the expiration of the 30-month period, if the litigation is still pending at that time; or (iii) “immediately” (i.e., upon issuance of the approval), if the patentee fails to file suit within 45 days.⁴ 21 U.S.C. § 355(j)(5)(B)(iii).

In addition to the prospect of obtaining FDA approval to market the generic before the brand-name patents expire, the Hatch-Waxman Act further incentivizes applicants to proceed under paragraph IV by granting a 180-day period of exclusivity to the first generic version of a brand-name drug that is approved with a paragraph IV certification. 21 U.S.C. § 355(j)(5)(B)(iv); see Actavis, 570 U.S. at 143; Purepac Pharm. Co. v. Thompson, 354 F.3d 877, 879 (D.C. Cir. 2004). “During that period of exclusivity no other generic can compete with the brand-name drug,” which can be a “valuable” benefit “possibly 'worth several hundred million dollars.'” Actavis, 570 U.S. at 143-44 (citation omitted).

B. Mylan's claimed deductions of legal fees

Mylan Inc. is the common parent of an affiliated group of corporations that files consolidated federal income tax returns. Mylan manufactures both brand-name and generic pharmaceuticals. (A13.) During the years at issue (2012-2014), Mylan regularly sought generic-drug approvals by submitting ANDAs with paragraph IV certifications. (A13-14.) Mylan recognized that paragraph IV certifications offered both the earliest opportunity to bring its generic versions to market and the possibility (in some cases) of first-to-file exclusivity, but it also understood that such certifications often resulted in litigation. (A14.)

Indeed, during the years at issue, Mylan defended itself in approximately 120 infringement suits brought under Section 271(e)(2) in response to its paragraph IV certifications, incurring substantial legal fees. (A13-14, A16.) Mylan also incurred additional, but significantly lower, legal fees during this period in preparing the notice letters associated with its paragraph IV certifications. (A14, A16.) These two categories of Mylan's legal fees exceeded $46 million in 2012 and approached $40 million in both 2013 and 2014. (A16.)

Mylan deducted those legal fees on its corresponding federal income tax returns as ordinary and necessary business expenses under I.R.C. § 162. (A16-17.) But the IRS (i.e., the Commissioner) disallowed those deductions on audit because it determined that the fees were incurred to facilitate the creation of intangible assets (i.e., FDA approvals to market various generic drugs) and therefore constituted nondeductible capital expenditures that must be capitalized under I.R.C. § 263(a) and are subject to a 15-year amortization period under I.R.C. § 197. (A17-18.) That treatment resulted in tax deficiencies of $16.4 million for 2012, $12.6 million for 2013, and $21 million for 2014. The IRS issued notices of deficiency to that effect, which Mylan challenged in the Tax Court. (A18.)

C. The Tax Court proceedings

The Tax Court consolidated the cases (A18) and received most of the facts by stipulation (see A77, A83). After a trial (which consisted largely of expert testimony that the court ultimately deemed “not necessary for the purposes of deciding these cases” (A18 n.4)), the court issued an opinion sustaining the IRS's determination of the deficiencies only as to Mylan's notice-letter fees and holding for Mylan as to its litigation fees. (A2-3, A47-48, A49.)

Consistent with the regulation, the court framed the capitalization issue as whether Mylan's legal fees “were incurred to facilitate the acquisition of a right obtained from a Government agency,” which depends on “whether the respective fees were paid in the process of investigating or otherwise pursuing that transaction.” (A28); see Treas. Reg. § 1.263(a)-4(b)(1)(v), (d)(5)(i), (e)(1)(i). The parties agreed (A29) that the right to market and sell a generic drug pursuant to an FDA-approved ANDA with a paragraph IV certification is a right obtained from a government agency that qualifies as an intangible. And the Tax Court adopted the IRS's definition of the relevant “transaction,” which the court articulated as “obtaining effective approval of an ANDA with a paragraph IV certification,” rather than obtaining approval without regard to the effective date, as Mylan had argued. (Id. (noting that FDA approval “does not confer any rights on an applicant until it becomes effective”).)

The court then addressed whether the two categories of legal fees at issue “facilitated” the transactions (as so defined) and must therefore be capitalized. (A31-41.) The court quickly concluded that the notice-letter fees facilitated the transactions, reasoning that Mylan incurred those fees “'investigating or otherwise pursuing'” the transactions because the preparation of notice letters “is a required step in securing an FDA-approved ANDA for those applicants that make a paragraph IV certification,” i.e., it is “a prerequisite for [such] approval.” (A32 (quoting Treas. Reg. § 1.263(a)-4(e)(1)(i)).)

But the court “reach[ed] a different conclusion with respect to Mylan's Section 271(e)(2) litigation expenses” (id.) — namely, that “expenses Mylan incurred in defending Section 271(e)(2) suits were not 'paid to facilitate' the transaction and are not required to be capitalized” (A41). The court did not expressly address whether Mylan incurred those expenses in the process of pursuing the transactions. The court relied instead on its conclusion that Section 271(e)(2) litigation, unlike notice-letter preparation, is not “a step in the ANDA approval process” (A33) and therefore “is not a step in obtaining effective FDA approval of an ANDA with a paragraph IV certification” (A41). And having thus concluded that Mylan's litigation expenses were not capital expenditures, the court held that Mylan could deduct them as ordinary and necessary business expenses under I.R.C. § 162(a). (A47-48.)

In rejecting the IRS's position that Mylan's Section 271(e)(2) litigation expenses facilitated the transactions within the meaning of the regulation, the court “note[d] that a Section 271(e)(2) suit is not [necessary] to obtain effective approval of an ANDA with a paragraph IV certification,” since “a brand name drug manufacturer is under no obligation to initiate such a suit in response to” such an ANDA. (A37.) And the court also found relevant and persuasive its conclusion that “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”; rather, the “statutory coordination” merely “ensures that the FDA does not run afoul of a District Court's resolution of the intellectual property rights of the parties.” (A37-38.)

In the court's view, the judicially created “origin of the claim” test also supported its conclusion. In this context, the relevant inquiry under the origin-of-the-claim test is “'whether the origin of the claim litigated is in the process of acquisition' . . . of a capital asset.” (A41 (quoting Woodward v. Commissioner, 397 U.S. 572, 577 (1970)).) The court answered that question in the negative, finding that Section 271(e)(2) litigation expenses “ar[i]se out of actions initiated by patent holders to protect their intellectual property from infringement.” (A41.) Citing this Court's decision in Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954), the Tax Court noted that expenses incurred by a patent holder in prosecuting a patent infringement suit are generally treated as deductible business expenses. (A42-43.) And the court “s[aw] no reason that Mylan should face different treatment” in defending against such a suit, particularly since such “defensive” expenses “have been found deductible in the past.” (A43 (citing F. Meyer & Bro. Co. v. Commissioner, 4 B.T.A. 481, 482 (1926), and Addressograph-Multigraph Corp. v. Commissioner, 4 T.C.M. (CCH) 147, 166 (1945)).)

The Tax Court also considered regulatory examples illustrating the scope of the term “facilitate” as used in Treas. Reg. §§ 1.263(a)-4 and 1.263(a)-5, respectively, and identified § 1.263(a)-5(l), Example 18, as the most apposite example. (A46.) In that example, a corporate defendant in multiple product-liability suits (X) filed a petition for reorganization under Chapter 11 of the Bankruptcy Code in order to manage all of the lawsuits in a single proceeding. Echoing § 1.263(a)-5(c)(4) (which addresses this specific situation using the same language), the example concludes that

amounts paid by X to its outside counsel 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.

Treas. Reg. § 1.263(a)-5(l), Example 18 (¶ (ii)). The Tax Court “s[aw] a strong parallel” to the case at bar, “where patent litigation is connected with but distinct from the broader project of obtaining effective FDA approval of ANDAs with paragraph IV certifications,” and found that “the conclusion reached by the example” — no capitalization — “thus attaches here.” (A46.)

The court rejected the IRS's reliance on Treas. Reg. § 1.263(a)-4(e)(5), Example 4. (A47.) In that example (which is based on the facts and holding of the Woodward case that the Tax Court cited elsewhere in its opinion), the majority shareholder (U) of a corporation was required by State law to buy out a minority shareholder who opposed a charter amendment. When the parties could not agree on a purchase price, U brought a State court action to determine a fair price. The example concludes that because the attorney, accountant, and appraisal fees incurred by U in connection with the negotiation and litigation helped to establish the purchase price of the minority interest, those fees facilitated the acquisition of that stock (a capital asset) and therefore must be capitalized. Treas. Reg. § 1.263(a)-4(e)(5), Example 4.

But the Tax Court concluded that “the instant case is not comparable” to Example 4. (A47.) According to the court, “the principle illustrated by this example” is that “litigation expenses incurred to establish a necessary element of the transaction (i.e., the purchase price) facilitate it and are subject to capitalization.” (Id.) And in the court's view, Section 271(e)(2) litigation expenses are “not incurred in connection with a necessary element of obtaining effective FDA approval but to resolve the question of patent rights.” (Id.)

In accordance with its opinion and the parties' agreed computations, the Tax Court entered decisions reflecting tax deficiencies of $392,907 for 2012, $336,727 for 2013, and $1,231,359 for 2014. (A50-55.)

SUMMARY OF ARGUMENT

As the Tax Court initially recognized, the issue in this case is whether Mylan's legal fees were incurred to “facilitate” the acquisition of effective FDA approvals of ANDAs with paragraph IV certifications, which depends, in turn, on whether the respective fees were paid “in the process of investigating or otherwise pursuing” such acquisitions. Under the Hatch-Waxman Act, a paragraph IV applicant that incurs Section 271(e)(2) litigation expenses necessarily does so in the process of pursuing effective FDA approval of its ANDA — in particular, approval that is effective before the brand-name drug patents expire. Indeed, obtaining pre-expiration approval is the only reason for an applicant to make a paragraph IV certification in the first place, and Congress made defending any Section 271(e)(2) infringement suits that are brought in response to the certification a prerequisite for such approval. Accordingly, the expenses Mylan incurred in defending against Section 271(e)(2) suits were incurred to facilitate its acquisition of effective FDA approvals and must therefore be capitalized.

In its analysis of those expenses, however, the Tax Court lost sight of the issue whether they were incurred in the process of pursuing the acquisitions, erroneously focusing instead on whether Section 271(e)(2) litigation is a “step” or “element” in the ANDA approval process. But that is not the issue. The issue is whether a paragraph IV applicant that actually incurs expenses in defending Section 271(e)(2) litigation does so in the process of pursuing the acquisition of effective approval of a paragraph IV ANDA. The Tax Court's observations that patentholders are not obligated to sue paragraph IV applicants for infringement under Section 271(e)(2), and that FDA approval with an effective date after the patents expire is available outside the paragraph IV process, are therefore beside the point.

Also irrelevant are cases holding that patent-litigation expenses are deductible outside the context of pursuing the acquisition of an intangible. Expenses incurred in patent litigation may well be deductible costs of doing business in most contexts. But unlike the litigants in ordinary infringement suits, a paragraph IV applicant that litigates a Section 271(e)(2) infringement suit does so to facilitate its acquisition of an intangible asset, which makes the expenses of that litigation capital expenditures. Moreover, requiring Mylan to capitalize its litigation expenses is also consistent with the judicially created origin-of-the-claim test, the regulatory examples, and the underlying purpose of the capitalization rules.

In short, the Tax Court erred in concluding that Mylan was not required to capitalize its litigation expenses. The decisions below should therefore be reversed and remanded to the Tax Court with instructions to enter decisions for the Commissioner in the amounts determined in the notices of deficiency.

ARGUMENT

Mylan's litigation expenses must be capitalized because Mylan incurred them to facilitate its acquisition of intangible assets

Standard of review

This Court reviews the Tax Court's legal conclusions de novo and its factual findings for clear error. Anderson v. Commissioner, 698 F.3d 160, 164 (3d Cir. 2012) (citing Cap. Blue Cross v. Commissioner, 431 F.3d 117, 123-24 (3d Cir. 2005)). The Tax Court's interpretation of the Internal Revenue Code and the regulations thereunder is an issue of law reviewed de novo. See, e.g., Metro Leasing Dev. Corp. v. Commissioner, 376 F.3d 1015, 1021 (9th Cir. 2004); Hosp. Corp. of Am. & Subs. v. Commissioner, 348 F.3d 136, 140 (6th Cir. 2003); Conn. Gen. Life Ins. Co. v. Commissioner, 177 F.3d 136, 143 (3d Cir. 1999). The Tax Court's application of facts to the Code and regulations is likewise reviewed de novo. See, e.g., Grand Ent. Grp., Ltd. v. Star Media Sales, Inc., 988 F.2d 476, 481 (3d Cir. 1993) (“Application of facts properly found to the governing legal principles receives plenary review.”).

The question whether Mylan was required to capitalize its Section 271(e)(2) litigation expenses depends on whether Mylan incurred those expenses to “facilitate” its acquisition of effective FDA approvals of its paragraph IV ANDAs. See Treas. Reg. § 1.263(a)-4(b)(1)(ii), (v), (d)(5)(i). The Tax Court acknowledged as much (A28-30) but then focused its analysis on an altogether different question: whether Section 271(e)(2) litigation is a “step” in the ANDA approval process or, in other words, whether it is always required for effective FDA approval of a paragraph IV ANDA (A33-41). The regulation, in contrast, broadly defines the scope of facilitative expenses as including any amount that “is paid in the process of investigating or otherwise pursuing” the acquisition of the intangible. Treas. Reg. § 1.263(a)-4(e)(1)(i). And under the Hatch-Waxman Act, a paragraph IV applicant that incurs Section 271(e)(2) litigation expenses necessarily does so in the process of pursuing effective FDA approval of its ANDA — in particular, approval that is effective before the brand-name drug patents expire.

Thus, as we explain more fully below, Mylan did incur its Section 271(e)(2) litigation expenses “to facilitate the acquisition” of effective FDA approvals, Treas. Reg. § 1.263(a)-4(e)(1)(i), and those expenses were therefore capital expenditures that Mylan was required to capitalize, Treas. Reg. § 1.263(a)-4(b)(1)(v). The Tax Court's erroneous decision to the contrary should be reversed.

A. As the Tax Court recognized, the regulation requires capitalization of expenses that Mylan incurred “in the process of . . . pursuing” — or to otherwise “facilitate” obtaining — effective FDA approvals of its paragraph IV ANDAs

The regulation establishes three rules that control the capitalization question in this case. First, a right obtained from a government agency “under a trademark, trade name, copyright, license, permit, franchise, or other similar [agency-granted] right” is an intangible capital asset. Treas. Reg. § 1.263(a)-4(d)(5)(i); see also Treas. Reg. § 1.263(a)-4(b)(1)(ii), (d)(1). Second, expenses paid to “facilitate” the “acquisition or creation” of such an intangible must be capitalized. Treas. Reg. § 1.263(a)-4(b)(1)(v). And third, “an 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.” Treas. Reg. § 1.263(a)-4(e)(1)(i).

Thus, as the Tax Court explained, the issue in this case is whether Mylan's legal fees “were incurred to facilitate the acquisition of a right obtained from a Government agency,” which depends, in turn, on “whether the respective fees were paid in the process of investigating or otherwise pursuing that transaction.” (A28.)⁵ The parties agree (A29) that the right to market and sell a generic drug pursuant to an FDA-approved ANDA with a paragraph IV certification is a right obtained from a government agency that qualifies as an intangible. See Treas. Reg. § 1.263(a)-4(d)(5)(i). And because a paragraph IV applicant does not acquire that right until the FDA's approval becomes effective, the Tax Court correctly concluded that the relevant “transaction” — i.e., “the acquisition . . . of [the] intangible,” Treas. Reg. § 1.263(a)-4(e)(1)(i) — is the acquisition of effective FDA approval of an ANDA with a paragraph IV certification. (A29-30.) As the court explained:

[FDA] approval does not confer any rights on an applicant until it becomes “effective.” 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.”

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 [a] governmental agency.”

(A30 (quoting 21 C.F.R. § 314.107(a); Treas. Reg. § 1.263(a)-4(d)(5)(i); and citing 21 U.S.C. § 355(a), (j)(5)(B).)

So with this understanding of the relevant intangible and transaction, the dispositive issue becomes whether Mylan incurred the legal fees at issue “in the process of investigating or otherwise pursuing” effective FDA approvals of its paragraph IV ANDAs. Treas. Reg. § 1.263(a)-4(e)(1)(i). Indeed, the Tax Court recognized as much when it analyzed the legal fees that Mylan incurred to prepare the required notice letters regarding its paragraph IV certifications. (A31-32.) And Mylan did not cross-appeal the court's conclusion that those notice-related fees were “incurred 'investigating or otherwise pursuing' the transaction” and must therefore be capitalized. (A32 (quoting Treas. Reg. § 1.263(a)-4(e)(1)(i)).) But as we explain below, the court then lost sight of the issue when it turned to the fees that Mylan incurred in defending against Section 271(e)(2) infringement suits, and as a result, the court failed to recognize that those litigation expenses were likewise incurred in the process of pursuing effective FDA approvals of Mylan's paragraph IV ANDAs.

B. Mylan's litigation expenses facilitated its acquisition of effective FDA approvals of its paragraph IV ANDAs because Mylan incurred them in the process of pursuing those transactions

Again, with certain exceptions not applicable here, “an 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.” Treas. Reg. § 1.263(a)-4(e)(1)(i). Thus, any expense paid by a paragraph IV applicant “in the process of . . . pursuing” effective FDA approval is, by definition, “[a]n amount paid to facilitate . . . an acquisition or creation of an intangible,” which the applicant “must capitalize.” Treas. Reg. § 1.263(a)-4(b)(1), (b)(1)(v), (e)(1)(i); see also id. § 1.263(a)-4(b)(1)(ii), (d)(5). And contrary to the Tax Court's erroneous conclusion, any Section 271(e)(2) litigation expenses that a paragraph IV applicant incurs are — by Congressional design — necessarily incurred in the process of pursuing effective FDA approval.

1. Section 271(e)(2) litigation is part of the statutory process that Congress prescribed for pursuing FDA approval to market and sell a generic before the brand-name patents expire

The FDA-granted right (i.e., the intangible) that paragraph IV applicants seek is not just the right to market and sell a generic drug, but the right to do so before the brand-name patents expire. Indeed, under the application and approval scheme that Congress established in the Hatch-Waxman Act, obtaining an FDA approval that is more valuable because it has a pre-expiration effective date is the only reason for a generic-drug applicant to ever proceed under paragraph IV in the first place. Unlike the post-expiration effective approval that is available by proceeding under paragraph III, the only way to obtain a generic-drug approval that is effective before the brand-name patents expire is to (1) commit an act of deemed infringement by making a paragraph IV certification, (2) notify the patent holders of that infringing certification, and then (3) contest any Section 271(e)(2) infringement suits that are brought in response. Thus, the process that Congress established for obtaining approval to market generic drugs before the brand-name patents expire makes inviting Section 271(e)(2) infringement suits — and defending any that are brought — a prerequisite.

Accordingly, any Section 271(e)(2) litigation expenses incurred by a paragraph IV applicant are necessarily incurred “in the process of . . . pursuing” the acquisition of effective FDA approval — specifically, FDA approval with a pre-expiration effective date, which is the entire point of the paragraph IV process. Again, pre-expiration effectiveness is part of the intangible itself (i.e., the agency-granted right) that a paragraph IV applicant seeks to acquire. And as a matter of law, that acquisition (i.e., “the transaction”) cannot occur unless the applicant incurs the expense of litigating any Section 271(e)(2) infringement suits that the patentholders bring against it.

That such litigation is not always necessary to obtain effective FDA approval of a paragraph IV ANDA — as when the patentholder declines to bring suit — is beside the point. The question is whether a paragraph IV applicant that does engage in Section 271(e)(2) litigation, as Mylan did here, does so as part of the statutory process for pursuing effective approval of its ANDA. And the answer to that question is clearly “yes.”

Indeed, without the deemed infringement that results from the applicant's paragraph IV certification, the patentholders would have no cause of action under Section 271(e)(2) to begin with. And as the Tax Court acknowledged (A37), when patentholders do file suit in response to an applicant's paragraph IV certification, the Hatch-Waxman Act ties the effective date of the approval of the applicant's ANDA to the pendency and/or outcome of that Section 271(e)(2) litigation. See 21 U.S.C. § 355(j)(5)(B)(iii). Obtaining an effective date that is earlier than the patent-expiration date — which is the sole purpose of the paragraph IV process — requires the applicant to litigate any such suit until it has either been pending for 30 months or been resolved sooner without a finding of infringement.

Also “relevant,” though not itself “determinative,” is the fact that Mylan would not have incurred its litigation expenses “but for the transaction.” Treas. Reg. § 1.263(a)-4(e)(1)(i). As the Tax Court acknowledged, “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.” (A40.) Although the Tax Court disagreed that this establishes a “but for” relationship, it did so on the theory that even if Hatch-Waxman had never been enacted, a company seeking FDA approval of a generic drug prior to the relevant patent-expiration date would have had to defend against a conventional patent-infringement suit in lieu of a Section 271(e)(2) suit. (A40 & n.13.)

But the question is whether Mylan would have incurred patent-infringement litigation expenses “[e]ven absent the transaction” (A40 (emphasis added)), not whether Mylan would have incurred such expenses even if it had it sought the same result — FDA approval with a pre-expiration effective date — under prior law. The Tax Court correctly defined the transaction as the acquisition of “effective approval of an ANDA with a paragraph IV certification” (A29-30). And absent that transaction, there would be no infringement because the subject generic could not be marketed before the brand-name drug patents expire, and marketing the generic after the patents expire would not be infringing. So without the transaction, the patentholder would have no infringement claim on which to sue (since the Hatch-Waxman Act made research and development of generics non-infringing as a matter of law, 35 U.S.C. § 271(e)(1)). Thus, any expenses that a paragraph IV applicant incurs in defending against Section 271(e)(2) infringement suits would not be incurred but for the transaction.

In short, there is simply no denying that the expenses of defending against Section 271(e)(2) suits are incurred “in the process of . . . pursuing” effective FDA approval of an ANDA with a paragraph IV certification. Treas. Reg. § 1.263(a)-4(e)(1)(i). And since expenses incurred in the process of pursuing the acquisition of an intangible are, by definition, incurred to “facilitate” that transaction, id., the plain language of the regulation compels the conclusion that Mylan was required to capitalize its Section 271(e)(2) litigation expenses, Treas. Reg. § 1.263(a)-4(b)(v).

2. Section 271(e)(2) litigation expenses are incurred in the process of pursuing effective FDA approval of paragraph IV ANDAs whether or not such litigation is a “step” in the approval process

The Tax Court did not squarely address whether Mylan incurred its Section 271(e)(2) litigation expenses in the process of pursuing effective FDA approvals of its paragraph IV ANDAs. (See A32-41.) After initially recognizing that the dispositive issue is whether Mylan incurred its legal fees “in the process of investigating or otherwise pursuing” (and, thus, to “facilitate”) those transactions (A28-29, 32), the court lost sight of that issue when it turned to the fees that Mylan incurred in Section 271(e)(2) infringement litigation. Instead, the court erroneously focused its analysis on a more abstract question: whether patent litigation is a “step” or “element” in the ANDA approval process. (A33-41.)

As a threshold matter, the Tax Court's conclusion that “Section 271(e)(2) litigation is not a step in obtaining effective FDA approval of an ANDA with a paragraph IV certification” is dubious at best. Again, the only reason for an applicant to make a paragraph IV certification — and thereby expose itself to deemed-infringement suits — is to obtain an approval that is effective before patent expiration. And Congress made defending any suits that are brought a further prerequisite to obtaining pre-expiration effectiveness. Thus, when a paragraph IV applicant is sued under Section 271(e)(2), litigation of that suit seems clearly to be a “step” in obtaining effective approval. The Tax Court's conclusion that expenses incurred in defending Section 271(e)(2) litigation are not “paid to facilitate” the transaction because such litigation “is not a step in obtaining effective FDA approval of an ANDA with a paragraph IV certification” (A41) therefore rests on a false premise.

Moreover, even if Section 271(e)(2) litigation were not a “step” in the approval process, that is not the issue under the regulation. The Tax Court cited (A32) a provision of the regulation that defines the term “transaction” as “includ[ing] a series of steps carried out as part of a single plan.” Treas. Reg. § 1.263(a)-4(e)(3) (emphasis added). But the purpose of that language is to prevent taxpayers from manipulating the $5,000 de minimis rule of Treas. Reg. § 1.263(a)-4(e)(4)(iii) by claiming that a multi-step transaction is actually multiple transactions over which facilitative costs may be spread. See Treas. Reg. § 1.263(a)-4(e)(3) (second and third sentences); § 1.263(a)-4(e)(5), Example 7. To the extent the Tax Court derived its “step” requirement from § 1.263(a)-4(e)(3), it erred in doing so.

Regardless of its origin, the Tax Court's “step” requirement improperly narrows the regulatory definition of expenses that “facilitate” a transaction, as “the process of investigating or otherwise pursuing” — i.e., “facilitat[ing]” — “the transaction” is necessarily broader than the steps that comprise the transaction itself. Treas. Reg. § 1.263(a)-4(e)(1). To read the regulation otherwise would render its definition of facilitative expenses meaningless. The true facilitation issue is whether expenses incurred in defending Section 271(e)(2) litigation are paid in the process of pursuing the acquisition of effective approval of a paragraph IV ANDA, not whether such litigation may be considered a “step” in obtaining such approval. Treas. Reg. § 1.263(a)-4(e)(1). Because the Tax Court lost sight of that issue, its conclusion that Mylan's litigation expenses “were not 'paid to facilitate' the transaction” (A41) relied on factors that are not even relevant.

Indeed, it does not matter, as the Tax Court wrongly supposed (A37, 39), that patentholders are not obligated to sue paragraph IV applicants for infringement under Section 271(e)(2). Under the plain language of the regulation, what matters is whether the litigation expenses that a paragraph IV applicant incurs when a patentholder does sue are incurred in the process of pursuing effective FDA approval. And as we have shown, they clearly are.

Nor does it matter that “the outcome of a Section 271(e)(2) suit has no bearing on the FDA's safety and bioequivalence review”; that “the FDA 'shall approve' an ANDA unless it fails to satisfy certain technical requirements”; that “[t]he FDA does not analyze patent issues as part of its review”; that “neither the statute nor the regulations suggest that patent issues might block approval of an ANDA”; and that, conversely, “winning a patent litigation suit does not ensure . . . approval, as the FDA can disapprove an ANDA for not meeting safety and bioequivalence standards.” (A33-34 (quoting 21 U.S.C. § 355(j)(4)).) As the Tax Court recognized elsewhere in its opinion (A29-30), the issue is not just FDA approval of an ANDA, but effective FDA approval of a paragraph IV ANDA. And as a matter of law, no approval of a paragraph IV ANDA can become effective — regardless of the safety and bioequivalence review or any of the other above-cited considerations — until the applicant has made the paragraph IV certification and any timely Section 271(e)(2) suit brought in response has either been litigated for 30 months or been resolved sooner without a finding of infringement.

Also irrelevant are the Tax Court's observations that deemed-infringement suits under Section 271(e)(2) operate in fundamentally the same way as ordinary patent-infringement suits (A35-36, 37-38), and were created to protect patentholders (A38-39). Both give short shrift to Congress's incorporation of Section 271(e)(2) suits into the ANDA process and miss the point that Congress did so in a way that made inviting and defending such suits a precondition to obtaining the special benefit that proceeding under paragraph IV affords. Although the Tax Court recognized that “[t]he 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” (A38), it failed to appreciate that defending against the infringement claim is therefore part of the process of pursuing effective approval.

The bottom line is that paragraph IV applicants who incur Section 271(e)(2) litigation expenses, as Mylan did here, necessarily do so in the process of pursuing the acquisition of effective FDA approval. Consequently, such expenses are, by definition, incurred to facilitate the acquisition of an intangible. Treas. Reg. § 1.263(a)-4(e)(1). And as a result, they are not deductible as ordinary and necessary business expenses, but rather are capital expenditures that must be capitalized. Treas. Reg. § 1.263(a)-4(b)(1)(v).

3. The tax treatment of patent-litigation expenses incurred outside the context of acquiring an intangible is irrelevant

Under the plain language of the controlling regulation, the fact that Mylan incurred its litigation expenses in the process of pursuing — and thus, by definition, to facilitate — the acquisition of effective FDA approvals is conclusive of Mylan's obligation to capitalize those expenditures. See Treas. Reg. § 1.263(a)-4(b)(1)(v), (e)(1)(i). The Tax Court's reliance (A42-43) on this Court's decision in Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954) — and other cases in which patent-litigation expenses were held to be deductible — is misplaced because none of the cited authorities involved expenses incurred in the process of pursuing, or to otherwise facilitate, the acquisition of an intangible. As the court itself acknowledged earlier in its opinion, “An expenditure, no matter its type, may be deductible in one setting but nevertheless required to be capitalized in another.” (A20-21 (citing Lychuk v. Commissioner, 116 T.C. 374, 388 (2001); Am. Stores Co. & Subs. v. Commissioner, 114 T.C. 458, 469 (2000).) In other words, “[s]imply because other cases have allowed a current deduction for similar expenses in different contexts does not require the same result here.” Am. Stores, 114 T.C. at 469 (citing Idaho Power, 418 U.S. at 13).)

Applying that principle here demonstrates the flaw in the Tax Court's reasoning because in none of the authorities that the court invoked, including Urquhart, were the patent-litigation expenses at issue incurred in the context of acquiring an intangible. There is no question, as those authorities demonstrate, that expenses incurred in patent litigation are generally just costs of doing business and deductible accordingly under I.R.C. § 162(a). And that includes the litigation expenses incurred not only by both parties to an ordinary infringement suit, but also by the patentholder in a Section 271(e)(2) infringement suit, because none of those litigants incurred the expenses to acquire, create, or facilitate the acquisition or creation of an intangible capital asset.

But that is not so in the case of the paragraph IV applicant in a Section 271(e)(2) infringement suit. Because the applicant litigates that suit to facilitate its acquisition of an intangible asset, the applicant's litigation expenses are capital expenditures and must therefore be capitalized. The decisions in Urquhart and the other cases cited by the Tax Court are not to the contrary, as none of them involved litigation expenses incurred by a paragraph IV applicant in a Section 271(e)(2) suit or to otherwise facilitate the acquisition or creation of an intangible.

The Tax Court discussed Urquhart and similar cases in the context of the judicially created “origin of the claim” doctrine (see A41-45), which the Supreme Court first applied to a capitalization case in Woodward v. Commissioner, 397 U.S. 572 (1970). In the Tax Court's view, the doctrine “likewise indicates that Section 271(e)(2) litigation expenses should be treated as deductible ordinary and necessary business expenses.” (A41.) But as the Tax Court appears to have recognized, the 2004 regulation is controlling, not the origin-of-the-claim test.⁶

And in any event, contrary to the Tax Court's conclusion, the origin-of-the-claim test confirms what the controlling regulation requires: Mylan's Section 271(e)(2) litigation expenses must be capitalized. Indeed, just as the regulation asks whether the litigation expenses were paid “in the process of . . . pursuing” the acquisition of a capital asset, Treas. Reg. § 1.263(a)-4(e)(1)(i), the Tax Court recognized that the relevant inquiry under the origin-of-the-claim test is “'whether the origin of the claim litigated is in the process of acquisition' . . . of a capital asset.” (A41 (quoting Woodward, 397 U.S. at 577).) But far more apposite than Urquhart and the other cases cited by the Tax Court in that regard (A42-43) — cases involving patent litigation, but not in the acquisition context — is American Stores, a case in which the court actually applied the origin-of-the-claim test. 114 T.C. at 470-73.

In American Stores, the Tax Court held that expenses incurred by a corporation to defend against antitrust litigation commenced in response to its acquisition of all of the outstanding stock of another corporation must be capitalized because “[t]he origin of the . . . antitrust suit was American Stores' acquisition of Lucky Stores.” 114 T.C. at 473. Stressing the importance of the context in which expenditures are incurred, the court explained that the taxpayer's reliance on cases allegedly “support[ing] the proposition that expenses incurred in an antitrust defense are always deductible [was] misplaced.” Id. at 469.

The same is true of the Tax Court's reliance, in the case at bar, on cases suggesting that patent litigation expenses are always deductible.

C. The regulatory examples support the Commissioner's position

The 2004 regulations include a number of examples illustrating the scope of the term “facilitate” as used in Treas. Reg. §§ 1.263(a)-4 and 1.263(a)-5.⁷ Although none are directly on point, two of the examples are apposite by analogy, and both support the conclusion that Mylan incurred its litigation expenses to facilitate its acquisition of effective FDA approvals.

Example 4 of § 1.263(a)-4(e)(5) is based on the facts and holding of the Woodward case, which first articulated the general rule, later adopted in the regulations, that “[a]n amount paid to determine the value or price of an intangible is an amount paid in the process of investigating or otherwise pursuing the transaction.” Treas. Reg. § 1.263(a)-4(e)(1)(i). The example involves a majority shareholder of a corporation who wishes to extend the corporation's charter indefinitely and is required by state law to buy out a dissenting minority shareholder, and who brings a state-court action to determine the buy-out price when the parties cannot agree. Treas. Reg. § 1.263(a)-4(e)(5) (Example 4). The example concludes that the expenses of litigating that suit are capital expenditures. Id.

Example 4 thus shares a key feature with the transaction here: the law effectively required the taxpayer (i.e., the majority shareholder in the example and Mylan here) to litigate a particular proceeding as a prerequisite to obtaining the intangible it sought if its counterparty (i.e., the dissenting minority shareholder in the example and the patentholders here) elected to contest the relevant issues. The Tax Court distinguished Example 4 on the ground that the expenses there were incurred to establish a “necessary element of the transaction.” (A47.) But that is not the rationale expressed in the example; rather, the example states that the expenses must be capitalized because — as is the case with the litigation expenses at issue here — they “facilitate[ ] the acquisition of” an intangible asset. Treas. Reg. § 1.263(a)-4(e)(5) (Example 4); see id. § 1.263(a)-4(e)(1)(i). In any event, as we have shown, Mylan did incur Section 271(e)(2) litigation expenses to establish a necessary element of the transactions here — i.e., pre-expiration effectiveness of the FDA approvals. So even under the Tax Court's “necessary element” approach, Section 271(e)(2) litigation expenses are analogous to the litigation expenses that Example 4 deems subject to capitalization.

Perhaps even more analogous are the litigation expenses in Example 10 of § 1.263(a)-5(l), which concludes that expenses incurred by a corporation to defend against antitrust litigation commenced in response to its acquisition of all the outstanding stock of another corporation must be capitalized as amounts incurred to facilitate that acquisition. Treas. Reg. § 1.263(a)-5(l) (Example 10) (based on American Stores). Here, the Tax Court ascribed great weight to the fact that not every paragraph IV applicant has to defend against Section 271(e)(2) litigation in order to obtain FDA approval with a pre-expiration effective date (because not every patentholder sues). But not every purchaser of a competing business has to defend against antitrust litigation in order to consummate that acquisition. So just as that fact does not affect the analysis in Example 10, it should not affect the analysis here.

The Tax Court found most compelling Example 18 of § 1.263(a)-5(l), in which a taxpayer that is a defendant in multiple product-liability suits files a Chapter 11 bankruptcy petition “in an effort to manage all of the lawsuits in a single proceeding.” (A46 (quoting Treas. Reg. § 1.263(a)-5(l) (Example 18(i)).) The example concludes that “amounts paid by [the taxpayer] to its outside counsel” in connection with resolving the taxpayer's tort liability as part of a bankruptcy reorganization “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” but for the bankruptcy. Treas. Reg. § 1.263(a)-5(l) (Example 18(ii)). The Tax Court failed to appreciate, however, that Example 18 is not intended to be broadly illustrative of the general “facilitates” rule, see Treas. Reg. § 1.263(a)-5(a), (b)(1), but rather illustrates a longstanding exception to a bankruptcy-specific rule.⁸ Treas. Reg. § 1.263(a)-5(c)(4); see Rev. Rul. 77-204, 1977-1 C.B. 40, 40. It is therefore not analogous to non-bankruptcy contexts. And even if it were, the terms on which the taxpayer in the example resolves its tort liabilities may have a practical bearing on the confirmability of its Chapter 11 plan, but that connection to the reorganization is, at best, much more attenuated than the link between Section 271(e)(2) infringement suits and the acquisition of effective FDA approval. Example 18 does not support Mylan's position.

D. Requiring Mylan to capitalize its litigation expenses is consistent with the purpose of I.R.C. § 263

It bears repeating that this case concerns only when, not whether, Mylan can deduct its litigation expenses. Mylan will no doubt argue that requiring it to capitalize those expenditures and deduct them ratably over the applicable amortization period is somehow an extreme or extraordinary result, but that is not so. Capitalization of Mylan's litigation expenses is not only required by the plain language of the regulation, but also is consistent with the policy behind the Internal Revenue Code's requirement to capitalize all capital expenditures.

As the Supreme Court has explained, the purpose of I.R.C. § 263 and related provisions governing capitalization is “to match expenses with the revenues of the taxable period to which they are properly attributable, thereby resulting in a more accurate calculation of net income for tax purposes.” INDOPCO, 503 U.S. at 84 (1992) (citing, inter alia, Idaho Power, 418 U.S. at 16). And requiring Mylan to capitalize the litigation expenses it incurred to facilitate its acquisitions of effective FDA approvals of its paragraph IV ANDAs — approvals that entitle Mylan to market its generics for many years to come — does just that. The extreme position is Mylan's (and the Tax Court's) contention that Mylan is entitled to fully deduct its litigation expenses years before it will pay the taxes on the income that is attributable to those expenses. “[D]eductions are exceptions to the norm of capitalization,” id., and the Tax Court's conclusion that the “norm” does not apply to Mylan's litigation expenses is contrary to both the regulation and the underlying purpose of capitalization.

CONCLUSION

The decisions of the Tax Court should be reversed and remanded with instructions to enter decisions for the Commissioner in the amounts determined in the notices of deficiency.

Respectfully submitted,

DAVID A. HUBBERT
Deputy Assistant Attorney General

ARTHUR T. CATTERALL (202) 514-2937
CLINT A. CARPENTER (202) 514-4346
D.C. Bar No. 991026
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

MAY 18, 2022