Locke Lord QuickStudy: Tax Court Finds Legal Fees Incurred in Defending Hatch-Waxman Lawsuits are ‎Deductible Expenses

On April 27, 2021, the U.S. Tax Court issued its decision in Mylan, Inc. v. Comm’r of Internal Revenue regarding which legal fees that a generic-drug manufacturer incurs in connection with its Abbreviated New Drug Application (“ANDA”) constitute tax-deductible expenses. Mylan, Inc. v. Comm’r of Internal Revenue, Case No. 26976-16, 156 T.C. No. 10 (T.C. Apr. 27, 2021). The court held that Mylan’s legal fees for defending itself against patent infringement suits brought under 35 U.S.C. § 271(e)(2) are ordinary and necessary business expenses that can be deducted, rather than capitalized. On the other hand, the court held that Mylan’s fees for preparing its Paragraph IV notice letters are not deductible and must be capitalized.


In its 2012-14 federal income tax returns, Mylan claimed deductions for the legal fees in question as ordinary and necessary business expenses under 26 U.S.C. § 162(a). The IRS issued notices of deficiency to Mylan for each of those years. Mylan at 2. Mylan filed petitions with the court for redetermination of the noted deficiencies, contending that all of its legal fees from 2012 through 2014 for preparing its notice letters and defending against patent infringement suits under the Hatch-Waxman Act qualify as deductible expenses under § 162(a) rather than capitalized expenses under 26 U.S.C. § 263(a).1 The matters were consolidated and a subsequent trial was held where it was Mylan’s burden to “clearly show[] [its] right to the claimed deduction.”2 Mylan at 19 (citation omitted).


In its opinion, the court reviewed what it termed the “highly reticulated statutory and regulatory scheme under which Mylan’s legal expenses were incurred” against the Tax Code and regulations to identify which fees qualify as ordinary business expenses and which are devoted to “acquire an existing intangible,” “create or enhance various ‘separate and distinct’ intangibles,” or “create or enhance a ‘future benefit’” and therefore subject to capitalization. Id. at 3, 21-22.‎


In general, Section 162(a) allows a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business” with an expense qualifying as “ordinary” if it is “customary or usual within a particular trade, business, or industry or relates to a common or frequent transaction in the type of business involved.” Mylan at 19; id. n. 5; 26 U.S.C. § 162(a). Relevant here, the deductibility of a legal expense generally depends on the origin and character of the claim giving rise to the expense.3 The court recognized that legal fees incurred as a result of defending against patent infringement suits are “directly connected with (or pertaining to) the taxpayer’s trade or business” and therefore deductible “as ordinary and necessary business expenses.” Mylan at 25. Those fees, however, are distinct from expenditures “arising out of the acquisition, improvement or ownership of property,” which are not deductible and must be capitalized under § 263(a). Id. (citations omitted). Non-deductible expenditures include those paid to facilitate the acquisition or creation of an intangible, such as “investigating or otherwise pursuing” the intangible. 24. Relevant here, the court noted that the governing regulations provided that “created intangibles” comprise, among other things, “rights obtained from a governmental agency.” Id. at 22.


After reviewing the statutory requirements in the Hatch-Waxman Act for a drug company to secure an FDA-approved ANDA, the court concluded that expenses incurred in “prepar[ing], assembl[ing], and transmit[ting] its notice letters” are necessary and required steps in securing rights from the government and therefore not deductible expenses. Id. at 31-32.


In contrast, the court held that litigation expenses incurred in defending against a § 271(e)(2) suit are not necessary to the ANDA approval process. Id. at 32-33. The court reasoned that although the filing of an ANDA with a paragraph IV certification is an artificial act of infringement that opens the door to patent litigation, neither the NDA holder nor the ANDA filer is required to file suit. Id. at 33-35, 37. Since an infringement action is not necessary to obtain ANDA approval under the Hatch-Waxman Act, the court held that fees incurred in defending against such actions are not linked to securing rights from the government and thus, not required to be capitalized. Id. at 41.


Although either party may appeal the court’s decision, as it stands, similarly situated companies may deduct legal fees incurred in defending against § 271(e)(2) actions as ordinary and necessary business expenses under § 162(a). We recommend that companies consult their tax, accounting and legal advisors regarding the best course forward, including potentially establishing separate ledgers for legal fees associated with notice letters and other aspects of the FDA approval process, and those incurred in defending against § 271(e)(2) suits filed by the NDA holder. In addition to future tax income returns and reporting, the court’s decision may also permit companies to amend their income tax returns that were filed for earlier tax years (possibly three or more years) to obtain tax refunds by claiming deductions for legal fees incurred in defending against § 271(e)(2) actions for such tax years. We recommend that companies consult their tax and accounting advisors to determine whether such amendments might be possible.


A copy of the court decision can be found here



1. For the years in question, Mylan reported that it had “incurred legal fees of $46,158,403, $38,211,911, and ‎‎$38,618,993,” “respectively, to prepare notice letters and to litigate the Section 271(e)(2) suits.” Mylan at 16. These legal expenses reflected “approximately 120 suits involving ANDAs with paragraph IV certifications and 15 additional ANDAs with paragraph IV certifications for which suits had not yet ‎been filed.‎” Id.
2. The court noted that although three expert witnesses testified extensively at trial on behalf of each of the parties, “their testimony [was] not necessary for the purposes of deciding these cases.” Id. at 18 n. 4.
3. The court identified this as the “origin of the claim” test: “the substance of the underlying claim or transaction out of which the expenditure in controversy arose governs whether the item is a deductible expense or a capital expenditure, regardless of the motives of the payor or the consequences that may result from the failure to defeat the claim.” Mylan at 25 (citation omitted).