Federal Circuit Affirms Deductibility of Hatch-Waxman Litigation Expenses

In a significant decision for generic drug manufacturers, the Federal Circuit recently affirmed that litigation expenses incurred in defending Hatch-Waxman patent lawsuits are deductible as ordinary and necessary business expenses under the Internal Revenue Code (IRC). The ruling in Actavis Laboratories FL, Inc. v. United States, No. 23-1320 (Fed. Cir. Mar. 21, 2025), resolves a key tax dispute, allowing tax deductions for these expenses in the year they are incurred rather than capitalizing them over time. This outcome provides clarity and potential tax benefits for qualifying businesses navigating the interplay of patent litigation and FDA drug approvals.

Background: Hatch-Waxman Litigation and Tax Treatment

The Hatch-Waxman Act facilitates the entry of generic drugs into the market by allowing manufacturers to file Abbreviated New Drug Applications (ANDAs) with the FDA. When a generic manufacturer files an ANDA with a Paragraph IV certification—asserting that the branded drug’s patents are invalid or not infringed—it often triggers patent infringement litigation from the branded drug manufacturer. These lawsuits, while tied to the timing of FDA approval, are a common hurdle for generic drug companies.

In this case, Actavis Laboratories FL, Inc. (“Actavis”) incurred substantial legal expenses ($3.8 million in 2008 and $8.4 million in 2009) defending itself in multiple Hatch-Waxman lawsuits. Actavis deducted these costs on its tax returns as ordinary and necessary business expenses under IRC Section 162(a), which permits deductions for expenses paid in carrying on a trade or business. The IRS disagreed, classifying the expenses as capital expenditures under IRC Section 263(a), arguing they were incurred to acquire an intangible asset—namely, FDA approval to market generic drugs. Capital expenditures must be amortized over time rather than deducted immediately which delays the tax benefits.

Actavis paid the assessed tax deficiencies and sued for a refund in the Court of Federal Claims, which ruled in its favor. The Federal Circuit upheld this decision, affirming the deductibility of these expenses.

The Tax Issue: Deduction vs. Capitalization

The core tax question was whether Hatch-Waxman litigation expenses qualify as:

• Deductible expenses under Section 162(a), allowing an immediate deduction in the year incurred, or
• Capital expenditures under Section 263(a), requiring capitalization and amortization over the life of the associated asset (here, FDA approval).

The IRS argued that the litigation expenses facilitated the acquisition of FDA approval—an intangible capital asset—because the lawsuits arose from Actavis’s Paragraph IV certifications, which are steps toward gaining approval to market generics before patent expiration. Actavis countered that the expenses stemmed from defending patent infringement claims, a routine business activity separate from the FDA approval process.

The Court’s Tax Law Analysis

The Federal Circuit analyzed the issue under two tax law frameworks and concluded that the expenses were deductible under both:

“Origin of the Claim” Test

• Derived from Supreme Court precedents (Woodward v. Commissioner, 397 U.S. 572 (1970); United States v. Gilmore, 372 U.S. 39 (1963)), this test examines what gave rise to the litigation expenses.
• The court found that the origin was the branded drug manufacturers’ patent infringement claims, not Actavis’s pursuit of FDA approval. Unlike cases where litigation directly resolves an asset’s acquisition (e.g., setting a purchase price), Hatch-Waxman litigation addresses patent disputes, while FDA approval hinges on separate safety and efficacy reviews.
• The litigation and FDA processes are distinct. Winning or losing the lawsuit does not determine FDA approval; it only affects the timing of when approval becomes effective (e.g., via the 30-month stay).

“Significant Future Benefit” Test (Treasury Regulation 26 C.F.R. § 1.263(a)-4)

• This regulation requires capitalization of expenses that “facilitate” the creation of an intangible asset, such as a government-issued license (here, FDA approval).
• The court held that Hatch-Waxman litigation does not facilitate FDA approval. The FDA’s review process operates independently of the litigation, and the lawsuit cannot grant approval—only delay its effectiveness. Thus, the expenses do not meet the regulation’s criteria for capitalization.
• The court distinguished this from scenarios like antitrust litigation blocking a merger (e.g., Example 10 in the regulation), where resolving the lawsuit is a prerequisite to acquiring the asset.

The court also noted consistency with traditional patent litigation, where both parties typically deduct legal expenses. Treating Hatch-Waxman expenses differently would create an unfair disparity between generic and branded drug manufacturers, undermining the Hatch-Waxman Act’s balance of innovation and competition.

Implications for Businesses

This ruling has significant tax implications, particularly for generic drug manufacturers:

Immediate Tax Relief: Provided companies otherwise qualify for a deduction, they may now be eligible to deduct Hatch-Waxman litigation expenses in the year incurred, improving cash flow and reducing short-term tax liabilities compared to capitalization.

Alignment with Precedent: The decision aligns with the Third Circuit’s ruling in Mylan Inc. v. Commissioner, 76 F.4th 230, (3d Cir. 2023) reinforcing a consistent tax treatment across jurisdictions.

Broader Relevance: While focused on Hatch-Waxman litigation, the court’s reasoning—separating litigation from regulatory asset acquisition—may apply to other industries where legal disputes intersect with government approvals.

Action Steps for Your Business

Review Past Returns and Potentially Qualifying Expenditures: If your company has capitalized Hatch-Waxman litigation expenses, consider eligibility for a deduction and whether filing amended returns to claim deductions for prior years, subject to statute of limitations (typically three years from filing) may be prudent.

Update Tax Planning: Consider current and future tax strategies to capture eligible expenditures to support deductibility, especially if involved in ongoing or anticipated Hatch-Waxman lawsuits.

Consult Advisors: Work with tax and legal professionals to assess how this ruling applies to your specific circumstances, including potential parallels in non-pharmaceutical litigation.

Conclusion

The Federal Circuit’s decision in Actavis Laboratories FL, Inc. v. United States is a win for generic drug manufacturers, clarifying that Hatch-Waxman litigation expenses are deductible as ordinary business expenses. This ruling reduces financial burdens and supports the Hatch-Waxman Act’s goal of promoting affordable generics. For tailored advice on leveraging this decision, please contact the Crowell Tax Team.