Generic drugmakers' ability to deduct patent litigation expenses related to filing Abbreviated New Drug Applications (ANDAs) under the Hatch-Waxman Act is affirmed by a recent appeals court decision supporting the deductibility of patent litigation expenses.
Companies that currently capitalize such costs and recover over a period of time may wish to file accounting method changes to immediately recover the costs.
In good news for generic drug manufacturers, Actavis Labs prevailed, and the Court of Appeals for the Federal Circuit affirmed the deductibility of patent infringement litigation fees related to Abbreviated New Drug Applications (ANDAs) filings in Actavis Labs. FL v. United States, No. 2023-1320 (Fed. Cir. March21, 2025). Companies incurring and capitalizing patent infringement litigation costs as a result of their Paragraph IV ANDA filings may want to revise their position to deduct such fees as a result of this appeal and other recent favorable court cases.
The Hatch-Waxman Act, passed by Congress, established a mechanism to expedite the approval of generic drugs through the Food and Drug Administration (FDA)’s ANDA process. Under this process, a generic drug manufacturer can apply for accelerated FDA approval by demonstrating that their drug has the same active ingredient or biological equivalence to an approved brand-name drug, thereby confirming its safety and efficacy.
If an Applicant lists an approved brand name drug with intent to market and sell the generic drug prior to its patent expiration, it must provide a “Paragraph IV” certification indicating the proposed generic drug does not infringe on the approved branded drug or that the patent for the approved branded drug is invalid.
Additionally, within a 20-day period the applicant must notify the patent holder of the currently approved drug with the basis for its Paragraph IV filing. The holder of the original patent has 45 days to file a patent infringement claim under section 271(e) and delay any potential FDA approval for up to 30 months or when the patent expires after successful litigation of patent infringement.
The ultimate FDA approval of the ANDA is based on the safety and efficacy of the generic drug and does not take into consideration any patent infringement, rather the litigation can only delay the effective date of any approval the FDA may proffer.
In Actavis Laboratories FL. Inc. v. United States, the taxpayer was a generic drug manufacturer that filed several ANDAs with Paragraph IV certifications. Several of the brand-name drug manufacturers subsequently brought Hatch-Waxman patent infringement suits against the taxpayer, resulting in the taxpayer incurring litigation expenses to defend the suits. The taxpayer deducted such costs as ordinary and necessary business expenses in the years incurred; however, the IRS refused to allow such deductions and instead required the taxpayer to capitalize the costs as amounts paid or incurred to facilitate the acquisition of the FDA-approved ANDA, an intangible asset.
In 2022, the Court of Federal Claims found in favor of the taxpayer in Actavis Laboratories FL Inc. v. United States and held patent infringement litigation expenses as currently deductible ordinary and necessary business expenses rather than capitalizable facilitative expenses for an intangible asset.
The court applied a two-step test in which it analyzed:
In the latter, the primary contention by the IRS was the litigation expenses facilitated or enhanced the creation of an intangible asset (the ANDA’s FDA approval).
The court found the origin of the claim arose from the original patent holder’s protection of its activities, and the litigation expenses did not facilitate or enhance the creation of an intangible asset because the litigation cannot affect FDA approval of the ANDA.
The IRS disagreed and appealed this decision. For additional information on this case, please review RSM’s summary of Actavis Laboratories FL Inc. v. United States.
On appeal, in addition to the disagreement over the deductibility or capitalization of the aforementioned litigation expenses, the IRS and Actavis disagreed on the appropriate standard applicable to determine if capitalization applied.
Actavis argued the standard to apply was the origin of claim test (as described in Woodward, 397 U.S. at 572, and United States v. Gilmore, 372 U.S. 39 (1963)). Alternatively, the IRS argued that the appropriate test to determine if the patent litigation expenses were capitalizable was if they generated a significant future benefit under Reg. section 1.263(a)-4 (and described in INDOPCO, Inc. v. Comm'r, 503 U.S. 79, 83-84 (1992)).
The Court of Appeals indicated under both the origin of claim and the significant future benefit standard that the patent infringement litigation expenses were currently deductible rather than capitalizable.
The origin of the claim test focuses on if the character and nature of the claim is “capital in nature”. The IRS argued the origin of the claim is the ANDA Paragraph IV filing, while Actavis argued the origin of the claim is the patent infringement claim by the holder of the patent. The court agreed with Actavis the patent infringement claim is the origin of the claim.
The court primarily found in favor of Actavis’ position on the basis that the ANDA FDA approval and patent infringement litigation were separate and generally independent processes. FDA approval does not review patent claims and focuses on whether the proposed drug is safe and effective. Each process has different decision makers and the outcome of the litigation could only delay an ANDA FDA approval rather than change the FDA approval outcome.
Further, the court indicated while an ANDA Paragraph IV filing does trigger a potential patent infringement claim, it does not automatically trigger litigation expenses since the patent holders may elect not to file a claim.
Additionally, the court indicated the outcome of the trial itself does not provide any right to the ANDA filer, while the FDA approval itself does provide a right. The court also considered the deductibility of patent infringement costs for the original patent holder and non-ANDA patent infringement litigation was currently deductible despite substantially similar situations.
Finally, the court distinguished this case from Woodward because the litigation in the latter was required to establish a sale price of an asset while in this case any intangible is not dependent on the litigation. Ultimately, the court deemed the origin of the claim to be the filing of the patent infringement claim by the patent holder rather than the ANDA filing.
The Court’s significant future benefit analysis trod much of the same ground as the origin of the claim analysis, focusing on the fact the litigation cannot create, enhance or facilitate the intangible asset of FDA drug approval.
The intangible (i.e. significant future benefit) in question is the final, effective approval of the ANDA, which only the FDA can grant, and the court cannot.
Moreover, the court can only delay the effective date of the FDA approval, and the litigation outcome is not considered in the approval beyond the effective date.
The Court again distinguishes this case from an example provided in Reg. section 1.263(a)-5(l) by the IRS, in which an acquisition of an asset would be prevented by the result of a lawsuit rather than merely a delay in the date of effectiveness of the asset. The Court was unpersuaded that a recent similar case, Mylan Inc. v. Comm'r of Internal Revenue, 76 F.4th 230, 233-38 (3d Cir. 2023) was wrongly decided for the aforementioned reasons listed above.
The Court of Federal Claims and the Court of Appeals for the Federal Circuit have found in favor of the deductibility of these expenses in the Actavis case. Further, both the Tax Court and the Court of Appeals for the 3rd Circuit, decided in favor of the deductibility of such expenses in Mylan Industries in a similar case in 2021 and 2023.
The judicial system favors the position that patent infringement litigation expenses are currently deductible ordinary and necessary business expenses rather than capitalizable intangible assets. Companies incurring and capitalizing patent litigation expenses related to Paragraph IV ANDA filings should consider deducting such expenses on their tax returns.
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