License vs. royalty: the constant question for pharmaceuticals.

• Author: Steinmetz, Adam

Mylan Inc., a publicly traded pharmaceutical company, filed a petition in Tax Court to challenge a $100 million tax deficiency {Mylan, Inc., T.C. Dkt. No. 16145-14, petition filed 7/11/14). The deficiency relates to a dispute between the parties regarding whether a transaction should constitute a license agreement or a sale under the tax laws.

Given the nature of the life sciences industry, including the desire of companies to share know-how and to enter into joint research agreements and other collaborative partnerships in the process of drug development, pharmaceutical companies often deal with the question of whether a transaction is a license or sale. The main tax difference between a license and a sale transaction is that license payments are taxed as ordinary income and sale proceeds are taxed as capital gains.

Other important tax differences must be considered though, especially since corporate taxpayers are taxed at the same rate for both ordinary income and capital gain. Two examples of the significant tax differences between licenses and sales are Sec. 1211, which limits the use of capital losses to offsetting capital gains only, and Sec. 1212, which limits the number of years for a capital loss to be carried forward. As such, the determination of a license versus sale may determine whether a taxpayer can use a valuable tax attribute or whether it will expire unused. The determination will also affect the timing of the tax deduction for the licensee/buyer, as license payments would typically be currently deductible to unrelated taxpayers, while sale payments would likely

be required to be capitalized and amortized. The determination would also affect whether the licensor/seller would need to recognize the payments immediately or could use the installment method. As evidenced by Mylan, the difference in timing can result in large tax deficiencies.

Mylan, Inc.

In its petition, Mylan challenged the IRS's characterization of a transaction as a license. In 2001, Mylan entered into an agreement with a Belgian company to acquire the exclusive right to develop drugs containing a patented compound called nebivolol (the compound) in the United States and Canada. In 2006, Mylan transferred its rights to the compound to a third party, Forest Laboratories Inc. Initially, this agreement called for Mylan to remain active in certain marketing and development efforts with the compound, but in 2008 the agreement was amended because Mylan made a...