The United States Tax Court on April 27, 2021, ruled that Mylan Inc. could deduct the legal fees it incurred in defending itself against patent infringement claims made by other drug manufacturers while pursuing generic pharmaceutical drug applications.
Normally, expenses incurred in the generic drug approval process are capitalized over multiple years, pursuant to Section 263(a) of the Internal Revenue Code of 1986, as amended (Code). Capitalized expenses under Section 263(a) must be amortized over years into the future, since such expenses are incurred to obtain intangible property, such as a patent from a government agency, which provides benefits in forthcoming years. By contrast, ordinary and necessary business expenses under Section 162(a) of the Code can be deducted when incurred and immediately be applied to reduce taxable income.
In a tax audit, the Internal Revenue Service (IRS) assessed taxes against Mylan, on the ground that it should have capitalized certain of its legal expenses from 2012 through 2014. The IRS disallowed more than $130 million in deductions over this three-year period. Mylan, in turn, appealed to the Tax Court and argued that such legal expenses were ordinary and necessary business expenses under Section 162(a).
Mylan, during this period, had prepared and sent notice letters to brand-name drug manufacturers, in order to be the first company to make a generic version of the particular pharmaceutical drug. As a result of receiving these notices, some drug manufacturers brought patent infringement suits against Mylan.
Judge Patrick Urda of the Tax Court made a key distinction between patent litigation, which is not part of the generic drug approval process of the Food and Drug Administration (FDA), and legal fees for preparing notice letters, which are required as part of the FDA generic drug approval process. Judge Urda first ruled that Mylan’s legal expenses incurred preparing notice letters that were part of the generic approval process facilitated Mylan’s acquisition of an intangible asset that had to be capitalized under Section 263(a) and, therefore, could not be immediately deducted.
On the other hand, Judge Urda ruled that legal expenses incurred for Mylan to defend itself against patent infringement suits, which arose in some cases from the notice letters, could be immediately deducted since such litigation was not technically part of the FDA’s generic approval process. The court determined that defending against such lawsuits allowed Mylan to defend its own intellectual property rights, and that such expenses were typically deductible under Section 162(a) as ordinary and necessary business expenses.
The case has potential implications for many drug manufacturers in determining which expenses can be immediately deducted under Section 162(a) and which expenses must be capitalized under Section 263(a). In particular, drug manufacturers should consider whether the court’s decision provides a basis for income tax refunds for prior tax years. Still, it should be kept in mind that the same issue could arise in different courts, which would not be bound by Judge Urda’s decision.