Guest Post: Transfer Prices Are an Evidentiary Gold Mine for Patent Defendants
Guest Post by Andrew Blair-Stanek, Assistant Professor of Law at University of Maryland Carey School of Law
Patent owners routinely tell the IRS, under penalties of perjury, that their patents have little value. Litigators representing defendants should take advantage of these remarkable admissions.
IP has become the world’s leading tax shelter. Multinational corporations develop IP in the U.S. and promptly transfer it for artificially low prices to subsidiaries in tax havens, where profits from the IP escape tax. As IP becomes increasingly essential to economic activity, more and more profits have been siphoned off to tax havens. The low transfer price is crucial to this strategy, minimizing the tax paid in the U.S. Tax law cannot easily stop this abuse, because of international tax law norms enshrined in bilateral tax treaties.
But this tax avoidance presents great opportunities for litigators representing IP defendants sued by multinationals. As I discuss in a new UCLA Law Review article, defendants can discover transfer-pricing evidence and use it to argue for invalidity, non-infringement, lower damages, and no injunctions.
For example, a low transfer price for a patent weighs towards lower damages. Tax law requires multinationals to use a transfer price equal to a patent’s fair market value. Multinationals must hire appraisers to justify this valuation and then attest that the valuation is accurate under penalties of perjury. The fair market value of a patent approximately equals the profits or royalties that it is expected to generate, so a low transfer price is an admission by the multinational that it expected low profits or royalties. Since patent damages are measured by either lost profits or royalties, the low transfer price is evidence weighing towards lower damages.
As another example, a patent’s low transfer price is nontechnical evidence – akin to the existing secondary considerations – that the patent is invalid for obviousness. Obviousness is measured by reference to a person having ordinary skill in the art before the patent application’s filing date. To minimize taxes, multinationals typically transfer patent rights as soon as possible, often around the same time the patent application is filed. A multinational is ideally situated to evaluate how substantial the advance was, because it employs the inventors, who have ordinary or above-ordinary skill in the art. In short, low transfer prices are admissions, at the relevant time, by an ideally-situated party, that the invention was not a substantial advance.
A low transfer price also negates evidence of a patent’s commercial success. Courts consider commercial success to be evidence of nonobviousness under the reasoning that if the invention had been both obvious and lucrative, then someone would have thought of it earlier. But this reasoning rests on the implicit assumption that the invention’s potential commercial success was perceived before its development. A low transfer price refutes this implicit assumption and severs any logical connection between commercial success and nonobviousness. A low transfer price proves that the multinational perceived little potential commercial success from the invention, even after its development.
Low transfer prices can also help defendants fight injunctions, which require the patentee to demonstrate that it faces irreparable injury that cannot be compensated by damages. But a patent’s value roughly correlates with the maximum damages for infringing it. A low transfer price for a patent demonstrates that harm from infringement can be quantified and, indeed, was quantified at a low number.
The transfer prices themselves are only half of the evidentiary gold mine. IRS regulations require that multinationals hire appraisers to prepare rigorous documentation justifying the low transfer prices as accurate valuations. This documentation typically makes as strong a case as possible that the patents have little profit or royalty potential. Sometimes the documentation even contains damaging opinions or facts about the patent’s validity or scope.
My article’s arguments do not impact patents transferred between unrelated parties, such as an individual inventor selling a patent to a manufacturer. When unrelated parties sell or license patents, the prices can reflect any number of distortions ranging from information asymmetries to differences in bargaining power. None of these distortions exist when a multinational transfers a patent to its own tax-haven subsidiary.
Individual inventors, start-ups, and other small businesses cannot avoid taxes by transferring their IP to tax-haven subsidiaries. Multinationals can. This advantage distorts the employment market for scientists and engineers, making them more likely to work for multinationals. This distortion likely reduces the overall progress of the useful arts, given the higher research productivity of start-ups and other small firms. By making the arguments discussed in the article, litigators representing patent defendants can not only serve their clients’ interests, but also reduce this distortion.
In sum, during discovery, patent defendants should request transfer prices and the supporting appraisal documentation.
