On March 10, 2016, Tax Court Judge Laro denied the Internal Revenue Service’s (IRS) motion for summary judgment in Mylan’s challenge of the IRS’s determination that approximately $372 million should be treated as ordinary income.  See Mylan Inc. and Subsidiaries v. Commissioner of Internal Revenue, T.C.M. 2016-45.  In its Tax Court petition, Mylan seeks a redetermination of tax deficiencies related to proceeds from the sale of “all substantial rights” in a patent that Mylan treated as capital gain.  The IRS recharacterized the income as ordinary income received under a sublicense of patent rights.

Mylan entered into a number of agreements, including a 2008 agreement in the form of an “exclusive license,” that Mylan contends effectuated a sale of patent rights and entitles it to capital gain treatment.  In deciding the motion for summary judgment, the Tax Court considered whether the tax treatment should be determined based upon Mylan’s licensing agreements.  The IRS argued that pursuant to Commissioner v. Danielson, 378 F.2d 771,775 (3d Cir. 1967), taxpayers are bound by the terms of their agreements.  Mylan argued that Danielson does not apply because the Third Circuit has previously examined not only the terms of the contracts but also the intent of the parties in determining whether “all substantial rights” under a patent were transferred, relying on such authorities as Merck & Co. v. Smith, 261 F.2d 162  (3d Cir. 1958) and E.I. du Pont de Nemours & Co. v. United States, 432 F.2d 1052 (3d Cir. 1970).

The Tax Court, however, determined that there is no inconsistency between Danielson, Merck and E.I. du Pont:

We do not see the inconsistency here.  In Danielson, a taxpayer sought to change the tax consequences of a transaction by challenging the validity of the underlying contract’s terms, specifically, allocation of consideration between the sale of stock and the covenant not to compete, because the taxpayer believed these terms did not reflect the agreement of the parties.  In Merck and E.I. du Pont de Nemours the taxpayers did not seek to alter or challenge the agreements in question.  Instead, the taxpayers disagreed with the Commissioner’s interpretation of those contracts and characterization of the related payments for tax purposes.  Here, unlike in Danielson, petitioners do not seek to change the tax consequences of the transaction by challenging the underlying agreements and reforming the contractual terms.  On the record before us, the facts here resemble those in Merck and E.I. du Pont de Nemours.  The question presented here is a question of proper tax characterization of the proceeds of valid and enforceable contracts, and we are mindful that the Commissioner and taxpayers often disagree on this issue.

The Tax Court found that there are issues of material fact in dispute, and denied the IRS’s motion for summary judgment.

Now that the Tax Court has denied summary disposition of the case, the parties will litigate the capital vs. ordinary tax treatment of transfers of patents.  We will report back as developments occur in this hotly contested area of tax law.