Tax developments
Actavis and deductible expenses
On March 21, 2025, the Court of Appeals for the Federal Circuit released a decision in
Actavis Laboratories FL, Inc. v. United States, holding that taxpayers could deduct rather than capitalize legal fees associated with patent defense. This Federal Circuit decision follows the outcome of a similar case from 2023 out of the Third Circuit,
Mylan Inc. v. Commissioner of Internal Revenue. In both cases, the taxpayers sought expedited approval from the Food and Drug Administration (FDA) under the Hatch-Waxman Act to sell generic versions of branded prescription drugs. As part of this process, the generic drugmaker can certify that any patent covering the branded drug is invalid or would not be infringed by the generic drug. Under Hatch-Waxman, this certification can be an act of patent infringement providing the branded drugmaker with a cause of action against the generic maker. The taxpayers in both
Actavis and
Mylan were sued by branded drugmakers for patent infringement related to their FDA approval processes.
In Actavis, the taxpayer argued the court should use the origin of the claim test in determining the deductibility of the litigation expenses. Under this test, the proper inquiry is whether the origin of the claim being litigated was a part of the process of the acquisition of a capital asset. The court looked at the FDA approval process and determined that it was separate and distinct from the patent infringement litigation. Hatch-Waxman litigation “often results only in delaying effective FDA approval” and cannot lead to “effective FDA approval occurring sooner than it would have if the lawsuit had never been brought.” Because the origin of the claim being litigated was patent infringement unrelated to the FDA approval process, the court determined that the litigation did not originate in the pursuit of a capital asset, and that under this standard, the expense would be deductible.
The government argued that the proper standard was the significant future benefit test of Treas. Reg. § 1.263(a)-4, which provides that an amount paid to facilitate the acquisition of an intangible must be capitalized if the amount is paid in the process of investigating the transaction. The Federal Circuit drew from Mylan saying that the Third Circuit “aptly” noted that “when generic manufacturers . . . defend themselves in patent infringement suits . . . they obtain no rights from a successful outcome.” Generic manufacturers do not acquire the intangible asset of a patent nor FDA approval if they prevail. The courts again focused on the fact that the patent infringement lawsuit had no bearing on the FDA approval process, so that amounts paid to litigate the patent infringement cases could not facilitate the acquisition of the FDA approval.
Although the IRS relied heavily on Treas. Reg. § 1.263(a)-4 in Actavis, the taxpayer never challenged the validity of the regulations. Consequently, the court did not have to consider the regulations under the lens of Loper Bright. The decision will likely have limited impact as its scope is limited to costs under Hatch-Waxman litigation. It will primarily affect generic drug manufacturers, which could see reduced tax burden as a result of the deduction, as opposed to the burden that would occur with a capitalization requirement for the costs of Hatch-Waxman litigation.
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