The Fourth Circuit of the United States Court of Appeals recently affirmed a decision involving Section 41 of the Internal Revenue Code, which encompasses the Research and Development (R&D) Tax Credit. Specifically, on June 24, 2024, the Fourth Circuit upheld a Tax Court decision in favor of the Internal Revenue Service (IRS).
The central issue of the case is the treatment of qualified expenditures utilized in two tax credits by the pharmaceutical company, United Therapeutics. United Therapeutics claimed qualified expenditures for both the R&D Tax Credit and the orphan drug credit, governed by Section 45 of the Internal Revenue Code (IRC). The orphan drug credit allows for pharmaceutical companies to claim a federal credit on a percentage of “qualified clinical testing expenses.” This credit is meant to incentivize companies to develop drugs and treatments for rare diseases, where ordinarily such companies would have no prevailing financial incentive to do so. As testing expenses can qualify as “qualified research expenses,” United Therapeutics claimed qualified testing expenses both under Section 41 and Section 45 in tax year 2014.
However, Congress anticipated that the potential expenses for Section 41 and Section 45 credits would overlap, and included a coordination provision in Section 45, which accounted for such a scenario. This provision holds that if a company claims testing expenses under Section 45 for the orphan drug credit, it cannot claim those same expenses for the R&D Credit. Further, the testing expenses still must be included in the baseline expenditures for the R&D Credit to ensure that the R&D Credit does not become inflated with the removal of such expenses in a calculation.
United Therapeutics was audited by the IRS, and the Commissioner found that United Therapeutics claimed testing expenses under Section 45, but improperly removed these testing expenses out of their baseline R&D calculation, which significantly increased its R&D Credit for tax year 2014. United Therapeutics argued that its treatment of expenses was proper. Specifically, United Therapeutics viewed the statutory language of Section 45 as moot, due to more recent Congressional changes to Section 41, and further argued that the language also disregarded the consistency rule central to consistent treatment of expenses for Section 41. Additionally, United Therapeutics argued the definition of a “base period” should be interpreted differently to the plain interpretation held by the tax court.
The Fourth Circuit ultimately agreed with the tax court on all arguments, agreeing that both the language of Section 45’s coordination provision, and the updates to Section 41, do not negate the applicability of the coordination provision.
If you are a company interested in tax credits and savings, the expertise of CTI can be invaluable. Our legal and tax experts will ensure that your expenditures and overall tax position are in compliance with the current guidance, and can answer any questions you might have about your qualification.
