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Pharmaceutical Industry Overview - Complete Version


" 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."

Table of Contents

  1. Introduction
    A. Purpose of Industry Overview
    B. Use of the Intranet and Internet
    C. General History of Industry Specialization Program (ISP)
    D. History of Pharmaceutical ISP
    E. Industry Specialist Staffing (Technical Advisors in LB&I)
    F. LB&I Industry Staffing
    G. History of Industry
  2. Trends
  3. Industry Terms
  4. Accounting Principles
  5. Industry Operating Procedures
  6. Government Regulatory Requirements
    A.   Federal Requirements
    B.   State Requirements
    C.   Local Requirements
  7. Significant Law and Important Issues
    A.   Coordinated Issues
    B.   Emerging or Other Significant Issues
    C.   Recent or Pending Legislation
    D.   Specific Industry Related Tax Law
    E.   Important Revenue Rulings or Revenue Procedures
    F.   Important Court Cases
    G.   Technical Advice Memorandums - Field Service Advices
  8. Alternative Issue Resolution Considerations
  9. Industry Resources
    A.   WEB Sites
    B.   Trade Associations
    C.   IRS and Other Training Courses/Videotapes
    D.   Trade Magazines and Newsletters
    E.   Industry Books
    F.    Internal Revenue Manual Citations
    G.   AICPA Auditing Standards and Publications
    H.   Market Segment Specialization Program (MSSP)
  10. Appendix

    A.   Complete Listing of Industry Overviews Available


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1. Introduction

A.   Purpose of Industry Overview - This overview is designed to provide industry-related information to all Large Business and International (LB&I).   This is the first step in the effort of LB&I to develop a greater level of expertise in the industry or industries to which you will be assigned.   This overview is one of a series of industry specific overviews.  See the Appendix for a complete listing of available overviews.

B. Use of the Intranet and Internet - It is anticipated that an industry web page will be established on the LB&I Intranet site that will contain detailed information involving each industry.  The topics included in this overview will be expanded upon and others will be included.  For example, an up-to-date economic analysis of the industry, current and future trends, and links to many other industry related web sites that can assist you in gaining the needed level of understanding of your industry will be included.   

C. General History of Industry Specialization Program (ISP)




1952 The Service was restructured in 1952 into a highly decentralized organization consisting of seven regions and 58 districts.  This reorganization was implemented in part to achieve greater sensitivity and responsiveness to pubic needs.  District Directors were given wide latitude and authority in administering the Service's policies, procedures and programs.  While decentralization of the Service proved to be a progressive action, communication between the regions and districts was made more difficult because of their quasi‑autonomy.  Positions taken by the Service on industry issues could differ significantly from one region to another on the same issues.
1971 The Service implemented the Industry Wide Examination Program to concurrently examine the major taxpayers in a given industry, coordinate selected issues common to that industry and to resolve those issues uniformly and consistently among all the industry taxpayers.  Under the direction of project coordinators (usually large case branch chiefs), the industry wide examinations were largely successful in achieving uniform and consistent treatment of issues.  Industry wide examinations were conducted in several industries between 1971 and 1979 and the ability to communicate freely across district and regional lines proved to be invaluable to the success of these examinations.
1977 The Industry wide Examination Program had one major drawback.  Since they existed for only two or three tax years and were then terminated, the program failed to provide continuity.  To correct this situation, a major study group was created in 1977 to review the Service's Coordinated Examination Program.  The study recommended that permanent positions be established for several Industry Specialists and a National Industry Coordinator.  In addition, the study group identified basic industries to which it recommended specialists be assigned.  The duties and responsibilities of the Specialists and the Coordinator were to be much broader than the former Project Coordinators whom they replaced.
1979 The recommendations of the study group were implemented greatly expanding the scope and depth of the Industry wide Examination Program.  The term, Industry Specialization Program, eventually evolved as a name that could encompass the varied concepts of Industry Specialists, National Industry Coordinator, Coordinated Issues, and the many refinements suggested by the study group.

D.  History of Pharmaceutical TA





ISP re-established.


Part-time research team member added.


First Coordinated Issue Paper on Medicaid Rebates Approved by AC Exam


IE added to the team

E. Industry Specialist Staffing (Technical Advisors in LB&I)


Name of Specialist

Telephone #


Lou Milano, 908-301-2106 908-301-2305
Lena C. Lee 415-522-6381 415-522-6123
Marjory Gilbert, Asst. Industry Counsel 312-368-8730 312-368-8710
Larry Foster, Appeals 615-250-5756 615-250-5869     

F.  LB&I Industry Staffing

The Industry Specialist is assigned to the Pre-Filing and Technical Guidance Division that is a part of LB&I Headquarters.  Each industry is assigned to one of the five Industry Functional Divisions.  Industry Specialists will be known as technical advisors in LB&I and will be supervised by a Manager, Technical Advisors.  Information relative to the management in the Industry Division that this industry is assigned as well as the Manager: of the Technical Advisor(s) of this industry is as follows:





Sergio Arellano Industry Director Downers Grove, IL
Lori Nichols Director Field Operations -  East  Louisville, KY
Jim Roosey Director Field Operations - West Downers Grove, IL
Greg Zielinski Manager, Technical Advisors Chesterfield, MO

G.   History of Industry




1800s Organic chemistry is the foundation of the pharmaceutical industry.  The European beginnings can be traced, in part to the Rhine Valley and Basel, Switzerland.  In the 19th century the Rhine provided power and water for a booming synthetic dye industry.  From the dye industry evolved chemical businesses with three local companies, Ciba, Geigy and Sandoz along with German companies Bayer and Hoechst blossoming into full fledged drug companies.  In 1896, Fritz Hoffman established another pharmaceutical company named after his and his wife’s family, La Roache. 
Early 1900s

The 20th century New Jersey and the surrounding area is the headquarters for many of the premier pharmaceutical companies in the world including, American Home Products, Johnson & Johnson, Warner Lambert,  Merck & Co., Pharmacia-Upjohn, Schering-Plough, BASF, Hoechst, Schering  AG, Hoffman LaRoche, and Novartis.  There are many other medium and small sized biotech, pharmaceutical and chemical companies in the Northeast corridor  from North Carolina to Massachusetts.

New Jersey became the capital of the U.S. pharmaceutical industry back around the turn of the 20th century, George Merck wanted to manufacture the drugs he had been importing from his family’s firm E. Merck in Germany.  His headquarters in New York were too small so he purchased a 150-acre parcel of land in New Jersey near Rahway.  That was the initial move to New Jersey where open space was available.  The State also had lower taxes and access to shipping ports just a short distance from their original New York headquarters.  The exodus began in earnest after WWII. 

Roche moved to New Jersey  in 1929 followed by Ciba –Geigy, Schering, Johnson & Johnson, American Cyanamid, Becton Dickinson

Mid 1900s In 1950 Sandoz took the plunge to New Jersey.  Hoechst whose original headquarters were in Cincinnati, OH moved in 1974.  In turn the move of these branded companies encouraged generic companies and other chemical companies to take the plunge.  The most recent New Jersey arrivals were Aventis, the merger of Rhone-Polenc and Hoechst, and Pharmaceutical-Upjohn moved from Kalamazoo, MI0.
Late 1900s


New Jersey remains the headquarters for the industry, some companies are moving south.  One of the main destinations is North Carolina, the U.S. headquarters for Glaxo-Wellcome.  They are one of the world’s largest pharmaceutical companies and are currently involved in a proposed merger with SmithKline Beecham.  The biotech industry has found the welcome mat out in several other areas of the country like the Boston/Cambridge area; the San Francisco Bay Area; San Diego, CA; Princeton, NJ; Washington DC metro area as well as Philadelphia and the surrounding suburbs.

Present Day

The biotech industry is just one of the many changes occurring in the search for new cures.  The biggest changes are in research and development as well as marketing.  Much of the reason for the recent mergers is the need to have critical mass and money for research.  Research is where the biggest changes are occurring in this industry.  Where once a researcher was lucky enough to synthesize a few new chemicals entities a year, mass screening can now produce thousands.    

The electrifying discovery of the structure of DNA, by James D. Watson geneticists to tell us what makes each of us individuals.  For pharmaceutical companies it means they will be able to tailor products to our genetic code.  But I am getting ahead of myself.  It took a long time to get here and there were many exciting discoveries critical to the success of the pharmaceutical industry. 

Think back to the days of the wild west where traveling salesmen would sell all types of concoctions as cure-alls.  Some of the cure-all treatments contained cocaine or other highly addictive derivatives.  In the short run these concoctions did make people feel better but.  it usually only lasted long enough for a quick exit from town.  The true frontiersmen learned from the native Indians and their medicine men how to use native plants and herbs.  Tobacco was one of those.

Bayer AG, the German pharmaceutical company is generally credited with the discovery of aspirin.  “The Aspirin Wars” goes behind the scenes of aspirin’s discovery and the legal battles fought to keeps its rights and details the many marketing battles that took place worldwide.  It is believed that aspirin is the highest grossing drug in the world.

Other discoveries include penicillin, polio vaccine, ibuprofen, Tagamet, and Valium.  The need to ensure the quality and safety of the products being sold to the American public. The government passed legislation and later established the Food and Drug Administration.   

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2. Trends

Since the mid-90’s the industry has been undergoing a consolidation period. Mergers involving many large and medium size companies have been common in this period. The success of the stock market has madelarge amounts of capital available at reasonable ratesfor borrowing or for raising equity.  The companies involved in the mergers are biotech companies, who develop products based on living cells.  Also involved are companies who have developed new technology in unlocking the genetic makeup of humans.

Many foreign companies have been entering the United States market because of its uncontrolled pricing structure, rapid approval processes, private and public insurance reimbursement policies and government support for basic research.  Additionally, the industry enjoys many tax benefits not available in other countries, although the benefits are narrowing.

The tax benefits include Research & Experiment Credit for research conducted in the United States, the IRC 936 Puerto Rican Tax Credit for possession companies, Orphan Drug Credit for illnesses afflicting two hundred thousand or less patients.   Benefits of relocation to the United States include the ability to advertise to both the medical community and direct to consumers in an effort to increase awareness and consumption.  

The restructuring of the United States’ Food and Drug Administration has had a tremendous impact in the ability of companies to bring drugs to market quickly.   A tremendous lobbying effort on the part of the drug industry has resulted in the reduction of the average approval time for new drugs from two or three years to one year or less.  A prime example of the quick approval process was the 42-day approval of reverse transcription drugs for HIV that stems the progression of the virus.   More than half of the new drugs approved in the United States in 1998 were the first approval anywhere.

Another segment of the industry that has enjoyed the changes has been the generic pharmaceutical industry.  This segment may manufacture drugs based on the original product once the patent on the original chemical entity expires.  The generic industry does not have to conduct the expensive clinical trials performed by innovator companies.  Clinical trials are performed in order to prove a drug is safe and effective for the illness they wish to treat.  Not having to conduct clinical trials has substantially reduced the cost of bringing a product to market.

The last segment of the pharmaceutical industry, which resulted from the early 90’s downsizing, is the Clinical Research Organization (CRO’s) segment.  These companies are primarily involved in the clinical trial, which shows the effectiveness of the drug.  Clinical trials are quite large, often involving 3,000 or more patients who volunteer to test the product.  These companies are contracted by innovator companies who pay them on a per patient basis to conduct the trials.  All the data belongs to the drug company that pays for the trial.  The trial results must be statistically valid


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3. Industry Terms



Industry Term

Definition or Explanation

ANDA Abbreviated New Drug Application, this is a simplified submission of an already approved drug. ANDA’s are for products with the same or very closely related active ingredients, dosage, strength etc.
Accelerated Approval A highly specialized mechanism intended to speed approval of drugs promising significant benefit over existing therapy for serious or life threatening illnesses.
Action Letter An official communication from the FDA to an NDA sponsor that informs of a decision by the agency.
Adverse Event Unwanted effects that occur and are detected in populations.
Advisory Committee A panel of outside experts convened periodically to advise on safety and efficacy issues about drugs.
Amendment to an NDA A submission to change or add information to an NDA or supplement not yet approved.
Bioavailability Rate and extent to which a drug is absorbed or is otherwise available to the treatment site in the body.
Bioequivalence Scientific basis on which generic and name brand drugs are compared.
Clinical Trials Human studies designed to distinguish a drug’s effect from other influences. Such studies conducted in the U.S. must be under an approved IND and in accord with FDA rules on human studies.
Compound A chemical synthesized or prepared from natural sources that is evaluated for its biological activities in preclinical tests.
Dosage Form The delivery system for a drug, such as a tablet, IV solution or cream.
Dose The amount of drug administered to a patient or test subject at a single time.
Drug Products The finished dosage form that contains a drug substance – generally but not necessarily in association with other active or inactive ingredients.
Drug Substance The active ingredient to diagnose, treat, cure, or prevent disease or affect the structure or function of the body.
Effectiveness The desired measure of a drug’s influence on a disease condition.
FDA Food and Drug Administration
GLP Good Laboratory Practices, FDA guidelines governing the conduct of Non Clinical studies from which data will be used to support applications for research or marketing permits.
Incidence Rate The rate at which new cases of disease, adverse reactions, or other events occur per unit of time in a given population at risk.
Informed Consent The voluntary consent given by a patient to participate in a study after being informed of its purpose, method of treatment, procedures etc.



Investigational New Drug, An application that a drug sponsor must submit to the FDA before beginning tests of a new drug on humans.
New Drug A drug first investigated or proposed for marketing after 1938 – that is, a drug that was not generally recognized as safe and effective.
NDA New Drug Application, An application requesting FDA approval to market a new drug for human use in interstate commerce.
NME New Molecular Entity, A compound that can be patented, which has not been previously approved.
Parallel Track Mechanism Policy that makes promising investigational drugs for AIDS and other HIV related diseases more widely available under parallel track protocols, while the controlled trials essential to establish the safety and effectiveness of new drugs are conducted.
Pharmacology The science that deals with the effect of drugs on living organisms.
Phase 1 The first trials in humans that test a compound for safety, tolerance and pharmacokinetics.
Phase 2 Pilot studies to define efficacy and safety in selected populations of patients with the disease or condition to be treated, diagnosed, or prevented.
Phase 3 Expanded clinical trials intended to gather additional evidence of effectiveness for specific indications and to better understand safety and drug related adverse effects.
Phase 4 Studies performed after a drug is approved for marketing.
PhRma Pharmaceutical Manufacturers Association
Postmarketing Surveillance FDA’s ongoing safety monitoring of marketed drugs.
Preclinical studies Studies that test a drug on animals and other non human test systems.
Priority Drugs A drug that appears to represent an advance over available therapy.
Raw Data Researchers’ records of patients, charts, x-rays, hospital notes etc.
Risk The probability of an event occurring during a specified period of time.
Safety Before a drug may be approved for marketing, the law requires the submission of test results adequate to show the drug is safe under the conditions of use in the proposed labeling.
Safety Update Report Reports that an NDA sponsor must submit to CDER about the safety information that may affect the use for which the drug will be approved.
Side Effect Any effect other than the primary intended effect resulting from drug or non-drug treatment or intervention.
Stability The drug products resistance to change of its physical and chemical properties.
Supplement A marketing application submitted for changes in a product that already has an approved NDA.
Surrogate Endpoint A laboratory finding or physical sign that may not, in itself, be a direct measurement of how a patient feels, functions or survives.
Treatment IND A mechanism that allows investigational drugs to be used in expanded access protocols.
User Fees Charges to drug firms for certain NDA’s, drug products, and manufacturing establishments.  FDA uses these fees to hire application reviewers, and to accelerate reviews using computer technology.

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4. Accounting Principles

The industry uses standard U.S. accounting GAAP. Foreign Controlled Companies may use Organization of Economic Community Development guidelines for their transfer pricing policies. They may also follow International Accounting Standards (IAS) which is becoming more popular.

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5. Industry Operating Procedures

Drug companies rely on the strength of their patents whether on the chemical or process involved in bringing the product to the market.  Clinical trial information that is generated on the safety and effectiveness of a product is also submitted to approving authorities in foreign countries to insure statistically valid results are observed.

Marketing is another area of strength for many companies.  Detail men, as they are called in the business, visit doctors to detail the benefits of the company’s products and encourage the medical staff to prescribe them to their patients.  Companies tend to specialize in specific therapeutic areas such as central nervous system (cns), gastrointestinal, etc. making it easier to level their sales force often striking deals to co-market products for other companies. 

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6. Government Regulatory Requirements

A. Federal Requirements

The Food and Drug Administration makes or breaks this industry’s potential for sales.  The FDA must give approval to market the product in the U.S.

The U.S.’ rigorous approval process is respected around the world and in many countries approval by the FDA is enough to approve a product in a foreign country.

A drug company, in order to get marketing approval for a drug, must show it is safe for human consumption through animal and human testing.  A drug company must also prove it is effective for the illness it intends to alleviate.  The FDA does not mandate a particular methodology.  The scientific community has established a four Phase method for establishing the effectiveness.

Phase I – Animal and toxicity studies.

Phase II – Investigational New Drug Application is filed to test in small numbers of humans and allow the transportation of unapproved drugs.  These trails usually involve a few hundred patients.  These trials will also involve determining the most effective dosage for the Phase III trial.

Phase III – Large scale trials are conducted involving thousands of patients to prove the product is effective against a specific disease.  Human trial subjects must provide consent to be part of the experimental group.  The results must be statistically valid and include the determination of side effects that may exist in the general population.  During this phase pharmacoeconomic data is generated.  Pharmacoeconomic data involves the costs involved in using the product versus standard current treatment, competitor products or non-treatment options.  The information is used for insurance and government reimbursement purposes.  If insurance plans or government reimbursement is available, the drug will suffer in the market place.

Phase IV – Post approval marketing testing.  These types of trials are conducted to generate marketing data that will be used in the competitive market.  The trials usually involve one or more  competitor products.

The Environmental Protection Agency (EPA) is involved in insuring the disposal of unused products and waste material as biological hazardous waste.

B. State Requirements - None

C. Local Requirements - None


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7. Significant Law and Important Issues

A. Coordinated Issues




Brief Summary of Issue

Medicaid Drug Rebates The position is that a pharmaceutical manufacturer may not accrue its rebate liability until the taxable year it receives the bill for the rebate because the all events test has not been met. The rebate liability is not fixed until the claim for reimbursement is sent by the state medicaid agency. I.R.C. 461(a),(h); Treas Reg 1.461-1(a)(2)(i); U.S. v General Dynamics 481 U.S. 239 (1987). Issue is further explained on the ISP Bulletin Board. Appeals Settlement Guidelines have been finalized and are available on the Appeals web page.  
Legally Mandated R and E Expenses

The issue is whether a taxpayer ,when allocating and apportioning its R&E expenses between U.S. and Foreign source income under Treas. Reg. 1.861-17, can exclude a category of R&E known as “legally mandated R&E” from the total R&E pool of expense prior to allocation and apportionment.  Taxpayers have to satisfy a three prong test under Treas Reg 1.861-17(a)(4) in order to exclude any R&E expenses. The tests are : the R&E has to be undertaken to meet legal requirements imposed by a political entity,  for the improvement or marketing of specific products or processes, and the results cannot reasonably be expected to generate amounts of gross income (beyond de minimis amounts) outside a single geographic source.  Taxpayers are having problems satisfying all prongs of the test, as such, any R and E expenses that were excluded as legally mandated should be placed back into the total R and E pool of expenses to be allocated and apportioned.  This issue is fact intensive and prevalent on all pharmaceutical cases. Allowing the exclusion, if all prongs of the test are not met, can have a dramatic impact on calculations of Foreign Source Taxable income utilized in the FTC limitation fraction under I.R.C. 904, Cost Sharing or Profit Split Combined Taxable Income under I.R.C. 936 and FSC Combined Taxable Income under I.R.C. 925.

A Coordinated Issue Paper was issued on   6/18/2003, an Industry Directors Directive was issued on 10/17/2003, an Appeals Settlement Guideline was issued on 12/23/2003, and a pro forma closing agreement is also available.

B.  Emerging or Other Significant Issues




Brief Summary of Issue

  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). 

Government Settlements


The issue in question is whether or not a False Claims (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. 

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]
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.

[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).

C.  Recent or Pending Legislation

Effective Date


Summary and Impact of Legislation

For expenditures paid or incurred on or after the date final regulations are published in the Federal Register NPRM REG-105170-97 [IRB 1998-50, 10 (Dec. 14, 1998)] Proposed regulations relating to the computation of the credit under section 41(c) and the definition of qualified research under section 41(a).
Proposed to be applicable for taxable years ending on or after the date proposed regulations are filed with the Federal Register, but are also proposed to be retroactive in certain limited circumstances to prevent abuse. To prevent taxpayers that are members of a controlled group from together claiming in excess of 100 percent of the credit with respect to prior taxable years, the rules for allocating the group credit would apply to any taxable year beginning after December 31, 1989, in which, as a result of inconsistent methods of allocation, the members of a controlled group as a whole claimed more than 100 percent of the allowable group credit.

REG-105606-99; 65 F.R. 258-263 (January 4, 2000)


Proposed regulations relating to the computation of the credit for increasing research activities (the research credit) for members of a controlled group and the allocation of the credit under section 41(f) of the Internal Revenue Code. These proposed regulations are intended to provide guidance on the proper method for computing the research credit for members of a controlled group and the proper method for allocating the group credit to members of the group.


For taxable years of a possessions corporation beginning on or after January 25, 2000.  Taxpayers may elect to apply retroactively for any open taxable year beginning after 12/31/95.  T.D. 8868 (January 21, 2000).Section 936 Possessions Tax Credit Final regulations relating to when a possessions corporation that adds a substantial new line of business during a taxable year or that has a new line of business that becomes substantial during the taxable years, loses its status as an existing credit claimant for that year and all years subsequent.
D.  Specific Industry Related Tax Law

Effective Date

Code Section

Summary and Impact of Law

8/20/86 45C Clinical Testing Expenses for Certain Drugs for Rare Diseases or Conditions (Orphan Drug Credit)
8/22/86 41 Credit for Increasing Research Activities
10/4/76 174 Research and Experimental Expenditures
12/31/76 861 Income from Sources within the United States
10/4/76 936 Puerto Rico and Possession Tax Credit

E.  Important Revenue Rulings or Revenue Procedures



Effective Date

Title and Number

Summary and Impact of Ruling and Procedure

2/14/2005 Domestic Production Activities –Notice 2005-14 This notice provides interim guidance to taxpayers regarding the deduction for income attributable to domestic production activities under section 199 of the Code. Section 199 was enacted as part of the American Jobs Creation Act of 2004, and allows a deduction equal to 3 percent (for 2005 and 2006) of the lesser of the qualified production activities income of the taxpayer for the taxable year, or the taxable income of the taxpayer for the taxable year, subject to certain limits. The applicable percentage rises to 6 percent for 2007, 2008, and 2009, and 9 percent for 2010 and subsequent years. 











Repatriation of Foreign Earnings under IRC 965 –

Domestic Reinvestment Plans and Other Guidance Under Section 965 Notice 2005-10

Limitations on Dividends Received Deduction and Other Guidance – Notice 2005-38

Foreign Tax Credit and Other Guidance Under Section 965 – Notice 2005-64

This notice provides guidance concerning new section 965 of the Internal Revenue Code (Code). It sets forth general principles and specific guidance on domestic reinvestment plans and on investments in the United States described in section 965(b)(4)(B).

This notice primarily addresses the limitations, described in section 965(b)(1), (2), and (3), on the amount of dividends that a corporation that is a U.S. shareholder of a controlled foreign corporation may treat as eligible for the dividends received deduction under section 965(a) (DRD or section 965(a) DRD), including the effects of certain transactions on such limitations.

This notice sets forth guidance on various issues arising under section 965, including issues relating to the foreign tax credit and minimum tax credit, expense allocation and apportionment, and currency translation.

2/11/1985 Charitable Contribution of Inventory under IRC 170(e)(3)–    Rev. Rul. 85-8 When a corporation donates products to a charitable organization shortly before their expiration date, the amount allowable as a charitable contribution deduction is equal to the unrealized appreciation, not to exceed twice the taxpayers basis in such property.
2/27/2003 Patent Contribution Deductibility to University – Rev. Rul. 2003-28 Ruling specifies when the contribution of a patent to a qualified charity is deductible under section 170(a).
5/9/2005 Medicaid Rebates – Rev. Rul.2005-28 Medicaid rebates incurred by a pharmaceutical manufacturer are purchase price adjustments that are subtracted fro gross receipts in determining gross income rather than a deductible business expense.
3/14/2005 Guidance Related to Section 936 Terminations – Notice 2005-21 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.

Limited Deferral Permitted for Certain Advance Payments – Rev. Proc. 2004-34


This revenue procedure allows taxpayers a limited deferral beyond the taxable year of receipt for certain advance payments.   This revenue procedure also provides the exclusive administrative procedures under which a taxpayer within the scope of this revenue procedure may obtain consent to change to a method of accounting
7/1968 Cost segregation/Clean rooms – Rev. Rul. 68-530 Clean rooms" in a factory building in which electronic equipment is tested do not qualify as section 38 property; however, operational equipment therein does qualify

F. Important Court Cases

Date Opinion Issued

Name of Court Case and Citation

Summary of Importance of Court Case

June 18, 1999 Talley Industries v. Comm., T.C. Memo 1999-200 Burden of proof on taxpayer to show that settlement of False Claims Act suit was compensatory in nature where agreement was silent as to nature of payment.
Aug. 30, 2005 Xilinx v. C.I.R. Corporate taxpayer petitioned for redetermination of federal income tax deficiencies, arising from IRS's determination that taxpayer and its foreign subsidiary, with which taxpayer had cost-sharing agreement to develop intangibles, were required to share costs of employee stock options (ESOs) that taxpayer issued to its research and development (R&D) employees.
Dec. 28, 2001

Plastics Engineering & Technical Services, Inc. v. Commissioner, T.C. Memo, 2001-324.[2]


In Plastics Engineering & Technical Services, supra, the U.S. Tax Court held that royalty payments made by a taxpayer for certain assembly systems covered by patent were indirect costs to the production of the end products, and, thus, capitalized and included in inventory, pursuant to the UNICAP rules. The case is a good source for an examiner to quickly obtain the applicable law and analysis in this area. 
April 26, 2000 Lockheed Martin Corp. v. United States, 85 AFTR2d Par. 2000-605 ( C.A.Fed. Cir.) Court held that taxpayer retained substantial rights in its research under regs. section 1.41-2(a) and 1.41-5(d) and thus, the research did not fall under the funded exclusion of the credit for increasing research activities.
June 29, 1998 Norwest Corporation and Subsidiaries v. Commissioner, 110 TC 454 appeal docketed sub. Non. Wells Fargo & Co. v. Commissioner, Nos. 99-3878, 99-3883 (8th Cir. Sept. 29, 1999) Sec. 41(d)(1), I.R.C., sets forth four tests for qualified research: (1) The expenditures must qualify as expenses under sec. 174, I.R.C.; (2) the taxpayer must discover information which is technological in nature; (3) the taxpayer must discover information the application of which is intended to be useful in the development of a new or improved business component; and (4) substantially all of the research activities must constitute elements of a process of experimentation. In the conference report accompanying the Tax Reform Act of 1986, Congress set forth three additional tests for qualified research under sec. 41, I.R.C., for the development of internal use software: (1) The software must be innovative; (2) the software development must involve significant economic risk; and (3) the software must not be commercially available. The parties agree that in order for the representative internal use software activities to constitute qualified research for purposes of the tax credit, all seven tests must be satisfied
October 17, 1997

United Stationers, Inc., v. United States, 982 F. Supp. 1253 (N.D. 1997)


A corporation was denied a research and experimentation tax credit relating to its implementation of eight computer software projects. The corporation did not discover any information that was technological in nature and did not intend to expand or refine existing principles of computer science. Instead, it merely applied and built upon pre-existing information. Further, the projects did not involve a process of experimentation because there was no uncertainty with respect to the projects designs or the corporation’s development of the means to achieve its stated goals.
June 18, 1998

FMR Corp. and Subsidiaries v. Commissioner, 110 TC 402


During the years in issue, taxpayer incurred costs for developing and launching 82 Regulated  Investment Companies (RICs). The expenditures incurred in launching new RIC,s were intended to, and did, provide significant future benefits to taxpayer.  The expenditures are not currently deductible under IRC 162(a), and must be capitalized under IRC 263(a).  Further, taxpayer failed to establish a limited life for the future benefits obtained from the costs of launching RIC’s.  Taxpayer may not amoritize such costs under IRC 167.
July 8, 1998 RJR Nabisco Inc. (Formerly R.J. Reynolds Industries, Inc.) and Consolidated Subsidiaries v. Commissioner, TC Memo. 1998-252 Action on Decision, 1999-012 (Oct. 4, 1999) (nonacquiesing in decision) A member of the affiliated group claimed a deduction pursuant to IRC 162 for graphic design expenditures relating to cigarette package designs.The IRS determined a deficiency in RJR’s consolidated income tax liability, disallowing the deduction as a section 162, IRC expense and recharacterizing the graphic design expenditures as capital expenditures.  The Court held that the graphic design expenditures for cigarette packages are advertising expenses, deductible under IRC 162.
September 9, 1994 St. Jude Medical, Inc., v. Commissioner,  34 F3d 1394 (8th Cir. 1994), Affirming in part, reversing in part and remanding the Tax Court, Dec. 47,719, 97 TC 457 A medical products developer and its related DISC were not exempted from allocating and apportioning research and development (R and D) expenditures relating to a successful heart valve to their gross export receipts in computing their combined taxable income (CTI). They were however, not required to include R and D expenditures relating to their unsuccessful attempts to develop an insulin pump and a cardiac pacemaker in their CTI computation. The R and D expense allocation moratorium of  223 of the Economic Recovery Tax Act of 1981 (P.L. 97-34) was inapplicable. The moratorium only applied for purposes of determining the geographical source of income, which is not relevant to the computation of CTI. Reg. 1.861-8, which required the developer to allocate its insulin pump and pacemaker R&D expenditures against its artificial heart valve export receipts, is unreasonable and inconsistent with congressional intent. Thus, its allocation rules are invalid as applied to DISC CTI computations. 
May 28, 1985

Eli Lilly and Company v. Commissioner of Internal Revenue,

84 T.C. 996 (1985),aff'd in part, rev'd in part, 856 F. 2d 855 (7th Cir. 1988)

U.S. parent transferred patents to its wholly owned Puerto Rican subsidiary in a section 351 transaction. Subsidiary manufactured drug and sold exclusively to U.S. parent. Tangible and intangible transfer pricing analysis by Court.


1980 E.I.DuPont v. United States, 608 F. 2d 445 (Ct. Cl. 1979),cert. denied, 445 U.S. 962(1980) U.S. parent established a foreign subsidiary for sales and marketing of its products abroad.  Court held that the Commissioner's reallocation of profits from subsidiary to parent were reasonable.
1987 G.D. Searle v. Commissioner, 88 T.C. 252 (1987) U.S. parent transferred trademarks, patents and other intangibles to wholly owned Puerto Rican subsidiary.  Court held that transfer to subsidiary caused a distortion in parent's income.
1991 Merck & Co. v. United States 24 CI.CT., 73 , 91-2 USTC  50,45(CI.CT. 1991) U.S. parent transferred patent for manufacture of active ingredient of drug in a section 351 transaction to its wholly owned Puerto Rican subsidiary. Court held that no 482 allocation warranted.

[2]  2000 WL 1659286 (U.S. Tax Ct. ), 82 T.C.M. (CCH) 1017, T.C.M. (RIA) 2001-324, 2001 RIA TC Memo 2001-324

G.  Technical Advice Memorandums - Field Service Advices




August 13, 1993 TAM 9346006 The Taxpayer's activities in developing of generic drugs are excluded from the definition of the term "qualified research" under the  duplication exclusion contained in  section 41 (d)(4)(C) of the Code.
October 22, 1993 FSA 1999-1023 IRS concluded that the expenses of developing a generic drug product are not qualified research expenditures eligible for the section 41 research credits.
December 14, 1994 PLR 9511011 Taxpayer requested rulings that: 1) Taxpayer and S are members of the same controlled group of  corporations under section 41(f)(5) and 2) any qualified research expenses paid or incurred by Taxpayer in performance of a development contract with S are considered to be part of Taxpayer's proportionate share of qualified research expenses giving rise to the credit for increasing research activities for the controlled group of   corporations under section 41(f)(1)(A)(ii).
October 17, 1995 PLR 9604004 The issue in this Technical Advice request is whether taxpayer's expenditures paid to another corporation for research and development activities were incurred in connection with taxpayer's trade or business so the expenditures qualify as "research and experimental expenditures" as that term is defined for section 174.
October 31, 1996 PLR 9707003 Whether the  disallowance of deductions claimed under section 174 of the Internal Revenue Code results in a change in the taxpayer's method of accounting for payments for research and experimental activities. The deductions were disallowed on the basis that the expenditures were not incurred in connection with the taxpayer's trade or business. 
June 24,1998 FSA on Patent Expense under IRC 41 Whether legal and patent expenses incurred by Taxpayer are "qualified research expenses" for purposes of computing the credit for increasing research under IRC 41.
November 24, 1999

CCA 20009012                     



As long as Rev. Proc. 63-10, 1963-1 C.B. 490, remains in effect, a section 936 corporation may take location savings into account in accordance with such revenue procedure for purposes of a cost sharing election under section 936(h)(5)(1).
March 4, 1999 TAM 199927001 Taxpayer's costs attributable to the construction of molds and other tooling used in the manufacture of plastic injection molded products are not deductible as research and experimental expenditures under I.R.C. 174.  Property was depreciable property in the hands of the customer and did not qualify.

December 8, 1999



PLR 200010040 and PLR 200010041 Following a spin-off, taxpayer permitted to switch from the percentage limitation method for calculating the section 936 credit to the economic activity credit, when a member of the former  group continued to use the percentage limitation method.
March 8, 1999 FSA 199925009 The Service determined that a pharmaceutical company must defer a deduction for the costs of samples until the time the samples are distributed.
August 9, 1999 FSA 199939035 Marketing and advertising costs incurred before a product received regulatory approval are ordinary and necessary business expenses.
October 6, 1999 PLR 200002012 A possessions corporation may revoke its section   936 election to allow a  338(h)(10) deemed asset sale election to be made and then re-elect  936 status for the tax year following the deemed sale.
October 15, 1999 PLR 200002034 The activities of a corporation and a new corporation that will acquire its manufacturing facilities will be classified under the  same SIC and NAICS codes for purposes of  936(j)(9).
January 1, 2006 TAM 200601029   Whether, under § 165 of the Internal Revenue Code, Taxpayer may claim a loss deduction upon the expiration of a “purchase option agreement” to acquire X if Taxpayer instead acquires X by other means.

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8. Alternative Issue Resolution Considerations - None

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9. Industry Resources

A. Web Sites

Name of Site

Summary and Available Information

FDA Home Page

Info. on Pharmaceutical and Medical Device Industries, Regulations, Issues, etc.

The World Health Organization

Info.on health and human services issues.

Dept of Health and Human Services

Info. on health and human services issues.

Center for Disease Control and Prevention

Info. on Center for Disease Control, prevention, issues, etc.


Info. on Science and Health Conferences and discussion topics.

American Association of College of Pharmacy

Info. on the American Association of College and Pharmacy and different types of specialty areas.

Drug Information Association

Info. on discovery, development, evaluation and utilization of medicines and health care technologies.

The Pharmaceutica Information Network

Provides information on Pharmaceutical industry and regulatory news.


Info. on Pharmaceutical Manufacturer’s Association of Medicines, issues, policy, and news releases.

The Virtual Library Pharmacy Page

Virtual library covering all areas of Pharmaceutical Industry from issues to regulations.

Clinical Trials Listing

Info. on status of clinical trials, services, approvals, etc.

Price Waterhouse Coopers

Provides information on the Pharmaceutical Industry based on the various relevant issues confronting the industry.

B. Trade Associations




Purpose, Goals, Objectives, etc.


Wash. D.C.

Umbrella organization for branded pharmaceutical manufacturing companies, goal is to lobby for health care legislation.


Wash. D.C.

Umbrella organization for Bio Technology research companies.


Wash. D.C.

Association of Generic Manufacturing companies

C. IRS and Other Training Courses/Videotapes - None

D. Trade Magazines and Newsletters



Frequency of Publishing

Summary of Purpose/Information Included/Availability


Twice Weekly

International Focus, Legislation, Approvals

Pink Sheets


U.S. Focus, Legislation, Approvals, Research

Pharmaceutical Executive


Company Focused, Wide overview of industry and trends, Focuses on the management of the companies.

E.  Industry Books


Date of Latest Edition


Summary of Contents

Jan 2004

Physicians Desk Reference

Contains all approved drugs, indications, ownership and manufacturing facilities

Jan 2004

Orange Book

Reference guide for marketed products, used principally by Generic Companies

Jan 2004

United States Adopted Names

Lists all names being used by pharmaceutical companies and their chemical compositions.

F.  Internal Revenue Manual Citations - None

G.  AICPA Auditing Standards and Publications - None

H.  Market Segment Specialization Program (MSSP) - None

Page Last Reviewed or Updated: 15-Apr-2015