Tax Matters
The enactment of the Leahy-Smith America Invents Act on September 16, 2011 addressed a decade-long controversy over the propriety of granting tax strategy patents, denying patents to “any strategy for reducing, avoiding, or deferring tax liability, whether known or unknown at the time of the invention or application for patent.” The Act’s stated purpose was to keep the ability to interpret the tax law in the public domain, available to all taxpayers and their advisors.

How will the new legislation affect tax practice and the development of tax-saving strategies? What (if anything) does the tax strategy debate tell us about the impact of horizontal equity on tax policy? Does it foretell a resurgence of horizontal equity concerns as the nation faces unprecedented budgetary pressures amidst increasing criticism of income and wealth inequality in America? Or does it represent merely reining in a USPTO that simply was not well equipped to adequately assess claims of novelty and non-obviousness in the tax context?

Paul L. Caron, Charles Hartsock Professor of Law, University of Cincinnati College of Law

3 Colum. J. Tax L. Tax Matters 1
The Path to the Tax Patent Prohibition
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3 Colum. J. Tax L. Tax Matters 4
Tax Patents
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3 Colum. J. Tax L. Tax Matters 7
Grandfathered Tax Strategy Patents
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* Partner, Covington & Burling LLP. All views expressed herein are solely those of the author.

The notion that tax strategies could be patented came as quite a shock to tax lawyers. The nearly universal reaction was, “That can’t be true!” Patent lawyers essentially responded by saying, “Get over it. Tax is just another area that will have to get used to the existence of business method patents.” While much of the reaction in the tax bar may have been based on resistance to such a “new reality,” the patent bar seemed to miss the larger public policy issues raised by tax strategy patents, issues that are not generally present with respect to business method patents. These policies prevailed with the enactment of section 14 of the Leahy-Smith America Invents Act (the “Act”), which essentially precludes tax strategy patents by deeming “any strategy for reducing, avoiding or deferring tax liability” to be “insufficient to differentiate a claimed invention from prior art.”

Unfortunately, the legislation is limited to patent applications pending on the date of enactment (September 16, 2011) and any patent issued after that date. That leaves a substantial number of existing tax strategy patents to deal with. The exact number of such patents is not easy to determine. Several years ago, the Patent and Trademark Office established a subclass of business method patents (36T) for tax patents that contains well over 100 patents, but other tax patents may have been granted and placed in other categories.

The legislation and associated legislative history are less than helpful in setting the stage for dealing with existing tax patents. One would have expected that the worst case would be language indicating that no inference should be drawn from the legislation that any tax strategy patents already issued were valid or that tax strategies were even patentable subject matter. Not only do the statutory language and legislative history omit such a statement, but the legislation itself can be read as implying the contrary. Section 14(d) of the Act states, “Nothing in this section shall be construed to imply that other business methods are patentable or that other business method patents are valid” (emphasis added). By banning tax strategy patents on a prospective basis and simultaneously saying that no inference is intended as to the validity of other business method patents, without addressing existing tax patents, did Congress create an inference that it thought tax strategies were patentable under prior law? That would seem to be a stretch, but it would have been nice if the “no inference” language had also encompassed existing tax patents.

In any event, the validity of existing tax patents remains uncertain. It is unclear when or whether this uncertainty will be resolved. My impression is that in the case of a number of the more sophisticated strategies that have been patented, the patent was obtained for defensive purposes. In other words, the developer of the strategy was concerned that someone else might obtain a patent for it and seek to prevent the developer from using the strategy or marketing the strategy to others. These patent holders are unlikely to raise infringement claims.

An example of a defensive patent is the patent on contingent convertible debt instruments (Patent No. 7,219,079), which was filed in 2001 and granted in 2007. A version of the transaction covered by the patent is described in Revenue Ruling 2002-31, 2002-1 C.B. 1023, which concludes that when properly structured, these debt instruments result in higher interest deductions to their issuers than traditional convertible debt. Many corporations issued contingent convertible debt instruments in the 2000’s, and did so in offerings registered with the SEC. Information as to these offerings was thus publicly available, yet as best I am aware, the patent holders have never asserted any infringement claims.

As to holders of existing tax patents who may be inclined to assert infringement claims, there remain significant obstacles to discovering potential infringement in light of the confidentiality between tax advisors and their clients and the confidentiality of tax return information. In the absence of promoters marketing a potentially infringing tax strategy or public documents disclosing the use of the strategy (as in the case of contingent convertible debt instruments), patent holders will typically have difficulty identifying potential infringers. Even if they can identify a potential infringer and assert a claim of infringement, there is a significant likelihood the claim will be settled. Patent litigation is notoriously expensive. Thus, any judicial resolution of the legitimacy of tax patents grandfathered under the Act may never occur. Given the frequent changes in the tax law, and the impact of those changes on the consequences of any tax strategy, the likelihood of any judicial resolution of this question seems likely to diminish rapidly over time.