Court rejects IRS take on intangible asset ‘facilitation’

The Third Circuit has affirmed a Tax Court determination in Mylan Inc. & Subsidiaries v. Commissioner (132 AFTR 2d 2023-5356), denying the IRS’s attempt to broaden the interpretation of “facilitate” in the intangible regulations and allowing the taxpayer to deduct certain legal fees associated with expedited Federal Drug Administration (FDA) drug programs.

The decision clearly benefits drug companies with similar legal costs, but the court’s rejection of the IRS attempt to expand the scope of legal fees that must be capitalized as facilitating the acquisition or creation of intangible assets could be more broadly favorable to other types of taxpayers.

The initial case arose from a pharmaceutical manufacturer’s treatment of a variety of legal fees paid during the time the taxpayer had applied to the FDA for an Abbreviated New Drug Application (ANDA). The ANDA program provides an expedited approval process for generic drugs that, upon certification and notification, gives a patent holder a short window to file an infringement lawsuit. The taxpayer originally tried to deduct both the legal fees for the preparation, assembly and transmittal of formal notification letters as required by the ANDA process, as well as the legal fees to defend itself against patent infringement lawsuits.

The Tax Court distinguished between the legal costs required to obtain FDA approval as part of the ANDA, which require capitalization, and legal fees attributable to the patent infringement lawsuit, which it said are deductible under Section 162. Unhappy with the Tax Court’s holding, the IRS filed an appeal.

The Third Circuit Court stated that the crux of this appeal is what the term “facilitate” means because Treas. Reg. Sec. §1.263(a)-4 requires taxpayers to capitalize amounts paid to acquire or create intangibles and amounts paid to facilitate the acquisition or creation of intangibles asset, like an ANDA. The IRS asserted that “facilitate” should be interpreted broadly to include any litigation costs associated with an ANDA because these suits would not occur but for the filing of an ANDA, so the costs are subject to capitalization.

The Third Circuit disagreed and focused on the language provided in the intangible regulations. Treas. Reg. §1.263(a)-4(e)(1)(i) provides that an amount is paid to facilitate the acquisition or creation of an intangible (the transaction) if the amount is paid in the process of investigating or otherwise pursing the transaction. Such a determination is a facts and circumstance analysis. Further, Treas. Reg. §1.263(a)-4(e)(1)(i) clarifies that the fact that the amount would (or would not) have been paid but for the transaction is relevant, but not determinative. The Third Circuit, affirming the Tax Court’s analysis, held that the litigation fees did not fall within the regulations definition of “facilitate” with regard to the ANDA approval process because the resolution or lack of resolution in the litigation did not impact approval or denial by the FDA.

Although the IRS correctly asserted that the litigation costs only arose because of the ANDA, the regulations clearly provide that assessment is relevant but not determinative. Therefore, the Court held that the IRS cannot broaden the definition of facilitate to include any costs related or associated to the creation or acquisition of the intangibles beyond the language of the regulations.

The clarity provided by the Third Circuit on the scope of “facilitate” within the regulations is beneficial guidance for taxpayers who incur costs to facilitate the creation or acquisition of intangibles as there is limited guidance on the proper tax treatment of those costs.