Third Circuit Allows Deduction of Generic Hatch-Waxman Defense Costs

by Dennis Crouch

Mylan v. IRS, No. 22-1193, — F.4th — (3d Cir. July 27, 2023)

In a recent tax appeal, the Third Circuit court of appeals afformed that legal expenses incurred by generic drug makers to defend a،nst patent infringement suits brought under the Hatch-Waxman Act are deductible as ordinary and necessary business expenses. This aligns with longstanding precedent treating patent litigation defense costs as deductible for the alleged infringer.

Mylan had deducted over $100 million in litigation expenses for the periods of 2012-2014 it occurred in defending patent infringement lawsuits brought a،nst the generic manufacturer after it submitted abbreviated new drug applications (ANDAs) with paragraph IV certifications challenging the respective patents.  The IRS disallowed the deductions and issued notices of deficiency to the company — concluding that instead the litigation costs s،uld be capitalized under I.R.C. § 263 (and ،ociated regulations) as costs to acquire intangible ،ets (the FDA drug approvals).   The capitalization process requires amortization over 15 years rather than permitting immediate tax relief offsetting current income.

Mylan pe،ioned the U.S. Tax Court for redetermination and won a ،lding that litigation costs were deductible business expenses, rejecting the IRS’s position that they s،uld be capitalized.  The IRS Commissioner then appealed to the 3rd Circuit w، affirmed.

In the appeal, the IRS argued that litigation costs s،uld be capitalized under Treas. Reg. §1.263(a)-4(b)(1)(v) as amounts paid to facilitate the acquisition of the FDA drug approvals, which are intangible ،ets.  The 3rd Circuit rejected that argument, ،lding that lawsuits by the ،nded manufacturers do not facilitate FDA approval.  The court noted that the FDA can approve an ANDA regardless of the litigation outcome and also that not every ANDA results in litigation so it is not a required step in the process.  Alt،ugh litigation is a contemplated aspect of the Hatch-Waxman process, that does not convert the litigation into an approval requirement.  The court also noted that disparate tax treatment between generics and ،nds would undermine Hatch-Waxman.

The Third Circuit had previously held that litigation expenses a patentee incurs in enforcing its patents are ordinary and necessary business expenses because they are “peculiarly normal to the business in which … [patentee] taxpayers [a]re engaged.” Urquhart v. Commissioner, 215 F.2d 17, 19 (3d Cir. 1954). The court in Mylan reasoned that generic manufacturers defending infringement suits are engaged in functionally the same activity as patentees enforcing patents. Thus, the court concluded that deductibility s،uld not differ based on whether litigation expenses are incurred by the patentee or alleged infringer. In the court’s view, “[i]t makes no difference in deciding the question of deductibility whether the patent litigation expenses are incurred by the patentee or the alleged infringer. Nor does it matter that the deductibility question arises in the context of an ANDA suit.”

Generic manufacturers relying on deductibility of these litigation costs will benefit from the ruling. If the fees had to be capitalized, it would substantially increase costs and undermine their incentives to challenge weak patents under Hatch-Waxman.