Federal Circuit Confirms Deductibility of Hatch-Waxman Litigation Expenses

On March 21, the Court of Appeals for the Federal Circuit held in a precedential opinion that legal fees incurred by generic drug companies in defending against patent infringement suits brought under the Hatch-Waxman Act constitute “ordinary and necessary business expenses that may be deducted in the year in which they are incurred,” and do not need to be capitalized over a period of years. (Actavis Laboratories FL, Inc. v. United States, No. 23-1320 [Fed. Cir.].) Unless the government obtains review by the Supreme Court, the case should put to rest the IRS’s attempts to subject generic drug companies to uniquely unfavorable tax treatment among all patent-infringement litigants. 

Background

In 2008 and 2009, Actavis Laboratories FL, Inc. incurred over $12 million in legal fees defending against patent infringement suits filed under the Hatch-Waxman Act by holders of new drug applications (NDAs). Actavis deducted those amounts as ordinary and necessary business expenses in the years they were incurred under Section 162 of the Internal Revenue Code. In auditing the relevant tax returns, however, the IRS determined that the expenditures were instead spent “facilitating” the creation of “intangible assets” in the form of FDA-approved abbreviated new drug applications (ANDAs) and so needed to be capitalized pursuant to 26 C.F.R.§ 1.263(a)-4. IRS therefore sent Actavis notices of deficiency. Actavis ultimately paid the alleged shortfall and then filed amended returns seeking a refund. 

When the IRS did not timely act on Actavis’s refund request, Actavis, represented by Goodwin, filed a claim in the Court of Federal Claims. The Goodwin team obtained a complete summary judgment victory in 2023, with the Court of Federal Claims reasoning that, under a Supreme Court doctrine known as the “origin of the claim” test, Actavis was entitled to deduct its legal fees. The court also rejected the IRS’s argument that Hatch-Waxman litigation “facilitates” acquisition of an ANDA, applying a two-step framework looking to both the “origin of the claim” test and the IRS regulation. Subsequently, the Third Circuit ruled for a different generic drug company in another case, reasoning that Hatch-Waxman legal fees are deductible under the IRS regulation, without applying the “origin of the claim” test.

The IRS appealed the Actavis case to the Federal Circuit, arguing that both the Court of Federal Claims and the Third Circuit had reached incorrect results under the tests that they applied. Actavis, still represented by Goodwin, argued that Hatch-Waxman expenses are properly deductible under the “origin of the claim” test, the IRS regulation, or the hybrid approach that the Court of Federal Claims adopted. 

Actavis Wins under the ‘Origin of the Claim’ Test or the Regulation

The Federal Circuit sided with Actavis in a precedential opinion, agreeing that Hatch-Waxman litigation expenses are deductible under either the “origin of the claim” test or the IRS regulation. 

The origin of a Hatch-Waxman claim, the court reasoned, is not the decision by a generic company to acquire FDA approval of an ANDA but instead is “a patent claim brought by the NDA holder.” “While the ANDA filer is, of course, pursuing the capital asset of an FDA approved ANDA, which gives the ANDA filer the right to sell its generic drug product, Hatch-Waxman litigation does not determine whether the ANDA is, or is not, approved.” That determination is made solely though the FDA approval process, which is “fundamentally separate” from any Hatch-Waxman litigation: “[A] party could win or lose in the litigation and that same party could succeed or fail in the FDA review—without either being influenced by the other.” Although it acknowledged that Hatch-Waxman litigation might have an impact on the timing of effective FDA approval, the court reasoned that this was a mere “consequence[]” of litigation and did not “transform the origin of the claim being litigated.” Instead, that origin remains rooted “in the patentholder’s decision to sue,” regardless of when an ANDA applicant ultimately obtains FDA approval. 

As further support for its decision, the court observed that the IRS’s analysis would result in two “incongruous outcome[s].” First, under the IRS’s analysis, brand-name drug companies would be allowed to deduct the expenses that they incur in Hatch-Waxman lawsuits. The court declined to accept such a result — imposing markedly worse tax treatment on companies on the generic side of the “v” — because doing so would be “at odds with” the Hatch-Waxman Act’s careful balancing of generic and brand interests. Second, outside of the Hatch-Waxman context, both plaintiffs and defendants in infringement suits under Section 271(a) can deduct their litigation costs as business expenses. And since suits under Section 271(a) are substantively identical to infringement suits under the Hatch-Waxman Act, the court reasoned that legal fees incurred in the latter ought to be deductible to the same extent as legal fees incurred in the former. 

For many of the same reasons, the Federal Circuit rejected the government’s argument that the IRS regulation requires capitalization. That regulation, the court explained, requires capitalization of amounts spent to “facilitate” the creation of intangible assets. But Hatch-Waxman litigation and the FDA approval process are separate, and “neither ‘facilitates’ the other.” Nor do expenses incurred by the generic applicant in Hatch-Waxman suits “facilitate” FDA approval, because, as the IRS argued, “[t]he only reason [that] applicant defends against a Hatch-Waxman suit is to obtain FDA approval that is prior to the patent-expiration date.” As the court explained, “[t]he ANDA filer would prefer not to be sued and then to obtain final FDA approval that becomes effective upon the FDA’s completion of its regulatory review, without a 30-month stay and risk of losing the litigation and needing to wait until the expiration of all pertinent patents.” In other words, Hatch-Waxman litigation can only delay, and does not “facilitate,” the acquisition of a fully effective ANDA.

Takeaways

Although the Federal Circuit did not decide whether the “origin of the claim” test or the IRS’s intangibles regulation controls, its decision squarely holds that expenses incurred defending against Hatch-Waxman suits are deductible under either. Generic drug companies now have binding authority holding that their Hatch-Waxman litigation expenses are properly deductible under the only two tests that the IRS has invoked to justify its uniquely unfavorable treatment of generic drug manufacturers.

 

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee similar outcomes.