IRS Treatment of Litigation Costs in ANDA Cases

The Third Circuit Court of Appeals will decide whether the IRS can force Mylan (and by extension other ANDA filers) to treat a) legal expenses to prepare notice letters and b) legal expenses to defend against infringement suits after paragraph IV certification both as capital expenditures that may not be deducted entirely in the year they are incurred.  The IRS is seeking this result and Mylan opposes it, arguing the second category (b) should continue to be treated like other patent litigation costs—deductible as ordinary business expenses.  If the Third Circuit result agrees with an earlier decision of the Federal Court of Claims, the litigation costs will continue to be deductible despite IRS efforts to the contrary.

In a tax court proceeding, Mylan petitioned to avoid owing the IRS $50,038,299 in deficiencies for three years during which Mylan had incurred costs in ANDA filings and subsequent litigations.  The tax court held that the expenses for the notice letters needed to be capitalized as of paragraph IV certification because they are required to obtain FDA approval and “effectively” this occurs when the certification is done, even though a tentative or final approval letter has not been obtained.  The tax court distinguished the litigation expenses, however, as ordinary business expenses, looking to Third Circuit precedent, so these could be deducted and not capitalized.  Mylan stipulated to reduced alleged deficiencies at a total of $1,960,993 (a 96% reduction).  The IRS appealed (Nos. 22-1193, 22-1194, and 22-1195 in the Third Circuit) and argued that even these litigation expenses need to be capitalized because they are amounts spent to obtain an intangible asset.  The IRS argued that under Treasury Reg. § 1.263(a)-4, amounts paid to acquire, or facilitate acquisition of, an intangible asset must be capitalized.  Because the paragraph IV certification allows pre-expiration approval and 180-day exclusivity, the litigation under 35 U.S.C. 271(e)(2) is a part of obtaining that approval and must be capitalized.  Although the Third Circuit appeared skeptical of this change in IRS treatment of ANDA litigation costs, the IRS is pursuing this not for the first time.  The Court of Federal Claims, in August 2022 in an appeal involving Actavis, rejected a similar attempt by the IRS to force capitalization and held the litigation expenses deductible based on an origin-of-the-claim test (a traditional test, also used in the Third Circuit, based on Woodward v. Commissioner, 397 U.S. 572, 577 (1970))—finding that Hatch-Waxman litigation has its “origin . . . in the branded drug companies’ patent enforcement efforts—a claim sounding in tort” and therefore not originating from the ANDA filer’s actions.

Tax Court proceedings should continue to find ANDA litigation costs deductible while finding notice letter costs subject to capitalization.  One appeals court has affirmed the tax court finding litigation costs deductible so in-house lawyers have precedent to continue pursuing deductibility of these expenses even though the IRS is pursuing capitalization elsewhere in this Mylan case.  The Third Circuit’s opinion should provide clarity on whether the IRS is likely to continue pursuing capital treatment of litigation expenses for ANDA filers.