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Biotech Industry Overview - Significant Law and Important Issues

LMSB-04-0207-019

"This document is not an official pronouncement of the law or the position of the Service and cannot be used, or cited, or relied upon as such."

9. Significant Law and Important Issues

A. Coordinator Issues - There are no coordinated issues at this time.

B.  Emerging and Other Significant Issues and Brief  Summary of Issues

Capital Loss – Special Purpose Entity  -  TAM 200601029:  Taxpayer may not claim a loss deduction under 165 of the Internal Revenue Code upon the expiration of a "purchase option agreement" to acquire X if Taxpayer instead acquires X by other means.

Cost Segregation:  The crux of cost segregation is determining whether an asset is I.R.C. §1245 property (shorter cost recovery period property) or §1250 property (longer cost recovery period property).  The most common example of §1245 property is depreciable personal property, such as equipment.  The most common examples of §1250 property are buildings and building components, which generally are not §1245 property. 1

The difference in recovery periods has placed the Internal Revenue Service and taxpayers in adversarial positions in determining whether an asset is §1245 or §1250 property. The Biotech/Pharmaceutical industry matrix recommends the categorization and general depreciation system recovery period of various assets utilized within the industry (refer to the cost segregation industry guide attachment A).

Deferred Revenue:  IRC sections 61, 446, 451. Biotech companies for promising research enter into alliance agreements with large pharmaceutical or biotech companies. The agreements call for up front fees, milestone payments and royalties upon commercialization. Biotech companies are deferring the reporting of the up front fee and including it into income ratably over the term of the agreement. The up front fee is for research already performed, taxpayer has unfettered use of the funds, deferral is not warranted.

Government Settlements: The issue in question is whether or not a False Claims Act (FCA) settlement with the DOJ is deductible in its entirety as a Sec 162 (a) deduction, or is some portion a non-deductible penalty under Sec 162 (f).

Experience has shown that almost every defendant/taxpayer deducts the entire amount of a (FCA) settlement as a business expense.  In most cases, a portion of the civil fraud settlement payment represents a penalty that is not deductible for tax purposes. 

Off-Balance Sheet Financing Vehicles:  IRC section 174.  Biotech companies utilize patents from their promising research to raise additional capital to fund their R&E activities.  The biotech will transfer the rights to the research to a newly formed entity.  The new entity at the time of the transfer will simultaneously enter back into a series of agreements with the biotech (i.e. R&E agreement, exclusive license agreement, manufacturing agreement and an option to purchase agreement).  The new entity typically has no employees, no R&E expertise, no assets other than the transferred technology, and no realistic prospect of exploiting the R&E and passive income (interest and royalties).  The issue therefore, is the new entity entitled to an I.R.C. 174 expense for research paid by it to the biotech?  Is the research in connection with the new entities trade or business?

Cost Sharing and Buy-In:  IRC section 482 and Treas. Reg. 1.482-7.  Biotech companies when deciding to globalize their business are electing cost sharing with their foreign affiliates and contributing pre-existing intangibles (in process R&E) to the agreement.  Taxpayer is entitled to a buy-in payment from the foreign affiliate for intangibles made available to the CSA.  Valuation questions and expected benefits questions need to be addressed.

Legally Mandated Research and Experimental Expenses:  IRC sections 861-864 and Treas. Reg. 1.861-8(e)(3) and 1.861-17(a)(4).  Biotech companies when allocating and apportioning R&E for foreign tax credit purposes are excluding from the total R&E pool before such allocation and apportionment an amount for legally mandated research.  Before such exclusion can take place, taxpayers must demonstrate they are in compliance with the requirements of the regulations.

License Fees & Milestone Payments:  In the pharmaceutical and biotech industries it is common for companies to license promising research candidates at various stages of discovery/development from related and unrelated parties. Fees are paid in order to acquire the rights to use or exploit such promising research or know how which may lead to the development of a bio-pharmaceutical product. Each year billions of dollars are paid in licensing fees and other commitments. Preliminary analysis indicates the inconsistent treatment of these fees by taxpayers. (see  Licensing Fees Emerging Issue Alert[7/7/2005] [doc]

Expansion vs. New Business Expenses:  IRC sections 162, 195, and 482.  Biotech companies are incurring expenses for the investigation of new business markets and start up costs of entry into those markets.  A determination of whether the costs are ordinary and necessary or capitalizable needs to be decided.

Section 936 – Exit Strategy :  Notice 2005-21 provides guidance to U.S. corporations allowed a credit under section 936 or 30A of the Internal Revenue Code (section 936 corporations) with regard to the termination of sections 936 and 30A for tax years after 12/31/2005. Specifically, this notice discusses certain issues that are likely to arise depending on the manner in which the business of a section 936 corporation continues to be conducted after this termination. Certain issues include : the offshore migration of intangibles under section 367 and the transfer pricing of U.S.-owned intangibles under section 482 that result from the restructuring of section 936 corporations.

C.  Recent Pending Legislation - There is no recent or pending legislation at this time.

D.  Specific Industry Related Tax Law

Code section:  45C
Summary and Impact of Law:  Clinical Testing Expenses for Certain Drugs for Rare Diseases or Conditions (Orphan Drug Credit)

Code section:  41
Summary and Impact of Law:  Credit for Increasing Research Activities

Code section:  61 & 451 (Rev. Proc. 2004-34)
Summary and Impact of Law:  Gross Income Defined; Deferred Revenue

Code section:  174
Summary and Impact of Law:  Research and Experimental Expenses

Code section:  195
Summary and Impact of Law:  Start up Expenditures

Code section:  167
Summary and Impact of Law:  Amortization of certain intangibles

Code section:  482
Summary and Impact of Law:  Allocation of Income and Deductions among taxpayers

Code sections:  861,862,863, 864
Summary and Impact of Law:  Income from Sources within and without the United States

 

Code sections:  901,902,904
Summary and Impact of Law:  Foreign Tax Credit

Code section:  936
Summary and Impact of Law:  Puerto Rico and Possession Tax Credit

E.  Important Revenue Rulings and Revenue Procedures:  There are no important Rev. Ruls. or Rev. Procs.  At this time.

F.   Important Court Cases

Date Opinion Issued:  2001
Name of Court Case and Citation:  Westpac Pacific Foods v. Commissioner, T.C. Memo 2001-175
Summary of Importance of Court Case:  Taxable Advance Payments vs. Deposits and Deferrals of Income.

Date Opinion Issued:  1957
Name of Court Case and Citation:  Automobile Club of Michigan v. Comm., 353 U.S. 150
Summary of Importance of Court Case:  Prepayment for goods and services. (Deferred Income Issue)

Date Opinion Issued:  1961
Name of Court Case and Citation:  Automobile Association v. U.S. , 367 U.S. 687

Summary of Importance of Court Case:  Prepayment for goods and services (Deferred Revenue Issue)
Date Opinion Issued:  1963
Name of Court Case and Citation:  Schlude v. Comm., 372 U.S. 128

Summary of Importance of Court Case:  Prepayment for goods and services (Deferred Revenue Issue)
Date Opinion Issued:  1979
Name of Court Case and Citation:  Thor Power Tool v. Comm., 439 U.S. 522

Summary of Importance of Court Case:  Disparity between tax and financial reporting (Deferred Revenue Issue)
Date Opinion Issued:  1974
Name of Court Case and Citation:  Snow v. Comm., 416 U.S. 500
Summary of Importance of Court Case:  Interpretation of in connection with a trade or business standard (Off-book financing and section 174 Issue)

Date Opinion Issued:  1984
Name of Court Case and Citation:  Green v. Comm., 83 T.C. 667
Summary of Importance of Court Case:  Trade or business standard (Off-book financing and section 174 Issue)

Date Opinion Issued:  1993
Name of Court Case and Citation:  Kantor v. Comm., 998 F.2d 1514
Summary of Importance of Court Case:  Trade or business standard (Off-book financing and section 174 Issue)

Date Opinion Issued1988
Name
of Court Case and Citation:  Ben-Avi v. Comm., T.C. Memo 1988-74
Summary of Importance of Court Case:  Trade or business standard (Off-book financing and section 174 Issue)

Date Opinion Issued:  2002
Name of Court Case and Citation:  Impact Research Corp. v. Comm., T.C. Memo 2002-107
Summary of Importance of Court Case:  Trade or business standard (Off-book financing and section 174 Issue)

Date Opinion Issued:  2001
Name of Court Case and Citation:  Lychuk v. Commissioner, 116 T.C. 374
Summary of Importance of Court Case:  Expansion vs. New Business deductibility of expenses.

Date Opinion Issued:  1972
Name of Court Case and Citation:  Briarcliff Candy Corp. v. Commissioner, T.C. Memo 1972- 43
Summary of Importance of Court Case:  Expansion vs. New Business deductibility of expenses.

G. Technical Advice Memorandums - Field Service Advices

Date:  2001
Number:  FSA 2001 - 45011
Description:  Off balance sheet financing and deductibility of R&E under IRC section 174.

Date:  1997
Number:  PLR 9707003
Description:  Off balance sheet financing and deductibility of R&E under IRC section 174.

Date:  1996
Number:  PLR 9604004
Description:  Off balance sheet financing and deductibility of R&E under IRC section 174.

Date:  1988
Number:  PLR 8802007
Description:  Off balance sheet financing and deductibility of R&E under IRC section 174.
Date:  1987
Number:  PLR 8749006

Description:  Off balance sheet financing and deductibility of R&E under IRC section 174.
Date:  1988
Number:  PLR 8806002
Description:  Expansion vs. New Business deductibility of expenses.

Date:  1996
Number:  PLR 9645002
Description:  Expansion vs. New Business deductibility of expenses.

Date:  2001
Number:  FSA 2001 - 09001
Description:  Expansion vs. New Business deductibility of expenses.

Date:  2000
Number:  FSA 2000 - 01018
Description:  Cost Sharing and Buy In.

Date:  2000
Number:  FSA 2000 - 23014
Description:  Cost Sharing and Buy In.

Date:  2000
Number:  FSA 2000 - 09022
Description:  Cost Sharing and Buy In

Date:  2000
Number:  FSA 2000 - 03010
Description:  Cost Sharing and Buy In

Date:  2002
Number:  FSA 2002 - 25009
Description:  Cost Sharing and Buy In.a

 


[1] I.R.C. §1245 can apply to certain qualified recovery nonresidential real estate placed in service after 1980 and before 1987.  See I.R.C. §1245(a)(5).

Chapter 8 | Table of Contents | Chapters 10 & 11

Page Last Reviewed or Updated: 03-Mar-2014