ataxingmatter

Tax Patents: cert is filed in Bilski business method patent case

[edited 1/30/09 to add link to AALS panel podcast]

For those tax aficionados who have been following with interest the treatment of business method patents generally, and tax strategy patents in particular, you are aware that the decision by the Federal Circuit in Bilski appeared to take a hard line to patent eligibility that might--depending on the ingenuity of patent lawyers--make tax strategy "inventions" and many other business method "inventions" ineligible for patenting.  See earlier ataxingmatter postings on this issue here and here, and this earlier 2007 posting, for example.

The Federal Circuit put forth a test in Bilski for business method patents that required either a "machine or transformation" for patentable subject matter.  The opinion seemed, even for someone in favor of a ban on tax strategy patents, not  very well written, in that it claimed a rigid Supreme Court test where language in the cited cases made clear that the Supreme Court hadn't yet reached that conclusion, and its description of the test it proposed left many questions both about manipulability and rationality of the distinctions it required. 

At a recent special panel on business method patents at the 2009 annual meeting of the American Association of Law Schools, several colleagues and I spoke about the meaning of Bilski.  See "Tax Patents, Surf, and Sun" on Info/Law for more on the Jan. 9 panel.  A podcast of the discussion, which primarily concerned the development of business method patents and the Bilski case, with speculation about the status of business method and, in particular, tax strategy, patents after Bilski, is available at this link on the AALS website.

The panel concluded that it was a difficult case to read, that manipulation of the eligibility standard might or might not be possible by claiming a requirement for specialized computer implementation (or perhaps even reaching for a tangible commodity at the bottom of the patent, like real estate--or even coins or oil at base of various financial derivatives?), and that it would be helpful for the Supreme Court to review the case so that a clear and strongly reasoned opinion could guide the law on this issue.  That panel was in early January, so we did not know if a petition for cert would be filed or not.  We've been waiting with bated breath ever since.

The wait is over.  A petition for cert has been filed: Bilski Petition for Writ of Certiorari.  The petition raises two questions:  whether the Federal Circuit erred in holding that the test for patentability of a claimed process invention is the "machine or transformation" test put forward and whether that test "contracdicts the clear Congressional intent that patents protect 'method[s] of doing or conducting business.' "

More on this will be forthcoming in the days and weeks ahead.

Tax Strategy Patents: fate after in re Bilski en banc decision

I ran a quick commentary on the In re Bilski decision in the "business method" patent decision by the Federal Circuit shortly after the decision came out on October 30, but wanted to give a more thorough discussion, especially of its potential impact on tax strategy patents, the issue that most concerns me.  Here's what I think is important to note about the decision.

In the recent past, the Federal Circuit had applied two tests to determine if a process is eligible subject matter for a patent—the Freeman–Walter-Abele two step test (does the claim recite an “algorithm” within the meaning of Benson, and if so, is the algorithm “applied in any manner to physical elements or process steps”) and the State Street  test requiring a “useful, concrete, and tangible result.”  The Federal Circuit rejected both of those tests in its opinion, without, however, actually overruling the State Street case.  In re Bilski, 2007-1130 (Oct. 30, 2008), at 18-20.    Various amici had argued for a “technological arts” test similar to the test used in Europe or categorical exclusions (such as “no business method patents”), but the court also rejected both of those alternatives, stating that "business method claims (and indeed all process claims) are ‘subject to the same legal requirements for patentability as applied to any other process or method’."  Id.at 21.

The court spent considerable time reconsidering Supreme Court precedent on the issue of subject matter eligibility.  It concluded, somewhat surprisingly for most patent lawyers, that the Supreme Court had set forth a single "definitive"  test  for patentability of process claims, citing Diehr, 450 U.S. 175 (1981) and Benson, 409 U.S. 63 (1972) .    Id.at 10-11.  The machine or transformation test finds a claimed process patent-eligible only if the claim “is tied to a particular machine or apparatus” or “transforms a particular article into a different state or thing.”   Id.at 10.

In applying that test in Bilski, the court  found that the patent claim is not tied to a particular machine, and so it does not develop that prong of the test to any significant degree.  This undoubtedly will encourage claimants in respect of abstract process patents to hire IT consultants as "co-inventors" to develop a specific machine process to which to tie the abstract process, in order to get under the wire on the "tied to a specific machine" prong.  See the comment on my earlier posting regarding the likely viability of this strategy, which certainly suggests that the "machine or transformation" test is inadequate for distinguishing mental process claims from genuinely patentable processes.

The court then considered whether the Bilski claim, which is a method of hedging commodities, is eligible subject matter under the transformation prong.  It’s conclusion here appears to suggest that the transformation prong is only satisfied if there is a transformation of a physical object or substance.

We hold that the Applicants’ process as claimed does not transform any article to a different state or thing.  Purported transformations or manipulations simply of public or private legal obligations or relationships, business risks, or other such abstractions cannot meet the test because they are not physical objects or substances, and they are not representative of physical objects or substances.  Applicants’ process at most incorporates only such ineligible transformations.  Id.at 28.

The Bilski en banc court concluded that "to the extent that some of the reasoning [in other opinions] … relied on considerations or tests, such as ‘useful, concrete and tangible result,’ that are no longer valid", aspects of its earlier decisions in this area (including In re Comiskey, 499 F.3d 1365 (Fed. Cir. 2007)) "should no longer be relied on."   Id.at 23.  The "machine or transformation" test thus leaves many business method patents—those not clearly and necessarily tied to a specific computerized implementation—in uncertainty.   In particular, the decision suggests that the nature of the article being transformed is significant, by suggesting that only transformation of physical objects falls under the second prong.   Although the decision doesn't explicitly overrule State Street, it is uncertain that the State Street patent would have been approved by the court applying the Bilski test "from scratch."  Certainly, many tax strategy patents and other legal method patents would appear to be difficult to approve under this "transformation" test (which, as noted above, will push applicants for such patents to develop an IT strategy that will at least ostensibly satisfy the "machine" prong of the new test). 

Yet the failure to reject any categories of patents outright, as noted above, casts considerable uncertainty on the scope of the decision.  There is a vigorous dissent that would have rejected patentability of business methods outright, paired with another dissent that complains that the court has acted against the trends in the development of patent law to adopt a "machine or transformation" test that is at odds with the historical development of patents and even with the Supreme Court precedent cited by the majority in support of its conclusion.  I expect there will be considerable commentary about this opinion and most interested parties will wait eagerly for the next case.

in re Bilski: Federal Circuit speaks on business method patents

The Federal Circuit finally delivered its long-awaited opinion on business method patents today: In re Bilski No 2007-1130, Oct. 30, 2008.  On May 8, the court  had heard the case en banc, asking for extensive briefing, including on the question of whether the court should reconsider the test enunciated in the State Street Banking case for business method patents.  State Street was a precedent breaking/precedent setting case, since it was the first case to clearly permit patenting of business methods that are not tied to machine developments, so long as the method produces "useful, concrete and tangible" results.  The question at issue in Bilski was the patentability of a method for hedging.

The State Street case, as it happens, was also a case dealing with the patentability of a tax patent, and the issue of tax patents has garnered considerable attention in the last few years.  Much has been written about the problems connected with these patents--see, e.g., my own article, Tax Patents: At the Crossroads of Tax and Patent Law, 2008 Journal of Law, Technology & Policy.  The ABA created a task force, chaired by Dennis Drapkin and Ellen Aprill, of which I am a member, and the task force has spent time at meetings educating other tax lawyers about the issue and providing comments to Congress and the Treasury about issues related to tax strategy patents.

The Bilski case decision today did not completely tear up the ground of patent subject matter but did provide a ruling that will impact business method decisions.  See, e.g., Nixon Peabody, Patentability of Computer Software and Business Methods: the Bilski Case, Oct. 30, 2008.  The Bilski decision seems to  overrule the "easy" test for process patents used in  State Street (anything that provides a  "useful, concrete, and tangible result"): that test seemed to permit almost any process to be treated as a patentable invention, so that it was extraordinarily difficult to predict where the line should be drawn between mental constructs and patentable processes.  The Bilski opinion, by a 9-member majority, references the Supreme Court's cases concluding that purely mental processes do not merit patents and draws from one of the cases an exclusive test for patentability, concluding that processes are eligible for patenting only if either (1) they are tied to a particular machine or apparatus or (2) they transform an article into a different state or thing (a "machine or transformation" test). 

There remains much to be determined about the meaning of the Bilski decision (about which i will write more on a future posting).  The court did not completely overrule State Street, leaving it unclear what the "tied to a particular machine" language may encompass.  As the Nixon Peabody blog post illustrates, the decision will likely lead to a change in the way patent applications are framed (attempting to claim a requirement for computerization, for example, or emphasizing the "transformative" nature of the process described in the patent application).  Suffice it to say for now that this will undoubtedly have an immediate impact on businesses, especially those that have taken out a large number of business method patents for proprietary computer programs. (It has been suggested that Microsoft has patented an entire arsenal of business methods since the State Street decision. See, e.g., this post.)  It is likely that a substantial number of business method process patents that have been obtained since State Street would not qualify under the Bilski decision--maybe even the State Street process itself.  For example, the SOGRAT patent--involving determinations in respect of stock options in a grantor trust-- has been widely discussed  by tax attorneys as a process that should not have qualified even under the other prongs of the patentability tests, since no sophisticated tax lawyer would consider the idea nonobvious.  It might also fail to be upheld under the Bilski test. 

Patented Tax Strategies: new developments

Just months after the Treasury Department's July 31 release of final regulations on reportable transactions (T.D. 9350), it has released new proposed regulations treating patented tax strategies as reportable transactions and requiring reporting by both taxpayers and material advisors (Download patented_transactions_reportable_transactions_regs. 092607.doc ).  The regulations define patented transactions in two contexts, by focusing on a taxpayer's payment of a fee to use a patent in one case and on rights to payments from a taxpayer to a patent holder in the second case.  Settlements or damanges in infringement suits are taken into account in the latter but not in the former case.  Responding to concerns that tax planning methods that involve tax software should not be treated as problematic, the regulations define covered tax planning methods broadly  (as a plan, strategy, technique, or structure designed to affect Federal income, estate, gift, generation skipping transfer, employment, or excise taxes), but exclude mathematical calculations or mechanical assistance in the preparation of tax returns. The threshold dollar amounts for the material advisor determination are substantially lowered in the case of patented transactions--$250 instead of $50,000 for natural persons, and $500 instead of $250,000 otherwise.  Material advisors have a list maintenance obligation under section 6112.

Interestingly, both patent holders and taxpayers who use patented strategies can be "participants" in patented tax strategies under the regulations.  The definition of participation hinges on reflection of the patent ina return.  The NPRM explains it this way.

A taxpayer has participated in a patented transaction if the taxpayer's tax return reflects a tax benefit from the transaction (including a deduction for fees paid in any amount to the patent holder or patent holder's agent).  A taxpayer also has participated in a patented transaction if the taxpayer is the patent holder or patent holder's agent and the taxpayer's tax return reflects a tax benefit in relation to obtaining a patent for a tax planning method (including any deduction for amounts paid to the United States Patent and Trademark Office as required by title 35 of the United States Code and attorney's fees) or reflects income from a payment received from another person for the use of the tax planning method that is the subject of the patent.

Today, BNA reports a discussion at a National Association of Bond Lawyers seminar in which Treasury attorney John Cross III indicated that the proposed regulations that make patented tax strategies reportable transactions for purposes of sections 6011 and 6111 is  actually not the preferred solution within Treasury.  A ban, as proposed in the House version of Patent Reform legislation, would be preferable because of the problem that taxpayers may be misled into viewing patented strategies as carrying the imprimatur of correctness because of the Patent Office's approval of the patent.

"The proposal is very nuanced and if you are interested in it you should look at all the rules under it," Cross said. "But I think in the big picture Treasury would prefer a statutory ban on tax planning patents as is done under the existing House bill (H.R. 1908) rather than a regulatory approach, which by scope of authority is necessarily more limited. The base of concern is a fear by IRS and Treasury that when people run around saying ‘we have a patent,’ they will somehow imply that whatever the tax approach taken has been blessed in some way by the government."

Tax Patents: PTO approach

At the ABA tax meeting in August, the Patent and Trademark Office representative indicated that they would continue to issue patents, juding them on the regular patent eligibility issues, not on whether they were "good or bad for the public."  See the BNA daily tax RealTime, August 16, 2007 (quoting PTO's Wynn Coggins.

Perhaps the most worrisome aspect of Coggins' statement is her view that the PTO is up to the task of determining the eligibility of tax strategies for patenting.  She commented at the ABA meeting that  the PTO has "'great expertise' in the tax area and a solid partnership with the Internal Revenue Service on this issue."  I find that a significant stretch.  The PTO has a number of highly trained technicians, but it does not have a stable of experienced tax lawyers.  The partnership with the IRS is better than no input from the IRS, but does not result in the PTO having the expertise that it needs.  It is a little like a graduate of a mid-tier law school purporting to develop tax expertise after a summer working with a few good tax lawyers on a couple of good tax deals, at best. 

I'm still pinning my hopes on Congress realizing that tax strategy patents are a public policy mistake--both from the perspective of patent and tax law.  There is no need to accelerate development of tax strategies so the purpose of patent law is not satisfied.  And regretably, the patenting of tax strategies would likely have the effect of strengthening rather than tempering the tax minimization norm that already leads many tax advisers to lose sight of the proper boundaries on advising aggressive tax measures.

PTO's Wynn Coggins noted that "the Patent Office doesn't look at whether a patent is good or bad for the public"  but whether it is truly new rather than based on prior art.

A Taxing Matter Break

Ataxingmatter will be 'off the air' until Monday, July 30, as I travel to Berlin for the annual Law and Society meeting where I'll be talking about the potential implications of tax strategy patents in a globalized economy.  Today, Europe and Japan, among others, are resisting the idea of providing patents to nonindustrial applications.  But the U.S. Patent and Trademark Office has begun issuing business method and tax process patents.  Will the rest of the world follow the USPTO's lead?

As readers of this blog well know, I am not supportive of tax strategy patents, for various reasons.  I suspect that they will worsen compliance and contribute to the view that the tax laws are merely a system to be gamed.   And like Bernard Wolfman (see his letter in Tax Notes), I don't think the government has any business granting a monopoly on an interpretation of the law.

The following is the abstract of my presentation.

The U.S. tax administration began a new era of enforcement by focusing on "cloned" tax shelters that were marekted by ambitious accounting and tax firms to small groups of customers.  That focus led to heightened transparency requirements--new disclosure rules, higher standards for tax reporting, and stiffer penalties.  Even the courts, which had seemed reluctant to apply judicial doctrines to stop aggressive tax structuring, have appeared to gain new backbone in this age of stiffer enforcement expectations.  Just at the time when it appears that the attention to tax shelter activity may reduce the amount of aggressive tax planning, the U.S. Patent and Trademark Office has thrown a wrench into the machinery by issuing a series of patents on tax planning strategies, after the State Stree Bank decision opened the way for business method patents generally.

The patenting of tax strategies may have significant effects well beyond the questions of royalties, liabilities for infringement, or difficulties of litigating against validity of a tax patent that are already the subject of discussion among tax practitioners and academics.  There are concerns, in particular, that the ability to patent legal processes relating to tax liabilities may make it more difficult for taxpayers to comply with the law.  This essay will briefly review the concerns raised by tax strategy patents, including ethical questions confronting practitioners who hold a tax strategy patent, the potential impact of tax patents on the development of the underlying "tax minimization norm" that this author has noted in earlier papers as a significant factor in tax shelter activity, and the anti-competitive effects of multijurisdictional tax strategy patents.

Tax Patents: Breaking News

The House Judiciary Committee today (July 18th) surprised most in the patent and tax practitioner communities by approving an amendment sponsored by Rep. Boucher  to the broad patent reform bill (H.R. 1908) Download bouche_amendment_banning_tax_patents.071807.pdf .  The amendment is clearly worded as an outright ban on tax planning methods as inappropriate subject matter for patents.  It defines tax planning method as "a plan, strategy, technique, or scheme that is designed to reduce, minimize, or defer, or has, when implemented, the effect of reducing, minimizing or deferring, a  taxpayer's tax liability." 

It may be that the Judiciary Committee felt the pressure of a number of different factors relevant to tax patents:

• the extraordinary nature of tax planning patents,
• the difficulty for the Patent and Trademark Office to determine whether a tax planning method satisfies the nonobviousness requirement (the patent granted on grantor trusts funded with annuities strained the credibility of the USPTO on that issue),
• the possibility of patent holders developing patents that act as traps for the unwary taxpayer simply trying to comply with the law,
• the potential for patent trolls who create mini-empires exacting a royalty tax based on mere compliance with the tax laws; and
• the complication for international business deals if the USPTO's approach were to be followed in other countries, resulting in extraordinary transaction costs and perhaps even dead deals due to impasses in multi-national negotiations for licenses on particularly useful deal structures.

This is the right answer, and it appears that the language of the amendment will not have the problem of eliminating useful technological patents, since it permits patents on tax preparation software. But this will require watching to see if the Congress carries through with the reform. There is a strong lobby for non-interference with the patent office processes, and many patent attorneys have told me to "get over it" when I have expressed concern about patents on tax planning processes.   I suspect the patent reform bill will not have an easy road to enactment by the full Congress.

Tax Patents: High Court Limits Obviousness

The Supreme Court has "raised the bar for obtaining patents on new products" in a landmark case, KSR v. Teleflex, that may cause the Patent Office to rethink its criteria for issuing patents.  Linda Greenhouse, High Court Puts Limits on Patents, NY Times, May 1, 2007.  The Court's ruling deals with the requirement that patents not provide protection to "obvious" innovations and makes obtaining and defending patents more difficult.  Justice Kennedy noted that "Granting patent protection to advances that would occur in the ordinary course without real innovation retards progress," resulting in patents that are "undesirable" because they may "deprive earlier innovations of 'their value or utility.' "  Id. 

In the opinion, the Court made it clear that obviousness precludes patents even for some strategies that have not been tried but that a person of ordinary skill in the area would consider.

[T]he [Federal Claims] court erred in concluding that a patent claim cannot be proved obvious merely by showing that the combination of elements was obvious to try. When there is a design need or market pressure to solve a problem and there are a finite number of identified, predictable solutions, a person of ordinary skill in the art has good reason to pursue the known options within his or her technical grasp. If this leads to the anticipated success, it is likely the product not of innovation but of ordinary skill and common sense.   KSR v. Teleflex.

The blogosphere has mixed views on the value of the decision. See, e.g., Has the Supreme Court Killed Off Patent Trolls? on silicon.com.  On Patent Baristas, the comment notes that making patents more difficult to acquire and more expensive to protect will be"good or bad depend[ing] on which side of the lawsuit you fall."

The ruling is a victory for technology companies but a defeat for pharmaceutical and biotech industries as well as many other companies that highly value patent protection, e.g., Procter & Gamble Co., GE, DuPont Co. and Johnson & Johnson. Patent Baristas.

The case could have a significant impact on the question of patentability of tax strategy patents.  Practitioners have argued, for example, that the SOGRAT patent, for which a patent infringement claim was recently settled, should not have been issued--even assuming arguendo that patents for tax strategies are legitimate--because the patented technique would have been obvious to any well-versed tax practitioner.

Tax Patents: Blend's Views

Incoming president of the ABA Tax Section Stanley Blend spoke at the U.S. Tax Court Judicial Conference on the 20th of April about tax patents.  Calling the idea of patenting tax strategies "a threat to the American tax system", Blend vowed to work to undo this new idea that tax strategies can be patented.

Blend is a partner at Oppenheimer, Blend, Harrison & Tate Inc. in San Antonio, Texas.  Before joining the firm in the early 1970s, he was with the tax court litigation division of the Internal Revenue Service in Washington.

For more information about tax patents, see earlier postings here and here, as well as the ABA Tax Section task force website.

Tax Patents: Colorado Bar Expresses Its Concerns

Joining the New York State Bar Association Tax Section, the American Institute of Certified Public Accountants (February 28, 2007), and the State Bar of Texas (asking for more disclosure of tax patents, in its comments on proposed reportable transaction regulation modifications), the Virginia Society of Certified Public Accountants and the Colorado Bar Association have now expressed their views on the granting of patents for tax planning advice.  For background information, see these prior postings on the granting of tax patents here (regarding S. 681 proposed by Levin, Coleman, and Obama) and here (regarding general issues about tax patents).

The Virginia CPAs note that legal process patents simply don't make sense.  The laws are part of the public domain.  "We do not believe that patents on tax advice are any more supportable than a patent on the process of defending against a criminal charge." Virginia Society of Certified Public Accountants.

The Colorado Bar suggests that patents "for business processes and financial products other than tax advice may have similar issues" but expresses deep concern about the impact of tax planning patents on the US tax system.  The Bar letter supports exempting tax advice from material that may be covered by a patent or eliminating remedies available to holders of tax patents.  The Bar letter, echoing the NYSBA tax section comment, notes that "[t]axpayers should not be faced with a decision of whether to pay taxes or to pay royalties."  The letter also comments on the dampening effect that tax patents will have on free interchange of ideas about the tax system: "[p]ractitioners may become more interested in obtaining patent protection for their tax advice and less interested in sharing their ideas so as to improve the tax system."  Finally, the Colorado Bar notes that tax patents will interfere with the professional responsibility requirement that lawyers maintain professional autonomy and not limit the freedom of their clients to choose their own lawyer.

Tax patents create new arenas for conflict of interest problems.  As the Colorado Bar notes, a tax adviser who must defend a claim of patent infringement may find it necessary to reveal confidential client information.  Although ethically allowed to do so under the Colorado rules, this will be one further area of pressure on client confidences that may change the way clients view the role of tax advisers.  Conflicts of interest will also exist when tax advisers consider whether work they are currently doing is translatable into a patent from which they can profit--at the expense of both the tax authorities and their future clients.

I've written about the prevalence of the "tax minimization norm" among tax practitioners, and the damaging effect the norm has on respect for the integrity of the tax system and structural coherence of the tax rules.  Tax patents potentially will magnify that problem, since lawyers and practitioners will have a further monetary incentive to invent loophole-creating interpretations that can be patented for personal profit.   

Tax patents make no sense.  Patents aren't needed to encourage innovations in tax planning in a context in which Congress, Treasury and the IRS are always playing catch-up to the latest tax shelter scheme invented by creative bankers, lawyers and accountants hoping to cash in on the lucrative tax-avoidance game.  At the least, the IRS and Treasury should require disclosure of patent use (or of a transaction that is substantially similar to a patented transaction) under the reportable transaction regulations.  But a better solution would be a simple Congressional ban on the patenting of tax planning strategies.