Tax Patents: A Worrisome Trend

The New York times ran a story last Friday by Floyd Norris on tax patents:  You Can't use that Tax Idea. It's Patented, NYTimes, Oct 20, 2006, at C1. After an appeals court ruled in 1998 that business methods could be patented, some bright tax practitioners got the idea of "owning" a piece of the action under the federal income tax code.  Now, 49 patents have already been granted for tax products, and 81 requests for patents are pending.  Id.

Patent lawyers seem to think tax lawyers and academics like me are just resisting being dragged into the twenty-first century of intangible property rights.  In a conference I attended this weekend, several intellectual property lawyers and tax lawyers discussed the tax patent phenomenon.  The intellectual property lawyers' response to tax lawyers' concerns about individual firms or practitioners being able to patent tax planning strategies was uniformly "Get over it!"  Intellectual property has a value, they told us, and people who "invent" new ways to do things should be able to patent those methods and earn royalties from licensing them to others. Every other business has to put up with the difficulties created by patents, so why shouldn't tax lawyers, they said.

But the problems with granting patents for tax strategies are multiple and need to be understood and discussed within the academy, law firms and, very soon, Congress. We are all required by law to file tax returns and to report our taxes in accordance with the tax code.  The tax code itself is a complex and large interrelated group of provisions that cover almost all aspects of individual and entity existence. 

In an article in Legal Times this week, Paul Devinsky, John R. Fuisz and Thomas D. Sykes, three lawyers from McDermott, Will & Emery, suggested that a company might figure out a tax strategy that would save it a lot of money, and then patent it. Then the company could refuse to license the patent to its competitors, thus raising its rivals’ cost of doing business.  Tax patents, the lawyers wrote, amount to “government-issued barbed wire” to keep some taxpayers from getting equal treatment under the tax code.  You Can't use that Tax Idea. It's Patented.

The ability of individuals to patent what amount to interpretations of the  Code, and force others to pay to use that interpretation or prevent their using strategies that the Code clearly allows altogether by refusing to license the strategy, seems to run counter to the core nature of the tax code as universally applicable law.

What if a taxpayer structures a business transaction in a way that seems reasonable under the rules of the Code, reports the transaction, and then finds that someone had already patented what seemed to be an obvious idea about structuring a reasonable business transaction in tax-efficient ways?  Presumably that taxpayer would be subject to patent infringement claims.  Conversely, if the taxpayer undertook the strategy with the aid of a tax lawyer, the lawyer may be subject to both a patent infringement claim (for advising a strategy that impinges the patent) and a malpractice claim (for failing to advise his client about the existence of a patent for the strategy used).

It's not clear what types of strategies can be patented.  One worries how a patent attorney who is not an expert in tax law decides that a tax strategy is patentable.  Just what kinds of features suggest the unique intellectual product that merits a patent?  Surely no patent would be permitted for transactions and strategies for reporting those transactions that are clearly available or "obvious" under the tax code.  The strategies will  have to be inventive enough to pass muster for issuance of a patent. 

That suggests that the main methods for which patents will be available will be ones that "stretch" the Code, juxtaposing novel contexts with novel interpretations to derive novel tax benefits.  A patent office representative at the ABA Tax Section meeting (described in the Oct. 24, 2006 BNA Daily Tax Report No. 25, at G-9), noted that "All we're saying is that the tax shelter is patentable. We're not saying whether it's a legitimate tax shelter or not."  Might not these patented strategies be likely to constitute abusive tax shelters?  Does that mean that the tax shelter bar will now be able to benefit from lucrative fees from clients and fees from other attorneys who pay them for a license to use their ideas, so that patenting tax strategies encourages (incentivizes) the tax shelter business?  If so, the patent process runs directly counter to the tax administration's current attempt to rein in abusive tax planning.

Tax partners at firms always know a good bit about what the tax shelter bar is doing, even if they don't do it themselves, so the rumor mill among tax practitioners will keep many in the know about the newest tax patents (and related shelters) available. But not everyone.  There may well not be the same open discussion about new strategies and interpretations of the Code among members of the regular tax bar that now provides some check against abusive tax treatment.  In other words, when some can get rich quicker by patenting their ideas, will that limit the healthy discussion across groups of tax experts about the strategy--whether it works, what its implications are for other tax issues?  With the discussion short-changed at the outset, will more abusive tax strategies be patented and put into play by taxpayers, leading to a downward spiral in compliance norms?

Furthermore, every new tax bill will lead to a rush to patent every potential tax strategy using the legislation.  The reward for first-in-time filing will encourage firms to hire eager, creative minds who will come up with strategies, like the inventive group who populated Arthur Andersen's and KPMG's aggressive tax practices before they were shut down.  Will that also influence the development of the practice of tax law?  A more measured response to new opportunities provides some means of ensuring that proper reflection on ethical consequences takes place, while a climate of rushing to patent will surely discourage reflective consideration.

How will tax advice work under this new regime?  Tax advisors will also have to become patent researchers or have some process in place for tracking patents as they are approved and cross-checking transactions against the list to ensure no infringement.  What if the client hears about a strategy through some kind of promotional marketing effort?  Presumably, the client's own tax advisor will still evaluate the strategy.  But will the licensing fees (and the tax advisor's inability to benefit from licenses held by others) sway the advice in inappropriate ways?  There might be conflicts of interest between a tax advisor and client if the advisor held a patent on a strategy that the client might use in a given situation but not on other potential strategies.  The tax advisor might push the client towards the advisor's own patented strategy and away from other strategies, whether patented or not, without regard to the best position for the client, in order to get the licensing fee. This would be similar to the problem observed in medical practices, where doctors may prescribe unnecessary and expensive (and perhaps even unnecessarily invasive) tests that are offered by affiliates of the doctors, because of the extra money to be made from the sale of those tests.

If patent holders are not required to disclose the details about patents they hold, tax planning (and tax advice) will even further complicated.  Taxpayers cannot avoid reporting their tax liabilities, after all, just because they are afraid they may have missed a tax patent landmine. 

At the ABA tax section meeting reported in the BNA Daily Tax Reports, Christine Albright of Winston & Strawn noted another problem.  Practitioners now depend on public confidence in their competence, geography and client relationships to build and maintain business.  But tax patents are likely to change the economics of tax practice in these respects, especially when patent holders refuse to license a strategy.

Comments

[The NJ Annuitant]

This is , indeed, a very worrisome trend. It is remarkable that an interpretation of a public law could rise to the level of "invention." It seems to me that Congress could and should end this assertion by adding (to the very next piece of tax legislation )a provision that makes legal interpretations of any kind non-patentable.

[Jake]

Congress could require an applicant for a tax patent to copy the IRS Office of Tax Shelter Analysis when the application is made.

Also, one wonders whether any applicant who has obtained a tax patent went to the trouble of seeking a PLR from the Service first. If so, did the applicant have the sheer brass to mention it in the patent application?

[LindaMBeale]

If Congress does not prohibit patenting of tax ideas altogether (which I am inclined to think it should), it should at least require copies of patent applications be provided to the IRS, as you suggest, and it should also require that all tax-related patents be publicly available at one easy-to-locate site online (probably, the IRS website). This would serve two purposes: (1) ensure that the patent is not permitted to be kept secret, leaving taxpayers prone to fall into the proverbial trap for the unwary and (2) permit the IRS to get a full review of the idea and act on it if it appears abusive.
Of course, once Congress recognizes the problem sufficiently to realize that these actions are necessary, wouldn't it make even more sense to prohibit patenting of tax strategies altogether?

[Andrew A. Schwartz]

This is an important subject and I appreciate the post and comments above. My own view is tax strategies or shelters are simply not patentable, because they cannot by their nature qualify as an "invention" within the meaning of the patent laws. See Andrew A. Schwartz, "The Patent Office Meets the Poison Pill: Why Legal Methods Cannot Be Patented," Harvard Journal of Law and Technology, Vol. 20, No. 2, Spring 2007 (forthcoming), available at www.ssrn.com/abstract=937398.

In addition, some of the comments above seem to be premised on an assumption that patents are somehow kept hidden from public view. This is definitely not the case.

Copies of patents are available for $3 from the Patent Office upon request. More importantly, all patents issued since 1976 are available on the web for free at www.uspto.gov in fully searchable text.

In addition, many patent applications are published eighteen months after they are filed pursuant to 35 USC 122(b). This represents a significant change in American law. Until 1999, all patent applications were kept in confidence. If an application were finally rejected, the public would never know that it had even been submitted to the Patent Office.