Third Circuit Rejects IRS Assertion That Generic Manufacturers Must Capitalize Legal Fees Incurred in Hatch-Waxman Litigation

August 01, 2023

Key Takeaways

  • Although legal fees spent preparing Paragraph IV notice letters must be capitalized (and thus amortized over 15 years), legal fees spent defending ANDA suits launched in response to those letters may be taken as deductions in the year they were incurred.
  • Because defending ANDA litigation is not part of seeking FDA approval, a generic drug manufacturer may properly deduct as ordinary and necessary business expenses the legal fees it incurs in its defense.

Regulatory Background

In 1984, Congress passed the Hatch-Waxman Act, which allows drug manufacturers to seek FDA approval to make generic versions of previously approved branded drug products by filing an Abbreviated New Drug Application (“ANDA”), in lieu of the lengthier and more expensive process of preparing and submitting a full-blown New Drug Application (“NDA”).1 To receive ANDA approval, the generic manufacturer must show that the generic drug has “the same active ingredients as, and is biologically equivalent to, [the already approved] brand-name drug.”2 As part of the Hatch-Waxman Act, Congress sought to “encourage manufacturers of generic drugs . . . to challenge weak or invalid patents on brand name drugs so consumers can enjoy lower drug prices.”3 Accordingly, the Act requires brand-name manufacturers to list the patents covering their drugs in the FDA’s “Orange Book,” and generic manufacturers seeking FDA approval to market their proposed generic product prior to expiration of any Orange Book-listed patents must include as part of their ANDA a certification that the relevant patent(s) are invalid or will not be infringed by the manufacture or sale of the product.4 A generic manufacturer may provide those assurances in one of four ways. It may certify that:

  1. No patent information on the branded drug has been submitted to the FDA (a “Paragraph I certification”);
  2. Any relevant patents have expired (a “Paragraph II certification”);
  3. Any relevant patents will expire on a stated date, implying that they will have expired by the time the generic drug goes to market with FDA approval (a “Paragraph III certification”); or
  4. Any relevant patents are “invalid or will not be infringed by the manufacture, use, or sale of the new [generic] drug for which the [ANDA] is submitted” (a “Paragraph IV certification”).5

If submitted, the Paragraph IV certification is treated as a technical act of patent infringement intended to give patentholders a chance to resolve any disputed issues of patent infringement, validity, or enforceability before the FDA grants final approval of the ANDA. A generic manufacturer filing a Paragraph IV certification must send a notice of the certification to the brand-name manufacturer, and include with the notice a detailed explanation as to why the generic manufacturer believes the patent at issue is invalid or will not be infringed.6 Upon receipt, the brand-name manufacturer may elect to sue the generic manufacturer for patent infringement, negotiate a patent license or other resolution of the patent dispute, or do neither and make no attempt to delay FDA approval during the term of the patent(s). If it chooses to sue, the litigation is brought under 35 U.S.C. § 271(e)(2). Importantly, a brand-name manufacturer’s decision to file a § 271(e)(2) suit (or declination to do so) plays no role in the FDA’s decision whether to approve or not approve the ANDA process.

Procedural Background

Mylan is a generic drug manufacturer that, between 2012 and 2014, regularly submitted ANDAs to the FDA, often including Paragraph IV certifications.7 As a result, Mylan defended itself in around 120 ANDA patent infringement suits, for which it incurred tens of millions of dollars of attorneys’ fees.8 Mylan deducted those fees, as well as the legal fees incurred in preparing and sending the required Paragraph IV notice letters, as ordinary and necessary business expenses in the years in which they were incurred.9 The IRS responded that Mylan could not deduct the nearly $130 million in fees in the years Mylan incurred them, and issued Mylan notices of deficiencies for each of the three tax years.10

After a consolidated trial addressing each of the three years at issue, the U.S. Tax Court issued an opinion holding that the legal expenses Mylan incurred to prepare and send the Paragraph IV notice letters must be capitalized because they were necessary for Mylan to obtain FDA approval, but the legal expenses Mylan incurred to defend ANDA infringement suits were properly deductible as ordinary and necessary business expenses because the patent litigation was separate and distinct from the FDA’s ANDA approval process.11

Third Circuit’s Opinion

On appeal, the dispute centered on “what the word ‘facilitate’ means”12 in the context of IRS regulations that require businesses to capitalize amounts paid to “facilitate” the acquisition of intangible assets, such as the acquisition of FDA approval of a generic drug approval.13 IRS regulations say that an expense “facilitates” the acquisition of intangible assets “if the amount is paid in the process of investigating or otherwise pursuing the transaction.”14 As the taxpayer, Mylan bore the burden of proving that its legal fees were properly deductible and should not be capitalized.15

Mylan argued ANDA litigation costs do not “facilitate the acquisition of FDA approval because approval can be granted regardless of the litigation.”16 The IRS countered that if a generic drug manufacturer makes a Paragraph IV certification then it necessarily “triggers the requisite step of resolving any litigation from a Paragraph IV certification.”17

The Third Circuit explained first that “[i]t has long been the rule that taxpayers may deduct the costs of defending one’s business against a tort because mounting such a defense is an ordinary business response,”18 and that “patent infringe claims ‘sound[ ] in tort.’”19 The court also noted that “both the U.S. Court of Appeals for the Sixth Circuit and the Tax Court have held that litigation costs incurred by defendants in patent infringement suits are indeed deductible.”20

Against that backdrop, the Third Circuit agreed with Mylan and the U.S. Tax Court and reasoned that “[p]atent litigation, if it occurs at all after a Paragraph IV certification, does not facilitate the acquisition of an FDA-approved ANDA because the two processes are distinct and ultimately separate.”21 Indeed, sometimes no ANDA infringement suit is ever filed, and when it is, although the ANDA litigation can delay the timing of the FDA’s approval, it does affect the FDA’s scientific review of the ANDA, which relates to the safety and efficacy of the proposed generic drug product.22 Thus, as the court noted, “[n]othing prevents a generic manufacturer from commercially marketing its approved drug under the cloud of patent litigation, as long as it has an effective FDA-approved ANDA.”23 That is true even though any such “launch at risk” may subject the generic manufacturer to damages if the patentholder ultimately prevails in the ANDA suit.24 Accordingly, because defending ANDA litigation is not a part of seeking FDA approval, a generic drug manufacturer may properly “deduct as ordinary and necessary business expenses the legal fees it incur[s]” in its defense.25


  1. See 21 U.S.C. § 355(j).
  2. F.T.C. v. Actavis, Inc., 570 U.S. 136, 142 (2013) (cleaned up).
  3. In re Lipitor Antitrust Litig., 855 F.3d 126, 134–35 (3d Cir. 2017) (cleaned up).
  4. See Caraco Pharm. Lab’ys, Ltd. v. Novo Nordisk A/S et al., 566 U.S. 399, 406 (2012); 21 U.S.C. § 355(b); 21 U.S.C. § 355(j)(2)(A)(vii)(IV); 21 U.S.C. § 355(j)(2)(A)(viii).
  5. Mylan Inc & Subsidiaries v. Commissioner of Internal Revenue, Nos. 22-1193, 22-1194, and 22-1195 (3d Cir. July 27, 2023) (slip opinion) at 8 (citing 21 U.S.C. § 355(j)(2)(A)(vii)(I)-(IV)).
  6. 21 U.S.C. § 355(j)(2)(B).
  7. Mylan Inc & Subsidiaries v. Commissioner of Internal Revenue, Nos. 22-1193, 22-1194, and 22-1195 (3d Cir. July 27, 2023) (slip opinion) at 22.
  8. Id.
  9. Id.
  10. Id.
  11. See id. at 23.
  12. Id. at 24.
  13. See id. (citing 26 C.F.R. § 1.263(a)-4(b)(1)(v), (d)(1), (d)(5)(i)).
  14. See id. (citing 26 C.F.R. § 1.263(a)-4(e)(1)(i).
  15. Id. at 16.
  16. Id. at 24.
  17. Id. at 24–25.
  18. Id. at 16 (citing Commissioner v. Heininger, 320 U.S. 467, 471–72 (1943)).
  19. Id. at 17 (quoting Schillinger v. United States, 155 U.S. 163, 169 (1894)).
  20. Id. (collecting cases).
  21. 29.
  22. Id. at 26 (e.g., “Put differently, ultimate FDA approval is never decided by the outcome of patent litigation under § 271(e)(2), even if it is delayed by such litigation.”).
  23. Id. at 26.
  24. Id.
  25. Id. at 1.

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