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Drug Company Opposes Summary Judgment on Economic Substance

JUN. 28, 2019

Perrigo Co. et al. v. United States

DATED JUN. 28, 2019
DOCUMENT ATTRIBUTES

Perrigo Co. et al. v. United States

PERRIGO COMPANY AND SUBSIDIARIES,
Plaintiff,
v.
UNITED STATES OF AMERICA,
Defendant.

IN THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF MICHIGAN
SOUTHERN DIVISION

Hon. Robert J. Jonker

PLAINTIFF'S BRIEF IN OPPOSITION TO
DEFENDANT'S MOTION FOR PARTIAL SUMMARY JUDGMENT

John B. Magee
Alex E. Sadler
Daniel M. Sosna
Drew A. Cummings
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Ave. NW
Washington, D.C. 20004

Thomas V. Linguanti
Jason D. Dimopoulos
Morgan, Lewis & Bockius LLP
77 West Wacker Drive
Chicago, IL 60601

Edward J. Bardelli (P53849)
Warner Norcross & Judd LLP
111 Lyon Street, Ste. 900
Grand Rapids, Michigan 49503
(616) 752-2165

Attorneys for Plaintiff


TABLE OF CONTENTS

INTRODUCTION

DEFENDANT'S SUMMARY JUDGMENT MOTION ON THE ECONOMIC SUBSTANCE ISSUE SHOULD BE DENIED

I. Introduction

II. Omeprazole Transactions — Background

A. Perrigo's Global Restructuring

B. Dexcel Contract

C. Formation of UK Finco, PITLP, and LLC

D. The Assignment

E. Funding of PITLP/LLC

F. Omeprazole Launch

III. Law and Argument

A. Material Facts Establish PITLP and LLC As Valid and Distinct Entities and the Business Purpose and Economic Effects of the Assignment, Reflecting Economic Substance Ab Initio

1. The Assignment Had Practicable Economic Effects

a. Captive Insurance Cases Do Not Prevent a Risk Transfer in General Business Circumstances such as the Assignment

b. The Performance Guarantee Did Not Negate LLC's Obligations or Risks

c. The Assignment Had Economic Effects at the Effective Date

2. PITLP/LLC and the Assignment Were Not Factual Shams

3. PITLP/LLC and the Assignment Were Not Shams in Substance

B. Defendant's Version of Summary Judgment Is Inappropriate Because Defendant's Sham Arguments Raise Genuine Issues of Material Fact

IV. Conclusion

DEFENDANT'S SUMMARY JUDGMENT MOTION ON THE ANDA ISSUE SHOULD ALSO BE DENIED

I. Introduction

II. Background on the ANDA Issue

A. Barriers to Generics before Hatch-Waxman

B. Hatch-Waxman

1. Streamlined FDA Approval

2. Patent Safe Harbor

3. Acceleration of Patent Disputes

C. Perrigo’s § 271(e)(2) Litigation Costs 

D. Perrigo’s Experts

E. Defendant’s Expert

F. Mylan, Inc. v. Commissioner 

III. Law and Argument 

A. Defendant’s Capitalization Theory Is Specious

1. Longstanding Precedent Establishes that Patent Infringement Litigation Defense Costs Are Deductible Business Expenses 

2. Hatch-Waxman Did Not Alter the Character or Longstanding Tax Treatment of Generics’ Patent Litigation Costs

3. § 271(e)(2) Litigation Costs Do Not Facilitate FDA Approval 

4. All Patent Infringement Claims, Including § 271(e)(2) Claims, Originate from Alleged Misuse of a Patented Invention 

B. Triable Issues of Material Fact Preclude Summary Judgment 

IV. Conclusion

TABLE OF AUTHORITIES

Cases

A.D. Transp. Express, Inc. v. United States, 290 F.3d 761 (6th Cir. 2002)

A.E. Staley Mfg. Co. v. Commissioner, 119 F.3d 482 (7th Cir. 1997)

aaiPharma Inc. v. Thompson, 296 F.3d 227 (4th Cir. 2002)

ABC Beverage Corp. v. United States, 756 F.3d 438 (6th Cir. 2014)

Agristor Fin. Corp. v. Van Sickle, 967 F.2d 233 (6th Cir. 1992)

Am. Elec. Power Co. v. United States, 326 F.3d 737 (6th Cir. 2003)

Am. Stores Co. v. Commissioner, 114 T.C. 458 (2000)

Andrx Pharms., Inc. v. Biovail Corp., 276 F.3d 1368 (Fed. Cir. 2002)

Appalachian Power Co. v. EPA, 208 F.3d 1015 (D.C. Cir. 2000)

Bass v. Commissioner, 50 T.C. 595 (1968)

Bates v. United States, 522 U.S. 23 (1997)

Bingham's Trust v. Commissioner, 325 U.S. 365 (1945)

Boagni v. Commissioner, 59 T.C. 708 (1973)

Bristol-Myers Squibb Co. v. Aurobindo Pharma USA Inc., No. 170-374-LPS, 2018 WL 5109836 (D. Del. Oct. 18, 2018)

Brown v. United States, 526 F.2d 135 (6th Cir. 1975)

Caraco Pharm. Labs., Ltd. v. Forest Labs. Inc., 527 F.3d 1278 (Fed. Cir. 2008)

Chamberlin v. Commissioner, 207 F.2d 462 (6th Cir. 1953)

Clougherty Packing Co. v. Commissioner, 84 T.C. 948 (1985)

Commissioner v. Tellier, 383 U.S. 687 (1966)

Deputy v. du Pont, 308 U.S. 488 (1940)

Dow Chem. Co. v. United States, 435 F.3d 594 (6th Cir. 2006)

Eli Lilly & Co. v. Accord Healthcare Inc., No. 14-00389, 2015 WL 8675158 (S.D. Ind. Dec. 11, 2015)

Appeal of F. Meyer & Bro. Co., 4 B.T.A. 481 (1926)

FTC v. Actavis, Inc., 570 U.S. 136 (2013)

Georgia-Pacific Consumer Prod. LP v. NCR Corp., No. 1:11-cv-0483, 2015 WL 11236845 (W.D. Mich. 2015)

Glaxo Grp. Ltd. v. Apotex, Inc., 376 F.3d 1339 (Fed. Cir. 2004)

Glaxo Inc. v. Novopharm Ltd., 110 F.3d 1562 (Fed. Cir. 1997)

Gregory v. Helvering, 293 U.S. 465 (1935)

Hague v. Commissioner, T.C. Memo. 2005-275, No. 21324-03, 2005 WL 3214581 (Nov. 29, 2005)

Harbor Bancorp v. Commissioner, 115 F.3d 722 (9th Cir. 1997)

Helvering v. Le Gierse, 312 U.S. 531 (1941)

Hosp. Corp. of Am. v. Commissioner, 81 T.C. 520 (1983)

Humana Inc. v. Commissioner, 881 F.2d 247 (6th Cir. 1989)

Ill. Tool Works v. Commissioner, T.C. Memo. 2018-121

INDOPCO v. Commissioner, 503 U.S. 79 (1992)

Estate of Kluener v. Commissioner, 154 F.3d 630 (6th Cir. 1998)

Kornhauser v. United States, 276 U.S. 145 (1928)

Mahoney v. Commissioner, 808 F.2d 1219 (6th Cir. 1986)

Merck & Co. v. United States, 24 Cl. Ct. 73 (1991)

Mgmt. Inv'rs v. United Mine Workers of Am., 610 F.2d 384 (6th Cir. 1979)

Mullins v. Cyranek, 805 F.3d 760 (6th Cir. 2015)

Munson v. McGinnes, 283 F.2d 333 (3d Cir. 1960)

Mylan Labs. v. Thompson, 389 F.3d 1272 (D.C. Cir. 2004)

N. Ind. Pub. Serv. Co. v. Commissioner, 115 F.3d 506 (7th Cir. 1997)

Nat Harrison Assocs., Inc. v. Commissioner, 42 T.C. 601 (1964)

New Phoenix Sunrise Corp. v. Commissioner, 132 T.C. 161 (2009)

Phillips v. Cohen, 400 F.3d 388 (6th Cir. 2005)

Provenz v. Miller, 102 F.3d 1478 (9th Cir. 1996)

Rassenfoss v. Commissioner, 158 F.2d 764 (7th Cir. 1946)

Rent-A-Center, Inc. v. Commissioner, 142 T.C. 1 (2014)

Richardson v. Commissioner, T.C. Memo. 2006-69, 2006 WL 931912, aff'd, 509 F.3d 736 (6th Cir. 2007)

Richardson v. Commissioner, 509 F.3d 736 (6th Cir. 2007)

Robert C. Herd & Co. v. Krawill Mach. Corp., 359 U.S. 297 (1959)

Roche Prods., Inc. v. Bolar Pharm. Co., 733 F.2d 858 (Fed. Cir. 1984)

Rose v. Commissioner, 868 F.2d 851 (6th Cir. 1989)

Sears Oil Co. v. Commissioner, 359 F.2d 191 (2d Cir. 1966)

Securitas Holdings, Inc. v. Commissioner, T.C. Memo. 2014-225

Siegel v. Commissioner, 45 T.C. 566 (1966)

Smith v. Thomas, 911 F.3d 378 (6th Cir. 2018)

Spirit Airlines, Inc. v. Northwest Airlines, Inc., 431 F.3d 917 (6th Cir. 2005)

St. Luke's Hosp. Ass'n v. United States, 333 F.2d 157 (6th Cir. 1964)

Teva Pharms, USA, Inc. v. Leavitt, 548 F.3d 103 (D.C. Cir. 2008)

United Parcel Serv. of Am., Inc. v. Commissioner, 254 F.3d 1014 (11th Cir. 2001)

United States v. Fitzgerald, 906 F.3d 437 (6th Cir. 2018)

United States v. Gilmore, 372 U.S. 39 (1963)

Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954)

Vasudevan Software, Inc. v. MicroStrategy, Inc., 782 F.3d 671 (Fed. Cir. 2015)

In re Vause, 886 F.2d 794 (6th Cir. 1989)

Villegas v. Metro. Gov't of Nashville, 709 F.3d 563 (6th Cir. 2013)

Welch v. Helvering, 290 U.S. 111 (1933)

Wellpoint, Inc. v. Commissioner, 599 F.3d 641 (7th Cir. 2010)

Wis. Cent. Ltd. v. United States, 138 S. Ct. 2067 (2018)

Woodward v. Commissioner, 397 U.S. 572 (1970)

Statutes & Regulations

21 U.S.C. § 355

26 U.S.C. § 162

26 U.S.C. § 263

26 U.S.C. § 482

26 U.S.C. § 7701(o)

35 U.S.C. § 271

Treas. Reg. § 1.263(a)-4

Treas. Reg. § 1.482-9

Drug Price Competition and Patent Term Restoration Act, Pub. L. No. 98-417, 98 Stat. 1585 (1984)

Food, Drug and Cosmetic Act, 21 U.S.C. §§ 301-399(d)

Legislative History

H.R. Rep. 98-857, pt. 1 (1984)

H.R. Rep. 98-857, pt. 2 (1984)

S. Rep. No. 107-167 (2002)

IRS Administrative Materials

2011 IRS NSAR 4901F, 2011 WL 6284624 (Sept. 14, 2011)

IRS Chief Counsel Att'y Mem. 2014-006, 2014 WL 4495163 (Aug. 11, 2014)

IRS Private Letter Ruling 2015-36-006 (June 1, 2015)

Revenue Ruling 77-316, 1977-2 C.B. 53

Other Authorities

Fed. R. Civ. P. 56(g)

OECD, Report on the Transfer Pricing Aspects of Business Restructurings: Chapter IX of the Transfer Pricing Guidelines, July 22, 2010

Proposed Rules, 67 Fed. Reg. 77701 (Dec. 19, 2002)

Staff of the Joint Comm. on Taxation, Technical Explanation of the Revenue Provisions of the “Reconciliation Act of 2010,” as Amended, in Combination with the “Patient Protection and Affordable Care Act,” (2010)


INTRODUCTION

On May 31, 2019, defendant filed a motion seeking summary judgment on two discrete issues: (1) that the November 2006 assignment (“Assignment”) of the Supply and Distribution Agreement (the “Dexcel Contract”) between a subsidiary of Plaintiff, Perrigo Company and Subsidiaries (“Perrigo”), and Dexcel Pharma Technologies Ltd. (“Dexcel”), an unrelated Israel pharmaceutical company, to a foreign affiliate of Perrigo “lacked economic substance through February 20, 2008” (PageID.2095); and (2) that Perrigo must capitalize (rather than deduct) legal fees paid in connection with the patent infringement litigation brought by brand-name drug companies with respect to generic drugs developed by Perrigo (“ANDA Issue”). (PageID.2096.) (“Defendant's Motion.”) The following address each issue.1

DEFENDANT'S SUMMARY JUDGMENT MOTION ON THE ECONOMIC SUBSTANCE ISSUE SHOULD BE DENIED

I. Introduction

Defendant asserts as a matter of law that the Assignment made by L. Perrigo Company (“LPC”) of its rights and obligations under the Dexcel Contract to Perrigo Israel LLC (“LLC”) lacked economic substance “until at least February 2008,” such that the effective date of the transfer of the Dexcel Contract should be disregarded for tax purposes. (PageID.2593-94.)

Defendant's Motion is meritless. It relies on multiple factual inaccuracies and omissions concerning the circumstances surrounding Perrigo's intercompany transactions and relationships related to Perrigo's omeprazole business, as well as inapposite case law. Defendant begins by mischaracterizing the transaction as a tax avoidance “scheme,” developed by Ernst & Young (“E&Y”), ignoring its business foundations. (PageID.2592.) In reality, the Assignment was a bona fide business transaction undertaken based on advice from E&Y as one of many steps in a complex business plan to further Perrigo's goal of internationalizing its increasingly global operations in a tax-efficient manner. Moreover, defendant's claim that “[t]here is little or nothing in the factual record to support” November 29, 2006 (the “Effective Date”), as the date on which LPC assigned the Dexcel Contract to LLC (PageID.2607) is belied by the early E&Y planning materials and the formation of LLC's Israeli parent, Perrigo Israel Trading Limited Partnership (“PITLP”), in June 2006, and LLC itself, in November 2006 (collectively “PITLP/LLC”), as well as by Perrigo's actual conduct. This factual evolution is more than sufficient to establish the Effective Date as the proper date to value the Assignment.

When the facts are viewed in their totality, the Assignment falls squarely within a long line of case law establishing that taxpayers may structure their real business transactions (e.g., transactions arising in Perrigo's regular pharmaceutical operations) in ways that produce tax savings. Defendant's reliance on “captive insurance” cases to nullify the transfer of risks associated with the Assignment is completely misplaced, as the risk transfer issues in those cases related to specific requirements for valid insurance transactions. Those insurance cases do not disturb in any way the longstanding authorities that permit taxpayers to engage in business-related tax planning generally and designate the entities in the group that will assume specific risks.

Defendant's Motion is principally based on its assertion that LLC lacked the capacity to bear the risks associated with the Dexcel Contract at the Effective Date for lack of capital. Defendant ignores the relationship between PITLP/LLC, the assignee of the Dexcel Contract, and its parent, Perrigo UK Finco Limited Partnership (“UK Finco”). UK Finco was Perrigo's offshore cash management and financing entity. The evidence shows that Perrigo always intended that UK Finco would fund PITLP/LLC with equity capital as and when required. Moreover, expert witness testimony that Perrigo intends to provide at trial will establish that UK Finco had the financial capacity to meet the obligations of its subsidiaries, including PITLP/LLC, at the Effective Date. These facts amply demonstrate that the Assignment had “practical economic effects” to merit respect at the Effective Date or, at a minimum, represent genuine issues of material fact that preclude the granting of Defendant's Motion.

Finally, the Court should be aware that Defendant's Motion, although nominally focusing on setting February 2008 as the earliest date for the Assignment, would effectively resolve the transfer pricing issue under section 482 in defendant's favor as well. As discussed below, the entire purpose of E&Y's plan was to shift ownership of contracts entered into between Perrigo and third parties involving products with significant remaining risks and contingencies, such as omeprazole, to newly formed Perrigo foreign affiliates, including PITLP/LLC. Shifting the Assignment forward approximately 15 months from the Effective Date to February 2008, after the December 2007 FDA approval of the drug and immediately before its launch, would leave few remaining risks or contingencies associated with the transfer. The consequence under section 482 would be to reallocate most if not all of PITLP/LLC's income to Perrigo, a result equivalent to defendant's “sham” theories, which disregard the Assignment in its entirety. Although Perrigo acknowledges that the original price paid by LLC for the Assignment was too low, the record reflects the parties' intention to comply with the arm's length pricing requirements of section 482. Accordingly, at trial Perrigo will introduce expert valuation evidence regarding the arm's length price of the Assignment at the Effective Date and its royalty implications for open tax years. Perrigo submits that the focus of this dispute should remain on the proper valuation of the Assignment under section 482 rather than defendant's arbitrary shifting of the Assignment date.

The factual record in this matter contains substantial support for the Assignment's Effective Date, and material facts that support Perrigo's non-tax business purpose for the Assignment. Perrigo thus should have “an adequate opportunity to fully develop [its] case by witnesses and a trial.” Mgmt. Inv'rs v. United Mine Workers of Am., 610 F.2d 384, 389 (6th Cir. 1979) (citation omitted).

II. Omeprazole Transactions — Background

A. Perrigo's Global Restructuring

Established in 1887, Perrigo is one of the world's leading manufacturers and distributors of over-the-counter (“OTC”) and generic prescription pharmaceutical products. In the early-to-mid 2000s, Perrigo was primarily a United States-focused enterprise based in Michigan with limited foreign operations. (Magee Decl., Ex. A at 27:16-18; Ex. B at 20:14-24.) During that time, Perrigo's attention began to shift to foreign markets as a source of potential growth and new revenues. (Magee Decl., Ex. A at 22:22-23:14, 28:12-14.) In late 2004, Perrigo engaged E&Y to provide advice on the expansion and restructuring of Perrigo's global operations. E&Y's assignment was to help Perrigo implement a tax-efficient international operating structure. (Magee Decl., Ex. C at 29:20-30:3, 40:3-6; Ex. D at 200:23-201:11; Ex. E at 233:4-11.) The goal was to restructure Perrigo's existing business to better utilize its worldwide cash to develop, manufacture, and distribute new drug products. (PageID.2148.)

In approximately October 2005, E&Y began reviewing contracts, which Perrigo had entered into with third parties regarding various drug products for potential transfer to an offshore structure with newly formed foreign affiliates, to identify agreements involving products in the early stages of development with significant remaining risks and contingencies. (Magee Decl., Ex. C at 37:21-39:9, 49:14-50:5; PageID.2581.) Affiliates in the countries of origin of the product would then acquire the contracts and assume the financial risks associated with the contracts. An October 2005 step plan prepared by E&Y described the proposal in greater detail and contemplated both the formation of UK Finco as an offshore financing entity and the transfer of the Dexcel Contract to an Israeli Perrigo affiliate. (DeGood Decl., Ex. 1.)

B. Dexcel Contract

In August 2005, LPC and Dexcel entered into the Dexcel Contract. Under the Dexcel Contract, LPC agreed to distribute omeprazole in the United States upon Dexcel's filing for and receipt of final approval for its generic omeprazole product from the United States Food and Drug Administration (“FDA”). (PageID.2209.)

C. Formation of UK Finco, PITLP, and LLC

Pursuant to its global restructuring plans, in November 2005 Perrigo formed UK Finco. (PageID.2582; PageID.2228.) UK Finco was formed to make, monitor, and manage investments on behalf of Perrigo group companies under the UK Limited Partnership Act of 1907. (Kennelly Decl., Ex. A at PER_MK00000014; PageID.2245.) Perrigo viewed UK Finco as the “international finance company for Perrigo's international subsidiaries.” (DeGood Decl., Ex. 2.) In this role, UK Finco operated as an “in-house bank for all Perrigo entities located outside the United States,” borrowing from and lending to Perrigo's direct and indirect foreign subsidiaries. (DeGood Decl., Ex. 3; Magee Decl., Ex. F at 142:23-143:1, 151:1-7, 202:2-6.) Michael Kennelly, an expert engaged by Perrigo to analyze, in part, UK Finco's capacity to function as an offshore finance and holding company, opined that UK Finco's “core activity is to act as the cash pool vehicle for Perrigo's international subsidiaries whereby subsidiaries with surplus cash lend via UK FINCO to subsidiaries requiring cash” and that this type of organizational structure is “common for large multinational companies.” (Kennelly Decl., ¶¶ 5-6.)

In June 2006, Perrigo formed PITLP, a partnership formed under Israeli law. (PageID.2582.) In November 2006, Perrigo formed LLC as a Delaware limited liability company to hold, among other assets, the Dexcel Contract. For United States tax purposes, LLC is treated as a “disregarded entity” whose assets (including the Dexcel Contract) are treated as owned directly by its sole member, PITLP.

D. The Assignment

Effective November 29, 2006, LPC assigned its rights and obligations under the Dexcel Contract to LLC for $877,832 (the Assignment, described above) representing costs incurred by LPC in procuring the contract based on an E&Y transfer pricing study. (DeGood Decl., ¶ 10.) In consideration for the Assignment, and also based on E&Y advice, LLC issued a demand note (the “Demand Note”) to LPC for the $877,832. (PageID.2583.)

At the Effective Date, there were still substantial uncertainties concerning FDA approval, ongoing patent litigation, and the size and competitive profile of the market for omeprazole.2 With the Assignment, LLC assumed the obligation to make all post‐Assignment milestone payments to Dexcel required under the Dexcel Contract. In fact, LLC fulfilled this obligation. (Broadhurst Decl., ¶ 5.)3

In furtherance of the E&Y plan, and also effective as of November 29, 2006, LLC engaged LPC to distribute the omeprazole product on its behalf in the United States (the “Sales and Distribution Agreement”). (PageID.2584.) The effect of this agreement was that, if the FDA approved Dexcel's product, LPC would act as a limited-risk distributor on LLC's behalf. LLC retained most of the risks under the Dexcel Contract, including its obligation to pay arm's length compensation for the Assignment.

The Assignment occurred during the second quarter of Perrigo's 2007 tax year, which ended on June 30, 2007. Perrigo's tax and accounting department documented the Assignment and recorded the transfer in Perrigo's accounting systems before the close of the 2007 fiscal tax year. (Magee Decl., Ex. B at 113:16-20; PageID.2088-89.) Perrigo also reported the consideration received under the Demand Note on its 2007 federal income tax return. (PageID.2583.)4 Defendant improperly concludes that actions taken at the end of the 2007 fiscal year in the normal course to document and book financial actions intended to be effective earlier in the fiscal year mean that the actions could not have their intended effective date.

E. Funding of PITLP/LLC

By October 2005, Perrigo and E&Y had formulated a plan by which UK Finco, the parent of PITLP/LLC, would fund PITLP/LLC with sufficient capital. In January 2006, months before the Assignment, William DeGood, a tax director at Perrigo, informed E&Y that funds for the Assignment would originate from UK Finco. (DeGood Decl., Ex. 4.) As Mr. DeGood further explained, Perrigo delayed funding PITLP/LLC, because Perrigo wanted to use those funds in other projects until needed to pay for the Assignment. As Scott Rush, Perrigo's former Vice President of Tax, testified at his deposition, Perrigo did not capitalize PITLP/LLC immediately upon formation in large part due to the significant uncertainty surrounding the potential approval of Dexcel's omeprazole product. (Magee Decl., Ex. B at 122:24-123:2.) It is also noteworthy that, given UK Finco's cash management role, any funds capitalizing PITLP/LLC would have been loaned back to UK Finco if not needed for operations. In other words, excess capital would just flow in an unnecessary circle pending FDA approval. Perrigo intends to provide expert testimony at trial that UK Finco had the financial capacity to meet the financial obligations of its subsidiaries, including PITLP/LLC, at the Effective Date of the Assignment.5

Indeed, UK Finco provided funds to PITLP/LLC as needed, starting in Perrigo's 2008 tax year,6 before the FDA's December 2007 approval of Dexcel's omeprazole product. For example, UK Finco paid $42,987 directly to Perrigo on LLC's behalf in September 2007 for services rendered to LLC by Perrigo and its U.S. subsidiaries during the 2007 tax year under intercompany services agreements. (Broadhurst Decl., ¶ 5.) Similarly, in October 2007, LLC borrowed $1,250,000 from UK Finco to pay Perrigo for services rendered. In January 2008, after the FDA approved Dexcel's product, LLC borrowed $12,000,000 from UK Finco to cover amounts it owed to Dexcel under an Advance Payment Agreement. (DeGood Decl., Ex. 5; Broadhurst Decl., ¶ 5.) Finally, in February 2008, UK Finco capitalized PITLP/LLC with approximately $3.1 million. PITLP/LLC used approximately $940,000 to satisfy LLC's obligation to LPC under the Demand Note, including interest from November 29, 2006, the Effective Date of the Assignment. (PageID.2261; PageID.2583.)7

F. Omeprazole Launch

Omeprazole sales to U.S. customers began in approximately March 2008. Thereafter, PITLP/LLC purchased product from Dexcel under the Dexcel Contract and LPC distributed the product on PITLP/LLC's behalf in accordance with the Sales and Distribution Agreement. Mr. Daniel Broadhurst, one of Perrigo's expert witnesses, will testify that Perrigo's accounting books and records contemporaneously reflected the reality of this arrangement, even though the Sales and Distribution Agreement was not formally signed until January 2010. (Broadhurst Decl., ¶ 5.)

As detailed in Perrigo's Motion, PITLP/LLC was responsible for the following activities during the years at issue (Perrigo's 2009 through 2012 tax years): (1) purchasing omeprazole from Dexcel and selling the product to LPC for distribution to United States customers; (2) earning profits on those sales; (3) making loans from these profits; (4) distributing profits to UK Finco (and other Perrigo entities) as dividends; and (5) paying royalties to Dexcel as required under the Dexcel Contract. (PageID.2584.)

III. Law and Argument

As Perrigo's Motion explained, defendant does not seriously dispute that Perrigo's entities and transactions had economic substance during the open tax years at issue in this litigation. Instead, defendant relies almost exclusively on evidence from closed tax years, even though the Internal Revenue Service (“IRS”) fully audited Perrigo's returns for those years without challenging the entities and transactions at issue here. (PageID.2554-56.) Moreover, the case law governing the recognition of entities and transactions for tax purposes does not support such a broad and reckless use of sham principles, especially where Congress and Treasury have created under section 482 a detailed statutory/regulatory regime to address the economic substance and pricing of transactions among related parties. In addition to the general impropriety of defendant's reliance on common law “sham” notions to disregard Perrigo's intercompany transactions, the Court should deny Defendant's Motion because: (1) defendant relies on an erroneous interpretation of the economic substance doctrine, including misplaced reliance on captive insurance cases; (2) defendant ignores critical undisputed facts and case law that refute its economic substance position; and (3) there are disputes over material facts, including those surrounding the Assignment, that preclude defendant's version of summary judgment.

A. Material Facts Establish PITLP and LLC As Valid and Distinct Entities and the Business Purpose and Economic Effects of the Assignment, Reflecting Economic Substance Ab Initio

1. The Assignment Had Practicable Economic Effects

Defendant argues that “as a matter of law, the assignment to LLC of Perrigo's rights and obligations under the Dexcel Contract lacked economic substance until at least February 2008, and that the purported assignment date of November 29, 2006 should therefore be disregarded for tax purposes.” (PageID.2593-94.) In defendant's view, this “conclusion that no transaction occurred in substance until at least February 2008 follows from Perrigo's failure to infuse PITLP or LLC with capital until that date.” (PageID.2614.)

Defendant asserts that Perrigo cannot “genuinely contest” certain events. (PageID.2614.) Each “event” that defendant cites, however, is either irrelevant or has an explanation consistent with Perrigo's stated business objectives:

Cited Event (PageID.2614-15)

Explanation

Perrigo failed to draft and execute the Assignment until at least May 2007

Perrigo's 2007 tax year ended on June 30, 2007. Thus, Perrigo's drafting and execution of the Assignment was completed by the end of the tax year in which it occurred, consistent with its business objectives.

Perrigo failed to recognize the Assignment on its general ledger until June 30, 2007

Perrigo's 2007 tax year ended on June 30, 2007. Thus, Perrigo recognized the Assignment on its general ledger by the end of its 2007 tax year, consistent with its business objectives and the Effective Date.

Perrigo failed to inform Dexcel of the Assignment until sometime in the summer or autumn of 2007

Whether Perrigo informed Dexcel of the Assignment until the summer or autumn of 2007 has no bearing on whether the Assignment had practicable economic effects.

Perrigo executed a “Performance Guaranty” that confirmed that the Assignment did not affect Perrigo's obligations to Dexcel

Perrigo's execution of the Performance Guarantee (defined below) did not affect the economic relationship between LLC and LPC or the remedies available to the parties. LLC remained legally obligated to Dexcel under the Dexcel Contract. A Dexcel demand for performance against Perrigo would only occur if LLC failed to meet its obligations under the Dexcel Contract, at which point Dexcel could demand performance from either LLC or LPC at its option. In reality, LLC met all of its contractual obligations, so this never became an issue. Moreover, the Performance Guarantee refers to November 29, 2006 as its effective date.

Perrigo failed to open a bank account for LLC until sometime in late 2007

UK Finco stood ready to fund all of LLC's obligations under the Dexcel Contract and actually funded such activities. LLC's “bank account” was UK Finco.

Perrigo failed to execute the subcontract (i.e., the Sales and Distribution Agreement) until January 20, 2010

The accounting books and records of Perrigo contemporaneously reflected the reality of this arrangement when omeprazole sales commenced in 2008, regardless of the timing of signatures on the Sales and Distribution Agreement.

Perrigo continued to operate as though LLC did not exist — for example, a United States Perrigo affiliate paid two invoices from Dexcel for litigation expenses in 2007

UK Finco stood ready to fund all of Perrigo’s obligations under the Dexcel Contract both before and after LLC had a bank account from which it could pay invoices from Dexcel. Moreover, LLC repaid LPC once the error was discovered. (PageID.2494.)

Moreover, each of these “events” presents genuine issues of material fact for trial. For example, the alleged “failure to draft and execute the purported assignment agreement until at least 2007” by necessity requires testimony by company individuals regarding the implementation of the E&Y step plan, and the drafting and execution of the Assignment within Perrigo's June 30, 2007, fiscal year. On that score alone, Defendant's Motion should be denied.

Notwithstanding the evidence demonstrating the bona fides of Perrigo's transactions, defendant asserts that “[t]he Sixth Circuit has identified two factors, both of which are indisputably present in this case, which suffice to set aside the assignment as lacking economic substance”: (a) undercapitalization of the entity accepting risk, and (b) guarantees of the performance of the entity accepting the risk. (PageID.2616.) As explained below, defendant's reliance on these factors is misguided. Furthermore, the facts show that the Assignment had practicable economic effects at the Effective Date.

a. Captive Insurance Cases Do Not Prevent a Risk Transfer in General Business Circumstances such as the Assignment

Defendant asserts that transactions engaged in by an undercapitalized entity cannot have economic substance, relying solely on cases involving “captive insurance” arrangements. (PageID.2616.) In those cases, domestic companies were denied deductions for casualty premiums paid to controlled subsidiary insurance companies. The courts determined that the insured corporations could not transfer their insurable risks, as required to meet the tax law definition of “insurance” in Helvering v. Le Gierse, 312 U.S. 531 (1941), and Revenue Ruling 77-316, 1977-2 C.B. 53, because in the group environment the parent would ultimately bear any losses as an economic matter. These cases are immaterial here as they only address the unique tax requirements for insurance.8 The courts have made it clear that the concept of “risk shifting” used to determine whether an arrangement qualifies as insurance for tax purposes is inapplicable to other contexts. See N. Ind. Pub. Serv. Co. v. Commissioner (“NIPSCO”), 115 F.3d 506, 512 (7th Cir. 1997) (rejecting the government's argument that captive insurance case law applied to disregard transactions between the United States taxpayer and its foreign subsidiary). Thus, for example, the Tax Court has explained that the “risk shifting” required to respect insurance arrangements is “limited to the deduction for insurance premiums.” Clougherty Packing Co. v. Commissioner, 84 T.C. 948, 957-58 (1985) (“Shifting of risk in transactions other than insurance are simply not relevant. . . .”).

Furthermore, defendant's characterization of PITLP/LLC as undercapitalized is incorrect. PITLP/LLC had ready access to UK Finco's cash to meet all of its obligations. The record demonstrates that Perrigo always intended for UK Finco to contribute funds to its subsidiary, PITLP/LLC, including responsibilities associated with the Effective Date of the Assignment onward. (DeGood Decl., ¶ 11, Ex. 4.) That is exactly what transpired. Immediately before omeprazole's launch in early 2008, UK Finco contributed approximately $3.1 million to PITLP/LLC, of which PITLP/LLC used approximately $940,000 to satisfy LLC's obligation to LPC under the Demand Note, including interest from the Effective Date of the Assignment. A contribution of funds by UK Finco much earlier in time would have made little sense, as Perrigo was in a holding pattern until the FDA process ran its course. In the interim, the monies were better utilized by UK Finco serving as Perrigo's international cash management and holding company.

Moreover, Perrigo will provide expert witness testimony that UK Finco had the financial capacity to meet the financial obligations of its subsidiaries, including PITLP/LLC, at the Effective Date. UK Finco's willingness and immediate ability to contribute funds to PITLP/LLC is enough to imbue the overall transaction with sufficient “economic effects” to respect the Assignment as structured.9

The Assignment also resulted in “actual, non-tax-related changes in economic position.” NIPSCO, 115 F.3d at 512. Specifically, it shifted legal ownership of the Dexcel Contract from LPC to LLC. Thereafter, PITLP/LLC was the primary obligor to third-party Dexcel and made itself or reimbursed others for all post-Assignment payments to Dexcel required under the Dexcel Contract. Additionally, the restructuring resulted in Perrigo ceding a “stream of income” that it otherwise would have received to a foreign affiliate in the same manner as the taxpayer in United Parcel Service of America, Inc. v. Commissioner (“UPS”), 254 F.3d 1014, 1019 (11th Cir. 2001). Viewed objectively, these facts give the Assignment economic substance warranting recognition at the Effective Date.

PITLP/LLC's reliance on UK Finco in this manner is consistent with the well-accepted principle that subsidiaries may benefit from being part of a large multinational enterprise. For example, the transfer pricing regulations recognize that subsidiaries benefit from their association with other members in their controlled group, but generally deem such benefits to be non-compensable. See Treas. Reg. § 1.482-9(l)(3)(v) (“Passive Association”). See also Ill. Tool Works v. Commissioner, T.C. Memo. 2018-121, at *50 (holding that a foreign subsidiary (CSE) could rely on its parent “to prevent CSE from taking steps that would endanger either company's financial integrity”). Furthermore, the Organization of Economic Cooperation and Development's (“OECD”) 2010 Transfer Pricing Guidelines provide that in certain circumstances a parent company's presence is sufficient to respect a shifting of risk to a subsidiary entity. See OECD, Report on the Transfer Pricing Aspects of Business Restructurings: Chapter IX of the Transfer Pricing Guidelines, July 22, 2010, at 10, ¶¶ 9.30, 9.31.

b. The Performance Guarantee Did Not Negate LLC's Obligations or Risks

Defendant also argues that an assignment lacks economic substance “where the transferor of risk guarantees the performance of the entity accepting the risk.” (PageID.2616.) Defendant both misinterprets the specific agreement between Perrigo and Dexcel and misunderstands the law regarding the impact of performance guarantees.

On December 10, 2007, Perrigo Company (the parent of the Perrigo group, rather than LPC) and Dexcel executed a performance guarantee (the “Performance Guarantee”), which also had an effective date of November 29, 2006. The Performance Guarantee expressly noted that LPC had “assigned all [of] its rights and obligations under the [Dexcel Contract] on November 29, 2006 to its Affiliate, Perrigo LLC.” (PageID.2467.) Defendant contends that the Performance Guarantee negated any economic effects of the Assignment. (PageID.2617.)

Defendant misinterprets the legal significance of the Performance Guarantee. LPC as the original signatory and LLC as the assignee each had legal obligations to Dexcel under the Dexcel Contract. Perrigo Company merely guaranteed that the obligations of its subsidiaries would be fulfilled. Dexcel's right to demand performance directly from Perrigo Company does not affect the economic relationship between LLC and LPC, their obligations to Dexcel, or the legal remedies available to the parties. Notwithstanding the guarantee, LLC was still independently obligated to Dexcel to perform the Dexcel Contract and could be required to provide redress if it failed to do so. A demand for performance by Dexcel against Perrigo Company would only occur if LLC first failed to meet any of its contractual obligations. If LLC performed those duties, there would be no cause for Dexcel to make a demand under the Performance Guarantee. In fact, LLC met all of its obligations under the Dexcel Contract — that is, Dexcel received all required post-Assignment payments, and LLC distributed omeprazole on Dexcel's behalf by engaging LPC as a limited-risk supplier. These facts demonstrate that “for all practical purposes,” LPC did not retain the rights and obligations of the Dexcel Contract by reason of its parent's Performance Guarantee.

To bolster its argument, defendant once again invokes the captive insurance case law. A corporate parent's guarantee of the obligations of its captive insurance subsidiary raises issues that go directly to whether there is sufficient risk shifting and risk distribution to satisfy the tax law definition of “insurance.”10 But this case law provides no insight as to whether the Assignment had economic substance.

Indeed, outside of the captive insurance context, courts have respected the separate existence and business activities of corporate entities despite the presence of a parental guarantee. For example, in Nat Harrison Associates, Inc. v. Commissioner, 42 T.C. 601, 615-16 (1964), the Tax Court held that a Panamanian corporation organized to construct missile-tracking stations in the Caribbean could not be disregarded as a sham when it “remained fully liable and responsible for completion of the contracts” entered into by the corporation. The Tax Court held that the IRS's attempt to reallocate 100 percent of the Panamanian corporation's income to its United States parent was “unreasonable.” Id. at 617-18. Similarly, in NIPSCO, the financing subsidiary's existence and business activities were respected notwithstanding the United States taxpayer's guarantee of the subsidiary's payment of interest and principal to its creditors and despite the fact that the sole purpose for the subsidiary's formation was to avoid U.S. withholding tax. 115 F.3d at 508. See also Hosp. Corp. of Am. v. Commissioner, 81 T.C. 520, 540 (1983) (holding that a foreign subsidiary was not a sham despite the fact that its parent “executed a written guarantee of” the foreign subsidiary's performance.).

The Performance Guarantee cannot negate the genuine economic effects generated by the Assignment.

c. The Assignment Had Economic Effects at the Effective Date

Defendant also contends that “the assignment date of November 29, 2006 should be disregarded for tax purposes.” (PageID.2618.)11 However, the record is clear that in November 2006 Perrigo took steps to implement E&Y's step plan and effectuate the Assignment by forming LLC. Further, Perrigo's subsequent actions establish its intent that the Assignment was to be effective on November 29, 2006. As Mr. Rush testified, Perrigo attempted (and succeeded) in documenting the Assignment before the end of the fiscal year in which the Assignment occurred (i.e., Perrigo's 2007 tax year), thereby memorializing in Perrigo Company's books and record the events that had occurred earlier that fiscal year. Specifically, Perrigo properly accounted for the Assignment (based on its effective date) in its internal books and records by June 30, 2007, and externally reported the consideration it received for the Assignment under the Demand Note on its 2007 federal income tax return. Finally, UK Finco fully funded PITLP/LLC's operations and obligations.

These facts are more than sufficient to justify respecting the Effective Date of the Assignment, notwithstanding the delays in executing the agreements at issue. In Nat Harrison Associates, for example, the Tax Court held that a transfer of assets by a partnership to a domestic corporation occurred in March 1957, even though documentation of the transfer was not executed until July 1958. The Tax Court reasoned that the parties “understood 'that in due course (the transfer) would be consummated as of April 1, 1957.'” 42 T.C. at 605. The same rationale applies here. As Mr. DeGood testified, consistent with E&Y's advice, “[t]he goal was to have [LLC] own [the Dexcel Contract] from day one.” (PageID.2492, at 117:1-8.) Similar to the situation in Nat Harrison Associates, Perrigo always intended that the Assignment “would be consummated” as of November 29, 2006, and its course of conduct following the Effective Date (e.g., recording the Assignment in its books and records prior the close of Perrigo's 2007 tax year) demonstrates this intent.

2. PITLP/LLC and the Assignment Were Not Factual Shams

The law recognizes two types of shams: “sham-in-fact” and “sham-in-substance.” See Am. Elec. Power Co. v. United States, 326 F.3d 737, 741-45 (6th Cir. 2003). Neither iteration applies to disregard PITLP/LLC's existence or the Assignment.

“Factual shams are 'transactions' that never actually occurred.” Id. at 745 (quoting In Re CM Holdings, Inc., 301 F.3d 96, 108 (3d Cir. 2002)). This doctrine has no place here. As Perrigo's Motion explained, both PITLP and LLC are real entities that currently exist and transact business. They were properly organized and established under the laws of Israel and Delaware, respectively. (PageID.2563.) Defendant has not disputed these facts. Furthermore, the Assignment actually occurred. LPC transferred the Dexcel Contract to PITLP/LLC by executing the Assignment and issuing the Demand Note to LPC. The parties acted in accordance with the Assignment and the Sales and Distribution Agreement, and Perrigo accounted for the Assignment in its books and records. There is no basis for disregarding PITLP/LLC or its activities as factual shams.

3. PITLP/LLC and the Assignment Were Not Shams in Substance

Under the sham-in-substance doctrine, a transaction may be disregarded only if it lacks “any practicable economic effects other than the creation of income tax losses.” Rose v. Commissioner, 868 F.2d 851, 853 (6th Cir. 1989). “If the transaction has economic substance, 'the question becomes whether the taxpayer was motivated by profit to participate in the transaction.'” Dow Chem. Co. v. United States, 435 F.3d 594, 599 (6th Cir. 2006) (quoting Illes v. Commissioner, 982 F.2d 163, 165 (6th Cir. 1992)).

The Supreme Court long ago emphasized that “[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.” Gregory v. Helvering, 293 U.S. 465, 469 (1935). Accordingly, taxpayers may legitimately structure their real business transactions in ways that produce tax savings. See, e.g., Chamberlin v. Commissioner, 207 F.2d 462, 468 (6th Cir. 1953); UPS, 254 F.3d at 1019 (“A 'business purpose' does not mean a reason for a transaction that is free of tax considerations. Rather, a transaction has a 'business purpose,' . . . as long as it figures in a bona fide, profit seeking business. This concept of 'business purpose' is a necessary corollary to the venerable axiom that tax-planning is permissible.”) (citation omitted). This principle extends to taxpayers' right to use a domestic or foreign corporation to obtain a tax benefit so long as the corporation engages in real business activity, even if the sole reason for using the corporation is to obtain a tax benefit.12 See Hosp. Corp. of Am., 81 T.C. at 583 (“[T]he fact that petitioner intended to obtain tax advantages by organizing LTD in the Cayman Islands does not in and of itself require a holding that LTD is a sham corporation.”) (internal punctuation marks omitted); Bass v. Commissioner, 50 T.C. 595, 600 (1968). Furthermore, a parent corporation is free to establish subsidiaries and decide which among them will earn income. See Merck & Co. v. United States, 24 Cl. Ct. 73, 88 (1991).

Defendant's Motion ignores this case law. Defendant begins by characterizing the transactions as a “scheme to shift earnings . . . beyond the reach of the IRS”13 and then describing how the “potential tax savings would arise.” (PageID.2592; PageID.2608.) However, as shown above, Perrigo was legally entitled to use tax-efficient means to achieve a business-oriented end. The only relevant question is whether the Assignment had “any practical economic effect.” See NIPSCO, 115 F.3d at 511 (observing that “tax avoidance motive is not inherently fatal to a transaction”); UPS, 254 F.3d at 1019. As discussed above, the Assignment had practicable economic effects and a valid business purpose and thus economic substance for tax purposes. Defendant places undue emphasis on Perrigo's purported tax-related motivations, when the correct inquiry is on Perrigo's non-tax business objectives and the practicable economic consequences of the Assignment.

B. Defendant's Version of Summary Judgment Is Inappropriate Because Defendant's Sham Arguments Raise Genuine Issues of Material Fact

As detailed above, the law does not support defendant's effort to “sham” the Assignment until February 2008. Additionally, defendant's attempt to have its sham theories adjudicated at this stage is inappropriate. Summary judgment is proper only when, assuming the truth of the non-movant's evidence and drawing all inferences in his favor, there is insufficient evidence for the finder of fact to decide in the non-movant's favor. See Mullins v. Cyranek, 805 F.3d 760, 765 (6th Cir. 2015). However, when issues of material fact exist, “a party should not be deprived of an adequate opportunity to fully develop his case by witnesses and a trial.” Mgmt. Inv., 610 F.2d at 389.

Inarguably, the application of the economic substance doctrine and other common law sham theories requires a facts-and-circumstances analysis. In Richardson v. Commissioner, T.C. Memo. 2006-69, 2006 WL 931912, aff'd, 509 F.3d 736 (6th Cir. 2007), the Tax Court considered whether two entities were “legitimate entities or . . . part of a sham arrangement designed to avoid taxes and should be disregarded for tax purposes.” 2006 WL 931912, at *13. The Tax Court resolved the issue “based on all the facts and circumstances of petitioners' particular situation.” Id. On appeal, the Sixth Circuit observed that “[t]he Tax Court's . . . economic-substance . . . rulings are factual ones.” 509 F.3d at 740.

Indeed, every case cited in Defendant's Motion was decided by a fact-finder that made factual determinations based on trial testimony. See, e.g., Estate of Kluener v. Commissioner, 154 F.3d 630, 634 (6th Cir. 1998) (courts should examine “all the facts and circumstances.”); Mahoney v. Commissioner, 808 F.2d 1219, 1220 (6th Cir. 1987) (“Much of the resolution of this case involved credibility determinations and factual findings.”); Harbor Bancorp, 115 F.3d at 727 (“[T]he Tax Court's determination that the New Year's Eve 1985 closings were shams is a finding of fact. . . .”); New Phoenix Sunrise Corp. v. Commissioner, 132 T.C. 161, 175 (2009) (“The presence or lack of economic substance for Federal tax purposes is determined by a fact-specific inquiry on a case-by-case basis.” (citing Frank Lyon Co. v. United States, 435 U.S. 561, 584 (1978)), aff'd, 408 F. App'x 908 (6th Cir. 2010). See also NIPSCO, 115 F.3d at 512 (“Whether a corporation is carrying on sufficient business activity to require its recognition as a separate entity for tax purposes is a question of fact. . . .”) (citation omitted).

At trial, Perrigo will present extensive expert and fact witness testimony on the issues raised in Defendant's Motion, including: (1) the viability of PITLP and LLC as separate entities; (2) the practicable economic effects of the Assignment; (3) the parties' intentions and course of conduct with respect to the effective date of the Assignment; (4) the risks transferred to LLC under the Assignment; (5) when those risks were transferred; (6) the role of UK Finco within Perrigo's new international structure; (7) whether UK Finco had the financial capacity and willingness, as PITLP/LLC's parent, to bear LLC's risks and fund its activities and obligations; and (8) the true economic value of the Dexcel Contract at the time of the Assignment.

Because the entirety of this testimony is critical to the factual determinations that the Court will make regarding the application of sham doctrines, summary judgment is inappropriate. See Agristor Fin. Corp. v. Van Sickle, 967 F.2d 233, 236 (6th Cir. 1992). This also accords with the “general rule [that] summary judgment is inappropriate where an expert's testimony supports the non-moving party's case.” Provenz v. Miller, 102 F.3d 1478, 1490 (9th Cir. 1996). See Spirit Airlines, Inc. v. Northwest Airlines, Inc., 431 F.3d 917, 931 (6th Cir. 2005) (“Our precedents hold that if the opposing party's expert provides a reliable and reasonable opinion with factual support, summary judgment is inappropriate.”); Villegas v. Metro. Gov't of Nashville, 709 F.3d 563, 575 n.6 (6th Cir. 2013) (“Defendants' well-qualified expert's opinion is sufficient to create a material factual dispute.”); Vasudevan Software, Inc. v. MicroStrategy, Inc., 782 F.3d 671, 683 (Fed. Cir. 2015) (holding that expert opinion contrary to movant's position “at least raises a genuine issue of material fact”).

Moreover, defendant has retained its own experts to address many of these same issues. Thus, the case presents the “classic battle of the experts and it is up to a jury to evaluate what weight and credibility each expert opinion deserves.” Phillips v. Cohen, 400 F.3d 388, 399 (6th Cir. 2005) (internal quotations omitted). Accord Georgia-Pacific Consumer Prod. LP v. NCR Corp., No. 1:11-cv-0483, 2015 WL 11236845, at *3 (W.D. Mich. 2015) (concluding that given “the testimony and conclusions of various experts hired by the parties . . . this is an issue for the trier of fact based on all the evidence”).

For these reasons, the issue raised by Defendant's Motion is not amenable to summary judgment.14 It differs fundamentally, however, from Perrigo's Motion, which asks the Court to find as a legal matter that common law sham principles are inapplicable to Perrigo's transactions because they are displaced by the detailed section 482 economic substance and transfer pricing regime and cannot invalidate transactions arising from real business arrangements executed by real entities that indisputably engaged in economic activities during the years in question.

IV. Conclusion

For the reasons given above, the Assignment had both practicable economic effects as of November 29, 2006, and a legitimate non-tax business purpose. In addition, Defendant's Motion presents genuine issues of material fact that are only properly resolved through trial testimony. Under the circumstances, therefore, summary judgment is inappropriate. Accordingly, Perrigo requests that the Court deny Defendant's Motion.

DEFENDANT'S SUMMARY JUDGMENT MOTION ON THE ANDA ISSUE SHOULD ALSO BE DENIED

I. Introduction

Before the 1980s, generic drugs were not a significant part of the pharmaceutical industry. That changed with the enactment of the Drug Price Competition and Patent Term Restoration Act (“Hatch-Waxman”)15 in 1984. Hatch-Waxman sought to expand the market for generic drugs by removing barriers imposed by the patent laws and the food and drug laws.

Before Hatch-Waxman, the case law was unmistakably clear that costs incurred by brand companies to prosecute patent infringement suits, and by generics to defend them, were deductible ordinary and necessary business expenses because, for both parties, the litigation costs served to protect their income-generating businesses. Defendant acknowledges that “Perrigo is in the business of developing generic drug products” (PageID.2594), and thus, under longstanding precedent, the patent infringement litigation defense costs incurred by Perrigo to protect this business are business expenses.

Defendant, espousing a legal theory announced 27 years after Hatch-Waxman's passage, contends that one result of Hatch-Waxman was to make the patent infringement litigation defense costs of generic drug companies (but not those of suing brand companies) nondeductible. Defendant has two alternative theories: (1) that the generics' patent litigation defense costs “facilitate” FDA approval of the generic drug; and (2) that, for generics but not brands, Hatch-Waxman changed the “origin of the claim” in patent suits from alleged patent infringement to the generic's filing of an application for approval with the FDA. Neither theory has merit. Nothing in the text or legislative history of Hatch-Waxman evidences a desire by Congress to change the character or nature of patent litigation costs generally or generics' litigation defense costs in particular. The tax regime defendant advocates would in fact frustrate, rather than implement, the statute by imposing an economic burden on generic manufacturers that would make it harder to overcome weak or invalid patents and commercialize new generics.

As a factual matter, Perrigo's litigation costs did not “facilitate” FDA approval. Perrigo's experts will explain that FDA approval and patent dispute resolution are separate and unrelated processes. The FDA does not adjudicate patent issues, enforce patents, or otherwise concern itself with the parties' patent positions, just as courts hearing patent infringement suits do not address technical drug approval issues within the FDA's domain. There is also no “facilitative” relationship between patent suit costs and FDA approval. A generic company might receive FDA approval while patent litigation is ongoing, prevail in the patent litigation yet never receive FDA approval, or lose the patent case and still receive FDA approval authorizing it to market upon expiration of the patent.

Moreover, Hatch-Waxman did not alter the origin of the claim for generic-defendants in patent suits brought under the statute. In every other context (including for brands in Hatch-Waxman lawsuits), the IRS acknowledges that the origin of the claim giving rise to patent infringement litigation is the alleged misuse of a patented invention. A generic's application to the FDA does not create a new claim or cause of action. It merely accelerates litigation so that the patent dispute can be resolved sooner and, if the generic wins the case, a new low-cost FDA-approved generic drug can be made available to consumers. Under governing precedent, Perrigo's motivations for filing the generic drug application or the potential consequences of the patent case on Perrigo's ability to sell its product are irrelevant.

In any event, material facts undercutting defendant's position, and expert opinions supporting Perrigo's, render the ANDA Issue unsuitable for summary judgment. This is evidenced by the fact that the Tax Court recently held a trial on this issue in which Perrigo's experts testified without governmental objection.

II. Background on the ANDA Issue

A. Barriers to Generics before Hatch-Waxman

Before Hatch-Waxman, two barriers prevented generics from reaching consumers. First, the Food, Drug and Cosmetic Act (“FDCA”)16 required generic companies, like brands, to file a New Drug Application (“NDA”) containing extensive clinical studies establishing safety and efficacy to get marketing authorization. “This requirement posed a formidable barrier to market entry for generic drug companies.” aaiPharma Inc. v. Thompson, 296 F.3d 227, 231 (4th Cir. 2002).

Second, under patent law, using a patented invention covering a brand drug to develop a generic version prior to patent expiration constituted infringement. Roche Prods., Inc. v. Bolar Pharm. Co., 733 F.2d 858 (Fed. Cir. 1984). As a result, “a generic manufacturer could not begin the necessary research and clinical studies until any patents on the brand name drug it sought to copy had expired.” aaiPharma, 296 F.3d at 231.

B. Hatch-Waxman

Congress intended Hatch-Waxman to help “bring low-cost, generic copies of [brand] drugs to market.” Andrx Pharms., Inc. v. Biovail Corp., 276 F.3d 1368, 1371 (Fed. Cir. 2002). Congress recognized that achieving this objective would require changes to the FDA approval process as well as changes to the patent laws.

1. Streamlined FDA Approval

Hatch-Waxman removed the FDCA barrier by creating a simplified approval pathway for generics. In lieu of filing an NDA, a drug company seeking approval of a generic version of a previously approved brand name drug may file an Abbreviated New Drug Application (“ANDA”). An ANDA avoids the need for extensive data supporting the safety and efficacy of the generic drug; rather, the generic need only establish that its product is “bioequivalent” to the previously approved brand drug it is copying. aaiPharma, 296 F.3d at 231. The FDA's role is solely to review ANDAs to ensure the generic is bioequivalent and satisfies other scientific and technical requirements. 21 U.S.C. § 355(j)(4).

2. Patent Safe Harbor

Hatch-Waxman removed the patent infringement barrier to generic drug development before patent expiration by overruling Roche Products, Inc. v. Bolar. The amendment, at 35 U.S.C. § 271(e)(1), creates a safe harbor whereby “a generic drug manufacturer no longer infringes the patents on a brand name drug by performing acts necessary to prepare an ANDA.” aaiPharma, 296 F.3d at 231.

3. Acceleration of Patent Disputes

Congress recognized that the changes to the FDA procedures and the § 271(e)(1) non-infringement safe harbor were not enough to achieve its purposes. Even if the brand companies' patent infringement claims were suspect, the potential for large monetary damage awards would deter generic companies from introducing new products into the market. Hatch-Waxman amended the patent law to accelerate the resolution of patent disputes without creating the risk of large monetary damage awards.

Listing patents with the FDA. Hatch-Waxman requires a brand company filing an NDA to list certain types of patents covering a new drug. 21 U.S.C. § 355(b)(1).

Publishing patent data. When the FDA approves an NDA, it publishes the patent data listed for the brand drug in the “Orange Book.” Id. § 355(j)(7)(A)(iii). This function is ministerial “because the FDA has no expertise in making patent law judgments.” aaiPharma, 296 F.3d at 241.

Patent certification. For each Orange Book-listed patent, an ANDA filer must certify that (1) no patent for the brand drug is listed (¶ I certification); (2) the patent has expired (¶ II certification); (3) the patent will expire on a specific date (¶ III certification); or (4) the patent is invalid or will not be infringed by the generic (¶ IV certification). 21 U.S.C. § 355(j)(2)(A)(vii).

The ANDA filer's certification determines the date on which FDA approval of the ANDA, if approved, becomes effective. Approval of an ANDA with ¶ I or ¶ II certifications may become effective immediately, while FDA approval of a ¶ III ANDA becomes effective at patent expiration. See 21 U.S.C. § 355(j)(5)(B). “In contrast, an ANDA applicant making a paragraph IV certification intends to market its product before the relevant patents have expired.” aaiPharma, 296 F.3d at 232.

Accelerated patent infringement litigation. Since Hatch-Waxman had overruled Bolar, the use of a patent to develop a generic drug would no longer be an act of infringement. Absent another amendment, a brand would have had to wait until FDA approval and marketing of a new generic to file suit. The potential for money damages could delay the generic's introduction for years.

Hatch-Waxman avoided this by adding 35 U.S.C. § 271(e)(2), which provides that filing a ¶ IV ANDA is an artificial act of infringement authorizing the brand to file suit (“§ 271(e)(2) litigation”). Section 271(e)(2) “create[s] an artificial act of infringement for purposes of establishing jurisdiction in the federal courts.” Glaxo Grp. Ltd. v. Apotex, Inc., 376 F.3d 1339, 1351 (Fed. Cir. 2004). Hatch-Waxman thereby “facilitates the early resolution of patent disputes between generic and pioneering drug companies.” Caraco Pharm. Labs., Ltd. v. Forest Labs. Inc., 527 F.3d 1278, 1283 (Fed. Cir. 2008).

Paragraph IV notice letter. A ¶ IV ANDA filer must provide a notice letter to the patent holder stating the grounds for the filer's opinion that the patent is invalid or will not be infringed by the generic drug. See 21 U.S.C. § 355(j)(2)(B).

30-month stay. If a brand brings § 271(e)(2) litigation within 45 days after receiving the ¶ IV notice, FDA approval is stayed up to 30 months. 21 U.S.C. § 355(j)(5)(B)(iii). A brand is not required to institute § 271(e)(2) litigation, and if it does so, it need not file within 45 days. If the brand sues later, no stay arises and the FDA may approve the ANDA without delay upon completing its review. Id. § 355(j)(5)(B)(iii).

If the brand sues within 45 days, and “[i]f the courts decide the matter within [the 30-month stay], the FDA follows that determination; if they do not, the FDA may go forward and give approval to market the generic product.” FTC v. Actavis, Inc., 570 U.S. 136, 143 (2013). If the FDA gives approval, the generic may launch its product, albeit at risk of damages if infringement is later determined. Alternatively, the generic may wait until the litigation ends. Either way, FDA approval is final. If the court then finds invalidity or non-infringement, the patent barrier is cleared. If it finds infringement of a valid patent, it will order FDA approval to become effective on patent expiration, 35 U.S.C. § 271(e)(4)(A), and the FDA will convert a prior approval to tentative. See Mylan Labs. v. Thompson, 389 F.3d 1272, 1278 (D.C. Cir. 2004).

C. Perrigo's § 271(e)(2) Litigation Costs

During its 2009-2012 tax years, Perrigo incurred legal fees and costs for over 20 § 271(e)(2) cases (“§ 271(e)(2) litigation costs”). Most of these costs were incurred during litigation, while a small portion were incurred in preparing ¶ IV notices. Perrigo deducted its § 271(e)(2) litigation costs as ordinary and necessary business expenses. The IRS disallowed the deductions, contending the costs must be capitalized.

D. Perrigo's Experts

To help the Court evaluate defendant's capitalization theory, Perrigo intends to offer expert testimony on the FDA's ANDA approval process, the process by which patent infringement disputes are resolved, and the limited extent to which these processes intersect. Specifically, Perrigo has engaged (1) Sheldon Bradshaw, a former Chief Counsel of the FDA, to opine on the FDA's approval process for new generics and the nature of the FDA's involvement in patent disputes; and (2) Anthony Figg, a nationally recognized patent litigator, to opine on how § 271(e)(2) cases are handled, their relationship to FDA drug approval, and how they compare to other types of patent suits.

Both experts have prepared reports and have been deposed. At trial, they will offer factual descriptions and opinions germane to defendant's capitalization theories based on their first-hand experience. Previously, Messrs. Bradshaw and Figg were both qualified as experts by the Tax Court and testified on the ANDA issue in Mylan, Inc. v. Commissioner, No. 26976-16 (U.S. Tax Ct.) (“Mylan”), where their opinions were admitted. Perrigo submits declarations executed by Messrs. Bradshaw and Figg summarizing their qualifications and opinions and attaching their reports. (Bradshaw Decl., Ex. A; Figg Decl., Ex. A.) Their opinions relevant to the Court's analysis of defendant's motion are highlighted below.

E. Defendant's Expert

Defendant engaged patent lawyer Steven Roth to rebut Messrs. Bradshaw and Figg. Mr. Roth opines that Hatch-Waxman's patent provisions hasten generic approval and market entry, the FDA is apprised of certain events in § 271(e)(2) cases, and the FDA's ANDA file and communications are routinely requested and produced in Hatch-Waxman cases.

F. Mylan, Inc. v. Commissioner

Although defendant correctly states “there are no known court decisions opining directly on this issue” (PageID.2595), it fails to mention both that Mylan also involves the same ANDA issue that is at issue in this case and that the Tax Court held a trial last year in which Messrs. Bradshaw and Figg and other experts testified.

III. Law and Argument

A. Defendant's Capitalization Theory Is Specious

The IRS first asserted that generics must capitalize § 271(e)(2) litigation costs in 2011, i.e., 27 years after passage of Hatch-Waxman and seven years after promulgation of Treas. Reg. § 1.263(a)-4. See 2011 IRS NSAR 4901F, 2011 WL 6284624 (Sept. 14, 2011). Neither the statute nor the regulation stated or implied that generics must capitalize their § 271(e)(2) litigation costs. In reality, the IRS conceived its legal theories several years later to mandate capitalization, but their underpinnings are unsound.

1. Longstanding Precedent Establishes that Patent Infringement Litigation Defense Costs Are Deductible Business Expenses

This is not the first case involving the question of whether patent infringement litigation costs are ordinary and necessary business expenses under I.R.C. § 162 or nondeductible capital expenditures under I.R.C. § 263.17 Courts have long recognized that such costs are deductible. In Appeal of F. Meyer & Bro. Co., 4 B.T.A. 481, 482 (1926), the Board of Tax Appeals rejected the IRS's contention that expenses incurred by the taxpayer in defending a patent infringement suit should be deferred and held that the item “was an ordinary and necessary expense for the year in which paid.” Id.

In Urquhart v. Commissioner, 215 F.2d 17 (3d Cir. 1954), patentees incurred fees defending litigation seeking declaratory judgment that their patents were invalid and not infringed. Expressing “no doubt that these expenses were ordinary and necessary,” id. at 19, the Third Circuit reasoned that “[t]he litigation which gave rise to the expenditures in issue was commonplace patent infringement litigation,” id., that “arose out of and related directly to the exploitation of the invention embodied in the patent.” Id. at 20.

In Kornhauser v. United States, 276 U.S. 145 (1928), the Supreme Court endorsed the treatment of patent infringement litigation costs as ordinary and necessary business expenses:

In the Appeal of F. Meyer & Brother Co., 4 B.T.A. 481, the Board of Tax Appeals held that a legal expenditure made in defending a suit for an accounting and damages resulting from an alleged patent infringement was deductible as a business expense.

The basis of these holdings seems to be that where a suit or action against a taxpayer is directly connected with, or . . . proximately resulted from, his business, the expense incurred is a business expense within the meaning of [the precursors to I.R.C. § 162]. These rulings seem to us to be sound. . . . 

Kornhauser, 276 U.S. at 153 (emphasis added).

Not long after Kornhauser, the Supreme Court reiterated that costs to defend litigation over business operations are business expenses “because we know from experience that payments for such a purpose, whether the amount is large or small, are the common and accepted means of defense against attack.” Welch v. Helvering, 290 U.S. 111, 114 (1933). Thereafter, it became well settled that, for I.R.C. § 162 purposes, the term “necessary” imposes “only the minimal requirement that the expense be 'appropriate and helpful' for the development of the taxpayer's business,” Commissioner v. Tellier, 383 U.S. 687, 689 (1966), and a cost is “ordinary” if the underlying transaction is “of common or frequent occurrence in the type of business involved.” Deputy v. du Pont, 308 U.S. 488, 495 (1940). Accord Bingham's Trust v. Commissioner, 325 U.S. 365, 376 (1945) (stating that businesses “may deduct litigation expenses when they are directly connected with or proximately result from the enterprise”); Wellpoint, Inc. v. Commissioner, 599 F.3d 641, 647 (7th Cir. 2010) (observing that such costs “are the sort of expense that is incurred to preserve the operation and profitability of the business rather than to acquire or retain or improve a specific capital asset”); A.E. Staley Mfg. Co. v. Commissioner, 119 F.3d 482, 487 (7th Cir. 1997) (reciting “the well-worn notion that expenses incurred in defending a business and its policies from attack are necessary and ordinary — and deductible — business expenses”); Rassenfoss v. Commissioner, 158 F.2d 764, 768 (7th Cir. 1946) (holding that legal fees for defending a business dispute “were ordinary and necessary” and “properly deductible”); Hague v. Commissioner, T.C. Memo. 2005-275, 2005 WL 3214581, at *6 (“Legal expenses . . . incurred in defending against claims that would injure or destroy a business are ordinary and necessary business expenses.”); Am. Stores Co. v. Commissioner, 114 T.C. 458, 468 (2000) (“Expenses incurred in defending a business and its policies from attack are generally ordinary and necessary — and deductible — business expenses.”).

These authorities rebut defendant's claim that existing cases “heavily favor” its position. (PageID.2595). On the contrary, they establish that the costs of defending against a claim of patent infringement are deductible business expenses because they are incurred to preserve and protect the alleged infringer's profit-generating business operations. In this regard, defendant acknowledges that “Perrigo is in the business of developing generic drug products” (PageID.2594, emphasis added) and “generic drugs are an important component of Perrigo's business.” (PageID.2598, emphasis added.) Money that Perrigo spent to protect this business from brand companies' allegations of patent infringement that, if successful, would block Perrigo's ability to realize profits from its generic drug products, are traditional business expenses. Moreover, the successful defense against a claim of patent infringement does not result in creation of any asset. All the generic company obtains from a successful defense is confirmation that the patent owner did not have the right to block the defendant from making or selling its generic drug. And FDA approval or rejection of the ANDA application does not in any respect hinge upon the outcome of the patent litigation.

This is why the IRS admits that, “[I]n general, costs to defend against a claim of patent infringement are deductible on the theory that the taxpayer is protecting or maintaining its income-generating business.” IRS Chief Counsel Att'y Mem. 2014-006, 2014 WL 4495163 (Aug. 11, 2014). Even more, the IRS concedes that litigation costs incurred by brands prosecuting § 271(e)(2) cases are deductible: “[W]here a drug manufacturer holds a patent on a drug for which an ANDA with ¶ IV certification is filed, the legal fees incurred by the drug manufacturer to try to establish that the manufacture, use, or sale of the drug subject to the ANDA would infringe the drug manufacturer's patent generally are not required to be capitalized” but “are generally deductible as ordinary and necessary business expenses.” Id.

Effectively, defendant envisions a regime where patent infringement litigation costs continue to be generally deductible, except that in § 271(e)(2) cases only the suing brand companies continue to deduct while defending generic companies must capitalize their legal expenses. Defendant reasons that, through the lens of tax law, Hatch-Waxman fundamentally changed the character and tax treatment of generics' § 271(e)(2) costs. Nothing could be further from the truth.

2. Hatch-Waxman Did Not Alter the Character or Longstanding Tax Treatment of Generics' Patent Litigation Costs

Defendant does not dispute that before Hatch-Waxman generics' patent infringement litigation costs were deductible business expenses, but asserts that Hatch-Waxman transformed these costs into capital expenditures.

Defendant's position is inconsistent with basic principles of statutory construction. “The starting point in determining legislative intent is the language of the statute itself.” In re Vause, 886 F.2d 794, 798 (6th Cir. 1989) (citations omitted); Wis. Cent. Ltd. v. United States, 138 S. Ct. 2067, 2070 (2018). Hatch-Waxman made no changes to the tax code and does not mention the word “tax.” Had Congress wanted to rescind deductions for generics' infringement litigation costs, it could have done so. See, e.g., I.R.C. §§ 162(b), (c), and (e) (denying deductions for charitable contributions, kickbacks, and lobbying expenditures).

Likewise, the legislative history contains no reference to the character or tax treatment of generics' infringement litigation costs. See H.R. Rep. 98-857, pt. 1 (1984); H.R. Rep. 98-857, pt. 2 (1984). Although the House Report explicitly describes Congress' plan “of reversing the holding of the court in [Bolar],” H.R. Rep. 98-857, pt. 2 (1984), 1984 WL 37417, at *27, it reveals no intention to override F. Meyer or Kornhauser as they relate to generics' litigation costs.

Absent such language, a court should not impute congressional intent to alter the costs' longstanding, Supreme Court-endorsed deductibility. Bates v. United States, 522 U.S. 23, 29 (1997) (“[W]e ordinarily resist reading words or elements into a statute that do not appear on its face.”); Robert C. Herd & Co. v. Krawill Mach. Corp., 359 U.S. 297, 302 (1959); Smith v. Thomas, 911 F.3d 378, 382 (6th Cir. 2018).

Hatch-Waxman must be interpreted in light of “object and policy” and to “serve, rather than frustrate, the statute's manifest purpose.” United States v. Fitzgerald, 906 F.3d 437, 443 (6th Cir. 2018). Furthermore, “interpretations of statutes should be avoided which produce absurd or unreasonable results.” St. Luke's Hosp. Ass'n v. United States, 333 F.2d 157, 163 (6th Cir. 1964). Hatch-Waxman manifestly intended “to make available more low cost generic drugs.” H.R. Rep. 98-857, pt. 1 (1984), 1984 WL 37416, at *14. Congress desired to incentivize generics to challenge weak or invalid patents, as well. Teva Pharms, USA, Inc. v. Leavitt, 548 F.3d 103, 106 (D.C. Cir. 2008) (“The legislative purpose underlying paragraph IV is to enhance competition by encouraging generic drug manufacturers to challenge the patent information provided by NDA holders in order to bring generic drugs to market earlier.”); S. Rep. No. 107-167, at 4 (2002) (“Under Hatch-Waxman, manufacturers of generic drugs are encouraged to challenge weak or invalid patents on brand name drugs so consumers can enjoy lower drug prices.”).

Given the stated purposes of Hatch-Waxman, it is unreasonable to construe the statute as rescinding generics' previously available deductions for patent infringement litigation costs, while permitting brands to continue deducting their litigation costs in the same types of cases. Such a distinction would place an additional economic burden on generic companies. Both parties in infringement suits are protecting their businesses, generics by commercializing new non-infringing products and brands by defending patent rights. Yet, defendant would deny generics the same tax treatment that brand companies receive for their legal costs, giving brands a decided financial advantage. Similarly, defendant would prejudice generics sued under § 271(e)(2) with required capitalization, relative to generics who are not sued under that statute within 45 days of the certification. These companies may continue to deduct patent litigation costs if they seek certainty regarding patent infringement by filing suit for a declaratory judgment of non-infringement (21 U.S.C. § 355(j)(5)(C)), or otherwise litigate patent issues outside of the § 271(e)(2) framework. Such asymmetric, unequal treatment frustrates, rather than advances, the objectives of Hatch-Waxman.

With deductions, a court “should be slow to attribute to Congress a purpose producing such unequal treatment among taxpayers, resting on no rational foundation.” United States v. Gilmore, 372 U.S. 39, 48 (1963); see id. (“[I]t was manifestly Congress' purpose with respect to deductibility to place all income-producing activities on equal footing.”). Defendant's theory does just that.

3. § 271(e)(2) Litigation Costs Do Not Facilitate FDA Approval

Defendant argues that Treas. Reg. § 1.263(a)-4, which addresses costs to acquire intangibles, requires capitalization. (PageID.2620-22.) Because Perrigo did not incur § 271(e)(2) costs to prepare ANDAs (e.g., conducting trials, assembling data) or pay them to the FDA, they are not direct costs of acquiring intangibles. Instead, citing Treas. Reg. § 1.263(a)-4(b)(v), defendant characterizes Perrigo's litigation expenses as transaction costs that “facilitate” acquisition of ANDAs. Defendant's theory lacks merit for at least two reasons.

First, the regulation is not “directly on point” as defendant claims. (PageID.2595.) When the IRS and Treasury promulgated the regulation in 2004, they did not envision that generics would capitalize their § 271(e)(2) litigation costs. At the time, judicial guidance clearly provided that patent infringement litigation costs, from the vantage of both patentees (Urquhart) and alleged infringers (F. Meyer and Kornhauser) were business expenses. By 2004, Hatch-Waxman had been law for two decades, during which time neither Congress nor courts suggested different tax treatment of generics' § 271(e)(2) litigation costs. Against this backdrop, and given the regulations' avowed purpose “to provide certainty for taxpayers by identifying specific categories of rights, privileges, and benefits, the costs of which are appropriately capitalized,” Proposed Rules, 67 Fed. Reg. 77701, 77702 (Dec. 19, 2002) (emphasis added), the IRS and Treasury would have said they were changing the longstanding treatment of generics' patent infringement litigation costs if they had intended do so.

On the contrary, they emphasized that the regulation was “not intended to require capitalization of amounts paid to protect the [intangible] property against infringement . . . As under current law, these costs are generally deductible. See, e.g., Urquhart v. Commissioner. . . .” Id. at 77705 (emphasis added). Since the origin of a patent infringement case is the same for both parties, one would have reasonably interpreted this admitted deductibility of brands' costs to apply equally to generics' costs.

Inescapably, the IRS's capitalization theory, conceived in 2011, stretched the regulation beyond its original limits to impose new and financially significant obligations upon generics without a reciprocal impact on brand owner. As “a major substantive legal addition to a rule,” Appalachian Power Co. v. EPA, 208 F.3d 1015, 1024 (D.C. Cir. 2000), not mere interpretation, the IRS should have followed rulemaking procedures. Instead, the IRS set out to impose its worldview through administrative notice. See A.D. Transp. Express, Inc. v. United States, 290 F.3d 761, 766 (6th Cir. 2002) (stating that an agency “may not attempt to subvert the rule-making process through interpretations that find no support in the regulation's language”).

Second, as a factual matter, generics' § 271(e)(2) litigation costs are not transaction costs facilitating FDA approval. An amount facilitates acquisition of an intangible if “paid in the process of . . . pursuing the transaction.” Treas. Reg. § 1.263(a)-4(e)(1). At trial, Messrs. Bradshaw and Figg will explain that generics do not pay § 271(e)(2) litigation costs to pursue FDA approval. Rather, judicial resolution of patent disputes and FDA drug approval are separate and distinct processes, not steps in a single highly integrated ANDA-acquisition transaction, as defendant would like to characterize them. (PageID.2595; PageID2620-21.)

As Messrs. Bradshaw and Figg will explain, the FDA approval and patent litigation processes sit on opposite sides of the fence. On the drug approval side, the FDA concerns itself solely with FDCA-required scientific and technical determinations. It has no patent expertise and does not analyze patent questions or participate in or even monitor patent cases. Patent litigation does not influence FDA review, which focuses on drug safety and efficacy. (Bradshaw Decl., ¶ 8; Figg Decl., ¶ 8.)

On the patent side, courts in § 271(e)(2) cases do not consider FDCA requirements, which are irrelevant to adjudging questions of patent validity and infringement. § 271(e)(2) cases present the same issues as do any patent infringement case. They proceed in the same manner as all other infringement suits. In reality, ANDA approval and patent infringement litigation are different processes conducted by different bodies for different purposes, each having different legal consequences and neither facilitating the other. (Bradshaw Decl., ¶ 8; Figg Decl., ¶ 8.)

Furthermore, there is no cause-and-effect relationship between § 271(e)(2) litigation costs and underlying litigation, on the one hand, and FDA approval, on the other. Generics can obtain FDA approval to sell a new drug without ever incurring § 271(e)(2) costs. This occurs, for example, when a generic files an ANDA with ¶ I-III certifications. Similarly, for ¶ IV ANDAs, a generic can obtain FDA approval without incurring § 271(e)(2) costs if the brand never sues (which happens) or, alternatively, strategically waits until commercialization to sue (which also happens). Clearly, § 271(e)(2) litigation costs are not part of a tightly integrated transaction to obtain FDA approval. Moreover, when a brand files a § 271(e)(2) case, the FDA can approve the ANDA after 30 months even if the litigation continues, without regard for any litigation costs the generic either has incurred or will incur. See Eli Lilly & Co. v. Accord Healthcare Inc., No. 14-00389, 2015 WL 8675158 (S.D. Ind. Dec. 11, 2015) (“Congress did not tie resolution of the patent litigation to approval of the product.”). Conversely, a generic may win the § 271(e)(2) case, clearing all patent barriers, but never receive FDA approval due to technical deficiencies in its ANDA.

Contrary to defendant's claims (PageID.2622; PageID.2625), all of these facts and circumstances are directly relevant to its facilitation theory because they show that § 271(e)(2) litigation costs, in fact, are unrelated and unnecessary to generics' acquiring FDA approval and do not hasten, ease, or otherwise facilitate that approval.

Lastly, the fact that a judicial determination of infringement by a generic drug will postpone the effective date of FDA approval until the expiration of the patent (35 U.S.C. § 271(e)(4)(A)), reinforces that patent litigation and FDA approval are separate and distinct processes. To accommodate brands' intellectual property rights, Congress harmonized the FDCA and patent law by deferring FDA approval of infringing generics. Thus, while § 271(e)(2) litigation never facilitates FDA approval, it can, if the generic loses the case, impede approval — i.e., the opposite of facilitating.

In sum, Hatch-Waxman did not make patent infringement litigation part of the FDA approval process or cause patent cases to facilitate FDA approval. In reality, it adjusted only the timing of the patent litigation in the context of new generics.

  • Through § 271(e)(1), it delayed the infringement litigation to allow new generics to be developed.

  • Then, through § 271(e)(2), it accelerated the litigation to occur concurrently with FDA review to eliminate a major patent roadblock that otherwise would have remained upon FDA approval.

  • Finally, it added the 30-month stay to give courts time to consider patent issues before FDA approval.

In every other respect, § 271(e)(2) cases are the same as any patent infringement case. As established nearly a century ago in F. Meyer and Kornhauser, Perrigo's costs in defending § 271(e)(2) cases are ordinary and necessary business expenses.

4. All Patent Infringement Claims, Including § 271(e)(2) Claims, Originate from Alleged Misuse of a Patented Invention

Defendant alternatively contends that the origin of the claim in § 271(e)(2) litigation is the ¶ IV certification filed to obtain FDA approval before patent expiration. (PageID.2622-25.) But, under the origin of the claim doctrine, the deductibility of costs incurred in defending a lawsuit is determined by reference to the nature of the claim that gave rise to the litigation. Gilmore, 372 U.S. at 49; Woodward v. Commissioner, 397 U.S. 572, 576-77 (1970); Wellpoint, 599 F.3d at 647. In any patent infringement case, the origin of the claim is the patent holder's belief that another has committed infringement. See Urquhart, 215 F.2d at 20.

Nothing in Hatch-Waxman changes the nature of patent infringement litigation or alters the origin of the claim analysis. First, the true origin of a § 271(e)(2) case is a brand company's belief that the generic product infringes on its patent. As explained above, before Hatch-Waxman, a generic infringed a brand patent merely by using the invention during R&D. Hatch-Waxman addressed this by adding the § 271(e)(1) safe harbor under which generics' use of a patent during development is no longer infringement. Then, so that the threat of infringement liability would not dissuade generics from launching FDA-approved generics, Hatch-Waxman added § 271(e)(2) to create an artificial act of infringement when a generic company files an ANDA with a ¶ IV certification. In substance, § 271(e)(2) does not create a new claim or cause of action. The ¶ IV certification is purely procedural: it does not establish or create a substantive act of infringement, but merely creates a “case or controversy” so that the brand company may initiate a lawsuit. The judicial inquiry in § 271(e)(2) litigation “is the same as it is in any other infringement suit, viz., whether the patent in question is 'invalid or will not be infringed by the manufacture, use, or sale of the drug for which the [ANDA] is submitted.” Glaxo Inc. v. Novopharm Ltd., 110 F.3d 1562, 1569 (Fed. Cir. 1997). In reality, all § 271(e)(2) did was accelerate the patent litigation; it did not change the origin of the brand company's infringement claim. See Bristol-Myers Squibb Co. v. Aurobindo Pharma USA Inc., No. 170-374-LPS, 2018 WL 5109836, at *6 (D. Del. Oct. 18, 2018) (rejecting arguments from brand-plaintiff that Hatch-Waxman placed § 271(e)(2) cases outside the patent infringement venue statute, finding that the case was “incontestably a 'civil action for patent infringement.”).

Second, the fact that § 271(e)(2) treats the filing of an ANDA with a ¶ IV certification as a litigation-triggering act of infringement is irrelevant to the origin of the claim inquiry. See Boagni v. Commissioner, 59 T.C. 708, 713 (1973) (ascertaining that the origin of a claim “does not contemplate a mechanical search for the first in the chain of events which led to the litigation”); Woodward, 397 U.S. at 577 (avoiding “resort to formalisms and artificial distinctions”). The ¶ IV certification is purely procedural and has no substantive effect. As defendant acknowledges, it creates an “artificial” act of infringement in order to provide jurisdiction for the courts to resolve a patent infringement dispute. But the litigation that follows is garden-variety patent infringement litigation that is independent of the FDA review of the ANDA.

Third, in a § 271(e)(2) case, there is only one claim applicable to both parties (i.e., alleged patent infringement). If, as the IRS freely admits,18 the origin of the claim in these cases is alleged patent infringement for brand-plaintiffs, there is no rational basis for inventing a different claim origin for generic-defendants. Indeed, a principal reason for the origin of the claim doctrine was to ensure that similarly situated litigants receive equal tax treatment. Gilmore, 372 U.S. at 48 (describing unequal treatment of similar taxpayers as “capricious”). See also Munson v. McGinnes, 283 F.2d 333, 336 (3d Cir. 1960) (“[I]t seems anomalous to require capitalization of expenses of the party who is on one side of a negotiation or controversy over the disposition of a capital asset while permitting the opposing party to claim an ordinary deduction of his equivalent expenses.”). Given this underlying purpose, it makes no sense to treat the origin of the claim for brand companies as alleged patent infringement, while taxing generic companies as if the origin of the claim was the filing of an ANDA with the FDA.

Fourth, it is immaterial that 35 U.S.C. § 271(e)(4)(A) requires a court, upon finding infringement, to delay FDA approval until the patent expires. While defendant acknowledges that a case's “potential consequences upon the fortunes of the taxpayer” are immaterial (PageID.2623), it argues without any sense of irony that the possibility that Perrigo may “realize benefits beyond the year in which it incurs the expenditure” (PageID.2619) if it wins the case, or may not obtain final FDA approval until patent expiration if it loses it (PageID.2624), proves that the origin of the claim is the ANDA filing. Defendant's argument ignores the distinction between the origin of the claim and the consequences of the litigation. Defendant had it right initially: the consequences of the cases on Perrigo are irrelevant and immaterial. See Gilmore, 372 U.S. at 629 (characterization “does not depend on the consequences” of litigation); Wellpoint, 599 F.3d at 647 (“[W]hether the origin of a claim is a dispute over a capital asset or over the day-to-day operations of the business is not to be decided by reference to the outcome of the suit.”).

Finally, that “the litigation arose out of Perrigo's efforts to obtain FDA approval” (PageID.2619) or “originates in its effort to obtain a capital asset” (PageID.2625) does not change the analysis. For litigation costs, “the test of deductibility relates to origin rather than purpose.” Brown v. United States, 526 F.2d 135, 139 (6th Cir. 1975). See also Woodward, 397 U.S. at 577 (rejecting test based on taxpayer's purpose). Thus, Perrigo's motivations for filing ¶ IV certifications are irrelevant, as are the consequences of its cases.

B. Triable Issues of Material Fact Preclude Summary Judgment

An independent reason to deny Defendant's Motion is that triable material facts undercut defendant's capitalization theory. In this regard, the ANDA issue is not purely legal but instead a mixed question of law and fact. “Classifying a particular expenditure as an expense on the one hand or as a capital expenditure on the other is applying a legal standard to facts.” Wellpoint, 599 F.3d at 645. Both the intangible regulations and the origin of the claim doctrine require consideration of facts and circumstances surrounding the expenses in question. Treas. Reg. §1.263(a)-4(e)(1)(i) (“Whether an amount is paid in the process of . . . pursuing the transaction is determined based on all of the facts and circumstances.”); Boagni, 59 T.C. at 713 (holding that the origin of the claim standard requires examining all facts and circumstances).

Concerning defendant's facilitation theory, Mr. Bradshaw will explain (1) that the FDA has no patent expertise, does not analyze or construe patents, and plays no role in patent litigation and (2) that infringement litigation does not influence the FDA's review process. (Bradshaw Decl., ¶ 8.) Mr. Figg will explain that in practice and operation § 271(e)(2) litigation is separate and distinct from the FDA review process and can only impede FDA approval of a generic drug. (Figg Decl., ¶ 8.)

Additionally, Messrs. Bradshaw and Figg will testify that, as a factual and not a legal matter, the origin and character of § 271(e)(2) litigation is perceived patent infringement, not acquiring a capital asset, and such litigation does not impact FDA approval. Concerning the origin of the claim, Mr. Bradshaw will explain that litigation often arises over generics' efforts to obtain ANDAs, such as lawsuits challenging the agency's approval authority because the new generic is not bioequivalent. (Bradshaw Decl., ¶ 8.) Such FDA-focused cases never present patent issues and differ from § 271(e)(2) cases, which do not involve the FDA and instead run on an entirely separate track. Mr. Figg will explain both that § 271(e)(2) cases fundamentally involve patent infringement and are no different than other infringement suits and that courts apply the same procedures and principles to resolve § 271(e)(2) cases as infringement suits outside Hatch-Waxman. (Figg Decl., ¶ 8.)

The knowledge and insights Messrs. Bradshaw and Figg will present are material to these inherently factual inquiries and will lead the trier of fact to find for Perrigo. Therefore, based on the cases reviewed on pages 21-23 above, summary judgment is inappropriate.

Apparently acknowledging that Perrigo's experts will present material facts undercutting its case for capitalization, defendant engaged its own expert, Mr. Roth, to rebut them. Whereas Messrs. Bradshaw and Figg provide first-hand insights into the FDA and patent dispute processes, Mr. Roth merely recites Hatch-Waxman's policy and framework, and thus his opinions are not particularly helpful and ignore the negative impact of defendant's theory on the purposes of Hatch-Waxman from disparate treatment of brand and generic litigants. Nevertheless, his competing viewpoints set up the classic “battle of the experts,” and it is up to the Court to evaluate what weight and credibility each expert opinion deserves. Just as the Tax Court benefited from hearing Messrs. Bradshaw's and Figg's opinions in Mylan, their views will help the Court evaluate defendant's theories and should be heard at trial.

IV. Conclusion

For the foregoing reasons, defendant's motion on this issue should be denied.

Dated: June 28, 2019

Respectfully submitted,

John B. Magee
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Ave., NW
Washington, D.C. 20004
Telephone: (202) 739-3000
john.magee@morganlewis.com

FOOTNOTES

1On the same date, Perrigo requested partial summary judgment to eliminate defendant's common law “sham” challenges to the transactions at issue and limit the case to 26 U.S.C. § 482 (“section 482”) economic substance and transfer pricing issues. (PageID.2051.) (“Perrigo's Motion.”)

2Multiple fact and expert witnesses will testify at trial as to the significant risks and uncertainties inherent in the Dexcel Contract at the Effective Date of the Assignment.

3A domestic subsidiary of Perrigo inadvertently made two post-Assignment payments to Dexcel on LLC's behalf, but LLC reimbursed LPC upon discovery of the error. (PageID.2494.)

4Administrative missteps led to bank accounts for PITLP/LLC not being opened until late 2007 and early 2008, but before then “[UK] Finco would have supported any” of PITLP/LLC's activities. (Magee Decl., Ex. B at 33:9-17.)

5Mr. Kennelly will testify on this issue at trial. (Kennelly Decl., ¶¶ 5-6.) Furthermore, Dr. Daniel Frisch, another of Perrigo's experts, will explain that from an economic perspective the proper valuation date for the Assignment is November 29, 2006. (Magee Decl., Ex. G at 258:10-18.)

6Perrigo's tax year ending June 28, 2008 (“2008 tax year”).

7Defendant cites an internal E&Y memo dated March 4, 2008, for the proposition that E&Y advised Perrigo that PITLP/LLC should be adequately capitalized and funded via an equity infusion rather than a loan. (PageID.2611; PageID.2472.) It is unclear when (if ever) this advice was presented to Perrigo, and defendant does not point to any evidence that Perrigo ever received it. Nor does defendant cite any authority establishing this as a legal requirement.

8In Humana Inc. v. Commissioner, 881 F.2d 247, 257 (6th Cir. 1989), the Sixth Circuit held that the insurance risk bar to premium deductions did not apply to brother-sister transactions. Here, the assignor, LPC, and the assignee, LLC, were brother-sister companies within the Perrigo group.

9Because PITLP/LLC had access to adequate capital on the Effective Date, defendant's citation to Harbor Bancorp v. Commissioner, 115 F.3d 722 (9th Cir. 1997), is also inapposite.

10Even in the captive insurance context, courts have upheld deductions for captive insurance companies notwithstanding the existence of parental guarantees. See Rent-A-Center, Inc. v. Commissioner, 142 T.C. 1, 22 (2014) (“Parental Guaranty Did Not Vitiate Risk Shifting”); Securitas Holdings, Inc. v. Commissioner, T.C. Memo. 2014-225, at *22 (“[W]e have previously held that the existence of a parental guaranty by itself is not enough to justify disregarding the captive insurance arrangement”).

11As explained previously, while nominally directed only at the date on which LLC and the Assignment should be recognized, if the Court adopted February 2008 as the assignment date, the arm's length price of the Assignment would be close to the full value of the contract in a risk-free transaction. Defendant acknowledges that the date of transfer will drive “the income that was earned by LLC during the tax years at issue.” (PageID.2593.)

12In 2010, Congress codified the economic substance doctrine, which applies only to transactions that are “relevant.” 26 U.S.C. § 7701(o). In explaining the new statute, the Congressional Joint Committee on Taxation identified, as a transaction to which the codified economic substance doctrine is not “relevant,” a “U.S. person's choice between utilizing a foreign corporation or a domestic corporation to make a foreign investment.” Staff of the Joint Comm. on Taxation, Technical Explanation of the Revenue Provisions of the “Reconciliation Act of 2010,” as Amended, in Combination with the “Patient Protection and Affordable Care Act,” 152 (2010). Although section 7701(o) does not apply to Perrigo's 2009-2012 tax years, the Joint Committee statement is consistent with longstanding case law. See, e.g., Siegel v. Commissioner, 45 T.C. 566, 576 (1966).

13Defendant also alleges that as part of “E&Y's scheme,” LLC was “an empty box, bereft of employees or operational capabilities.” (PageID.2592.) This ignores that LLC had officers and directors. In addition, the law permits an entity to undertake business activities by contracting with related or unrelated parties. See, e.g., Hosp. Corp. of Am., 81 T.C. at 520 (foreign affiliate not a sham even though domestic parent performed services on its behalf).

14Defendant argues alternatively that if the Court does not deem this to be a legal question, then defendant is entitled to a ruling that the assignment did not transfer risk from Perrigo to LLC until LLC was capitalized. (PageID.2096.) Such a ruling is inappropriate because there are numerous disputed facts on that question, as described above. See Fed. R. Civ. P. 56(g) (a material fact may be established only if it “is not genuinely in dispute”).

15Pub. L. No. 98-417, 98 Stat. 1585 (1984).

1621 U.S.C. §§ 301-399(d).

17Defendant cites INDOPCO v. Commissioner, 503 U.S. 79 (1992), ABC Beverage Corp. v. United States, 756 F.3d 438 (6th Cir. 2014), and Sears Oil Co. v. Commissioner, 359 F.2d 191 (2d Cir. 1966), for certain broadly stated capitalization principles. (PageID2619-20.) These cases do not involve litigation costs and are of little relevance.

18See IRS Private Letter Ruling 2015-36-006 (June 1, 2015) (“The nature of the claims against the competitor infringing the patent and the counterclaims of the competitor are . . . a dispute over whether the competitor infringed upon Affiliate's patent and whether Affiliate's patent was properly issued. . . . These expenses are deductible as ordinary and necessary business expenses.”).

END FOOTNOTES

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