October 10, 2017
Appeal from the United States Tax Court (T.C. No. 13-10729)
Tax Court Judge: Honorable Albert G. Lauber
Killian [Argued] Robert R. Martinelli Michael E. Kenneally
Morgan, Lewis & Bockius LLP William F. Colgin, Jr.
Morgan, Lewis & Bockius LLP Attorneys for Appellant.
A. Hubbert Acting Assistant Attorney General Bruce R. Ellisen
Clint A. Carpenter [Argued] United States Department of
Justice Attorneys for Appellee.
Before: HARDIMAN, SHWARTZ, and ROTH, Circuit Judges.
HARDIMAN, Circuit Judge.
appeal requires us to decide whether royalties paid on a
technology license agreement should have been treated as
ordinary income or as capital gains. The distinction is
significant for taxpayers like the Appellant, Dr. Spiridon
Spireas, who earned $40 million in such royalties over just
two tax years. If those earnings were ordinary income,
Spireas owed a 35 percent tax; if they were capital gains he
owed 15 percent.
claimed the favorable capital gains treatment pursuant to 26
U.S.C. § 1235(a), which applies to money received
"in consideration of" "[a] transfer . . . of
property consisting of all substantial rights to a
patent." The Commissioner of Internal Revenue disagreed
that Spireas was entitled to § 1235(a) treatment,
finding that Spireas should have treated the royalties as
ordinary income. Accordingly, the Commissioner gave Spireas
notice of a $5.8 million deficiency for the 2007 and 2008 tax
years. Spireas petitioned the Tax Court for a redetermination
of the deficiency, but after a brief trial the Tax Court
agreed with the Commissioner. Spireas appeals that final
paid under a license agreement are usually taxed as ordinary
income. An exception to this general rule is found in section
1235 of the Internal Revenue Code, which affords special
treatment to payments earned from certain technology
transfers. The statute provides that "[a] transfer . . .
of property consisting of all substantial rights to a patent
. . . by any holder shall be considered the sale or exchange
of a capital asset held for more than 1 year." 26 U.S.C.
§ 1235(a). Payments made "in consideration of,
" id., transfers that meet the statutory
criteria are taxed at a long-term capital gains rate that can
be about half of that applicable to ordinary income.
Compare 26 U.S.C. § 1(a), (i)(2) (2008)
(providing a top marginal rate of 35 percent for married
taxpayers filing jointly), with 26 U.S.C. §
1(h)(1)(A)-(C) (2008) (providing a top rate of 15 percent for
most long-term capital gains).Section 1235's basic
requirements are straightforward. To qualify for automatic
capital-gains treatment, income must be paid in exchange for
a "transfer of property" that consists of "all
substantial rights" to a
"patent." Id. § 1235. As this case
illustrates, not every transfer of "rights" will
suffice because the statute grants capital gains treatment
only to transfers of property.
is a pharmaceutical scientist who, with Dr. Sanford Bolton,
invented "liquisolid technology." That term
describes certain drug-delivery techniques meant to
facilitate the body's absorption of water-insoluble
molecules taken orally. It is not, however, a
one-size-fits-all solution. Rather, each application of
"liquisolid technology . . . is specific to a particular
drug." App. 50-51 (Stipulation ¶ 21). And creating
a clinically-useful liquisolid formulation of a given drug is
not a matter of rote recipe; it requires creating, through
trial and error, a process specific to the substance
uniqueness of each liquisolid formulation meant that
commercializing the technology was a tricky business. Before
a drug could go to market in liquisolid form, a specific
formulation had to "progress from . . . conception to .
. . prototyp[ing] . . ., to extensive further development, to
a form that c[ould] be . . . sold to the public, to actual
manufacture for sale . . ., and, finally, to actual marketing
to the public." See 1-6 William H. Byrnes &
Marvin Petry, Taxation of Intellectual Property and
Technology § 6.02 (2017). Like most inventors,
Spireas was unable to do all that alone, so in June 1998 he
signed a licensing agreement with an established drugmaker,
Mutual Pharmaceutical Co. (the 1998 Agreement). The 1998
Agreement established a comprehensive framework for licensing
liquisolid technology to Mutual, selecting prescription drugs
to develop using the technology, developing and selling those
drugs, and paying Spireas royalties out of the proceeds.
the 1998 Agreement, Spireas granted Mutual two sets of
exclusive rights: a circumscribed grant of rights to
liquisolid technology and a much broader set of rights to
specific drug formulations developed using that technology.
First, the 1998 Agreement granted Mutual "[t]he
exclusive rights to utilize the Technology, " but
"only to develop [liquisolid drug] Products
that Mutual . . . and [Spireas] . . . [would] unanimously
select." App. 69 (1998 Agreement § 2.1.1) (emphasis
added). Second, Mutual received "[t]he exclusive right
to produce, market, sell, promote and distribute . . . said
Products." Id. (1998 Agreement § 2.1.2).
allocated Spireas and Mutual their respective rights to the
liquisolid technology and liquisolid products, the 1998
Agreement established a multistep process for producing
marketable products and paying Spireas for his work. That
process began when Spireas and Mutual "select[ed] a
specific Product to develop." App. 72 (1998 Agreement
§ 5.1). Selections had to be unanimous and made in
writing. The parties' practice was to memorialize their
selections in letters noting the "formal engagement of
[Spireas] and Mutual" for a particular product. 1 T.C.
Rec. 262-75. Once the parties were so engaged with respect to
a particular drug, the process continued with the development
of a practical liquisolid formulation, clinical testing, FDA
approval, and actual marketing. And as sales were made and
funds were received, Mutual would pay Spireas a 20 percent
royalty on the gross profits it earned from liquisolid
March 2000, Spireas and Mutual entered into an engagement
letter (the 2000 Letter) in accordance with the 1998
Agreement. The 2000 Letter engaged Spireas to develop, using
liquisolid technology, a generic version of a blood-pressure
drug called felodipine. That development process succeeded
after what the Tax Court found was "considerable work .
. . to adapt [liquisolid technology] to felodipine's
idiosyncrasies." Spireas v. Comm'r of Internal
Revenue, T.C. Memo 2016-163, 2016 WL 4464695, at *6
(Aug. 24, 2016). Spireas completed those efforts in
relatively short order. "When he signed the March 2000
engagement letter, [Spireas] had completed roughly 30% of the
work that ultimately resulted in" the liquisolid
formulation of felodipine that he finished inventing
"sometime after May 2000." Id. at *6, *10.
approved Mutual's Abbreviated New Drug Application for
liquisolid felodipine, and Mutual marketed it to great
success. During the relevant time period, Spireas's
royalties on felodipine sales totaled just over $40 million.
Spireas reported all of those royalties as capital gains on
his personal returns for tax years 2007 and 2008.
2013, the Commissioner sent Spireas a notice of deficiency
for 2007-2008. "The deficiencies arose from [the
Commissioner's] conclusion that the Royalties [Spireas]
received under [the 1998 Agreement] are taxable as ordinary
income rather than as capital gain." Spireas,
2016 WL 4464695, at *1. The Commissioner determined that the
royalties under the 1998 Agreement should have been treated
as ordinary income, and Spireas therefore owed some $5.8
million in additional taxes.
receiving the Commissioner's notice of deficiency,
Spireas petitioned the United States Tax Court for a
redetermination, and a brief trial was held. The main dispute
in the Tax Court was whether Spireas had satisfied §
1235's requirement that he transfer "all substantial
rights to a patent." Spireas, 2016 WL 4464695,
at *8-9. IRS regulations define "all substantial rights
to a patent" to mean "all rights . . . which are of
value at the time the rights to the patent . . . are
transferred." 26 C.F.R. § 1.1235-2(b)(1); see
also E.I. du Pont de Nemours & Co. v. United States,
432 F.2d 1052, 1055 (3d Cir. 1970).
Tax Court put it, the parties' differences were
"encapsulated in the question: 'All substantial
rights to what?'" Spireas, 2016 WL
4464695, at *9. The Commissioner argued that the dispositive
point was Spireas's admitted failure to transfer all his
rights to liquisolid technology generally. Mutual
was not free to exploit every one of the technology's
"potential application to thousands of drugs, "
id. at *12, and could only develop and sell those
"Products that Mutual . . . and [Spireas] . . .
unanimously select[ed], " App. 69 (1998 Agreement §
2.1.1). Spireas acknowledged that he had retained valuable
rights in the overall technology, but emphasized that he had
transferred away all of his rights to the liquisolid
formulation of felodipine. Spireas, 2016 WL
4464695, at *9.
Court agreed with the Commissioner. It held that Spireas
could not have transferred the rights to any particular
liquisolid products in 1998 because no products existed at
that time. Id. Thus, the only rights Spireas could
have granted Mutual in 1998 were in liquisolid technology
generally-"the rights to use the liquisolid technology .
. . and to make and sell any 'Products containing the
Technology.'" Id. And since Spireas had
granted Mutual far less than "all substantial
rights" to the overall liquisolid technology, the
royalty payments he received in 2007 and 2008 did not satisfy
the requirements of § 1235 and were thus taxable as
ordinary income. Id. at *14.
the Tax Court entered its final order, Spireas timely
argument on appeal is clear: his royalty payments qualify for
capital-gains treatment under § 1235 because he received
them in exchange for "all substantial rights" to
liquisolid felodipine. Spireas claims the 1998 Agreement
prospectively assigned Mutual the relevant rights
long before he actually invented that particular formulation.
The Commissioner responds that Spireas has waived any
argument based on a prospective transfer of rights by not
presenting it to the Tax Court. Spireas replies by declaring
that his "position has been consistent." Reply Br.
ipse dixit is contrary to the record. In the Tax
Court, Spireas asserted a transfer of rights that took place
sometime "after [the felodipine formulation] was
invented, " 2 T.C. Rec. 323 (Spireas T.C. Opening Br. 12
¶ 40), which happened "sometime between the end of
2000 and spring 2001." 2 T.C. Rec. 319 (Spireas T.C.
Opening Br. 8 ¶ 23). Indeed, Spireas could hardly have
been more explicit that he "did not transfer
the felodipine technology in 1998." 2 T.C. Rec. 322
(Spireas T.C. Opening Br. 11 ¶ 36) (emphasis added). In
the Tax Court Spireas argued the "fundamental" view
that it was the post-March 2000 transfer of the felodipine
formulation that "constituted a transfer of 'all
substantial rights'" to Mutual. 2 T.C. Rec. 326-27
(Spireas T.C. Opening Br. 15-16).
dissenting colleague disputes our reading of the record,
contending that "Spireas [has] presented a complicated
but consistent argument throughout, " and that further
consideration of waiver is therefore "not
necessary." Dissent at 8, 11. The dissent makes two
arguments to that effect, neither of which we find
the dissent emphasizes the many points of commonality between
Spireas's position here and in the Tax Court. To be sure,
Spireas has consistently "relie[d] on both the 1998
Agreement and the March 2000 Engagement letter, " and
argued that they "operat[ed] in conjunction" to
transfer to Mutual rights to liquisolid felodipine. Dissent
at 1. And the dissent rightly notes that Spireas has always
maintained that those two documents are "of a piece and
related, " making up a "consistent course of
dealing, " Dissent at 2, and that the ultimate terms on
which Mutual obtained "rights to drug 'Products'
. . . depended upon the terms of the 1998 Agreement, "
Dissent at 3.
absent, however, from that discussion of which
instruments served to transfer rights in liquisolid
felodipine is any mention of when Spireas claimed
that transfer took place. The dissent appears to suggest that
Spireas's consistency on the former point suffices to
insulate him from waiver. Dissent at 5 ("Spireas's
consistent emphasis on the same contractual provisions
distinguishes his case from cases in which we have found
waiver."). But where waiver is concerned, the question
is not whether a party's position has been mostly
consistent, or generally inclined toward the same subject as
that raised on appeal, but whether the same
"theory" was "squarely" raised in the
trial court. Doe v. Mercy Catholic Med. Ctr., 850
F.3d 545, 558 (3d Cir. 2017) (citing United States v.
Joseph, 730 F.3d 336, 338-42 (3d Cir. 2013)). So even
accepting at face value the dissent's account of
Spireas's consistency on some issues, that sheds no light
on whether Spireas has waived his new (and contradictory)
argument regarding the timing of the transfer.
dissent's second point-that Spireas has been consistent
in distinguishing between legal transfer of rights
to felodipine in 1998, followed by a physical handover of
possession in 2000-fares no better. Although that
argument does address Spireas's timing theory head-on,
its core premise is belied by the record. As we have noted,
Spireas's opening brief to the Tax Court made his
position clear: (1) "Spireas transferred the felodipine
. . . technolog[y] . . . at some point after March 2000,
" and (2) "Spireas' transfer . . .
constituted a transfer of 'all substantial
rights' . . . to [Mutual]." 2 T.C. Rec. 327
(Spireas T.C. Opening Br. 16) (emphasis added).
dissent's distinction between an earlier "legal
transfer" and subsequent "physical transfer"
exists only in what we find to be a strained reading of the
single oral colloquy quoted in that opinion. See
Dissent at 6. Spireas's briefing discussed only a single
"transfer" that allocated "rights"
(whether or not it involved a physical handover as well). 2
T.C. Rec. 327 (Spireas T.C. Opening Br. 16). We will not read
an isolated extemporaneous exchange to advance a theory so at
odds with the one Spireas labeled "fundamental" in
his written submissions. 2 T.C. Rec. 326 (Spireas T.C.
Opening Br. 15).
our seminal precedent in United States v. Joseph,
730 F.3d 336 (3d Cir. 2013), the Commissioner contends that
Spireas cannot argue on appeal that he transferred rights to
felodipine in 1998 after he took the contrary position in the
Tax Court. See also Gen. Refractories Co. v. First State
Ins. Co., 855 F.3d 152, 162 (3d Cir. 2017) (applying
Joseph to a civil case). Under Joseph,
"merely raising an issue that encompasses the
appellate argument is not enough." 730 F.3d at 337.
Whether an argument remains fair game on appeal is determined
by the "degree of particularity" with which it was
raised in the trial court, id. at 341, and parties
must do so with "exacting specificity, "
id. at 339. "[O]ur precedents reveal at least
two characteristics that identical arguments always have.
First, they depend on the same legal rule or standard.
Second, the arguments depend on the same facts."
Id. at 342 (citation omitted).
even under that strict standard, Spireas's shifting
position on the fact of when Mutual obtained its
rights in liquisolid felodipine does not necessarily mean his
entire argument is waived. Applying
Joseph's particularity analysis is not a matter
of comparing every stray statement or claim made in the Tax
Court. Rather, Joseph instructs us to compare
arguments, a term that we have explained is synonymous with
"theories, " "grounds, " or
"bases" for "granting relief." 730 F.3d
at 340-42. To be sure, Joseph teaches that two
arguments can be the same only if they "depend on the
same facts, " id. at 342, but not every fact
that appears in a brief is one on which an argument
"depends." Whether an argument "depends"
on a given fact requires reference to the applicable legal
standard. As the Supreme Court has observed in another
context, "the substantive law"-in this case, §
1235 of the Internal Revenue Code-"will identify which
facts are material." Anderson v. Liberty Lobby,
Inc., 477 U.S. 242, 248 (1986).
§ 1235's test for capital-gains treatment, changing
the date on which Spireas granted Mutual rights to liquisolid
felodipine changes the legal theory on which his position
depends. Spireas's royalty payments are entitled to
capital-gains treatment only if Mutual paid them in exchange
for a transfer of "property consisting of all
substantial rights" to the liquisolid formulation of
felodipine. 26 U.S.C. § 1235(a) (emphasis added).
Spireas cannot make that argument for the first time on
appeal because it depends on a different legal standard for
when that formulation became "property" than his
argument to the Tax Court.
1235 is explicit that in order to secure capital-gains
treatment, an inventor must make a transfer of property
rights that he actually possesses at the time of the
grant. Accordingly, Spireas had to explain: (1) when he
granted Mutual rights to liquisolid felodipine, and (2) how
he obtained a property interest in that formulation prior to
the grant. The account Spireas presented to the Tax Court was
clear: he granted Mutual its rights after the
invention of the liquisolid formulation was complete, which
happened sometime after March 2000. 2 T.C. Rec. 327 (Spireas
T.C. Opening Br. 16).
timeline included a straightforward theory of when and how
Spireas obtained his interest in the felodipine formulation.
To possess a transferable property interest in an invention,
the inventor generally must have "reduced [it] to actual
practice." See Burde v. Comm'r of Internal
Revenue, 352 F.2d 995, 998 n.3 (2d Cir. 1965); see
generally Byrnes & Petry, supra, §
6.05. That basic patent-law rule accords with
the text of § 1235, which provides that a non-inventor
may be a patent "holder" entitled to capital-gains
treatment on the proceeds of a subsequent transfer only if he
obtained his interest in exchange for consideration paid to
the inventor prior to the invention's "actual
reduction to practice." 26 U.S.C. § 1235(b)(2). Put
another way, "actual reduction to practice" is the
line between a transfer of a then-existing
"property" interest (which entitles the
holder-transferor to immediate capital gains
treatment) and a transfer or grant of some other legal
interest (which makes the transferee the new
"holder" entitled to pay the capital gains rate
against the proceeds of a transfer that takes place
after a subsequent reduction to practice).
reduction to practice" is a term of art in patent law,
see generally U.S. Patent and Trademark Office,
Manual of Patent Examining Procedure §
2138.05(II) (9th ed. Rev. 7, Nov. 2015), that has a slightly
looser meaning in the tax context. "Generally, an
invention is reduced to actual practice when it has been
tested and operated successfully under operating
conditions." 26 C.F.R. § 1.1235-2(e). The Tax Court
decision from which the IRS borrowed that language clarifies
things a bit further: "it [is] not necessary that
testing . . . proceed to the point where the invention was
actually ready to be put into commercial production . . .,
but rather . . . that the tests should suffice to persuade .
. . that the ...