Federal Circuit: Drug Manufacturer Can Deduct Patent Litigation Expenses

(Parker Tax Publishing April 2025)

The Federal Circuit affirmed the Court of Federal Claims and held that a generic drug manufacturer was entitled to deduct patent litigation expenses incurred in defending its business practices. The court rejected the IRS's argument that the expenses were incurred in pursuit of an intangible capital asset: namely, regulatory approval to lawfully market a generic drug product in the United States. Actavis Laboratories FL, Inc. v. U.S., 2025 PTC 102 (Fed. Cir. 2025).

Background

Actavis Laboratories FL, Inc. (Actavis) filed Abbreviated New Drug Applications (ANDAs) with the U.S. Food and Drug Administration (FDA), seeking FDA approval to market and sell generic versions of branded drug products already being sold in the United States. Once the FDA gives its approval, an applicant may manufacture and market the generic drug product to provide a safe, effective, lower cost alternative to the brand-name drug it references.

In 1984, the Drug Price Competition and Patent Term Restoration Act of 1984, commonly known as the "Hatch-Waxman Act," established a new, expedited process for obtaining FDA approval to market and sell generic versions of previously approved pharmaceutical drug products (often referred to as "brand-name" drugs). For any of the listed patents that have not yet expired, the ANDA filer must submit one of two certifications: a "Paragraph III" certification, which requests that the FDA make any approval to market the generic drug effective only upon the expiration of the listed patent(s); or a "Paragraph IV" certification, by which the ANDA filer is representing to the FDA that any patent covering the New Drug Application (NDA) holder's drug product is invalid or will not be infringed by the manufacture, use, or sale of the new drug for which the ANDA is submitted.

By filing a Paragraph IV certification, it is possible that the ANDA filer will obtain effective FDA approval, allowing immediate sale of its proposed generic drug product, before the expiration of the NDA holder's patents. However, making a Paragraph IV certification has several consequences. First, submitting a Paragraph IV certification to the FDA triggers a requirement that the ANDA filer send a notification letter ("Paragraph IV Notice") to the patent owner. Second, under 35 U.S.C. Section 271(e)(2), filing an ANDA with a Paragraph IV certification is, under the Hatch-Waxman Act, an act of patent infringement. Third, this process gives the NDA holder-patentee the ability to prevent the FDA from giving final, effective approval to the ANDA for up to 30 months. It can accomplish this by filing a Section 271(e) claim against the ANDA filer within 45 days of receiving the Paragraph IV Notice.

In response to Actavis' ANDA filings and pursuant to the Hatch-Waxman Act, the manufacturers of those branded drugs - who already held NDAs for their products, and also owned patents covering those products - sued Actavis for patent infringement and the parties then engaged in litigation over infringement and the validity of any pertinent patents.

During 2008 and 2009, Actavis was a defendant in at least nine Hatch-Waxman lawsuits brought by NDA holders under Section 271(e) and incurred substantial litigation expenses in these Hatch-Waxman suits: $3,882,951 and $8,481,237 in 2008 and 2009, respectively. Actavis deducted those litigation expenses as ordinary and necessary business expenses under Code Sec. 162(a). The IRS, however, considered these expenses as capital expenditures because they were incurred in pursuit of an intangible capital asset: namely, FDA approval to lawfully market a generic drug product in the United States. Thus, the IRS said, such expenses were not deductible and instead had to be amortized over the life of the asset. Actavis paid the taxes assessed by the IRS and then sued in the Court of Federal Claims to recover the taxes paid. The Court of Federal Claims, in Actavis Laboratories, FL, Inc. v. U.S., 2022 PTC 246 (Fed. Cl. 2022), sided with Actavis and held that the litigation expenses were deductible.

The IRS appealed to the Federal Circuit. The parties' principal disagreement centered on whether Actavis' Hatch-Waxman litigation expenses were deductible as ordinary business expenses or should, instead, be treated as capital expenditures. The parties also disputed the method of analysis the court should undertake to resolve the issue.

Specifically, Actavis argued that the Federal Circuit should apply the "origin of the claim" test under which the origin of the claim with respect to which an expense was incurred, rather than its potential consequences, is the controlling test of whether an expense is a deductible business expense or a capital expense. Actavis contended that the origin of the claim giving rise to the expenses it deducted was the NDA holders' filings of complaints containing a Section 271(e) Claim. The IRS, however, insisted the origin of the claim litigated was Actavis' filing of ANDAs with Paragraph IV certifications. The IRS also argued that the "significant future benefit" standard of Reg. Sec. 1.263, which was adopted in response to the Supreme Court's decision in INDOPCO, Inc. v. Comm'r, 503 U.S. 79 (1992), was the preferred analytical approach to deciding the issue. In INDOPCO, the Supreme Court held that expenditures that create or enhance separate and distinct assets or produce certain other future benefits of a significant nature must be capitalized under Code Sec. 263(a).

The IRS also relied on Reg. Sec. 1.263(a)-4, which identifies a variety of payments that must be treated as capital expenditures, including an amount paid to create rights obtained from a governmental agency, such as a license. The regulation further requires that an amount paid to facilitate an acquisition or creation of an intangible asset must be treated as a capital expenditure. The term "facilitate" is broadly defined in the regulations to cover the process of investigating or otherwise pursuing a "transaction", which the regulation defines to mean "all of the factual elements comprising an acquisition or creation of an intangible."

Analysis

The Federal Circuit affirmed the Court of Federal Claims and held that Actavis could deduct its Hatch-Waxman litigation costs as ordinary and necessary business expenses. The question of deductibility, the court said, turned on whether the litigation facilitated the transaction of Actavis' acquisition of the intangible asset at issue (i.e., FDA approval of its ANDA).

With respect to the government's argument that, under Reg. Sec. 1.263(a)-4, expenses relating to "the process of investigating or otherwise pursuing the transaction" must be capitalized, the court found that the Hatch-Waxman litigation was not part of the "process of pursuing" approval of an ANDA because while the FDA regulatory approval process and the Hatch-Waxman litigation may proceed in the same timeframe, neither "facilitates" the other. Obtaining regulatory approval from the FDA, the court observed, requires the ANDA filer to show that its proposed generic drug product is safe, effective, and the bioequivalent to the reference drug of the NDA holder. On the other hand, the court said, prevailing in Hatch-Waxman litigation requires the ANDA filer to defeat the NDA holder's patent infringement claim or prove the patent claims are invalid. There is no necessary link, the court said, between these two showings: whether the NDA holder succeeds or fails before the FDA, it may also succeed or fail in the district court.

In short, the Federal Circuit concluded that the issues in the litigation and the issues in the regulatory approval process are different, and they are resolved by different decision-makers. Because the litigation expenses incurred by the ANDA filer are incurred in defending against the Section 271(e) Claim - that is, while proceeding in the Hatch-Waxman lawsuit "lane" - and not in seeking to obtain FDA approval, the court said it is proper to deem the origin of the claim giving rise to the expenses in question as being the patent claim. The intangible asset sought by the ANDA filer is final, effective approval of the ANDA itself - and acquisition of that asset, the court found, was not facilitated by Hatch-Waxman litigation.

For a discussion of deducting legal fees as ordinary and necessary business expenses, see Parker Tax ¶80,185. For a discussion of the tax treatment of amounts paid to acquire or create intangible assets, see Parker Tax ¶99,580. For a discussion of the judicial and administrative interpretations of the capital expenditure rules, including the INDOPCO decision, see Parker Tax ¶99,510.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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