The Court of Appeals for the Federal Circuit issued a precedential opinion on March 21 ruling that generic drug companies can deduct legal fees incurred in Hatch-Waxman patent litigation as ordinary business expenses in the year they occur, rather than capitalizing them over multiple years.
The ruling in Actavis Laboratories FL, Inc. v. United States (No. 23-1320) represents a significant victory for generic pharmaceutical manufacturers, who have faced what the court described as "uniquely unfavorable tax treatment" compared to other patent infringement litigants.
Case Background
The dispute originated when Actavis Laboratories incurred over $12 million in legal fees defending against patent infringement suits filed under the Hatch-Waxman Act by brand-name drug companies in 2008 and 2009. Actavis deducted these expenses as "ordinary and necessary business expenses" under Section 162 of the Internal Revenue Code.
During an audit, the IRS determined that these expenditures were instead spent "facilitating" the creation of "intangible assets" in the form of FDA-approved Abbreviated New Drug Applications (ANDAs). The IRS argued these expenses needed to be capitalized pursuant to 26 C.F.R.§ 1.263(a)-4 and issued notices of deficiency.
After paying the alleged shortfall, Actavis filed amended returns seeking a refund. When the IRS failed to act on this request, Actavis filed a claim in the Court of Federal Claims, which ruled in the company's favor in 2023.
The Federal Circuit's Analysis
The Federal Circuit sided with Actavis, confirming that Hatch-Waxman litigation expenses are deductible under either the "origin of the claim" test or the IRS regulation.
The court reasoned that the origin of a Hatch-Waxman claim is not a generic company's decision to acquire FDA approval of an ANDA, but rather "a patent claim brought by the NDA holder." The court emphasized that Hatch-Waxman litigation and the FDA approval process are "fundamentally separate" from each other:
"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."
The court noted that a party could win or lose in litigation while succeeding or failing in FDA review independently, without either outcome influencing the other.
Preventing "Incongruous Outcomes"
The Federal Circuit highlighted two "incongruous outcomes" that would result from the IRS's position:
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Brand-name drug companies would be allowed to deduct their Hatch-Waxman lawsuit expenses while generic companies could not—a result "at odds with" the Hatch-Waxman Act's careful balancing of generic and brand interests.
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Outside the Hatch-Waxman context, both plaintiffs and defendants in patent infringement suits can deduct litigation costs as business expenses. Since Hatch-Waxman infringement suits are substantively identical to other infringement suits, the court reasoned that legal fees should be deductible to the same extent.
Rejecting the "Facilitation" Argument
The court also rejected the government's argument that the IRS regulation requires capitalization of amounts spent to "facilitate" the creation of intangible assets. The Federal Circuit determined that Hatch-Waxman litigation does not "facilitate" FDA approval—in fact, it can only delay it.
"The 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," the court explained.
Implications for Generic Manufacturers
This ruling provides generic drug companies with binding authority that their Hatch-Waxman litigation expenses are properly deductible under both tests the IRS has used to justify its treatment of generic manufacturers.
Unless the government obtains review by the Supreme Court, this decision effectively ends the IRS's attempts to subject generic drug companies to tax treatment that the court found to be unfavorable compared to all other patent-infringement litigants.
The ruling aligns with a similar decision from the Third Circuit in a separate case involving a different generic drug company, creating consistent precedent across multiple jurisdictions on this important tax issue for the pharmaceutical industry.
