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Licensing Contracts Is Taxable as Income

Licensing Contracts Is TaxablePhoto Credit: James Steidl

Millions of dollars a pharmaceutical inventor received under a technology license agreement should be treated as ordinary income, rather than capital gains, for tax purposes, a split federal appeals panel has ruled.

A divided three-judge panel of the U.S. Court of Appeals for the Third Circuit ruled Monday that Dr. Spiridon Spireas, who developed a “liquisolid” application of a successful blood pressure drug, could not claim the more favorable tax treatment because the licensing agreement at issue did not include a transfer of all property rights. The decision affirmed a ruling of the Tax Court that determined the $40 million Spireas received under the agreement was not eligible for capital gains treatment.

According to Third Circuit Judge Thomas Hardiman, who wrote the court’s precedential decision, Spireas initially argued that he transferred all his property rights regarding the blood pressure medication felodipine after the drug was created in 2000. However, Hardiman said, on appeal Spireas contended that he transferred his rights in 1998 under a much broader licensing agreement with Mutual Pharmaceuticals to begin adapting “liquisolid” versions of medications.

Hardiman ultimately determined that, based on recent precedent regarding waiver, Spireas had abandoned any argument that he transferred his rights in the 1998 agreement, and further that Spireas could not have transferred the rights under the broader licensing agreement, because his concept of creating a liquisolid version of felodipine haven’t yet moved into actual practice.

“Because that was at least two years before the invention of the felodipine formulation, Spireas’ current position cannot depend on the legal standard for reduction to actual practice to establish that he held a property right at the time of transfer,” Hardiman said.

Judge Jane Roth said in a dissent that the majority misunderstood Spireas’ argument by confusing the legal transfer of rights with the physical transfer of the specific felodipine formulation.

“Undoubtedly, Spireas’ trial counsel could have used more precise language to distinguish between the legal transfer of rights and the physical transfer of the formulation,” Roth said. “But, under this court’s precedents, that mistake alone provides an insufficient basis to find that Spireas has waived his argument on appeal.”

According to Hardiman, Spireas invented liquisolid technology, which is a formulation for medications that allows the body to absorb water-insoluble molecules. The technology, however, must be adapted for each individual medication, which requires a lot of testing and development, Hardiman said.

In 1998, Spireas entered into an agreement with Mutual Pharmaceuticals licensing the technology generally, and granting the company the rights to make and sell the specific products. In 2000, Spireas also entered into an engagement letter with Mutual to develop a liquisolid version of felodipine.

Over two years, Spireas earned $40 million under the agreement regarding felodipine. He paid 15 percent of that in taxes, claiming that it counted as capital gains. However, the Tax Court determined the money was ordinary income, and he owed 35 percent—which was $5.8 million more than he paid.

Bryan Killian of Morgan, Lewis & Bockius argued before the Third Circuit on behalf of Spireas, and Clint Carpenter argued for the U.S. Department of Justice. Killian declined to comment.

A spokeswoman with the DOJ declined to comment.

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