ataxingmatter

Patent Reform Bill Passes Senate

The Senate on Thursday passed the patent reform bill, H.R. 1249 (passed by the House in June) that makes significant changes to US patent law, including a ban on new tax strategy patents.  (There is an exception for tax filing and preparation software and financial management software.  The protection for financial management software--dear to all the too-big-to-fail banks--was added by the House in June.  Many who have been following the controversy over business method patents consider those exceptions problematic since such items shouldn't be protected by patent but by copyright.)  The bill now goes to the President for his signature.

Senators Baucus and Grassley justified their position in support of the ban as protecting the right of taxpayers to have equal access to tax planning strategies.   The bill's ban on tax strategy patents in section 14 relies on the requirement that patents be non-obvious, indicating that tax strategy patents are deemed to be within prior art. Too bad the legislation didn't just say outright that legal strategies are not patent-eligible material because they are not appropriate subject matter for patents under section 101.

I'm not sure the many other patent reforms make sense--in particular, it seems that they make life better for the giant corporations like Microsoft and Goldman Sachs, but likely remove protections from the real inventors, the not-so-well-funded innovative kid working out of his garage.  See, e.g., Patent Reform Ok'd: Critics Say It Impedes Startups, Milwaukee Journal Sentinel, Sept. 8, 2011.  The bill generally furthers the corporatist agenda as a "sellout to big business," with a "first to file" rule replacing the "first to invent" rule and provision for third parties to initiate patent litigation (rewarding big businesses with big litigation warchests).

Tax Patent Ban up for vote Wednesday

The House of Representatives is set to vote, probably on the 22nd, on the patent reform legislation that would ban tax strategy patents, H.R. 1249 (The America Invents Act) (easily readable summary on Thomas.gov available here).

Sec. 14 of the act would deem any strategy for reducing, avoiding, or deferring tax liability insufficient to differentiate a claimed invention from the prior art when evaluating specified conditions of patentability.

It seems that there is momentum on this issue and finally Congress may act to make tax strategy patents a thing of the past (except, of course, for the 140 or so already granted).

One member of the House, Congressman Jared Polis, apparently wants Congress to grandfather in all the businesses that have submitted application for tax patents.  That would about double the number of patents.  As the AICPA-led coalition put it in a letter to Congress objecting to the idea,

We understand that some of these patent applicants, awaiting a decision by PTO, may argue that they divulged certain proprietary information or business strategies when they applied for their patents, and therefore, at this point in the process, they should be entitled to continue. However, all patent applicants send in their applications with the understanding that they may not ultimately receive a patent. Should Congress continue to allow the PTO to issue these anti-taxpayer patents just because someone applied for one? The answer is a resounding no. Tax strategy patents are simply not in the public interest, and Congress must put a stop to them.

AICPA-Coalition letter is available Download Patent_Reform_TSP_Coalition_Letter_in_Opposition_to_Polis_Amendment_June_21_ 2011.

 

Tax Patents

The Senate Judiciary Committee did a markup of its patent reform legislation (S.23) today (Feb. 3, 2011) and --in a unanimous vote-- sent it to the floor of the Senate with the broad ban on the patenting of tax strategies intact. 

The accounting group AICPA has been leading the tax practitioner charge against patentable tax strategies, as the ABA tax section is hampered by the overall ABA's decision to let the patent bar handle any comments on the matter.  The patent bar tends to object to subject matter exclusions to patentability, claiming that broad patentability best serves innovation. 

Significant patent reform has been on the table for several years, but has been the subject of intense negotations, since it is the first major amendment to patent law in 60 years.  Some practitioners have urged Congress to pass a stand-along tax strategy patent ban, but that has been politically difficult, possibly because of the patent bar's interest in the matter and those in the technology industry who fear that bans on tax strategy patents will affect tax software (such as tax preparation software).  While there are arguments that software, like tax strategy patents, simply shouldn't be patentable, those in Congress in support of tax strategy patent bans generally have indicated that tax preparation software is not intended to be covered.  Sen. Grassley, for example, supports a ban on tax strategy patents but is cognizant of the technology industry's concerns.  He stated  that he believes the ban can be written so as to protect tax preparation software and similar applications.

The following is excerpted from his Feb. 3, 2011 statement for the record on the tax strategy patent issue (available in BNA Daily Tax Report, Feb. 4, 2011).

I want to particularly thank the Chairman for working with me on a provision that would curtail patents on tax strategies that Senator Baucus and I strongly believe needed to be part of this patent reform package. During the 10 years that Senator Baucus and I alternated as Chair and Ranking Member of the Finance Committee, we worked on many proposals to protect taxpayer rights. The tax patent provision in this bill is one such provision. The American Institute of Certified Public Accountants started expressing concern about tax strategy patents after the then-Chairman and CEO of Aetna was sued for patent infringement for using a widely-known tax planning strategy. He eventually settled, but most taxpayers don't have the resources to fend off such challenges. I ask consent that a 2007 article describing the AICPA's concerns and the lawsuit be inserted in the record.

In July 2006, the House Ways & Means Committee held a hearing on the use of tax strategy patents in facilitating abusive tax avoidance transactions. The Joint Committee on Taxation prepared a document for this hearing that outlines in detail the issues that tax strategy patents present. That document, JCX-31-06, is available on the Joint Committee's website. The bottom line is that tax strategy patents may lead to the marketing of aggressive tax shelters or otherwise mislead taxpayers about expected results. Tax strategy patents encumber the ability of taxpayers and their advisors to use the tax law freely, interfering with the voluntary tax compliance system. If firms or individuals were able to hold patents for these strategies, some taxpayers could face fees simply for complying with the tax code. And, tax patents provide windfalls to lawyers and patent holders by granting them exclusive rights to use tax loopholes, which could provide some businesses with an unfair advantage.

Tax strategy patents are unlikely to be novel given the public nature of the tax code and related guidance. Moreover, tax strategy patents may undermine the fairness of the Federal tax system by removing from the public domain particular ways of satisfying a taxpayer's legal obligations. The provision in the bill before us today expressly provides that a strategy for reducing, avoiding or deferring tax liability cannot be considered a new or non-obvious idea, and therefore, a patent on a tax strategy cannot be obtained. This ensures that all taxpayers will have equal access to strategies to comply with the tax code. In addition to Chairman Baucus, Senators Levin, Bingaman, Wyden, Conrad, Enzi, Kerry, Stabenow and Whitehouse support this provision.

I want to express my appreciation to Senators Leahy, Hatch, Sessions and Kyl for working with me in the Judiciary Committee to include this provision in the comprehensive patent reform bill we are debating today. It's important that this provision remain in the bill since the number of tax strategy patents issued and pending are growing rapidly. As of the publication date of the 2007 article I inserted in the record, there were 60 patents issued and 86 pending applications just under PTO's 36T classification. Just three years later, there are 137 issued and 157 pending. These are just the ones PTOs classified as tax strategy patents, but PTO's classification isn't perfect so there could be other tax strategy patents under other classifications.

On the issue of software, I'd like to make crystal clear that those of us working to limit the patenting of tax strategies do not intend for this to apply to tax preparation and other software, tools or systems used to prepare tax or information returns or manage taxpayer's finances. I'm aware that various technology industry groups have written in opposition to this provision because of their concerns over how this impacts their ability to patent software. However, we've also heard from the public accountants and other consumer advocate groups, including the U.S. Public Interest Research Group, supporting this provision. I ask unanimous consent that their letter be inserted into the record.

I believe that we can protect taxpayer rights while also protecting the intellectual property rights of software companies. I encourage the technology groups to work with us to ensure we achieve that result and look forward to working with them to do so.

 

The Supreme Court's Decision in In re Bilski:: does it allow tax patents or not?

[edited 12:58 pm to better organize the description of the two parts of the Court's opinion not supported by a majority, to note Scalia's joining Breyer's concurrence and to improve the description of Breyer's conclusion]

The Supreme Court handed down its decision in Bilski Monday, holding, as almost everyone had predicted, that the hedging process that was the subject of the Bilski claim was unpatentable.  Download Bilski at SCOTUS 08-964. The question for those of us following the case, of course, was not whether the Court would consider the claim patentable.  The question was on what  ground the Court would rest its decision and whether the decision would shed any light on the larger category of business method patents generally and tax strategy patents specifically.

The opinion of the Court was written by Justice Kennedy and joined by the four justices on the right--Alito, Roberts, Thomas and Scalia.   The opinion agreed that the Federal Circuit's "machine-or-transformation" test was a valuable clue to the question of process patents eligibility, but rejected the Federal Circuit's conclusion that it was the exclusive test for process patents.  The statutory analysis in the opinion was the kind of stretched, "ordinary meaning" dictionary and common usage based interpretation that becomes absurd quickly in the context of a highly technical statute such as the Patent Act.  Consistent application of that everyday definition of process would allow patenting of almost any novel human activity, including a series of steps to implement a tax planning strategy.  Further, the opinion treats a remedies provision (enacted in the wake of the State Street Bank case to protect those who might be accuse of infringing this new cateogry of business method patents approved by the court) as an amendment of the key patentability categories language rather than as the stopgap measure it was clearly intended to be  because of the Federal Court's condoning of business method patents.

The Court concluded that the hedging claim at issue was unpatentable under its exceptions for abstract ideas (not found directly in the statute, but claimed (awkwardly) to be consistent with the statute's "new and useful" language).  This is the place where the Court could have shed considerable light on patentability, since it is very unclear from prior precedent just how far the "abstract idea" exception extends.  But instead, this opinion created even more confusion.  While hedging in itself is an abstract idea, the application of a hedging algorithm to a particular commodity is not necessarily.  So it seems that there is something beyond mere abstract idea operating here, but the Court was either reluctant or unable to put its fingers on what it was. 

Interestingly, while it rejected the Federal Circuit's machine-or-transformation test as the sole basis for deciding process claims, it nonetheless encouraged the court to develop additional definitive criteria that would help narrow down the kinds of process claims that are patentable.  There is a good bit of language in the Court's opinion, in fact, that suggests that process claims should not be interpreted overly broadly, even though the patent law generally has been viewed as having wide scope.  The Court makes clear that the remedies provision in section 273 does not istelf suggest a broad reading of business method patentability.  The Court indicates as well that process claims require a test with a higher hurdle to prevent inappropriate claims from being treated as patentable, else the Patent Office would be "flooded with claims" that could place a "chill on creative endeavor" and literally stifle competition.  It encourages the Federal Circuit to come up with additional ways to define a narrower category of process claims based on the Flook, Benson and Diehr trilogy of cases that outlined the exceptions for "abstract ideas, laws of nature and physical phenomena" and yet approved an application of an algorithm in a rubber curing method.  It indicates that nothing in the opinion should be read as an endorsement of the lax State Street Bank test.  Nonetheless, it concludes that "the Patent Act leaves open the possibility that there are at least some processes that can fairly be described as business methods" that would be patentable.  In sum, that is weak support for business method patents and tax strategy patents in particular, but it certainly leaves the door open for some business method patents, particularly the computer programs that were the subject of several amicus briefs and, by extension, possibly some tax strategies that are dependent on application by computer.

Scalia, however, did not join in two parts of the opinion that (i) acknowledged the extreme rarity of business method patents until the 1990s under well-established principles  but nevertheless (ii) accepted the idea that "unforeseen innovations" such as computer programs might need to be treated as patentable in accommodation of "Information Age" technologies.  These parts of the opinion are the most supportive of the corporatist position favoring broad scope of business method patentability, but Scalia's tendency to rely on originalism may have made it hard for him to take this step.  That may be a good sign for those of us who think that business methods should not be patentable, and in particular that patent claims setting forth tax planning strategies for transactions designed to conform to legal requirements should never be patentable.

Stevens wrote a concurring opinion, in which Ginsburg, Sotomayor and Breyer joined.  That opinion relied on statutory analysis and the history of the patent laws to conclude that business methods should not be eligible for patentability as process patents.  The opinion notes the inconsistencies in Kennedy's arguments, and the ultimately conclusory holding that the Bilski claim was an unpatentable abstract idea.  It faults the majority opinion for weak statutory analysis, using the history of the British and US patent laws to establish the well-settled principle through the 1980s that business methods were not patentable.

Breyer also wrote a separate concurrence, in which Scalia joined, claiming to set forth the agreed views of all members of the Court that may not be obvious from the multiplicity of opinions, as follows:

1. Section 101 has broad scope, but it is limited by the three judicially created exceptions (laws of nature, physical phenomena, abstract ideas );
2. The machine-or-transformation test is a critical clue to patentable processes;
3. The machine-or-transformation test is not the sole test for process claims, but broadly speaking, process claims must be consistent with the function that the patent laws are designed to protect;
4. The fact that the machine-or-transformation test is not the exclusive test for patentability does not mean that State Street Bank applies--the test in that case (which approved business method patents generally) led to "truly absurd" patent grants;

Breyer concluded that the Court means NEITHER to "deemphasize" the machine-or-transformation test's usefulness NOR to suggest that there might be many patentable processes that would otherwise have been excluded by that test.  This conclusion implies that it would be rare for a claim to be patentable that did not satisfy the machine or transformation test.  Again, the fact that Scalia did not join in the Information Age discussion in Kennedy's opinion and did join Breyer here suggests his reluctance to accept patentability for (most?) business method patents.

The dissolution of the majority on the question of an expanded view of process patentability in light of "Information Age" technologies suggests that the Court might well reject tax strategy patents except perhaps in the cases where they are clearly interrelated with computer applications that cannot be treated as "mere post-solution activity."  In effect, this leaves the issue even more in limbo than before.  The machine-or-transformation test appeared to have loopholes that would allow computerized applications of tax strategies to be patentable, and the opinion of the Court appears to support that possibility.  Scalia's refusal to join the sections on Information Age technologies, however, pushes back against easy acceptance of patents based on legal strategies.  And certainly the four justices in the minority would not find tax strategy claims eligible for patentability.  This was the last case in which Justice Stevens will participate, so there is also the uncertainty of the new Justice's approach to these issues and ability to persuade others on the Court to his or her opinion.

The AICPA, which has spearheaded the tax practitioner and accountant community's lobbying against tax strategy patents, issued a release on Monday that noted the continuing uncertainty about patentability of tax strategies.  It called on Congress to enact a clear ban to resolve the issue once and for all.  AICPA Renews Call for Congressional Action to Ban Tax Patents, PRNewswire, June 28, 2010. 

Congress should act, but one suspects that the health and financial battles make enactment of the major Patent Reform Bill practically untenable for now.  That means that the most likely possibility for a ban on tax strategy patents would be through a dedicated bill dealing solely with that issue.  But you can bet that the IP bar will fight such a bill tooth and nail, as a toe in the door towards narrowing of patent law (and their turf), under the banner of "innovation" and "public disclosure."  Innovation is not an inherent good in finance or tax, and there is little merit to the public disclosure of tax strategies for helping people avoid even more taxes than they already do.  Meantime, we will remain in suspense as the Patent Office and Federal Circuit work through the Supreme Court's opinion.

A quote from Amartya Sen, and my New Year's Tax Resolutions (for Congress and the Obama Administration)

The time between December 30 and January 4 seems to be filled with lists.  Along with the ever-present list of "to dos" that haven't been done and still are hanging around waiting for our attention, there are everyone's "10 best" lists (e.g., the ten best movies--regretably, I don't think I saw ten new movies in 2009, so can only say I thought Slumdog was a decent showing) or their opposite (e.g., the ten worst celebrities of the year, every one of them with Tiger Woods and Gov. Sanford firmly placed near the top).  And of course there are those New Year's resolutions that we are supposed to deliberate over and then deliver on when the New Year rolls around--mine is to join my hubby in his morning walk and to give up doughnuts completely.

Not being one to gather quotes all year just for this final celebration, here's one quote that I believe is worth thinking about as we head into the new year.  Amartya Sen writes, in "The Idea of Justice" (Belknap Press 2009), at 32:

Being smarter may help the understanding not only of one's self-interest, but also how the lives of others can be strongly affected by one's own actions.  Proponents of so-called 'Rational Choice Theory' (first proposed in economics and then enthusiastically adopted by a number of political and legal thinkers) have tried hard to make us accept the peculiar understanding that rational choice consists only in clever promotion of self-interest (which is how, oddly enough, 'rational choice' is defined by the proponents of brand-named 'rational choice theory').  Nevertheless, our heads have not all been colonized by that remarkably alienating belief.  There is considerable resistance to the idea that it must be patently irrational--and stupid--to try to do anything for others except to the extent that doing good to others would enhance one's own well-being."

In light of Sen's helpful clarity about the ridiculousness of 'rational choice theory', I also offer the following as the resolutions that I wish Congress and the Obama administration (and/or various administrative agencies thereof) would make (and follow through on) for this new year of 2010.

1) The Treasury should resolve that it will no longer provide special dispensation to the financial institution powers that be, such as its invalid notice indicating that it would not enforce the law on loss corporations for too-big-to-fail banks, thus allowing too-big-to-fail banks to become even bigger by buying loss banks, and then allowing them to use those losses in direct contravention of the law and avoid paying income tax for years (or perhaps decades).  A similar "notice" went out recently--Notice 2010-12--stating that Treasury will continue to fail to enforce the rules under section 956 regarding what constitutes an obligation and hence relieving US shareholders of controlled foreign corporations ( many of them possibly the same too-big-to-fail banks) of further US taxpaying obligations.  (This notice continued the nonenforcement decision Treasury had made in 2008, in Notice 2008-91.  Too bad decisions do not make a good decision.)

2) The Supreme Court should resolve to deal with the problem of financial institutions claiming patent protection for all kinds of financial software and financial engineering "solutions" and for others claiming patent protection for tax planning strategies by releasing a decision in the Bilski case that clarifies the "abstract idea" exception.  The Court should say that no patent can be granted for innovations that merely utilize the positive laws to assert that a transaction carried out in a particular way will have a particular legal result, or for other methods of conducting transactions or of organizing human activity that do not involve the technological arts, as understood under European patent law.

3)  Congress should resolve to end the preferential treatment of those few Americans who own most of the financial assets of the country by ending the capital gains preference.

4) Congress should resolve to eliminate the preferential tax treatment of the earned income of hedge fund and equity fund managers (the so-called "carried interest"), and any other "partners" that manage partnerships and earn a share of the partnership's gains as their compensation (such as real estate partnerships).

5) In order to restore some sort of balance between worker and employer, Congress should eliminate the business deduction for any compensation in excess of 20 times the average salary (about $1 million).  The cap on compensation deduction to apply to compensation in any form (stock, assets, cash), whether or not "performance related". 

6) In order to treat the gifts of ordinary Americans to charities of their choice the same as the gifts of multi-millionaires to charities of their choice, Congress should repeal the special rule that permits a charitable contribution deduction for the value of stocks rather than the investment basis in the stocks.  Will that limit contributions that are made?  Perhaps, though it is clear that contributors do so for many reasons and not merely for the contribution deduction.  

7) Congress should resolve to resolve the estate tax situation once and for all, before some do-nothing heir-to-be decides that 2010 is the right time for the wealthy person in his life to go.  Congress should enact a modest exemption of $2 million but should make the estate tax rates progressive (beginning at2009s 45%, but moving up to at least 65% for the largest estates). 

8) Congress should resolve to revisit the tax brackets.  We have an economy in which the average income is around $50,000, but there are individuals who make more than $500 million a year.  That spread is so large that it cannot be adequately addressed by brackets that focuse on the first $350,000 or so.  Those who make $200 million a year have incredibly more freedom of choice, and the few dollars they pay in taxes are merely peanuts compared to the precious funds from an average family.  We need to make the income tax more progressive by adding additional rate brackets--perhaps as many as 3 or 4 more.  That would still be a far cry from the income tax system before Reagan took office, when we had top rates more than double today's top rates.  But it would address the dire fiscal need of the country in a way that is doable without creating undue suffering.

9) Congress and Treasury should resolve to clean up the partnership tax rules so that they do not offer such extraordinary flexibility to partners to arrange their affairs to avoid taxation--for example, by eliminating the electivity permitted to partners in many places in the rules (make the remedial method the only method allowed for taking into account book-tax disparities in contributed property) and by changing the way that partners take account of partnership debt (such as being able to get distributions of nonrecourse debt that monetize partnership property appreciation). 

10) Congress should re-visit the rules on mergers and acquisitions, so that a tax-free merger becomes an unusual event.  Part of the problem we are facing today is that multinational corporations have grown so big that they wield enormous power globally and can sometimes appear to be able to order laws to suit them.  Witness the fact that we are well beyond the beginnings of the financial system crisis, and no single piece of legislation imposing new and better regulations on the banks have been enacted.  The size of corporations ensures that they will become as focused on raising rents for their managers as they will on making profits for shareholders, and that they will care not one whit for the ordinary American who is their customer, or their low-wage employee, or the resident of a town that they leave derelict when they move to sunnier shores.  We say that the rationale for tax-free reorganization provisions is to encourage efficient organization of corporations.  But efficiency is not God, and in fact focus on efficiency may leave democracy and fairness far behind.  We should give tax-free treatment only to shareholders who get no boot for any of their stock, and only in transactions where a high percentage of the consideration is stock (perhaps 80% or more). 

 

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.