[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
HEARING ON ISSUES RELATING TO
THE PATENTING OF TAX ADVICE
=======================================================================
HEARING
before the
SUBCOMMITTEE ON SELECT REVENUE MEASURES
of the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
JULY 13, 2006
__________
Serial No. 109-77
__________
Printed for the use of the Committee on Ways and Means
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30-450 PDF WASHINGTON : 2006
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COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
E. CLAY SHAW, JR., Florida CHARLES B. RANGEL, New York
NANCY L. JOHNSON, Connecticut FORTNEY PETE STARK, California
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
PHIL ENGLISH, Pennsylvania JOHN S. TANNER, Tennessee
J.D. HAYWORTH, Arizona XAVIER BECERRA, California
JERRY WELLER, Illinois LLOYD DOGGETT, Texas
KENNY C. HULSHOF, Missouri EARL POMEROY, North Dakota
RON LEWIS, Kentucky STEPHANIE TUBBS JONES, Ohio
MARK FOLEY, Florida MIKE THOMPSON, California
KEVIN BRADY, Texas JOHN B. LARSON, Connecticut
THOMAS M. REYNOLDS, New York RAHM EMANUEL, Illinois
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
BOB BEAUPREZ, Colorado
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
DEVIN NUNES, California
Allison H. Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
______
SUBCOMMITTEE ON SELECT REVENUE MEASURES
DAVE CAMP, Michigan, Chairman
JERRY WELLER, Illinois MICHAEL R. MCNULTY, New York
MARK FOLEY, Florida LLOYD DOGGETT, Texas
THOMAS M. REYNOLDS, New York STEPHANIE TUBBS JONES, Ohio
ERIC CANTOR, Virginia MIKE THOMPSON, California
JOHN LINDER, Georgia JOHN B. LARSON, Connecticut
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
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C O N T E N T S
__________
Page
Advisory of June 22, 2006 announcing the hearing................. 2
WITNESSES
James Toupin, General Counsel, U.S. Patent and Trademark Office.. 5
The Honorable Mark Everson, Commissioner, Internal Revenue
Service........................................................ 11
______
Richard S. Gruner, Professor of Law, Whittier Law School, Costa
Mesa, California............................................... 24
Ellen Aprill, Associate Dean of Academic Programs, Professor of
Law, and John E. Anderson, Chair in Tax Law, Loyola Law School,
Los Angeles, California........................................ 36
Dennis I. Belcher, Partner, McGuireWoods LLP, Richmond, Virginia. 42
SUBMISSIONS FOR THE RECORD
Gavalis, Albert, Graf Repetti & Co., Llp, New York, NY, statement
and attachment................................................. 59
Schreiner, Stephen, Hunton & Williams Llp, statement............. 59
HEARING ON ISSUES RELATING TO
THE PATENTING OF TAX ADVICE
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THURSDAY, JULY 13, 2006
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:30 a.m., in
room B-318, Rayburn House Office Building, Hon. Dave Camp
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
SUBCOMMITTEE ON SELECT REVENUE MEASURES
CONTACT: (202) 226-5911
FOR IMMEDIATE RELEASE
June 27, 2006
SRM-9
Camp Announces Hearing on
Issues Relating to the Patenting of Tax Advice
Congressman Dave Camp (R-MI), Chairman, Subcommittee on Select
Revenue Measures of the Committee on Ways and Means, today announced
that the Subcommittee will hold a hearing on issues relating to the
patenting of tax advice. The hearing will take place on Thursday, July
13, 2006, in B-318 Rayburn House Office Building, beginning at 10:30
a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only. However,
any individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Subcommittee and
for inclusion in the printed record of the hearing.
BACKGROUND:
In recent years, patents for ``business methods'' have been issued
by the Patent and Trademark Office. A number of patents have been
issued for tax reduction strategies, particularly in the area of estate
and gift taxation.
In announcing the hearing, Chairman Camp stated, ``This hearing is
an opportunity to explore a relatively recent phenomenon. At first
glance, it seems odd that anyone should be permitted to patent means of
complying with federal law. While intellectual property experts rightly
note that patents can help promote the development of new technologies
and ideas, tax practitioners have expressed concerns about giving one
person the ability to charge others for using relatively common
structures. We also need to get a sense of whether patents may
contribute to tax avoidance schemes which make the IRS's job of
blocking tax shelters more difficult in the long run.''
``There are no preconceived goals here,'' Camp noted. ``We want to
explore this development and that's why we're inviting the IRS, the
Patent and Trademark Office, academicians and practitioners to give us
their views of the practice.''
FOCUS OF THE HEARING:
To explore issues relating to the issuing of patents for tax
reduction strategies, particularly in the area of estate and gift
taxation.
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Chairman CAMP. Good morning, the Committee on Ways and
Means on Select Revenue will come to order. Today, we will
explore a relatively recent phenomenon, patenting tax methods
and strategies. To date, only a few patents have been issued
for business methods involving the Tax Code. However, we are
examining what the practice might mean to taxpayers and the
legislative process if it expands. This hearing is about the
overlap of two important Federal policies: patents and general
tax compliance. With patents, the government seeks to promote
public access to innovative products and developments by
providing inventors with the ability to control the use of an
invention for a period of years. Tax legislation is generally
written with the idea that the rules, and particularly those
rules that provide benefits, ought to be equally available to
every eligible taxpayer.
Our panelists have been invited to provide us with an
overview of how key government agencies are dealing with this
phenomenon and perspectives on potential pluses and minuses
such patents may have. There are two major issues we will
explore with them. First, does the existence of a patent appear
to legitimize an otherwise inappropriate tax arrangement and
thereby contribute to tax compliance problems or, worse, create
a misunderstanding of our tax laws. Second, and perhaps more
important over the long term, is the effect of patents on
taxpayers seeking to comply with enacted laws intended to
benefit broad groups.
Our first panel includes James Toupin, general counsel of
the Patent and Trademark Office (USPTO) and an individual well
known to many of us, Internal Revenue Service (IRS)
Commissioner Mark Everson. Their agencies have been working
together on matters related to tax patents, including
increasing scrutiny and awareness.
The second panel includes Members of the academic
community, Professor Richard Gruner, who teaches intellectual
property and Whittier Law School; and Professor Ellen Aprill,
who teaches tax law at Loyola Law School in Los Angeles. Our
third witness, Dennis Belcher, is a partner at the McGuireWoods
Law Firm, who practices estate and trust administration and
estate planning, as well as serving as the secretary of the
American College of Trust and Estate Counsel. He will offer a
perspective from the practitioner's point of view. The panel
will give Members an opportunity to evaluate the pros and cons
of patenting tax compliance concepts and views on what might be
done to expand the transparency of the patent process to reduce
risks to taxpayers.
I would now yield to the Ranking Member, Congresswoman
Stephanie Tubbs Jones, for any remarks she would choose to
make.
Ms. TUBBS JONES. Any day I could be Ranking Member or a
Chair, I can't wait, okay. Hi, everybody.
Chairman CAMP. Let's hope it is a little bit of a wait.
Ms. TUBBS JONES. Okay, all right. No offense, Dave. In
1998, the U.S. Court of Appeals' decision held that tax
strategies and financial products could be protected as
patentable ``business methods.'' This has led to the issuance
of about 40 tax patents by the U.S. Patent and Trademark
Office, and 60 more are pending. I could go on and read this
but everybody knows why we are here. I will submit this written
opening statement for the record. I am pleased to have the
opportunity to get engaged in this discussion. When I realized
this is what we were going to do, I called a couple of my
friends who do patent work and then some who did tax work. They
said, ``We are not paying any attention to that.'' I said,
``Wait a minute, it is important.'' So, I sent them the
information, I am hoping to get some outside response to this
whole issue.
Gentlemen, I am glad to have you both here. If you see me
slip out, it is only for a moment. All of you recognize that
the Voting Rights amendment Act (P.L. 109-246) is being debated
this morning, and I have got to go put my two cents in. Once I
do that, I will go and come back. I am really interested, and I
thank the Chairman for calling this hearing. I think it is
going to be very interesting.
[The prepared statement of Ms. Tubbs Jones follows:]
In 1998, a U.S. Court of Appeals decision held that tax
strategies and financial products could be protected as
patentable ``business methods.'' This has led to the issuance
of about forty tax advice patents by the U.S. Patent and
Trademark Office, and sixty more are pending. These patents
involve, for example, techniques for converting a regular IRA
to a Roth IRA, creating tax-deferred real estate exchanges,
enhancing donations of artwork through a tax-exempt
organization, performing tax computations and tax-advantaged
transactional structures, and converting future Social Security
payments into current benefits. The most controversial patent
to the tax practitioner community is called SOGRAT.
It involves techniques for transferring appreciated assets
to family Members while incurring minimal estate and gift
taxes. Such a patented estate tax strategy, and others that are
not patented but are still common, begs the question of whether
we need to eliminate or drastically reduce the estate tax. That
said, I think that the following basic issues should be
addressed at this hearing: At the outset, should tax advice be
eligible for a patent--as an ``invention'' based on
interpretation of the Tax Code and IRS regulations? Should tax
patent holders be able to control, and potentially profit from,
application of the tax laws as enacted by Congress? What role
does the IRS have to ensure that aggressive tax schemes or
illegal shelters do not receive patents? Are tax patents being
used as marketing tools to mislead taxpayers into believing
that the product they are buying has a federal government
``seal of approval?''
I look forward to discussing these issues with the Internal
Revenue Service, the U.S. Patent and Trademark Office, and the
tax experts joining us today as witnesses. Thank you, Mr.
Chairman, I yield back the balance of my time. Chairman Camp.
Thank you. Again, I also want to welcome our witnesses. We will
start with Mr. Toupin. Thank you both for being here. I know
you have very busy schedules. We have your full statements,
those will be part of the record and you can summarize those in
5 minutes. You now may begin. Thank you for being here.
STATEMENT OF JAMES TOUPIN, GENERAL COUNSEL, U.S. PATENT AND
TRADEMARK OFFICE
Mr. TOUPIN. Chairman Camp, Ranking Member Tubbs Jones,
members of the Subcommittee, thank you for inviting me to
testify today on the patenting of business method inventions
concerning tax strategies. I appreciate the opportunity to
provide some background on the subject, which I hope will be
helpful to the Subcommittee.
In administering the U.S. patent laws, the USPTO takes its
direction from Congress and our reviewing courts. The current
act specifies four basic statutory requirements that must be
met to obtain a patent. The claimed invention must define
eligible subject matter and have utility. It must be novel. It
must not have been obvious to a person having ordinary skill in
the art at the time the invention was made. It must be
sufficiently disclosed in the text of the patent application to
show that the inventor had possession of the claimed invention
upon filing, and the skilled practitioner would be able to
practice the claimed invention without undue experimentation.
The threshold inquiry as to whether subject matter is eligible
to receive patent protection is whether an invention is new and
useful and whether it fits into one of the enumerated
categories, which includes any process, machine, manufacturer
or composition of matter or any new and useful improvement
thereof.
As discussed in greater detail in my written statement, the
courts have recognized the breadth of this statute. In
particular, the Court of Appeals for the Federal Circuit in the
1998 decision in State Street v. Signature Financial explicitly
rejected the notion that a business method exception exists in
United States patent law. It thus ended any notion that
inventions deemed to be business methods, by whatever criteria,
would be excluded from patent ability on that basis alone.
State Street created a new awareness that business method
claims could be patented. Patent applications in that area went
from 1,500 filings in Fiscal Year 1998 to approximately 9,000
filings in Fiscal Year 2001. Filings are currently running at a
somewhat lower rate of 8,200 filings a year.
This expansion of business method patent applications
created challenges for the USPTO and the business community.
Because business methods had been commonly not regarded as
eligible for patenting, examiners did not have available to
them a large database of prior art. Thus, in a number of areas
the office undertook extensive outreach to assure that it had
the best possible information on published business methods.
In determining novelty and obviousness, the examiner
consults a variety of databases directed to the subject matter
being examined. For applications involving tax strategies, the
resources include U.S. patent databases, foreign databases, IRS
databases available to the public, and a significant number of
commercial databases directed to accounting, finance, and
banking. Moreover, the examiner will under USPTO rules request
from the applicant information as to which section or sections
of the Tax Code are applicable so that those sections may be
consulted.
To gain knowledge and expand, and improve our examination
of applications relating to tax strategies, the USPTO has
partnered with IRS and is currently consulting with the
American Bar Association's tax section about possible training
and information exchange opportunities. Our existing
partnership with the IRS has resulted in training by the IRS
for our finance examiners on financial products, wealth
transfer, and pensions. The USPTO also provided a modified
patent examiner initial training session to selected IRS
employees. We are looking at proposed training by the American
Bar Association (ABA) that would complement the training that
we received and provided to the IRS. We are also discussing
follow-up training with the IRS on tax strategy matters. We
will continue to conduct business partnership events with
Members of the financial services community at large.
Mr. Chairman, the grant of a patent enables a patent owner
to exclude for a limited time others from making, using,
offering for sale, or selling the invention in the United
States. It is not a license to use the invention or a stamp of
approval by the Federal government. This principle applies to
tax strategy patents as well as to any other patent.We at the
USPTO recognize that the patenting of tax planning strategies
has raised a number of concerns in Congress, the IRS, and the
financial services community. We look forward to working with
all interested parties to make sure that these concerns are
appropriately addressed within the scope of applicable law.
Thank you.
[The prepared statement of Mr. Toupin follows:]
Statement of James Toupin, General Counsel, U.S. Patent and Trademark
Office
Introduction
Chairman Camp, Ranking Member McNulty, and Members of the
Subcommittee:
Thank you for inviting me to testify today on the patenting of
business method inventions, and specifically on those business method
patents concerning tax strategies. Patents in this area are a topic of
considerable interest and debate and, as has been the case in the past
with certain other categories of invention, concerns have been raised
about whether business methods involving tax strategies should be
patentable. I commend the Subcommittee for holding this hearing.
U.S. Patent System
In order to understand the patentability of business method
inventions, I believe it is helpful to first review the underpinnings
of the U.S. patent system itself and the role of the United States
Patent and Trademark Office (USPTO) in administering this system.
The basis for our patent system is found in Article 1, Section 8,
Clause 8 of the Constitution, which provides that Congress shall have
the power:
``To promote the progress of science and useful arts, by securing
for limited times to . . . inventors the exclusive right to their . . .
discoveries.''
Thus, in order to promote the disclosure of new inventions, a
patentee is given the right, for a limited time, to exclude others from
making, using, offering for sale, or selling the invention in the
United States.
Following this Constitutional authority, our Founding Fathers
designed an extremely flexible patent system based on principles that
have proven remarkably adaptable in supporting over 200 years of
economic and technological change. The uniformity and flexibility of
the patenting standards of novelty, non-obviousness, adequacy of
disclosure, and utility--coupled with the incentives patents provide to
invent, invest in, and disclose new technology--have allowed millions
of new inventions to be developed and commercialized. This has enhanced
the quality of life for all Americans and helped fuel our country's
transformation from a small, struggling nation to the most powerful
economy in the world. Equally as impressive, the patent system has
withstood the test of time. This is powerful evidence of the system's
effectiveness in simultaneously promoting the innovation and
dissemination of new products and processes and the creation of new
industries and jobs.
Patentability Criteria and ``Business Methods''
In administering the U.S. patent laws, the USPTO takes its
direction on what subject matter is patentable from Congress and our
reviewing courts. The current Act that details the standards of
patentability, the Patent Act of 1952, specifies four basic statutory
requirements that must be met to obtain a patent: (1) the claimed
invention must define eligible subject matter and have utility; (2) it
must be novel; (3) it must not have been obvious to a person having
ordinary skill in the art at the time the invention was made; and (4)
it must be fully and unambiguously disclosed in the text of the patent
application to show that the inventor had possession of the claimed
invention upon filing and that the skilled practitioner would be able
to practice the claimed invention without undue experimentation.
Before it grants a patent, the USPTO examines each patent
application to determine whether it meets these four criteria, as set
forth in title 35 of the U.S. Code. With respect to the statutory
requirement of eligible subject matter, 35 U.S.C. 101 states that any
person who ``invents or discovers any new and useful process, machine,
manufacture, or composition of matter, or any new and useful
improvement thereof, may obtain a patent . . .'' subject to the
conditions and requirements of the law. Thus, the threshold inquiry as
to whether subject matter is eligible to receive patent protection is
whether an invention is ``new and useful'' and whether it fits into one
of the enumerated categories.
The courts have recognized the breadth of this statute. In the
landmark case of Diamond v. Chakrabarty, 447 U.S. 303 (1980), the U.S.
Supreme Court acknowledged that Congress intended the statutory subject
matter under 35 U.S.C. 101 to include ``anything under the sun that is
made by man.'' The Supreme Court also noted that there are limits to
patentability. Indeed, in Diamond v. Diehr, 450 U.S. 175 (1981), the
Court explicitly identified three specific areas of subject matter that
are excluded from patent protection. These three areas are: (1) laws of
nature, (2) natural phenomena and (3) abstract ideas. Thus, an
invention directed towards a pure algorithm or manipulation of abstract
ideas with no practical application is not patentable.
The broad coverage of the Patent Act helps assure that the patent
system is equally available to provide stimulus for innovation in all
areas, not just some. The growth and importance of computers have led
to a significant increase in investment and development in computer-
related processes, particularly with regard to electronic commerce.
This has inevitably led to more individuals seeking patent protection
in these areas. In response to this increased patent activity, a number
of cases arose in the 1990s involving issues of defining the boundaries
of patent eligibility. Accordingly, the Court of Appeals for the
Federal Circuit rendered a series of decisions following the Supreme
Court in Diehr and Chakrabarty that further defined patentable subject
matter. I would like to briefly discuss these cases, which very clearly
set forth the standards for patentability according to our patent law.
In the case of In re Alappat, 33 F.3d 1526 (Fed. Cir. 1994), the
Court of Appeals for the Federal Circuit, sitting en banc, overturned
the USPTO and found that inventions that include mathematical formulas
or algorithms are not unpatentable if they are practically applied.
Thus, the mere presence of an algorithm within an invention does not
exclude the entire invention from patentability. The key question to be
answered is whether the claimed invention, when looked at ``as a
whole,'' is an abstract idea, such as a disembodied mathematical
concept, or whether the invention produces a practical application,
which achieves a ``useful, concrete and tangible result.''
Four years after In re Alappat came the most well-known case with
regard to business methods: State Street Bank and Trust Co. v.
Signature Financial, Inc., 149 F.3d 1368 (Fed. Cir. 1998). The State
Street case involved a patented data processing system that transformed
data representing discrete dollar amounts into a final share price
momentarily fixed for recording and reporting purposes. The Federal
Circuit noted that a process, machine, manufacture, or composition of
matter employing a law of nature, natural phenomenon, or abstract idea
may be patentable subject matter even though a law of nature, natural
phenomenon, or abstract idea would not, by itself, be entitled to such
protection. As such, the court held that a machine programmed to
transfer data which represents discrete dollar amounts into a final
share price through a series of mathematical calculations does, in
fact, constitute the practical application of a mathematical algorithm,
formula, or calculation because it produced a ``useful, concrete and
tangible result.'' The final share price resulting from this process
enabled investors and their brokers to make investment decisions for
investment and tax advantage purposes.
The significance of State Street goes beyond its immediate holding.
The Federal Circuit in State Street explicitly rejected the notion that
a ``business method'' exception exists in United States patent law,
thereby ending any notion that inventions deemed to be business
methods, by whatever criteria, would be excluded from patentability on
that basis alone. Thus, the State Street decision clarifies that an
invention deemed to be a ``business method'' will be treated in the
same manner as any other method or process invention. In other words,
the patent system is technology neutral and there shall be no disparate
treatment for different categories of inventions. This principle was
reaffirmed by the CAFC in 1999, where the court remanded the case of
AT&T Corp. v. Excel Communications, Inc., 172 F.3d 1352 (Fed. Cir.
1999) to the district court and concluded that had the court applied
the proper analysis, the claimed telephone call tracking method fell
comfortably within the ``broad scope of patentable subject matter under
Sec. 101.''
Business Method Filing Information
While State Street did not change United States law and practice,
it did create a new awareness that business method claims could be
patented. For example, in fiscal year 1998 there were fewer than 1,500
filings in the U.S. classification area 705, which includes much of
what is commonly known as computer-implemented ``business method''
inventions. By contrast, there were approximately 9,000 filings in
fiscal year 2001; approximately 7,400 filings in fiscal year 2002;
approximately 7,700 filings in fiscal year 2003; approximately 8,200
filings in fiscal year 2004; and approximately 8,200 filings again in
fiscal year 2005.
The change in the understanding of the law that led to this
expansion of business method patent applications created challenges for
the USPTO and the business community. In particular, because business
methods had been commonly not regarded as eligible for patenting,
examiners did not have available to them an extensive database of prior
art in the form of existing patents. Accordingly, in a number of
business areas, the Office undertook extensive outreach to the
concerned public to assure its access to the best possible information
on published business methods. In the initial period after the State
Street decision, allowance rates for business method patent
applications were relatively high, but with the Office's and the
public's increasing focus on this art, the allowance rate has fallen.
As of mid-year, fiscal year 2006, the allowance rate for business
method applications was approximately 20%, which is lower than the
overall USPTO patent allowance rate of approximately 54% at mid-year.
Today, the computer-implemented ``business method'' area includes
business practices in many fields such as health care management,
insurance and insurance processing, reservation and booking systems,
financial market analyses, point of sale systems, tax processing,
inventory management, accounting and financial management.
In fiscal year 2005 we hired 36 patent examiners in the business
method area for a total of 132 examiners. Our goal for fiscal year 2006
is to have a total of 160 examiners in this area by the end of the
year.
Recently, subclass 36T in Class 705 has been established and
dedicated to tax strategies.
We have identified 41 issued patents related to tax strategy.
Further, 61 published applications, not yet examined, relate to tax
strategy.
The average pendency to first office action in the tax strategy
area is approximately 44 months and the average pendency to issue or
abandonment is approximately 50 months. Currently, applications in this
area filed in May 2001 are receiving their first office action.
Issurance of Patents
As discussed, the USPTO is charged with examining patents following
certain patentability criteria as enacted by Congress and interpreted
by the courts. In examining patent applications, the Court of Appeals
for the Federal Circuit has recognized that the utility requirement
under 35 U.S.C. 101 is ``not high.'' Juicy Whip, Inc. v. Orange Bang,
Inc., 185 F.3d 1364, 1366 (Fed. Cir. 1999). Importantly, the Federal
Circuit has stated that there is no clear provision that allows the
USPTO to reject an invention solely on the grounds that the invention
may be against public policy, specifically:
The requirement of ``utility'' in patent law is not a directive to
the Patent and Trademark Office or the courts to serve as arbiters of
deceptive trade practices. Other agencies, such as the Federal Trade
Commission and the Food and Drug Administration, are assigned the task
of protecting consumers from fraud and deception in the sale of food
products. Cf. In re Watson, 517 F.2d 465, 474-76, 186 USPQ 11, 19 (CCPA
1975) (stating that it is not the province of the Patent Office to
determine, under section 101, whether drugs are safe). As the Supreme
Court put the point more generally, ``Congress never intended that the
patent laws should displace the police powers of the States, meaning by
that term those powers by which the health, good order, peace and
general welfare of the community are promoted.'' Webber v. Virginia,
103 U.S. (13 Otto) 344, 347-48, 26 L.Ed. 565 (1880). Of course,
Congress is free to declare particular types of inventions unpatentable
for a variety of reasons, including deceptiveness. Cf. 42 U.S.C.
Sec. 2181(a) (exempting from patent protection inventions useful solely
in connection with special nuclear material or atomic weapons). Until
such time as Congress does so, however, we find no basis in section 101
to hold that inventions can be ruled unpatentable for lack of utility
simply because they have the capacity to fool some members of the
public. Juicy Whip, Inc., 185 F.3d at 1367-68.
The USPTO has issued patents to inventions that may arguably be
illegal at least in certain jurisdictions, and may be considered to be
immoral or offensive by some. For instance, a patent to a method of
producing alcoholic liquids from which certain toxic chemicals had been
removed (1,785,447 issued December 16, 1930) issued during Prohibition,
even though the method could be used for then-unlawful purposes. Other
examples include a radar detector (7,023,374 issued April 4, 2006) the
use of which is unlawful in some jurisdictions; a device for use in
cock fights (6,928,960 issued August 16, 2005); a gambling device
(6,540,609 issued April 1, 2003); a method of euthanizing a mammal
(5,290,775 issued March 1, 1994); and a method of preparing ricin toxin
useful for toxicological warfare (3,060,165 issued October 23, 1962).
In issuing these patents, the USPTO has endeavored to carry out its
mission to grant patents as allowed by law, and to refrain from making
policy decisions not within its legal authority. To cite the USPTO
Board of Patent Appeals and Interferences (BPAI) in the context of an
application for a gambling device, ``this Office should not be the
agency which seeks to enforce a standard of morality.'' Ex parte Murphy
, 200 USPQ 801 (Bd. Pat. App. & Interf. 1977).
Hence, a wide range of products, services and processes may be
patentable, but their sale or use is subject to applicable federal,
state and local rules and regulations. Accordingly, while the USPTO may
grant a patent on a tax strategy, that patented strategy should not be
practiced or marketed unless it complies with applicable law, rules and
regulations administered by the Internal Revenue Service.
Examination Process of Tax Strategy Patents
The examiner who is assigned a patent application involving a tax
strategy examines that application using the same statutory
requirements for patentability under 35 USC 101 (useful), 112
(disclosure requirements), 102 (novel), and 103 (non-obvious) as that
examiner would use in examining any other technology. In determining
novelty and obviousness, the examiner consults a variety of databases
directed to the subject matter being examined to find the best prior
art. For applications involving tax strategies, the resources include
U.S. Patent databases, foreign databases, IRS databases available to
the public, and a significant number of commercial databases directed
to accounting, finance, and banking. The examiner also has a library
dedicated to finance and accounting subject matter.
Moreover, if in the course of examination, the examiner identifies
a tax strategy claimed or disclosed, the examiner will, under Rule 37
CFR 1.105, request from the applicant information as to which section
or sections of the tax code are applicable so that those sections may
be consulted.
Importantly, in order to gain knowledge and improve our examination
of applications relating to tax strategies, the USPTO is working on
developing two significant relationships. Specifically, the USPTO has
partnered with the IRS and is currently developing a partnership with
the American Bar Association's Section of Taxation (ABA) to pursue
training and information exchange opportunities. The partnership with
the IRS has resulted in training by the IRS for our finance examiners
on financial products, wealth transfer, and pensions. The USPTO also
provided a modified Patent Examiner Initial Training (PEIT) for non-
examiners for selected IRS employees. Topics included: (a) statutory
requirements of a patent application; (b) concept of prior art under 35
USC 102 and 103; (c) patentability under 35 USC 102 and 103; (d)
identifying and searching relevant databases; and (e) and post-grant
review procedures by the USPTO for issued patents. We are looking at
proposed training by the ABA that would complement the training
received by and provided to the IRS. We are also discussing follow-up
training with the IRS on tax strategy issues.
Thus, as it has in other areas of business method practice, the
USPTO is actively seeking assistance to assure that it has the best
possible information and understanding of the tax strategy area. While
the USPTO does not employ outside sources or ``experts'' as consultants
in the examination of specific patent applications directed to tax
strategies, we are developing the expertise necessary to examine these
types of applications. Moreover, the publication of applications now
allows participation by third parties in the examination process.
Publication of Applications
Approximately 90% of patent applications are published 18 months
after the earliest effective filing date, although an applicant may
request that the application not be published if the invention has not
been and will not be the subject of an application filed in a foreign
country that requires publication 18 months after filing. Following
publication, the application for patent is no longer held in confidence
by the USPTO and any member of the public may gain access through our
website to the entire file history of the application.
Third-Party Participation During the Examination Process
The Patent Act places limitations on the USPTO's ability to
entertain third-party submissions in examining patent applications. In
particular, 35 USC 122(c) requires the USPTO to ensure that no protest
or other form of pre-issuance opposition may be initiated after an
application is published except on consent of the applicant.
Accordingly, under 37 CFR 1.291 and 1.99, although a third party may
file a protest against a pending application before the date it is
published or allowed, once an application is published or a notice of
allowance mailed, a third-party may only submit prior art, without
comment.
After the patent is granted, there are other procedures by which a
third party may challenge an issued patent.
USPTO Review and Thrid-Party Participation After the Patent Issues
Post-grant review of patent claims takes place before the USPTO
under certain circumstances, including when: (1) a patentee files an
application to reissue a patent to correct at least one error in the
patent, (2) an applicant and a patentee claim the same invention and an
interference is declared between the patentee and the applicant, and
the applicant seeks judgment based on unpatentability of patent claims,
and (3) a patent owner or third party requests the reexamination of a
patent.
Congress has incrementally added to the range of proceedings within
the USPTO's jurisdiction under which third parties can invoke Office
review of issued patents. Ex parte reexamination, enacted in 1980,
permits a third party to petition for reexamination of the patent. In
1984, section 135 of the Patent Act was amended to allow issues of
patentability, as well as priority, to be included in interference
proceedings. As part of the American Inventors Protection Act of 1999
(AIPA), Congress created inter partes reexamination, whereby the third
party could participate in the reexamination proceeding and appeal to
the USPTO's administrative Board of Patent Appeals and
Interferences.The AIPA's inter partes reexamination practice was
expanded in 2002 to afford third parties the right to appeal to the
CAFC.
The most common third-party participation is through reexamination
proceedings. An important check on patent quality relates to the
occasions when prior art (i.e., printed publications and patents) is
brought to the USPTO's attention that may raise a substantial new
question of patentability. Often, this evidence may be identified and
submitted by a third party, such as a commercial rival that wishes to
challenge the patent's validity. Congress established this
administrative procedure for the USPTO to take a second look at an
issued patent and consider questions of validity during the life of the
patent.
However, although Congress has increased, through these amendments,
the USPTO's role in helping guarantee the efficacy of the patent system
after patent issuance, none of these procedures alone, or collectively,
has proven sufficient to optimize the USPTO's post-grant capability.
Accordingly, the USPTO recommended a new post-grant review
procedure in its 21st Century Strategic Plan. A version of such a
procedure is currently under consideration in Congress. It would serve
as a quicker, lower cost alternative to expensive litigation in
reviewing patent validity questions. Such a procedure would complement
rather than displace ongoing quality-focused initiatives at USPTO,
which include measures to address the hiring, training, certification
and retention of an adequate number of examiners. The USPTO will work
with Congress and other stakeholders in developing a post-grant review
procedure that effectively serves the interests of the patent
community.
Conclusion
We recognize that the patentability of tax planning strategies has
raised a number of concerns in Congress, the Internal Revenue Service
and the financial services community. We look forward to working with
all interested parties to make sure those concerns are appropriately
addressed in a manner consistent with applicable law, rules and
procedures.
Thank you.
Chairman CAMP. Thank you very much. Now the Honorable Mark
Everson. You have 5 minutes and your statement also will be
part of the record.
STATEMENT OF THE HONORABLE MARK EVERSON, COMMISSIONER, INTERNAL
REVENUE SERVICE
Mr. EVERSON. Thank you. Chairman Camp, Ms. Tubbs Jones,
Congressmen, I am pleased to be before the Subcommittee today
to discuss this important issue of patenting tax products. At
the IRS, we constantly work to improve our service to
taxpayers. By ``service,'' we mean enabling taxpayers to
understand the tax law and helping them to meet their
obligations under the Code. Patented products can help
taxpayers plan for and pay their taxes. Patents can encourage
the invention of software to make paying taxes easier. In this
regard, patented or trademark products can ease the compliance
burden on taxpayers and lessen the enforcement load for the
IRS. That having been said, taxpayers should understand what a
tax patent really is, or rather what it is not. A patent is not
a government seal of approval for a particular product. A
patent simply protects the invention against infringement by
others. In the area of tax structures or strategy, a patent has
no bearing on whether a tax product is legitimate or not. That
is for the IRS and the courts to determine.
In fact, over time, proliferation of tax patents may create
enforcement problems. We have been concerned that some
taxpayers may attempt to patent abusive tax schemes.
Fortunately, thus far, we have found little evidence of this,
but we remain watchful. The rising use of patents for tax
strategies and structures will also place a burden on tax
professionals. A lawyer may need to do an extensive search of
the United States Patent and Trademark Office databases to
determine whether advice to a client, such as tax planning
strategies, could be a patent infringement. This can be a time-
consuming and complex process. Without such a search, a
practitioner could expose himself or herself, or possibly even
his or her client, to potential liability for royalties or
infringement litigation.
Since 2004, the IRS has worked with the Patent and
Trademark Office to make the tax patent system more transparent
and make information about tax patents more accessible. A
classification system has been created to help identify whether
a patent application includes a tax strategy. We have
encouraged practitioners, such as the ABA or the AICPA, to
contribute their expertise to this effort. In sum, we have
strengthened our relationship with the Patent and Trademark
Office, and we have increased awareness of the potential for
misbehavior in the tax patent area.
Before closing, let me turn briefly to two additional
subject. First, the President's 2007 budget request for the
IRS. While I appreciate the difficult choices facing Congress,
overall I am very disappointed by the funding level established
by the House bill, which falls over $100 million short of the
President's request. The House bill would damage our efforts to
attack the tax gap and reduce the Federal deficit. The bill
would even result in personnel reductions within the IRS.
Second, I also urge your support of several legislative
proposals to strengthen tax administration that accompany the
budget.
The most important proposal would mandate reporting to the
IRS of gross receipts by credit card issuers for their business
customers. We know that where there is third party reporting to
the IRS, compliance rates are high because income is reported
accurately by the taxpayer. I urge you to review the
President's proposals and actively support them. Thank you.
[The prepared statement of Mr. Everson follows:]
Statement of The Honorable Mark Everson, Commissioner, Internal Revenue
Service
Introduction
Chairman Camp, Ranking Member McNulty and members of the
Subcommittee, I am happy to be here this morning to address the issue
of patenting tax strategies including potential tax shelters. This is
an issue with which we have become much more familiar in recent years
and have worked with the United States Patent and Trademark Office
(USPTO) as more patents have been granted for tax products.
Framing the Issues
As the Subcommittee focuses on the larger issue of tax patent
strategies (TPSs), I think it is important to properly frame the issue
and understand IRS' role or lack thereof in the patent process.
First, we need to draw a distinction between the granting of
patents to tax products or strategies that are in compliance with the
tax laws, and to abusive tax shelters or other products that may not
be. On the one hand, the ability to obtain a patent could encourage the
development of products to help people comply with the tax law, similar
to other protections of commercial interests such as trademarks and
copyrights.
Our operating philosophy at the IRS is that service plus
enforcement equals compliance. From that perspective, tax
administration could in fact benefit from the granting of patents to
tax products that facilitate the ability of taxpayers to plan and
conduct their tax affairs in compliance with the law. For example, a
patent for a novel type of tax computation software that makes filing
easier could benefit many taxpayers. This category of patents is
potentially helpful to our mission by encouraging needed research and
innovation by the private sector.
Second, we recognize that there are substantial policy issues as to
whether or not business methods involving tax strategies or products
should be granted protection by the government. Granting patent
protection to such strategies could limit the use of that particular
tax strategy by other taxpayers and have a negative impact on their
ability to comply with the tax law.
While the policy issues are significant, many are outside IRS'
jurisdiction and field of expertise. Importantly, the granting of a
patent on a tax strategy provides protection to the patent holder
against infringement by other parties, but has no bearing on its
legitimacy or illegitimacy under the tax laws, which remain under the
jurisdiction of the IRS.
Unlike a private letter ruling, a pre-filing agreement, or an
advance pricing agreement, a patent carries with it no assurance
whatsoever that the patented process, transaction or structure will
pass IRS muster. We are concerned, however, that taxpayers may be
confused about this and may view a patent as a government seal of
approval of all aspects to which the patent pertains, including the tax
aspects.
We understand that some developers of tax-related patents may
advertise and promote their ``patented'' concepts to the general
public. We are currently considering ways to reduce the risk of
taxpayers mistakenly believing that the issuance of a patent is
indicative that the IRS has approved the particular technique being
marketed.
Just so there is no misunderstanding today on this point, let me be
clear. The grant of a patent for a tax strategy has absolutely no
impact on IRS' determination of the effectiveness or the legitimacy of
the strategy under tax law. The IRS will issue a policy statement that
will make this clear to all taxpayers.
Third, we recognize that taxpayers may attempt to patent abusive
tax schemes. As I will discuss later, however, we have not seen such an
abuse in our review of existing tax patents.
Finally, patented tax strategies place an increased burden on
practitioners who, while simply developing good gift, estate or
business planning strategies for their clients, would be obligated to
conduct ``due diligence'' searches for existing patents on such
strategies.
I will talk later about the patent searches that the IRS has done
from the USPTO public data base. That experience has taught us that
patent searches can be cumbersome and time-consuming. This burden is
accentuated if a patent has been granted for a commonly used ``tried
and true'' technique within a field. In these cases, a practitioner who
wishes to use a standard planning technique could expose himself and
his client to potential liability for royalties or infringement
litigation.
As you can see, tax-related business process patents raise issues
for the IRS. They raise even more complex policy issues for others.
I would now like to discuss what we have done and are doing to
monitor tax patents as well as how we are working with the USPTO. The
point of this work has been three-fold: first, to use the USPTO
databases as another potential source of information about the
marketing of abusive tax schemes; second, to detect whether patents are
being used as a way to avoid other characteristics the IRS has
identified as indicating potentially abusive transactions; and third,
to assist the USPTO in carrying out its mission.
Patent Reviews
IRS's principal interest in patented tax strategies is in
determining whether promoters are patenting abusive tax avoidance
transactions (ATATs).
To that end, in 2004 and 2005 we performed two searches of the more
than 6.5 million patents in the USPTO data base. The first search,
conducted in November 2004 was designed to identify patents and public
applications of known tax shelter strategies, specifically of IRS
transactions identified as ``listed'' transactions in Notices 2004-67,
which is the list of thirty transactions that have been determined by
the Internal Revenue Service to be ``listed transactions'' as of
October 12, 2004, and Notice 2005-13 which listed another transaction
on February 28, 2005. That search, which was updated in November 2005
and again in June 2006, found no evidence of patents or public patent
applications embodying any of the abusive tax shelters or listed
transactions.
A second type of search was conducted in July 2005 and is updated
periodically. The goal of this search was to measure the occurrence and
type of business patents that might involve tax strategies. The initial
search just asked for patents that included the word ``tax'' in
applications and granted patents in all classifications. Of the 6.8
million patents in the USPTO data base we had fewer than 300 ``hits''.
A further analysis showed that approximately 100 of these dealt with
``Business methods'' and the majority of those appeared to be software
models for computing tax impact or effect, and not tax strategies.
We were left with 14 patents and applications primarily in the
areas of employee compensation, wealth transfer, and financial
products. Upon initial examination, none of the 14 patents were found
to be abusive tax avoidance transactions. We have subsequently
completed our review of 12 of the 14, one of which was allowed by the
applicant to expire for non-payment of fees. While we do not consider
them to be ATATs, we are continuing to review two of the transactions
to fully satisfy ourselves that they do not present compliance risk
requiring follow up action on our part. Ultimately, we often need to
see a real world example of how the transaction is carried out before
we can be confident that the transaction is not abusive
Based on this analysis, we thus far have not seen the use of the
patents in developing or marketing aggressive or abusive tax
strategies, but we continue to monitor on a quarterly basis the USPTO
tax patent data base.
Working with the USPTO
Since 2004, we have been working with the USPTO to help it address
concerns about patents granted. Specifically, we formed a task force
with members from both agencies to establish the scope of our effort.
Last summer, we conducted a cross-Agency workshop which encompassed
topics requested by the USPTO. This was an awareness workshop and was
similar to what industries have historically done with the USPTO to
keep them abreast of the latest sources of information, trends in
practice, and the like. Our goal was to assist the USPTO in developing
the resources to determine ``prior art'' in the area of tax strategies
and structures.
The prior art doctrine is a cornerstone in the patent application
examination process. Under this doctrine, a patent application should
be rejected if the subject matter is neither new nor original.
IRS does not consult with the USPTO in the review of ``prior art''.
Our contribution to this process would be tangential to our core
mission. Moreover, if the IRS were to have a special or official role
in evaluating the novelty and non-obviousness of a patent, this might
be mistaken for IRS approval of the strategies or structures being
patented.
There are also significant confidentiality restrictions on both
agencies that could hinder a cooperative effort in the review or prior
art. As a result, USPTO must instead rely on input from the
practitioner and other stakeholder communities to develop a reliable
profile of what qualifies as prior art.
Practitioners are generally the creators of business methods and
tax strategies. As they have raised concerns, the IRS has encouraged
practitioner organizations, such as the American Bar Association and
the American Institute of Certified Public Accountants, to play an
active role in supplying the USPTO with useful information on business
methods for consideration as prior art.
We have also offered USPTO ideas on how to ferret out a tax
strategy during a patent examination. USPTO has also created a
classification category dedicated to TPSs. This is a sub-classification
(36T) of Business Method Patents dedicated to tax strategies. In March
2006, we began quarterly monitoring of this TPS sub-classification.
In addition, we consulted with the USTPO in the development of a
protocol to allow patent examiners, once it is determined that the
patent has a tax aspect, to request that patent applicants reveal
specific Internal Revenue Code regulations and procedures affected by a
patent application.
These steps should not only make it easier for the IRS to track
patents of tax strategies and structures, but it should help tax
professionals identify these patents for whatever purpose.
Conclusions
In conclusion, Mr. Chairman, the cooperative efforts between the
USPTO and the IRS have resulted in significant strides in monitoring
and reviewing tax strategy patents. Transparency of these types of
patents has increased; USPTO examiners have a broader base of knowledge
on which to assess patent applications; and the IRS has benefited by
gaining an understanding of the patent process and the rights a patent
bestows on its owner. This latter point is a key factor in valuation
issues addressed by IRS examiners such as donations made under prior
law, off-shore transfers, and arm's length consideration for patents.
We recognize that some patents or trademarks actually benefit both
taxpayers and the IRS in that they protect techniques that ease the
compliance burden on taxpayers and may lessen the enforcement load of
the IRS. In addition, while the IRS has worked to gauge the impact of
patented tax strategies and structures on compliance and
administration, we have found little evidence to suggest that tax
shelters or aggressive tax avoidance transactions are being patented.
But we recognize that the potential for significant problems could
exist.
While patenting tax strategies and structures make the transactions
more transparent, there are several negative by-products to this
process. First, we believe that the public may be largely unaware about
both the rights that a patent owner enjoys and the fact that a patent
does not guarantee that the transaction has the desired tax
consequences. Let me repeat what I said earlier: a patent for a
particular technique carries no weight with the IRS in assessing
compliance with tax laws and regulations.
Second, we believe that the trend toward increased patents of tax
strategies and structures places an increasing burden on tax
professionals. They must do an extensive search of the USPTO data base
to determine if a particular strategy is protected.
We will continue to work with the USPTO in targeted areas. We also
strongly encourage the practitioner community to take an active role in
assisting the USPTO in addressing developing issues with this evolving
area of patent law.
Thank you again, Mr. Chairman for the opportunity to be here and I
will be happy to respond to any questions that you may have.
Chairman CAMP. Thank you very much. Thank you both. Now we
will have a period of questioning. Mr. Toupin, is tax law
really appropriate for patents?
Mr. TOUPIN. Well, the courts have interpreted the broad
language of the Patent Act that the Act is designed to provide
innovative stimulus equally across the board and to all forms
of innovation that meet the broad language of the statute. The
courts have held that the question of whether or not a
particular invention may be against some form of public policy
or may be contrary to the regulatory scheme of another agency
is not for the patent office to decide. That is rather a
question for the other regime. Our job is simply to see whether
or not it meets the criteria for patent ability.
Chairman CAMP. Mr. Everson, given that much of tax advice
is done confidentially, is tax law really appropriate for the
patent process, and, particularly, asking people to pay a
royalty to comply with the law is what a patent on a particular
method might do, do you have any thoughts on that?
Mr. EVERSON. There are a couple of points in there, sir, I
would suggest to you that one of the real problems is the
complexity of the Code. That is a huge problem. The President
has called for simplification. I know that the Congress and
everybody else want to get that done, it is just hard to do.
The complexity of the Code creates real reasons for people to
search for ways to help folks comply. That having been said,
when you get to the question of seeking to reduce the tax, the
question is when do you approach that line where you get to
non-compliance, if you will. My concerns here are with the
confidentiality of the return, so it is very hard, I believe,
for the patent folks to understand what is the common practice
out there. They don't have an ability to look in and see what
the return is. That is confidential between the practitioner
and the taxpayer and the service. So, I am not sure that it is
easy to get an understanding of what is known or prior art--
these are the terms that my colleague is more familiar with
than I am. So, I think we are applying a set of incentives to a
different model here, and it is very, very hard to do that
effectively.
Chairman CAMP. I realize that the Patent Office, if you are
patenting a better mousetrap, that doesn't necessarily say that
it is going to be effective, just as they don't say that this
necessarily means you are complying with the law. It seems when
it comes to tax matters, that it is not a golden seal of
approval, as you were sort of mentioning. How is the average
citizen supposed to know that because most people are going to
say this is the government. If I am reading an advertisement
for a particular method and it has been patented, I am going to
think the government has looked at it. We realize that there is
not necessarily a commitment that that is a legal strategy or
even tax compliance at all but how is the average person
supposed to figure this out?
Mr. TOUPIN. Well, I think there are two answers to that
question. One is that an advisor, relying on the patent, will
have an ethical obligation to accurately advise the client as
to the significance of a patent. The second is, and I know that
the Internal Revenue Service is working on this, to develop
outreach that would explain the significance of these patents.
Chairman CAMP. Well, I appreciate both of you being here.
At this time, I will recognize the gentle woman from Ohio for
inquiry.
Ms. TUBBS JONES. Thank you, Mr. Chairman. In my prior life,
I was the Cuyahoga County prosecutor doing both civil and
criminal work, and I was a judge for 10 years, eight years in
general jurisdiction. I am sitting here thinking, saying what
if this came into my courtroom, what would I have done with
this particular situation? I am concerned that we would develop
a patent for tax advice, and I have nothing against tax
attorneys and I want them to make all the money in the world,
not all the money, we want to make some too.
Mr. TOUPIN. The IRS might want to make some.
Ms. TUBBS JONES. Of course, you will get your piece, you
always do sooner or later anyway. That would be available to
some people and not to all people. In my mind, and I am not a
patent expert, I don't know if our laws contemplated the
ability of some to access advantages in the Tax Code and others
to not access advantage. That being said, assume a patent
application met all the patent law criteria, would or could the
Patent Office approve a patent for an illegal tax shelter?
Mr. TOUPIN. Can I address the first part and then the
second part?
Ms. TUBBS JONES. No, no. Yes, sure you can.
Mr. TOUPIN. I think that there is a bit of a confusion
about what access means in this regard. An alternative strategy
to patenting is to keep strategies as trade secrets. Now those
trade secrets may be known to some advisers and not other
advisers. The existence of a patent--the trade-off for the
existence of a patent is to make it known to the world. Our
database is an absolutely terrific body of knowledge for the
public to access. So, in terms of whether a patent would make a
strategy more available or less available, it is a bit of a
trade-off between whether the cost of the license that might be
requested outweighs the cost of each tax adviser inventing the
same strategy for each client.
The second issue is if Members of the tax advice community
want to establish that certain strategies are well known, they
will begin to publish the information about those strategies
that they may not have published previously. So, the net
effect--it is possible that the net effect of patenting is to
make strategies more readily available to the public rather
than less.
Ms. TUBBS JONES. I see somebody in the audience shaking
their head. I won't identify who it is but go ahead.
Mr. EVERSON. Can I jump in for a second before we get to
that second piece, is that okay?
Ms. TUBBS JONES. No, go ahead. I could order the head of
the IRS around. Let me try this one more time. No, I am
kidding, go ahead.
Mr. EVERSON. I read the paper that the Joint Committee
staff put together, which was excellent. One of my favorite
lines is on page 25. It says, ``Regardless of whether tax
strategies are socially beneficial, there is no need for patent
protection''--some people are saying this--``in order to
encourage their development as they seem able to proliferate
without such protection.'' I think that is absolutely true. The
testimony that you submitted talks about the Constitution
talking about patents and incentives and that sort of thing. In
our country, you go back to the Boston Tea Party, people have
been trying to lower their taxes for a long time, and I think
there is plenty of activity here, so I would question this
balance as to incentives and protections in this instance.
Ms. TUBBS JONES. The second question.
Mr. TOUPIN. The patent examiners are required to examine
whether or not the patent application--the claimed invention is
useful. In some of these applications that may or may not
require examination of whether or not it would in fact achieve
the advantage claimed. In that context, they are doing a
scrutiny that is not different from what they do when they are
looking at a claim to a mechanical invention. In that context,
they will look to see whether one of ordinary skill in the art
would believe that the thing would work as claimed. They do
that on the basis of the information they have. That judgment
can be challenged in a subsequent infringement action or
declaratory judgment action if it proves to be incorrect.
Ms. TUBBS JONES. Well, your answer is yes or no?
Mr. TOUPIN. They will look to see--if it is claim to a
specific tax advantage, and that is the only utility claim,
which I think is a rare--they will look to see whether on the
basis of the facts they have one of ordinary skill in the art
would believe that it would be operable as claimed. So, would
it work? They will look at that issue.
Ms. TUBBS JONES. So, yes?
Mr. TOUPIN. Yes.
Ms. TUBBS JONES. Thanks, Mr. Chairman.
Chairman CAMP. Thank you. The gentleman from Georgia may
inquire.
Mr. LINDER. Mr. Toupin, are there any other business
practices that have been patented?
Mr. TOUPIN. Yes.
Mr. LINDER. Along the same lines as these?
Mr. TOUPIN. Well, we recently put to the Office of
Personnel Management (OPM) a request to expand the
classification for patent examiners and that included incentive
programs, such as--the subject matters that we were looking at,
incentive motions, such as coupons, operation research,
finance, banking and accounting, electronic shopping, health
care, insurance, inventory controls, business processing. So,
there is a wide variety.
Mr. LINDER. This is mostly software?
Mr. TOUPIN. Oftentimes they will include an information
technology (IT) application.
Mr. LINDER. How many of these tax patents have been issued
so far?
Mr. TOUPIN. About 40.
Mr. LINDER. How many are pending?
Mr. TOUPIN. The published applications are around 60 that
are pending.
Mr. LINDER. Do you expect this trend to continue?
Mr. TOUPIN. Well, the trend is that it is a very low level
of filings. It is very low in relation to business method
patents as a whole. It is certainly very low in relationship to
the 400,000 applications we get a year. The grant rate for
business method applications has declined over the years since
State Street Bank. So, my expectation is that the leveling off
of business method patents as a whole, which we have
experienced in the recent years, probably is likely to
continue.
Mr. LINDER. Does your office make any assessments as to
whether this procedure or this business practice deals with
aggressive deducting?
Mr. TOUPIN. No.
Mr. LINDER. Have you looked at these, Mr. Commissioner,
these 40 patents?
Mr. EVERSON. Yes, sir. I guess we did some searches of the
database, and we got it down to where we looked at 100 patents.
Some of them mentioned tax and, they weren't really in the end
tax products. We got down to about a dozen or more that we were
potentially concerned with. Thus far, as my testimony
indicates, we haven't seen any real problems. Now, let me say
this though, this is very important. What we often find with
shelters and abusive transactions in general is that somebody
will structure a transaction and it will be okay. Then a month
later, there will be another transaction that moves just a tiny
bit. There is a bell or a whistle that is attached. Then over a
very long period of time, you have something that has
approached and then crossed the line. My fear or concern in
this area is the same thing--you could conceivably patent
something that would work and then very quickly it could be
modified, and it would just take a long time through litigation
and everything else to get it all settled out as to whether the
product had moved away from a legitimate patent. In the
interim, there could be a lot of damage to the tax system.
Mr. LINDER. Well, with 60,000 pages of regulations and
complexities, I think there are probably dozens and dozens of
ways to legally abuse the system. I think there are some
people--there is a huge article about a lawyer in New York City
who is very smart and he understands the Tax Code as well as
anyone, and he finds ways to abuse it legally. Even though I
have a modest tax reform bill that would take us back to the
Boston Tea Party and solve your complexity at the same time.
Thank you, Mr. Chairman.
Chairman CAMP. Thank you. Yes?
Ms. TUBBS JONES. Gentlemen, I am going to leave, as I said
earlier, but I have some questions I would like to submit for
the record to get some written responses, if you don't mind.
One of those is ``Is tax advice legal advice and can legal
advice be patented?'' That is my kind of curious thinking.
Chairman CAMP. Yes, and without objection, and if you could
respond in writing to those questions. The gentle woman from
Pennsylvania may inquire.
Ms. HART. Thank you, Mr. Chairman. I appreciate the
opportunity to be here, and I will certainly review your
testimony in greater detail. Sorry, I am just walking in. We
had a little discussion about some of these issues yesterday
and they really kind of throw more questions open when you
start looking at this issue. I have maybe the good fortune or
bad fortune of having served on the Intellectual Property
Subcommittee and Judiciary before I came to Ways and Means, so,
now, it is even more--have a bizarre view. So, I guess I am
most interested in your reflection on what the IRS views as
listed transactions or tax shelters.
If there are patents issued for these particular products
or processes or procedures, I guess in some cases they are, how
does the IRS pursue compliance? Is there any point at which
there is some kind of deference given to a procedure because it
is patented or does it go the other way around with the PTO
regarding the respect for something that may be or a lack of
respect for something that may be opposed by the IRS, back and
forth?
Mr. EVERSON. As I indicated in the testimony, the actions
that are taken by the Patent Office have no bearing on how we
come down on a particular transaction. Now, you mentioned
listed transactions, those are transactions that we list as
potentially abusive and subject to scrutiny, special scrutiny
by our examiners. Someone suggested that what we ought to do is
make people report whether they are using a patented
transaction. I would not endorse that at this time for two
reasons. First, as I indicated, thus far we haven't seen
substantive problems here. We have theoretical concerns about
what could happen, but we haven't seen substantive problems.
Second, we set up a screen, criteria for what people need to
disclose, and it would be unfair to tar all patents, as long as
that is the law, with having them be disclosed in the tax
preparation process since there is no evidence at this stage
that they are a particular problem.
Ms. HART. Regarding the process back and forth between the
agencies, what would trigger a consultation with the IRS and
the PTO regarding these issues? Is there something that would
sort of throw up the red flag and actually cause that
consultation to occur, I guess application for a patent?
Mr. TOUPIN. Right, as we discussed earlier, there is
consultation on the overall issue of mutual training. With
respect to specific consultation on a particular application,
the PTO is constrained by the laws that are applicable to it.
It is required to keep applications confidential. Upon their
publication, it is required not to provide for opposition
proceedings. So, it is difficult at best for the agency to
reach out and entertain objection or seek consultation on that
point.
Now the Members of the public can submit prior art
currently for 2 months after an application is published and
the office is now proposing to extend that to 6 months without
comment to avoid the statutory prohibition on oppositions. That
probably doesn't create the opportunity for the kind of
consultation with the IRS that you are referring to.
Ms. HART. Yes?
Mr. EVERSON. I would be very reluctant to have the IRS
inserted in an actual approval process. The point being that we
have procedures in place where taxpayers come to us and they
get private letter rulings, advance pricing agreements based on
certain factual circumstances. That is the only time when we
step forward and we look at things in advance. Were we to go
down this corridor of working on some applications sometimes or
even all applications, you would be giving broad pre-approval
to transactions that had not yet taken place, and I think to do
that would really change the way everything works in a way that
we would have to carefully consider before we would do that.
Ms. HART. If the Chairman will indulge just one quick
follow-up.
Chairman CAMP. Yes.
Ms. HART. I appreciate that. So, has there not then been a
case to this day where--or has there been a case to this day
where a patent was actually granted and then the IRS came back
and said this is contrary to the Code?
Mr. EVERSON. We are just getting into the examination
stream on some of the issues. As my colleague indicated, this
has all happened since 1998, I guess when this was started.
Then you get the application of the use of the patent itself.
Then years down the road, returns come under audit. So, it is
too early to say. What I had indicated before is we have
studied the dozen or so patents that we thought are potentially
of concern, and we haven't seen a theoretical problem with
them. I would add, though, that in several instances, if just
modified slightly, some of those patented transactions could
cause real problems. So, again, you have to get down, do the
actual audit, and then make your judgment.
Ms. HART. Thank you. I thank you, Mr. Chairman.
Chairman CAMP. Thank you. I understand your testimony,
Commissioner, that there is no formal process between IRS and
the Patent Office to examine these business method patents. So,
how are these brought to your attention, just informally
looking through the website?
Mr. EVERSON. I think what the Patent office has done is now
set a distinct category for these, which makes it a lot easier
for us to find them and for all interested parties. So, we are
sort of in the same boat as everybody else. Then, as was
indicated earlier, we are sharing--as we share with the Patent
Office emerging concerns on our end and back and forth. So, I
think we have a good discussion of what is emerging in terms of
the use of these, but that doesn't tie in in terms of the
specific time line as to a particular structured transaction or
strategy.
Chairman CAMP. Well, the follow-up to that is then if you
don't readily identify known practices, and then as
applications come in and a patent is issued. Would the burden
of challenging that patent fall on the taxpayers who employ
this strategy? Whose burden is it? This is part of what I think
we are trying to get at?
Mr. TOUPIN. Well, there are two elements. First, after a
patent issues, there is a current process for re-examination of
a patent. A Member of the public, or even the patentee,
believes there is new prior art or a new issue of patentability
involving a prior patent or printed publication that should be
brought to the Patent Office's attention. The Patent Office has
also favored legislation that would involve a more broad-scale
post-grant review of patents, which would probably provide a
better opportunity for those who might claim that there was a
prior public use but not necessarily a patent or printed
publication about it. Apart from that, the burden would be on
potential users of the patented method through district court
proceedings.
Chairman CAMP. It seems as though this is a growing area?
Mr. TOUPIN. Well, it is hard to know whether 41 issued
patents since 1998, what the trend is.
Chairman CAMP. What I see that in your testimony you are
increasing the number of patent examiners in the business
method area from 130 examiners to 160 in a year.
Mr. TOUPIN. In the area of business method patents at
large, yes. We are now getting 8,500 of those a year,
applications. We currently have 60-odd published applications
with respect to this particular subject matter.
Chairman CAMP. Again, realizing the tax method is a smaller
part of that growing area, it seems to me that you don't have
to purchase some of these other products, it is a choice. Every
American has to comply with the U.S. Tax Code which does make--
again, kind of going back to my original question, is really
tax law appropriate for patenting given that there is an
obligation and a legal requirement that you must comply with
the tax laws. Then to require Americans to pay a royalty to
then do that in the best possible way seems to me a problem. I
guess I am more concerned--I realize you don't want to have a
formal process between the IRS and the Patent Office but how
then do you coordinate this area because it clearly is--there
is an overlap here.
Mr. EVERSON. I think it is a serious problem because there
is not the transparency. Tax returns are confidential. The
advice that is given by a professional is confidential. So,
there is not the visibility of a television set or a drug
product that is taken out on the market where you say we have
got a product that does ``X'' and it says ``patent pending'' or
whatever it says down on the jar and then it is held up to a
certain scrutiny. That is not what takes place here. So, I do
find it--I am sure it is a real challenge for people who are
trying to assess the patent application to get to this novel or
known standard for just that reason.
Mr. TOUPIN. The other answer though is that the IRS and the
PTO over the last year to two have begun an active consultation
process in terms of mutual training. The advantage of patents
is that they are published and they can be known about. As
knowledge of those expands over time, I am sure that, though on
an interagency exchange basis that is not directed to specific
applications, that exchange will become better and better
educated as we deal with more of these.
Chairman CAMP. Is there any other kind of legal protection
that might work better than a patent for these tax business
methods that either of you might comment on? It seems there are
some drawbacks to the patent process. First of all, the length
of time of getting it. It looked like 44 months I think in the
materials I saw, I don't know if that is accurate.
Mr. TOUPIN. No, we are----
Chairman CAMP. Doing better than that?
Mr. TOUPIN. It is very long in many business method areas.
We are hiring up to try to deal with that problem.
Chairman CAMP. Yes, so it is a long wait. Is there another
way that would bring this technology or this information to the
market sooner and still provide legal protection to the author?
Mr. EVERSON. I don't think there is a lack of ideas in this
area, as I have indicated, and as the Joint Committee staff has
indicated. There is plenty of creativity and, in my view,
sometimes too much.
Mr. TOUPIN. One of the consequences of a patent regime is
that it does encourage those who are using strategies or
methods of whatever kind who don't want them patented by others
to publish them. We have worked with a number of areas to
develop--help them develop ways of publishing their ideas where
they don't want something patented in ways that we could access
for purposes of making judgments about patent applications.
That is a consequence of the patent system that can lead to
more things being available as a byproduct of patenting.
Chairman CAMP. All right, thank you. The gentleman from
Florida may inquire.
Mr. FOLEY. I arrived late, so I am trying to still get my
hands around the conversation. Are we talking about patenting
things like software that applies to tax compliance or are we
talking about strategies, such as hedging against--using hedge
funds or some other product in which to avoid taxes?
Mr. TOUPIN. I think both.
Mr. EVERSON. I draw the distinction in my testimony, sir. I
say that because of the complexity of the Code, there are many
products that help a taxpayer get through this terribly
burdensome Code. That is a good thing. Your second piece, that
is the area of concern.
Mr. FOLEY. Right, because I know into it are some of these
other software devices or H&R Block named a number of people
who have software that helps you process your return and make
certain you have used every calculation necessary to get the
best possible tax advantage. The other question becomes does
patent protection provide some legal definition. Remember the
cases they were using, some large brokerage houses will be
anonymous for the moment, but using very creative real estate
shelters and techniques in which to reduce income that have now
been proven to be fraudulent and challenged in court. Some have
gone to jail using those concepts. Does the patent provide any
additional legal protection?
Mr. TOUPIN. No, and indeed the IRS has found that--looking
at the patents that have issued, that indeed these aren't
aggressive. They might be aggressive strategies if they were
tweaked a little bit but they are not aggressive as patented. I
think there is a reason for that. That is that the patent puts
the method out for the whole world to see. Somebody who is
trying to do something that is not quite kosher might not want
that strategy being published for the whole world, including
the Internal Revenue Service, to see.
Mr. FOLEY. I guess it is still hard to realize that if you
are into the tax planning process, and the Code is fairly
specific on items, deductions, and scenarios by which you may
apply, how this novel idea of using the Code and using what is
in law becomes patentable. I guess there is where I am
scratching my head and say if I create a tax shelter like a
hedge fund that creates an opportunity to shelter money but is
using every mechanism available to me under the definition of
Code, why is that a unique enough idea that I get a patent
protection for it?
Mr. TOUPIN. Well, there is a variety of these patents and I
can't speak to any one of them in particular. The original
State Street Bank decision, which led to this growth, was about
a means of tracking transactions to maximize the accountability
of capital gains so that those could be captured and used. It
was a hub and spoke method for accomplishing that purpose. The
Federal Circuit Court held that that kind of a method, which
optimized the ability to use--among other things a tax
advantage, was useful subject matter that could be patented.
Mr. FOLEY. So, what they are doing in a particular instance
is the timing element of their securities or whatever they were
selling, they were using a program in which to determine
whether it was ready for capital gains treatment?
Mr. TOUPIN. I am sorry, Congressman, I am sure that is a
subject matter that you know a lot more about than I in terms
of exactly how they are accomplishing.
Mr. FOLEY. No further questions.
Chairman CAMP. Thank you. Mr. Weller may inquire.
Mr. WELLER. Thank you, Mr. Chairman. Welcome to our
panelists here. This is an interesting hearing, Mr. Chairman. I
know when I was talking to some constituents yesterday, and I
was telling them that you realize there are some people who
want to patent tax advice and tax strategies, and the folks
back home, their response was, ``You got to be kidding.'' So, I
appreciate having this what is kind of an unusual subject,
something that caught a lot of people by surprise that this
would be occurring, that people would be patenting advice and
strategies in response to tax law.
Looking at this, I am interested in knowing the number of
professionals at the PTO that are actually capable of assessing
applications for tax patents? It is the novelty and utility of
devices in which patents are sought requires expertise. I was
wondering, Mr. Toupin, if you can share with us how many
professionals with tax law or accounting backgrounds does PTO
have employed?
Mr. TOUPIN. If I could read from a sheet of paper for you.
We currently have 26 examines working in the finance area of
business methods. Of that number, one examiner holds a Ph.D. in
finance and is a past associate professor of finance at the
University of Maryland and a past financial planner. Eight
examiners have either a MBA or a master's in finance or are
close to finishing the master's in finance. Four examiners have
law degrees. One examiner has a master's in economics. One
examiner worked as a chief accountant in a private firm. Two
examiners have an undergraduate degree in finance. So, we have
been looking in this area to put people who have educational
and professional backgrounds that suit them well to this. As I
indicated earlier, we have worked with the Office of Personnel
Management to modify the classification for patent examiners to
allow us on a pilot basis for a couple of years to hire people
with financial type backgrounds who do not also have other
technical backgrounds, and we are hoping to add to our
expertise in that way.
Mr. WELLER. So, all these people that you have mentioned,
what is the number again, 40?
Mr. TOUPIN. Well, there are 26 and I described----
Mr. WELLER. Twenty-six but all 26 of them are engaged on
assessing these applications?
Mr. TOUPIN. I don't know exactly what the assignment is of
each of these people. The finance area is broader than the tax.
Mr. WELLER. You feel there is a need to hire additional
people to address this type of application?
Mr. TOUPIN. In the business methods area generally, which
is a large and expanding area of our practice, we are looking.
I can't say exactly when we expand that, how many of them will
specifically be assigned to tax matters.
Mr. WELLER. Admittedly, this is a new subject for me,
realizing people are patenting business and tax strategies. How
widespread is an effort to patent business strategies,
essentially putting something in paper and saying this strategy
needs to be patented to protect our intellectual property
rights?
Mr. TOUPIN. As I indicated, in terms of tax strategies in
particular, and that describes a variety of different kind of
structured processes, we have issued about 40. There are
published----
Mr. WELLER. You have issued 40 patents on tax strategies
already?
Mr. TOUPIN. Variously described. Some of them may or may
not exactly fit the definition that you are using, and about 60
published applications. In the business method area as a whole,
well, we are running about 8,500 applications a year. So, it is
a very small part relative to the overall.
Mr. WELLER. Okay, thank you. Thank you, Mr. Chairman.
Chairman CAMP. Thank you. Would any other Members seek to
inquire? All right. I want to thank our witnesses very much for
their very helpful testimony and appreciate your attendance.
Thank you very much. We will now begin panel two, including Mr.
Richard S. Gruner, professor of law at Whittier Law School; Ms.
Ellen Aprill, associate dean of Academic Programs, professor of
law at Loyola Law School; and Dennis Belcher, a partner at
McGuireWoods of Richmond, Virginia. I want to thank you all for
coming this morning. We do have your written testimony. You
will have 5 minutes to summarize your statement and then we
will go to questions after all three of you have an opportunity
to make your statements. Why don't we begin with Mr. Gruner.
Again, welcome, and thank you for being here.
STATEMENT OF RICHARD S. GRUNER, PROFESSOR OF LAW, WHITTIER LAW
SCHOOL, COSTA MESA, CALIFORNIA
Mr. GRUNER. Mr. Chairman and Members of the Subcommittee,
it is my honor and privilege to be here with you today and
contribute to the efforts of this Subcommittee. Let me use my
limited amount of time to summarize how I think we got here on
this extraordinary occasion discussing the intersection of
patent law and tax law, two areas of the law that until
recently most parties would have said could not intersect. Yet,
here we are.
The emergence of tax planning patents reflects the
convergence of three important trends: one legal, one
technological, and one professional. First, patentable subject
matter standards have been steadily expanding in scope. Federal
court standards have recognized over the past two decades that
our patent system should encourage and reward advances in
fields as divorced from traditional physical engineering and
chemistry as bio-engineering, computer software, communication
information processing, accounting recordkeeping, financial
investment strategies, and business methods. In this march
toward ever broader patent system scope, it is a small step to
extend patents to advantageous tax planning methods, which
produce important financial results for taxpayers.
Second, a technological trend. The impacts of computers and
computer-based analyses have expanded the range of
sophisticated tax planning strategies that are appreciated and
implementable. Computer analyses of potential asset and income
management strategies and tax results have expanded our
understanding of what is desirable, leading to types of
potentially patentable tax planning methods which would not
have been understood a few years ago.
On the implementation side, computer management and
tracking processes allow for the implementation of tax planning
strategies which would not have been possible in an earlier
era. These developments in computer technologies applied to tax
planning methods have expanded the range of computer-related
tax planning patents just as the presence of computers has
expanded the number of patents in so many fields.
Finally, a professional change. The increasing issuance of
patents in the financial and tax planning services fields may
encourage firms to extend more resources toward the development
of highly sophisticated methods for tax planning, with the
amount of those resources augmented by expectations of large
rewards achieved through patent control of the resulting
innovations. If a given advance developed by a firm can only be
marketed by the firm to that firm's particular client set, and
may become available for marketing by competitors for
disclosure of the method, the firm pursuing the development of
the method will only be encouraged to devote such resources to
the development of the method as will be paid back in extra
payments from their own clients in later transactions.
However, if a firm can develop a sophisticated new tax
planning strategy and know that it can look to patents as a
source of rewards, the firm will be encouraged to develop that
strategy with a devotion of greater resources, knowing that all
the taxpayers who wish to benefit from using the method will
need to pay a royalty to gain this advantage. Under this latter
type of system, the full range of taxpayer advantages from a
given new technique will define the extent of development
expenditures that are justified in producing it. This system
will also encourage firms to focus on the types of highly
innovative, non-obvious extensions of prior designs that are
capable of qualifying for patents.
This last analysis suggests why patents on tax planning
methods, though highly foreign and seemingly dysfunctional to
tax planners at this time, may ultimately be beneficial to this
field. If the future of tax planning methods lays in highly
sophisticated computer-intensive means of asset and income
management, then substantial development rewards and
protections may be needed to encourage the invention of these
methods. Patents on such methods will encourage the very best
designers of such methods to devote their time to this kind of
development. Patents will also encourage the devotion of
extensive combinations of computer and financial accounting
resources for the development of these methods with the
knowledge that the successful results can lead to valuable
patents. This type of development pattern has prevailed in a
number of other fields where patents serve to allow smaller,
highly innovative concerns to focus on innovation with the
assurance that other less innovative firms will need to pay for
the use of the resulting innovations.
In short, a patent mediated world of tax planning may be
one in which greater efforts are devoted to the types of
innovative tax planning methods that are non-obvious advances
over prior methods and that can qualify for patents. It may
also lead to a restructuring in the field where innovators are
significantly advantaged in competition with non-innovators and
in which specialists in innovation can be sure that their
useful results will be paid for by the numerous clients and tax
specialists who use and benefit from the innovative tax
planning methods which emerge. Thank you, and I look forward to
answering your questions.
[The prepared statement of Mr. Gruner follows:]
Statement of Richard S. Gruner, Professor of Law, Whittier Law School,
Costa Mesa, California
It is my pleasure to appear today to offer comments on the role of
patents in protecting tax planning methods. A number of United States
patents now apply to sequences of steps of asset and income management
which are aimed at achieving advantageous tax results for taxpayers.
The developers of these methods have claimed that their tax planning
steps are significantly new and useful methods for achieving practical
results and have accordingly obtained patents covering the methods. If
valid, these patents will preclude other parties from using the
patented method without the patent holder's permission.
Patents regarding these techniques are emerging as significant
concerns within the tax planning community. Tax attorneys and other tax
planning specialists have raised concerns that patents will limit their
ability to provide valuable services to their clients and produce
unexpected patent infringement liability for themselves and their
clients. At the same time, parties seeking and obtaining these patents
assert that they have developed advances in tax planning methods which
are significant departures from earlier methods and deserving of the
sorts of patent protections and rewards that have traditionally applied
to useful advances.
For its part, the United States Patent and Trademark Office (USPTO)
has implicitly agreed that advances in this field can qualify for
patents by issuing a number of patents in this domain. Records of
published patent applications regarding tax planning methods indicate
that the number of patent applications in this field is growing,
meaning that the number of issued patents and related patent disputes
concerning tax planning patents is likely to expand in the future.
My comments today will not attempt to address all of the legal
issues that may surround the issuance and enforcement of tax planning
patents. I will focus on three principle areas. First, I will describe
the ways that patents may influence the development of tax planning
methods and other ``intangible inventions'' that entail the management
of information and other intangible items for personal gain. Second, I
will describe one of the existing tax planning patents and the manner
in which it may be enforced against taxpayers, attorneys, accountants,
and financial institutions. Third, I will suggest actions that will
improve the quality of patents issued in this area, with the goal of
maintaining the incentive effect of patents in this important area
while diminishing the effect of improperly issued patents in deterring
legitimate tax planning strategies.
I. The Role of Patents in Promoting Tax Planning Innovations
A. Introduction to Utility Patents
A patent for an invention gives the inventor the ability to control
the use and commercialization of the invention for a limited period. A
United States patent is granted based on an application to and review
for legal sufficiency by the USPTO. Generally, the term of a new patent
is 20 years from the date on which the application for the patent was
filed in the United States. United States patents are effective only
within the United States, U.S. territories, and U.S. possessions.
The right conferred by the patent grant is to exclude others from
making, using, offering for sale, or selling the patented invention in
the United States or importing the invention into the United States. 35
U.S.C. Sec. 271(a). What is granted is not the right to make, use,
offer for sale, sell or import the invention, but rather the right to
exclude others from making, using, offering for sale, selling, or
importing the invention. Once a patent is issued, the patentee must
enforce the patent without aid of the USPTO.
There are three types of patents:
1. Utility patents covering new and useful devices, materials, and
processes;
2. Design patents covering new, original, and ornamental designs for
articles of manufacture; and
3. Plant patents covering distinct and new varieties of asexually
reproducing plants.
When parties speak of patents, they usually mean utility patents.
In the remainder of these written comments, the term ``patent'' refers
to a utility patent. Utility patents are granted for new inventions
that are useful, including procedures for undertaking a useful task.
Most tax planning patents will be aimed at protecting useful procedures
for obtaining desirable tax results.
Under the Patent Act, any person who ``invents or discovers any new
and useful process, machine, manufacture, or composition of matter, or
any new and useful improvement thereof, may obtain a patent,'' subject
to the conditions and requirements of the law. 35 U.S.C. Sec. 101.
Advances falling within this statutory definition are ``patentable
subject matter.'' The word ``process'' in this standard is defined by
law as a process, act or method. The term ``machine'' as used in the
statute includes artificially created assemblages that operate on some
other subject matter, often transforming that additional matter. The
term ``manufacture'' refers to articles that are made, and includes all
manufactured articles. The term ``composition of matter'' relates to
chemical compositions and may include mixtures of ingredients as well
as new chemical compounds. These classes of subject matter taken
together include practically everything that is made by man and the
processes for making the products.
The Patent Act specifies that patentable inventions must be
``useful.'' The term ``useful'' in this connection refers to the
condition that an invention has a useful purpose and operates to
achieve its intended purpose. Court cases have held that steps for
expanding financial profits or keeping track of financial activities in
a useful way are examples of processes that meet the utility
requirements of the patent statute. In light of this, tax planning
methods leading to advantageous tax results and lower tax liabilities
for taxpayers are likely to be seen as having sufficient practical
utility to qualify for a patent.
Judicial interpretations of the Patent Act have defined some limits
on the field of subject matter that can be covered by a utility patent.
For example, it has been held that laws of nature, naturally occurring
phenomena, and abstract ideas are not patentable subject matter.
A patent cannot be obtained upon a mere idea or suggestion. A
patent is only available for a new machine, manufacture, chemical or
process with specific, implementable details and not for the idea or
suggestion of the new invention. A complete description of the actual
machine or other subject matter for which a patent is sought is
required in a patent application and in the resulting patent if one
issues.
In order to qualify for a patent, an invention must not only be new
(that is, different from prior designs publicly known as of the date of
invention), but also a nonobvious departure from the prior knowledge in
the field. See 35 U.S.C. Sec. 103. In order to determine if this is the
case, it is necessary to consider the state of the prior knowledge in
the field (commonly referred to as the ``prior art'') at the date an
invention was made, the differences of the invention from the prior
art, and whether a party of average skill in the field was likely to be
able to develop those differences. If the average practitioner was
capable of developing the invention under these circumstances, then the
invention is considered to be an obvious advance and not properly
patentable. See id.
B. Expanding Application of Patents to Intangible Innovations
1. Open Ended Extension of Patents to New Technologies and Domains
Some parties have argued that historical notions of engineering and
patentable subject matter should govern the outer boundaries of the
patent system. Up until a few decades ago, patents were applied almost
exclusively to promote the development of physical technologies,
including physical devices, materials, and processes. A continuing
emphasis on this history would support a view of the patent system that
was limited to the types of advances emerging from useful trades or
industrial activities in the past.
However, courts have thus far seen the patent system as far more
dynamic than this. They have interpreted Congress's will in enacting
patent laws to be that incentives should exist under those laws to
expand the boundaries of what we consider to be technology and useful
inventions. With this notion of evolving patterns of innovation and
product and services characteristics have come major new advances that
turn primarily on changes in the intangible features of modern goods
and services. Persons need reach no further than their purses or
pockets for their cell phones to locate a primary example of this new
trend in innovation. Cell phone advances have turned largely on
information processing breakthroughs and the associated abilities of
companies around the world to implement and manage highly complex
communication systems to support cell phone calls. Many of the key
technology breakthroughs in this field were patented under the expanded
notions of information processing patents and technologies applied in
recent years.
In general, courts have adopted a highly inclusive view of what is
a new and useful advance that is potentially patentable. By viewing the
patent system as a forward-looking institution with the aim of
encouraging useful designs well beyond our present knowledge, courts
have rejected a view of patentable subject matters that would look to
the past and limit patents to historically important lines of
innovation. Rather, courts have disengaged definitions of patentable
subject matter from old notions of technologies or industrial
practices. Indeed, a failure to take this sort of encompassing view of
the potential range of patentable inventions would risk rendering the
patent system irrelevant amidst modern modes of technological advance.
Actual patterns of technological advance and application should dictate
the directions of valuable additions to consumer products and the
patent system must keep up by extending patents to the full range of
innovations that are widely replicable, distributable, and, therefore,
of widespread public importance.
2. Emphasis on Patents Regarding New Information Technologies
The result of this view of patentable subject matter has been a
trend towards the patenting of advances that emphasize information
processing methods and devices incorporating such methods. Examples of
fields in which information processing advances have been highly
important--as vehicles for both commercially significant products and
highly valuable patents--have included:
Biotechnology--Use of DNA-based information for diagnostic
procedures and biological product designs
Computer Controls--Use of advanced information processing
technologies to control older devices and processes
Communications--Use of new information processing methods to
increase the volume and quality of communications systems
Interpretive Systems--Use of information processing advances aimed
at squeezing new insights out of existent information (e.g., heart
monitor data processing systems or seismic data analysis systems)
3. Judicial Analyses Embracing Broad Views of Patentable Subject Matter
While there are many other examples in the case law of federal
courts, the following highlights illustrate the broadly inclusive views
that federal courts have taken of patentable subject matters. These
cases define a path that leads to the coverage of patents for numerous
information processing advances, financial management methods, and, by
little or no extension, tax planning processes.
a. Biotechnology
In Diamond v. Chakrabarty, 447 U.S. 303 (1980), Chief Justice
Berger, writing for the Supreme Court, held that United States patent
laws extend to advances in biotechnology including a newly
bioengineered type of bacteria that was useful in helping to break down
oil products and clean up oil slicks. The Court observed that the
patent system should not be limited to older notions of what
constituted technology or engineering. Rather, the Court felt that
Congress intended patentable subject matter to include ``anything under
the sun that is made by man.'' Id. at 308.
b. Computer Systems for Information Processing
In re Alappat, 33 F.3d 1526 (Fed.Cir. 1994) (en banc) involved a
computer system for controlling visual output on a video screen. A
computer system carefully evaluated electronic signals and determined
how to best display the signals on a video screen. The only new
components in computer system were the information processing sequences
defined by the applicable computer program. The Court of Appeals for
the Federal Circuit found this invention to entail patentable subject
matter because the system was ``a specific machine that produces a
useful, concrete, and tangible result.'' Id. at 1544.
c. Financial Information Processing Method
State St. Bank & Trust Co. v. Signature Fin. Group, Inc., 149 F.3d
1368 (Fed.Cir. 1998) considered a patent on a business method calling
for central investment of funds from multiple financial institutions,
with frequent status reports made to the contributing institutions (a
so called ``hub and spoke'' system of investment and reporting). This
method was found to be a patentable process because the information
handling involved had practical consequences in managing funds. The
Federal Circuit court specifically noted that, given their practical
consequences, business methods should be treated no differently than
other practical advances and that innovative business methods should
qualify as patentable subject matters like other useful advances.
d. Business Record Keeping Method
The Federal Circuit court reaffirmed its support for business
method patents in AT&T Corp. v. Excel Communications, Inc., 172 F.3d
1352 (Fed.Cir. 1999). That case involved a new electronic record
keeping method for handling information on long distance calls. This
method was found to be patentable subject matter based on the practical
usefulness of the method in phone usage record-keeping and associated
billing systems.
e. Medical Information Processing Method
In Arrhythmia Research Technology, Inc. v. Corazonix Corp., 958
F.2d 1053 (Fed.Cir. 1992) the Federal Circuit court considered the
patentability of a computer-implemented method for interpreting
heartbeat monitor data to detect possible heart problems. This system
was patentable because the results it produced were not abstract data
but rather information ``related to the patient's heart activity.''
Patentable subject matter was present here because heartbeat monitor
signals were ``transformed'' to produce a practically useful result in
identifying heart abnormalities. Id. at 1059.
4. General Standard For Patentable Subject Matter in Intangible
Innovations
The cases to date--particularly the rulings of the Court of Appeals
for the Federal Circuit which hears all patent appeals--indicate that a
new method of undertaking a useful procedure will be a potentially
patentable innovation if the method:
Fills a user need with identifiable value;
Addresses a need shared by multiple parties;
Operates in a regular manner producing consistent
results; and
Is capable of being described clearly so as to permit
effective evaluation of the innovation and its results by potential
users.
See generally Gruner, Intangible Inventions: Patentable Subject
Matter for an Information Age, 35 Loyola L.A. L. Rev. 355 (2002). An
innovative tax planning method, capable of use by a broad set of
taxpayers and producing favorable, valuable tax results, would appear
to meet this standard for patentable subject matter.
C. Potential Impacts of Tax Planning Patents
Commentators analyzing the development of patents regarding
financial services and products have identified a number of ways that
such patents are changing the way businesses in this field operate.
These developments concern how businesses in the financial services
field are perceived by customers, the choices these business make
regarding the targeting of innovation and marketing efforts, and the
relative mix of innovators versus non-innovators in the field. The same
sorts of impacts are likely to be seen in the tax planning field as tax
planning patents become more common and have greater impact. See, e.g.,
James F. Baueric, ``Beam Me Up, Scotty''; Business Method Patents as a
Transformational Device in Financial Services, 119 Banking L.J. 376
(2002); John C. Spaccarotella, Patents Continue to Gain Visibility,
Value in the Lucrative Derivatives, Hedge Fund, and Allied Financial
Services Market, Futures & Derivatives L. Rep., Oct. 2005 at 3.
1. Expertise Validation
One impact of patents obtained for particular financial services is
to validate the apparent expertise of the developers of the patented
services. The issuance of a patent is viewed as a confirmation by the
USPTO that the patented financial service or product is a distinctive
departure from the prior knowledge in the field. The approval of the
patent by the PTO indicates that its neutral patent examiners have
compared the claimed invention to the prior knowledge in the field and
found the invention to be a nonobvious addition to that knowledge. The
patent, as a symbol of the underlying analysis by the USPTO, therefore
becomes credible evidence of both the newness of the patented invention
and of the analytic skill of the invention developer in being able to
produce a nonobvious extension of prior designs.
This is a reflection of the ``signaling'' role of patents regarding
technological developments generally. Clarisa Long, Patent Signals, 69
U. Chi. L. Rev. 625 (2002). As described by Clarisa Long, patents
provide:
``a means of credibly publicizing information. Patents can reduce
informational asymmetries between patentees and observers. Under some
circumstances, the informational function of patents may be more
valuable to the rights holder than the substance of the rights. . . .
If an easily measurable firm attribute such as patent counts is
positively correlated with other less readily measurable firm
attributes such as knowledge capital, then patent counts can be used as
a means of conveying information about these other attributes. Knowing
this, firms may choose to obtain and use a portfolio of patent rights
to signal information about themselves that would be more expensive to
do through other means. Alternatively, firms can use the patent
document itself to convey information that would not be as credible
when revealed in other contexts.'' Id. at 625.
2. Product Differentiation
Another impact of issued patents in the financial services industry
is to differentiate products of patent holders from those of
competitors. A company marketing a particular financial services
product incorporating a patented features can assure its customers that
this same product--and whatever advantages it provides--can not be
obtained from other vendors since the patent involved will preclude
adoption of the feature in other parties' products and services.
Through this type of product differentiation, a firm can establish a
pattern of ``sustainable differentiation'' from its competition built
on a foundation provided by the firm's patents. See Spaccarotella,
Patents Continue to Gain Visibility, Value in the Lucrative
Derivatives, Hedge Fund, and Allied Financial Services Market, Futures
& Derivatives L. Rep., Oct. 2005 at 3 (noting the potential of
financial services patents to enhance the marketing of an ``allegedly-
proprietary product and technology to current and potential clients'').
This type of sustainable differentiation has been seen as highly
valuable in other fields. In a detailed study of patenting and
investment generation practices in the computer software field, Ronald
J. Mann found that venture capitalists were particularly interested in
patents and associated them with company value because the patents
provided a vehicle for sustainable differentiation of software
developers from their competitors. Ronald J. Mann, Do Patents
Facilitate Financing in the Software Industry?, 83 Tex. L. Rev. 961
(2005). Mann described the linkage between patent holdings and
perceived company value in the eyes of venture capitalists as follows:
``[F]or firms that have a credible product idea and the expertise
to implement it, venture capitalists plainly accept the idea that their
goal is to identify firms that will have sufficient market power to
earn extraordinary profits. IP protection is important only indirectly,
as a tool that might provide that market power. The key is
``sustainable differentiation'': something special about the particular
firm that will enable it to do something that its competitors will not
be able to do for the immediate future. . . . [I]t is clear that the
key to a desirable investment opportunity is in the expectation of
market power, and all other attributes of the company are indirect
predictors of that ultimate goal.'' Id. at 975 (footnotes omitted).
3. Channeling Competitors' Actions
Patent issuance, coupled with substantial publicity regarding a
patent and its probable enforcement, can be a means to either direct
competitors' activities away from a particular domain of product
development and offerings or to compel competitors to seek licenses and
pay handsome royalties for access to products or services that are so
essential that they can not realistically be avoided. The motivation to
either avoid infringement of a competitor's patents or to voluntarily
seek a license stems from the considerable threat of patent
infringement damages for parties who make, use, or sell a patented
invention without the permission of the patent holder.
In a services setting, persons who undertake a patented service
even without notice of the patent involved, are liable to the patent
holder for compensatory damages. 35 U.S.C. Sec. 284. Once a party is on
notice of a patent and the practices or devices the patent covers,
subsequent efforts by the party to make, use, or sell the invention
risk not just compensatory liability, but also further punitive
liability for willful patent infringement which can equal as much as
three times the losses of the patent holder. See Stickle v. Heublein,
Inc., 716 F.2d 1550, 1556 (Fed.Cir. 1983). If the patent holder is a
producer or provider of competing products or services, the patent
holder's losses will be measured from the lost sales profits resulting
from the infringer's conduct, provided that those profits can be proven
accurately. See Panduit Corp. v. Stahlin Bors. Fibre Works, Inc. 575
F.2d 1152 (6th Cir. 1978). If the patent holder is not a producer of
products or provider of services or if the patent holder's lost sales
profits can not be proven accurately, a patent holder will be entitled
to recover a reasonable royalty from an infringer equal to the amount
of the royalty payment that the patent holder and infringer would
probably have agreed to in negotiations conducted at arms length prior
to the infringement. Id.; Hanson v. Alpine Valley Ski Area, Inc., 718
F.2d 1075 (Fed.Cir. 1983).
When combined with the incremental threat of trebling for willful
infringement, patent infringement damages can easily rise to large
levels, making the threat of liability for such damages a considerable
deterrent to actions even approaching patent infringement.
4. Signaling Future Innovation Strengths
Patents concerning a particular type of product can also signal
future business strategies to customers and competitors. The investment
of large research expenditures in developing new financial products or
services in a particular area, coupled with the revelation of those
expenditures through the publication of patent applications or patents
describing inventions resulting from the innovative efforts, can
provide business intelligence information to customers and competitors.
For customers, the message is that the firm involved is serious
about being a technology and product leader in the domain of the
innovation being patented, with the possibility of more similar
advances to come. Such a message can establish a degree of trust in the
future products of an innovative patent holder that encourages
customers to establish long term business relationships with the
innovator.
For competitors of a patent holder, the implications of a valid
patent may be that the competitors will find it difficult to pursue
innovation in the same direction as the innovation covered by the
patent (since they will need to license rights under that patent in
order to pursue such innovation) and that the competitors will need to
pursue other paths of innovation departing significantly from the
patented approach if they want to be innovators in the same field. This
pressure to ``design around'' an existing patent and produce
alternative solutions to consumer problems that are outside the patent
can drive innovation efforts of competitors into other areas that are
unaddressed by the patent holder.
5. Increasing Innovation Specialization
As a patent holder and its competitors pursue different innovative
paths in reaction to an issued patent, each has incentives to develop
specialized expertise and knowledge that will aid it in producing
innovations and, perhaps, additional patents that will reserve a
particular product niche to the firm. This type of strategy will tend
to strengthen the specialization and firm differentiation effects in
the field involved.
As this process goes forward, specialized innovators may need to
cross-license patents to and from their competitors so that each can
gain the specialized advances of the other to produce viable,
competitive products. The patents that each firm has on their
specialized advances in the narrow slice of the field where they have
particularly strong innovative capabilities will become the
``currency'' with which they can bargain for rights to use the advances
of their competitors.
6. Rewarding Innovators Over Non-Innovators
The winners in this sort of arrangement will be those firms that
have innovations and patents which enable them to be highly successful
competitors in the field. The losers will be companies with no
innovations and no patents to bargain with. In effect, this sort of
process should help to filter out less innovative firms, leaving only
ongoing innovators that can bargain for the latest designs in their
fields and keep the firms competitive in consumer markets.
II. Anatomy of a Tax Planning Patent and Its Potential Enforcement
In order to appreciate the potential scope and enforcement impact
of patents on tax planning methods, it is useful to consider the terms
of one of these patents. This section will briefly describe a patent
issued in 2003 covering a method for achieving an advantageous tax
result by establishing and managing in a specified fashion a trust
funded by a particular type of stock options.
A. The SOGRAT Patent
United States patent number 6567790 purports to protect:
``[a]n estate planning method for minimizing transfer tax liability
with respect to the transfer of the value of stock options from a
holder of stock options to a family member of the holder. The method
comprises establishing a Grantor Retained Annuity Trust (GRAT) funded
with nonqualified stock options. The method maximizes the transfer of
wealth from the grantor of the GRAT to a family member by minimizing
the amount of estate and gift taxes paid. By placing the options
outside the grantor's estate, the method takes advantage of the
appreciation of the options in said GRAT.''
U.S. Patent No. 6567790. A ``nonqualified stock option'' for tax
law purposes is any stock option that does not qualify as an incentive
stock option (ISO) and which does not receive the favorable tax
treatment accorded to ISOs. Generally, a nonqualified stock option is
not taxed at the date it is granted, but is instead taxed upon the
exercise of the option. The amount subject to tax is the difference
between the fair market value of the stock on the date of the exercise
of the option and the exercise price paid for the stock. After the
exercise of an option, the taxpayer holds the corresponding stock as a
capital asset and is subject to normal capital gains rules on the
disposition of the stock.
Because the GRAT used in this method involves stock options, the
patent applicant describes this method as involving a ``Stock Option
Grantor Retained Annuity Trust'' or ``SOGRAT.'' As a further measure of
intellectual property protection, the patent applicant claims trademark
protection for the use of the term ``SOGRAT'' (this claim is noted in
the patent covering the method). In the remainder of this document, the
above patent is referred to as the ``SOGRAT patent.''
B. Scope of Protection
The scope of protection granted by this patent can only be gauged
from the claims stated in the patent. These claims, located at the end
of the patent document, describe the ``metes and bounds'' of the legal
rights conferred by the issuance of the patent. The patent holder will
be able to prevent others from using a tax planning method only if the
method of the other party is with the description of the protected
process provided by the claims. In patent law terms, a tax planning
method of a party other than the patent holder will be infringing if
the claims describe or ``read on'' the method of that other party.
The SOGRAT patent has a number of claims describing different
versions of the claimed method. The first claim is the broadest and
reads as follows:
``What is claimed is:
1. A method for minimizing transfer tax liability of a grantor for
the transfer of the value of nonqualified stock options to a family
member grantee, the stock options having a stated exercise price and a
stated period of exercise, the method performed at least in part within
a signal processing device and comprising: establishing a Grantor
Retained Annuity Trust (GRAT); funding said GRAT with assets comprising
stock options, the stock options having a determined value at the time
the transfer is made; setting a term for said GRAT and a schedule and
amount of annuity payments to be made from said GRAT; and performing a
valuation of the stock options as each annuity payment is made and
determining the number of stock options to include in the annuity
payment.''
The portions of this claim separated by semicolons identify the
steps or elements that a tax planning process will need to have to fall
within this claim and to be infringing. These elements provide a
checklist for analyzing the activities of other parties for the purpose
of determining if they are infringing this patent. Using this approach,
a party would appear to infringe this patent (assuming that the patent
is valid and enforceable) if the party (using, at least in part, a
``signal processing device'') completed the following steps:
1. establishing a Grantor Retained Annuity Trust (GRAT);
2. funding said GRAT with assets comprising stock options, the
stock options having a determined value at the time the transfer is
made;
3. setting a term for said GRAT and a schedule and amount of
annuity payments to be made from said GRAT; and
4. performing a valuation of the stock options as each annuity
payment is made and determining the number of stock options to include
in the annuity payment.
Assuming that a tax planning method had these features, it would be
infringing, even if the method had other details or characteristics. If
a method did not include exact counterparts to every one of these
steps, it would still be infringing if it included an equivalent action
to each of these steps. A step will generally be seen as an equivalent
of a claimed step if the alternative step involves a similar means of
operation, function, and result to the counterpart step in the patent
claims.
C. Potential Infringers
1. Clients
Clients for whom tax planning methods are implemented and who
benefit from the resulting taxation outcomes would be the primary or
``direct'' infringers of a patented method like that described above. A
party seeking to implement this strategy without the patent holder's
permission could be enjoined from doing so. A party who implemented the
patented method (even without being aware of the patent involved) would
be liable for patent infringement damages equal to a reasonable royalty
payment for use of the patented method. 35 U.S.C. Sec. 284. If the
party was aware of the patent and aware that the course of conduct he
or she contemplated was apparently covered by the patent, but went
ahead anyway with the infringing conduct having no good faith reason to
believe that it was non-infringing or that the patent was invalid, the
party could be held liable for punitive damages of up to three times
the patent holders compensatory damages. Id.
2. Attorneys/Accountants
The federal Patent Act holds persons who induce others to engage in
patent infringement equally liable with the parties who actually
undertake the infringement. 35 U.S.C. Sec. 271(b). The notion here is
that an inducer is essentially an ``aider and abetter'' of the patent
infringer and should be equally responsible for patent damages.
Numerous cases hold that persons who instruct others how to infringe a
patent or who help to design implementations of an infringing design
are deemed to be inducers of infringement and liable under the Patent
Act. Since tax attorneys and accountants who specialize in tax matters
will commonly provide advice, instruction, and relevant document
creation services aiding clients in setting up tax planning strategies,
if these professionals are aware that the tax planning methods that
they are helping clients to implement are patented, attorneys and
accountants may incur patent infringement liability by inducing the
patent infringement of their clients.
In order to establish liability for inducement of patent
infringement, the following elements must be proven by a preponderance
of the evidence: (1) an inducer's knowledge of the asserted patent; (2)
the presence of infringement by the party allegedly induced; (3) an
inducer's actual intent to cause the acts which he knew or should have
known would induce actual infringements; and (4) the commission of a
positive act that materially furthers the infringement, not merely the
power to act or the failure to act. TI Group Automotive Systems, (North
America), Inc. v. VDO North America L.L.C., 62 USPQ2d 1599, 1601 (D.
Del. 2002); see also Black & Decker (US) Inc. v. Catalina Lighting,
Inc., 953 F. Supp. 134, 138 (E.D. Va. 1997). Where a tax attorney or
accountant is aware of a tax planning method patent and instructs a
client or materially assists a client in carrying out the patented tax
planning method, all of these criteria would seem to be met.
3. Financial Institutions Managing Accounts
Financial institutions or other entities that agree to carry out a
patented tax planning method (perhaps by establishing or acting as
trustee for the relevant trust) may also carry out the patented steps
and be liable as a direct patent infringer. Here, the financial
institution would be acting as the agent of the taxpayer for whom the
infringement was undertaken, but this will not undercut the fact that
the institution has carried out the patented steps and has acted as an
infringer.
III. Potential Steps to Limit the Issuance and Enforcement of Improper
Tax Planning Patents
A number of steps may be useful in ensuring that tax method patents
are limited to innovative tax planning methods that are significant,
nonobvious departures from prior methods in this field. This section
summarizes these possible strategies for future action.
A. Identify Field-Specific Prior Art Sources for Use in Patent
Examination Processes and Enforcement Disputes
Tax specialists might profitably work with the USPTO to identify
publicly accessible sources of information about past tax planning
strategies so that these known strategies can be taken into account in
the processing of applications for patents on tax planning methods.
These prior art sources are different in both location and content from
many other types of information commonly considered by patent examiners
and a complete picture of the prior art against which tax method patent
applications should be measured may require personnel in the patent
office to gain new information on the sources and meaning of publicly
available descriptions of ``state of the art'' tax planning methods.
This same information on sources and implications of prior art, if made
available to the public, would assist defendants in patent cases to
challenge the validity of improvidently issued patents on tax planning
methods.
B. Develop Means to Expand the Knowledge of Patent Examiners Regarding
Tax Planning Methods and Improvement Patterns
To the extent that methods of tax planning and techniques for
extending prior tax planning methods to produce new methods are
unfamiliar to patent examiners, presentations by tax practitioners to
USPTO personnel on current tax planning techniques may be highly
valuable. These sorts of presentations might be modeled on similar
information sessions that the USPTO conducted to learn more about
computer software programming methods and advances in the period when
software patents and their examination were growing concerns for the
Patent Office.
C. Encourage the Patent Office to Frequently Reexamine Tax Planning
Patents
The USPTO has the ability to reexamine and invalidate issued
patents in light of prior art that was not originally considered in the
initial examination of the patents. Given the uncertain state of prior
art in the field of tax planning patents, a policy adopted by the
Patent Office which encourages the submission of prior art in this
field to trigger reexamination proceedings might be a valuable means to
ensure that unwarranted patents do not reach the stage of active
enforcement.
D. Develop an Information Distribution System to Inform Tax
Practitioners of Assertedly Restricted Tax Planning Methods
An additional useful advance might be a system for better informing
tax practitioners regarding the issuance of patents on particular tax
planning methods to prevent the inadvertent implementation of a
patented strategy without gaining appropriate permission from the
patent holder. This type of information distribution system might be as
simple as a means for specially flagging patents on tax planning
methods in the patent records system or otherwise identifying patents
in this category to facilitate quick searching for patents affecting
this type of legal practice. The Patent Office has begun to implement a
special coding system for patents in this field, but it is unclear that
all of the relevant patents are being identified by the appropriate
coding. The Patent Office also might consider the issuance of special
reports on this category of patents given their new character and the
general unfamiliarity of many tax practitioners with the types of tax
planning patents that are emerging.
E. Implement a Public Comment System Whereby the IRS Notes the
Ineffectiveness or Impropriety of Patented Tax Planning Methods
As a matter of taxpayer protection, a system under which the IRS
identifies patented tax planning methods as either abusive or incapable
of achieving a meaningful tax advantage would help taxpayers and their
attorneys and accountants to properly discount the value of the
patented methods involved and to avoid those practices. To the extent
that recognizing a tax planning method with a patent suggests that the
method is particularly special and valuable, this type of corrective
information from the IRS might be needed to ensure that taxpayers and
tax specialists make decisions about tax planning methods with an
accurate picture of the merit of the methods involved.
IV. Conclusion
The emergence of tax planning patents reflects the confluence of
three important trends in patent law. First, patentable subject matter
standards have been steadily expanding in scope. Federal court
standards have, over the past two decades, recognized that our patent
system should encourage and reward advances in fields as divorced from
traditional physical engineering and chemistry as bioengineering,
computer software, communication information processing, accounting
record keeping, financial investment strategies, and business methods.
In this march towards ever broader patent system scope, it is a small
step to extend patents to advantageous tax planning methods which
produce important financial results for taxpayers.
Second, the impacts of computers and computer-based analyses have
expanded the range of sophisticated tax planning strategies that are
appreciated and implementable. Computer analyses of potential asset and
income management strategies and tax results have expanded our
understanding of what is desirable, leading to types of potentially
patentable tax planning methods which would not have been understood a
few years ago. On the implementation side, computer management and
tracking processes allow for the implementation of tax planning
strategies which would not have been possible in an earlier era. These
developments in computer technologies applied to tax planning methods
have expanded the range of computer-related tax planning patents just
as the presence of computers has expanded the number of patents in so
many fields. See generally Gruner, Better Living Through Software:
Promoting Information Processing Advances Through Patent Incentives, 74
St. John's L. Rev. 977 (2000).
Third, the increasing frequency of patents in the financial and tax
planning services fields may encourage firms to extend more resources
towards the development of highly sophisticated methods for tax
planning, with the amount of those resources augmented by expectations
of large rewards achieved through patent control of the resulting
innovations. If a given advance can only be marketed to a given firm's
particular client set and may become available for marketing by
competitors through public disclosure of the method, the firm pursuing
the development of the method will only be encouraged to devote such
resources to the development of the method as will be paid back in
extra payments from their own clients in later transactions. However,
if a firm can count on patent protections for a new and highly
innovative tax planning strategy, the firm will be able to afford to
devote greater resources to the development of the method knowing that
all taxpayers who wish the benefit of using the method will need to pay
a royalty to gain this advantage. Under this latter type of system, the
full range of taxpayer advantages from a given new technique will
define the extent of development expenditures that are justified in
producing it. It will also encourage firms to focus on the types of
highly innovative, nonobvious extensions of prior designs that are
capable of qualifying for patents. See generally Gruner, Everything Old
is New Again: Obviousness Limitations on Patenting Computer Updates of
Old Designs, 9 B.U. J. of Science and Tech. L. 209 (2003).
This last analysis suggests why patents on tax planning methods,
while highly foreign and seemingly dysfunctional to tax planners at
present, may ultimately be beneficial to this field. If the future of
tax planning methods lies in highly sophisticated, computer-intensive
means of asset and income management, then substantial development
rewards and protections may be needed to encourage the invention of
these methods. Patents on such methods will encourage the very best
designers of such methods to devote their time to this development.
Patents will also encourage the devotion of extensive combinations of
computer and financial accounting resources to the development of these
methods with the knowledge that successful results can lead to valuable
patents. This type of development pattern has prevailed in a number of
other fields where patents serve to allow smaller, highly innovative
concerns to focus on innovation, with the assurance that other, less
innovative firms will need to pay for use of the resulting innovations.
In short, a patent-mediated world of tax planning may be one in
which greater efforts are devoted to the types of innovative tax
planning methods that are nonobvious advances over prior methods and
that can qualify for patents. It may also lead to a restructuring of
the field where innovators are significantly advantaged in competition
with non-innovators and in which specialists in innovation can be sure
that their useful results will be paid for by the numerous clients and
tax specialists who use and benefit from the innovative tax planning
methods which emerge.
Chairman CAMP. Thank you very much. Ms. Aprill, you have 5
minutes as well.
STATEMENT OF ELLEN APRILL, ASSOCIATE DEAN OF ACADEMIC PROGRAMS,
PROFESSOR OF LAW, AND JOHN E. ANDERSON CHAIR IN TAX LAW, LOYOLA
LAW SCHOOL, LOS ANGELES, CALIFORNIA
Ms. APRILL. Mr. Chairman, Members of the Committee, thank
you for inviting me here today. This morning, I would like to
discuss three points briefly: first the practical issues raised
by tax strategy patents, first; second, how we might improve
the quality of such patents; and, third, how the policy behind
tax laws and patent laws compare. In brief, I want to suggest
to you that because tax strategy patents constitute a
government-granted monopoly regarding interpretation of and
compliance with Federal laws, they differ from other business
method patents in ways that raise concerns among all of us and
require attention from the Subcommittee, the PTO, the IRS, the
Treasury, and associations of tax professionals.
First, the impact on tax practice. The adverse consequences
for infringing or inducing the infringement of patents can be
substantial. If tax patents proliferate, tax professionals who
are advising clients on ordinary transactions will need to
begin to conduct patent searches and seek expert advice to
protect themselves and their clients. I wanted to stress the
concern for the individual client. Moreover, the proliferation
of tax strategy patents could affect professional culture.
Historically, tax lawyers have shared information and ideas
freely. If patents become an important part of the landscape,
the atmosphere will become more secretive, less cooperative,
and the tax system as a whole will suffer.
Second, improving the patent examination process. As we
have heard today, this is a new area for patent examiners. To
ensure that, the quality of patents that are granted, the tax
community, both public and private, need to assist patent
examiners in understanding the tax law and in identifying prior
art in non-patent literature. As you have heard, such efforts
have begun and they need to be expanded. As we have also heard,
under the patent law, however, questions of tax policy are not
for the Patent Office; they are for Treasury and the IRS to
decide. I suggest that Treasury and the IRS establish a program
letting everyone know they are going to be reviewing tax
patents to prevent any abuses. I suggest that some changes be
made so that IRS and Treasury can see the patent application
sooner. Again, I want Treasury to be involved as well because
of the policy concerns raised by the ordinary transactions, and
not only the extraordinary tax shelter ones.
Finally, let me turn to a comparison to patent policy and
tax policy. The fundamental purpose of providing patents, as I
understand it, is to promote innovation. Again, as we have
heard, there does not seem to be a lot of need to provide
economic incentives for the development, promotion, and
implementation of tax planning strategies. The purposes of our
tax laws is to raise money for the government to protect the
public. Granting a government monopoly in the form of a patent
that could undermine this key Federal function, the collection
of revenue, and affect compliance with Federal law seems
peculiar to me, if not contradictory, and raises fundamental
questions about the appropriateness of such patents. We need
the policy people to work on that basic question.
Of course, any decision to limit patent protection
legislatively should be taken only after much deliberation and
study. My hope is that this hearing will be the first step in
careful consideration of any such step. One idea I would throw
out for your consideration is parallel a provision that we see
for medical procedures, to consider having a statutory
protection against infringement or individual taxpayers in
their individual capacity and as well as small businesses up to
a certain amount. Thank you.
[The prepared statement of Ms. Aprill follows:]
Statement of Ellen Aprill, Associate Dean of Academic Programs,
Professor of Law, and John E. Anderson Chair in Tax Law, Loyola Law
School, Los Angeles, California
Mr. Chairman and members of the Subcommittee, thank you for
inviting me to speak here today. My name is Ellen Aprill. I am the John
E. Anderson Professor of Tax Law and Associate Dean for Academic
Programs at Loyola Law School in Los Angeles; I have had the privilege
of serving in the Office of Tax Legislative Counsel in the Department
of the Treasury in the late 1980's and as a law clerk to the Hon. Byron
R. White, Associate Justice of the United States Supreme Court, in the
early 1980's. I am currently a member of the Council of Directors of
the American Bar Association Section of Taxation. While I first became
aware of the issues related to the patenting of tax strategies through
my involvement on the ABA Tax Section, I am speaking today in my
individual capacity as a tax lawyer and tax professor. My comments
represent my own personal views and are not necessarily those of Loyola
Law School or any other organization with which I am affiliated.
Tax strategy patents are considered a subcategory of business
method patents.\1\ Representatives of the United States Patent and
Trademark Office (``PTO''), who have been most generous, gracious, and
helpful in discussing these matters, have explained that the PTO
classifies tax strategy patents as subclass 36T in Class 705, ``Data
Processing: Financial, Business Practice, Management, or Cost/Price
Determination.'' \2\ The PTO website shows that 48 patents have been
issued in that subclass and 81 such applications are pending.\3\ These
tax strategy patents have involved many aspects of the tax law,
including financial products, charitable giving, estate planning, and
tax-deferred exchanges.
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\1\ After State Street Bank & Trust v. Signature Financial Group,
Inc., 149 F.3d 1368 (Fed. Cir. 1998), held that business methods could
be patentable subject matter, the number of business method patents
exploded. Criticism of the concept of business method patents and the
ability of the PTO to consider adequately prior art quickly followed.
See Jay Dratler, Jr., Does Lord Darcy Yet Live? The Case against
Software and Business-Method Patents, 43 Santa Clara L. Rev, 823
(2003); cf. John R. Allison and Emerson H. Tiller, The Business Method
Patent Myth, 18 Berkley Tech. L.J. 987 (2003).
\2\ See http://www.uspto.gov/go/classification/uspc705/
sched705.htm.
\3\ See http://www.uspto.gov/patft/index.html (using search term
ccl/705/36T in Advanced Search).
---------------------------------------------------------------------------
The topic of patenting tax strategies raises a broad range of
issues, from the most theoretical to the most practical. Questions of
theory and policy include whether it is desirable for the patent law to
authorize tax strategy patents and whether the government monopoly
granted to a patent holder is fundamentally inconsistent with the
policies underlying our tax system. Important practical issues include
the impact on how tax practitioners advise their clients and their
potential liability for inducing patent infringement. Issues in the
middle of this spectrum include questions of institutional capacity,
namely how best to ensure the quality of such patents.
Like other tax lawyers who have looked at this issue, I have
concerns both about tax strategy patents that may not meet the patent
criteria of novelty and non-obviousness and about others that may be
novel and innovative, but are inconsistent with our tax laws. My
testimony will address both categories, although I am, in fact, more
concerned about the former--tax strategy patents that are not in fact
novel--than the latter, tax strategy patents that are inconsistent with
the tax law. I will begin with the practical issues raised by tax
strategy patents, go on to the consideration of how we might improve
the quality of tax strategy patents, and end by comparing the purposes
of the tax law with the purposes of the patent law. In brief, I
conclude that because a tax strategy patent constitutes a government-
granted monopoly that turns on the interpretation of federal law, tax
strategy patents differ from other business method patents in ways that
require attention and action from the PTO, the IRS, associations of tax
professionals, and this Subcommittee.
A. Tax Strategy Patents Could Change and Burden the Practice of Tax Law
Compliance with the tax laws is enormously expensive and time
consuming. However diligent and well-intentioned taxpayers and their
advisers may be, compliance becomes more difficult every year.
Proliferation of tax strategy patents will add to that difficulty. Tax
practitioners and taxpayers will have to become more sensitive to the
possibility that a tax strategy has been patented and adjust behavior
accordingly.
The adverse consequences for violating or inducing the violation of
patents can be substantial. Patent holders generally seek injunctions
against alleged infringers as well as any inducers of infringement to
bar them from acting without paying damages equal to lost profits or a
reasonable royalty. A taxpayer can infringe a patent without intent or
actual knowledge of the patent; ignorance of an applicable patent is
not a defense to an infringement action. Moreover, patents have a
presumption of validity; an alleged infringer defending use of a
technique must show the invalidity of a patent by clear and convincing
evidence. Patent infringement litigation is extraordinarily
expensive.\4\ Tax advisers whose clients face patent infringement suits
may themselves face malpractice claims.
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\4\ In 2005, the American Intellectual Property Law Association
reported that the average patent infringement case as typically costing
$650,000 for each party when the amount at risk is less than $1 million
and $2 million for each party when the amount at risk is between $1
million and $25 million. Am. Intellectual Prop. Law Ass'n, Report of
the Economic Survey 22 (2005).
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As a result, taxpayers, their advisers, and others may need to
begin considering whether to conduct patent searches in connection with
any tax planning activity, whether to seek expert advice, and depending
on the results, what course of action to pursue in response to a
possible patent claim. One prominent practitioner recently told me that
a holder of a tax strategy patent obtained the list of all the
attendees at a meeting held to consider the area of tax law involved in
the patent. The patent holder sent all of the attendees a letter saying
that their business activities might be infringing his patent. Some of
those who received the letter in fact paid royalties, as the least
costly course of action; others went though the burden and expense of
asking their lawyers to review the patent to ensure that they were not
guilty of any infringement.
Note that these burdens on the tax system are created without
regard to whether the patent involves a tax strategy that the IRS would
consider abusive. The mere possibility of a relevant tax strategy
patent creates the compliance burden. Indeed, if the patenting of tax
strategies were to flourish, I would expect that the additional burdens
would be greater in connection with tax strategies that may not in fact
be novel or non-obvious than they will be for abusive tax strategies.
Abusive planning techniques not only constitute a relatively small
percentage of all tax planning, but also receive considerable attention
from the IRS.
The proliferation of tax strategy patents would also affect
professional culture. Historically, the dissemination of tax planning
ideas has been open and widespread. Tax lawyers and accountants
currently share information and ideas with each other freely. There is
an astonishing array and number of meetings, conferences, conventions,
and listservs where tax planning ideas are shared. Although the patent
system is designed to encourage the dissemination and discussion of
ideas and information, many tax lawyers are concerned that the spread
of tax strategy patents will have the opposite effect, namely, that
those with new ideas or the beginnings of ideas will hesitate to enter
into discussion with others. If patents become an important part of the
tax landscape, the atmosphere could become more secretive and less
cooperative. The tax system as a whole will suffer if, in order to
protect their patentable intellectual property, tax professionals are
no longer willing to discuss, evaluate, and criticize each other's
insights regarding how to comply with the tax system.
B. The Process of Examining Tax Strategy Patents Could be Improved
1. Lessons from other kinds of business method patents.
In order to review the validity under the patent law of
applications for tax strategy patents, patent examiners need expertise
in software, finance, and tax. They need to understand the conceptual
basis of a range of areas of tax--financial products, estate and gift
tax, pension and deferred compensation, to name a few where tax
strategy patents already exist. Such expertise is difficult to obtain.
Few tax lawyers have such broad knowledge in such varied aspects of the
tax law. Most of us work very hard just to keep up in developments and
changes in the law in our areas of specialization.
Tax strategy patents, like all other patents, must be both novel
and non-obvious. For tax strategy patents, as with other patents,
examiners look to prior art to determine novelty and non-obviousness.
Identifying prior art in this area is particularly difficult. This is a
new arena for patent law, and the traditional source for that
determination, the body of pre-existing patents, is not helpful. In the
case of tax strategy patents, to decide whether the idea for which the
application is made is ``new,'' examiners need to know how to go about
doing specialized tax research in non-patent literature and must do
such research as quickly and as efficiently as possible, particularly
given the severe time constraints they face.\5\
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\5\ I understand from the PTO that the average amount of time for
examining a tax strategy patent is 32 hours.
---------------------------------------------------------------------------
To a large extent, these issues involving the learning curve of the
PTO for reviewing tax strategy patents parallel the issues it faced
with software, Internet and other business method patents after State
Street Bank. Solutions found there will apply here as well. In the
years following the State Street Bank case, which established the
validity of business method patents, many business method patents were
subject to criticism as being invalid. Soon after State Street Bank,
the PTO began partnerships and outreach efforts with business method
customers, including requests for resources showing prior art and
expanding non-patent literature information and data bases.\6\ My
understanding is that this collaboration has been successful and helped
to improve the PTO review process.
---------------------------------------------------------------------------
\6\ See http://www.uspto.gov/web/menu/busmethp/partner.htm; Allison
and Tiller, supra note 1, at 1024-25.
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The tax community, both public and private, has begun such a
partnership with the PTO. I understand, for example, that the IRS
recently provided several days of training on tax law to those in the
PTO who examine tax strategy patents. Such training should be done
regularly. Various associations of tax professionals have begun to
study tax strategy patents and would be eager to help as well. For
example, there was an overwhelmingly enthusiastic response when I asked
tax law professors whether they would be interested in setting up a
session to give PTO examiners training in how to do tax research
thoroughly and quickly, and I am currently working with the PTO to try
to arrange such a session. The PTO and the tax community need to
continue to expand such efforts. In addition, the private tax bar needs
to educate its members about the existence of tax strategy patents and
their impact on tax practice. Such efforts are also underway.
Moreover, I urge various professional organizations to monitor
individual applications for tax strategy patents and, as described
below, to submit instances of prior art in connection with such
applications. I also recommend that these organizations do regular
reports on the nature of and issues involving tax strategy patents and
patent applications. These reports could, for example, survey the
number of such patents, their subject matter, issues involving prior
art and non-obviousness as well as issues involving consistency with
the tax laws. Such reports would enable the bar and policymakers to
understand better the nature and dimension of this issue.
2. Special considerations applicable to tax strategy patents.
Two considerations seem to me to differentiate tax strategy patents
from other business method patents. The first implicates the
relationship between utility and public policy in the patent law. Under
the patent law, a patent must be useful for some valid purpose. The
usefulness of a tax strategy patent is likely to turn, at least in
part, on interpretation of the tax law. That is, a tax strategy patent
may achieve its intended purpose only if a particular interpretation of
the tax law is correct or, at least, permissible. The issuance of the
patent, however, does not decide the correctness of the legal
interpretation. Patents are not a government seal of approval, although
they are often seen--and marketed--as such.
Under the patent law, ``[t]he threshold of utility is not high: An
invention is useful'. . . if it is capable of providing some
identifiable benefit.''\7\ Although Justice Story wrote in the 19th
century that inventions ``injurious to the well-being, good policy, or
sound morals of society'' are unpatentable,\8\ modern courts have
avoided consideration of broad public policy in awarding patents and
concluded that ``[t]he requirement of utility' in patent law is not a
directive to the Patent and Trademark Office or the courts to serve as
arbiters of deceptive trade practices.''\9\ Such policy decisions, the
courts have declared, are the duty of other agencies or for Congress
itself.\10\
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\7\ Juicy Whip, Inc. v. Orange Bang, Inc., 185 F.3d 1364, 1366
(Fed. Cir. 1999).
\8\ Id. (quoting Lowell v. Lewis, 15 F. Case. 1018, 1019 (C.C.D.
Mass. 1817)).
\9\ Juicy Whip, Inc., 185 F.3d at 1368.
\10\ Id.
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Thus, the tax policy issues embedded in tax strategy patents are
for the Treasury and the IRS, not the PTO, to consider. For many years,
the Treasury and the IRS have been battling a constant flow of tax
shelters and other questionable tax avoidance schemes. The IRS must be
constantly vigilant in identifying new schemes and significant
variations on old ones that require fresh IRS scrutiny to determine
their validity under the tax laws. Tax patents, although they offer the
IRS the advantage of public availability, are likely to make this task
even more difficult. Patents carry with them the appearance of federal
government approval and the legal presumption of validity. I am
concerned that taxpayers and others who consider employing tax strategy
patents will rely on the appearance of government approval and the
presumption of validity a patent carries and, therefore, fail to
evaluate carefully whether the underlying tax strategy actually works.
If such is the case, the impact on federal tax revenue could be
substantial.
To address such tax-specific concerns, I urge the Treasury and the
IRS to consider establishing procedures by which every patent that
involves tax strategies interpreting the Internal Revenue Code will be
subject to IRS scrutiny as soon as possible, which currently would mean
as soon as the patent application or the patent itself is made public
on the PTO website. This IRS review would be followed, if needed, by a
notice along the lines of notices now published in connection with
potentially abusive tax shelter transactions alerting potential
investors to possible liabilities if they participate in the
transaction. The very existence of such a program by the IRS should
discourage the filing of questionable patent applications. Its benefit
would, I believe, outweigh the costs to the IRS of establishing such a
review. Such a program is crucial to our learning the full scope and
potential impact of the phenomenon of tax strategy patents, in
particular the extent to which these tax strategy patents involve
abusive tax shelters.
The other tax-specific issue relates to procedures for publication
of patent applications. Under the patent regulations, a member of the
public can submit publications relevant to a pending published patent
application within two months of its publication date.\11\ Since 2000,
patent applications have generally been published within 18 months of
their filing. However, a patent application can be kept confidential if
the applicant certifies that the same idea will not be the subject of
an application filed in another country requiring publication within 18
months after filing. \12\ Since inventors generally desire protection
of their ideas in other countries, most patent applications are
currently made public. I understand that the PTO estimates that
approximately 10-15% of all patent applications and a slightly larger
percentage of business method patents are kept confidential.\13\
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\11\ See 37 C.F.R. 1.99. Members of the public can also file
protests based on prior art against pending applications, see 37
C.F.R.1.291, and cite prior art to the PTO during any period of
enforcement, see 37 C.F.R. 1.502, as well as request reexamination, see
35 U.S.C. 302.
\12\ 35 U.S.C. 122(b)(2)(B).
\13\ Allison and Tiller, supra note 1, at 1049 n. 192, observe that
Europe does not recognize business method patents. Nonetheless,
applicants may wish to permit the PTO to publish business method patent
applications, including tax strategy patent applications, even if they
will not seek foreign patent protection, since publishing a patent
application offers the advantage of triggering liability for patent
infringement as of the date of such application, rather than the date
the patent issues. See 35 U.S.C. 154(d).
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For those tax strategy patents that are kept confidential, the
public will be unable to submit to the PTO publications showing prior
art, and the IRS will not be able to undertake early consideration of
any policy issues implicated in a particular tax strategy patent.
Because of the public policy issues involved in tax strategy patents, I
urge that the PTO establish special publication rules to give the IRS
access to all tax strategy patent applications.
The patent statute allows the Director of the PTO to determine
``special circumstances'' overriding confidentiality.\14\ The patent
regulations explain that the PTO, ``either sua sponte or on petition,
may also provide access or copies of all or part of an application if
necessary to carry out an Act of Congress or if warranted by other
special circumstances,''\15\ and I would argue that such access is
necessary to carry out the Internal Revenue Code. If the IRS had access
to all applications for tax strategy patents early in the examination
process, it could review the tax policy issues raised and prepare any
necessary notices regarding the technique as a matter of tax law, as
described above, before a tax strategy patent is issued and marketed.
Meaningful and ongoing interagency cooperation in this regard is as
essential as continuing education in tax developments for PTO examiners
in order to monitor this emerging and potentially significant
development. Efforts of this Subcommittee and its staff can help to
ensure such cooperation.
---------------------------------------------------------------------------
\14\ 35 U.S.C. 122(a).
\15\ 37 C.F.R. 1.14(h).
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If the PTO does not believe it has regulatory authority to permit
the IRS with early access to tax strategy patent applications,
legislation to authorize and direct the PTO to do so may be appropriate
and desirable.\16\ Other more general legislative changes to our patent
law already under discussion, such as expanded post-grant opposition
that would permit submission of ``the common general knowledge of
practitioners . . . not fully described in the published literature
likely to be consulted by patent examiners,'' could also be useful in
ensuring the quality of tax strategy patents.\17\ Proposed legislation
applicable to all business method patents would be helpful for the
issues raised by tax strategy patents as well.\18\
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\16\ Such legislation would help to guard against tax strategy
patents that are novel in ways inconsistent with the tax laws, but
would not guard against the grant of patents for which prior art in
fact exists. The need for public input on prior art might argue for
making all business method patent applications or at least all tax
strategy patents applications public in order that members of the
public could submit instances of prior art during the examination
process, but such a change to the patent law would, I realize, alter
substantially the current balance between public access and
confidentiality struck by the statute.
\17\ Bronwyn H. Half and Dietmar Harhoff, Post-Grant Reviews in the
U.S. Patent System--Design Choices and Expected Impact, 19 Berkeley
Tech. L. J. 1, 13 (2004) (quoting NAt'l Acad. of Sci., A Patent System
for the 21st Century (Stephen A. Merrill et al. eds, 2004) at 5. See
Hearing before the Subcommittee on Courts, the Internet, and
Intellectual Property of the Committee of the Judiciary, House of
Representatives, on Patent Quality Improvement: Post-Grant Opposition,
108th Congress, 2nd Session, June 24, 2004, Serial No. 91.
\18\ See Hearing before the Subcommittee on Courts, the Internet,
and Intellectual Property of the Committee of the Judiciary, House of
Representatives, on The Business Method Patent Improvement Act of 2001,
H.R. 1332, 107th Congress, 1st Session, April 4, 2001, Serial No. 5.
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C. Patent Policy and Tax Policy Differ in Important Ways
The fundamental purpose of providing patents, as I understand it,
is to promote innovation. While no one can dispute this as a generally
desirable goal, it would be hard to identify a subject less in need of
further innovation than tax planning. Existing economic incentives
already provide ample inducement for the development, promotion, and
implementation of tax planning strategies.
The primary purpose of our tax laws is to raise money for the
government and protect the public fisc. Many, perhaps most, tax
strategy patents have as their fundamental objective the reduction of
federal tax liabilities. While taxpayer efforts to reduce taxes are, of
course, permitted and tax advisers spend many hours in such efforts,
tax strategy patents seem to me different from such efforts because
patents constitute a government-sanctioned monopoly. If tax strategy
patents and their use proliferate, encouraged by the marketing
advantages conferred by patents' government-granted monopoly and
presumption of validity, many tax lawyers anticipate that there will be
a corresponding reduction in federal tax revenues, generating revenue
losses that would have to be made up from other sources. Granting a
government monopoly in the form of a patent that undermines another key
federal function--the collection of revenue--seems peculiar, if not
contradictory, and raises fundamental questions about the
appropriateness of such patents.
Of course, decisions to limit patent protection legislatively
should be taken only after much deliberation and study.\19\ Experience
with the review programs by professional organizations and the IRS
suggested above could be enormously helpful in evaluating whether
legislation prohibiting tax strategy patents should be enacted. The
need for careful deliberation, however, does not rule out the need to
consider such an approach. My hope is that this hearing will be the
first step in such consideration.
---------------------------------------------------------------------------
\19\ For Congressional limitations in connection with patents on
particular technologies, such as the provision immunizing physicians,
hospitals, and other health care providers for infringement liability
for using patented medical procedures, see Allison and Tiller, supra
note 1, at 994 n 19. Congress has enacted some special rules for
business method patents. The First Inventor Defense Act of 1999, Pub.
L. No. 106-113, 113 Stat. 1536 (codified as amended at 35 U.S.C. 273),
creates a special patent-infringement defense if an inventor used a
business method in secret and was later sued by a patent holder who had
subsequently been granted a patent on the method.
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D. Summary and Conclusion
Allow me to summarize the various concerns I have identified. The
proliferation of tax strategy patents would change and burden tax
practice. Given such an impact, it is important that we act to ensure
that the examination process be as accurate as possible, particularly
with respect to identifying prior art. The PTO should be provided the
necessary resources and training. Professional organizations have a
role to play, both in helping to train PTO personnel and in identifying
prior art. Given the significance of such patents to the proper
administration of the tax law, I have suggested removing any legal
obstacles to sharing tax strategy patent applications with the IRS, so
that the IRS can review all such patent applications and take
appropriate and early remedial action where necessary. Cooperation
between the IRS and the PTO is essential.
I ask that this Subcommittee continue to monitor tax strategy
patents to determine whether they in fact undermine the efficacy of the
tax laws and increase tax compliance burdens, as we tax lawyers fear,
or, instead, provide additional incentives for innovation and increase
openness regarding new ideas, as patent lawyers suggest. Such a
determination will be vital to further, informed discussion of whether
legislation should be enacted to prohibit or limit sharply tax strategy
patents.
In closing, I suggest that this Subcommittee view tax strategy
patents not as an instance of the now-established category of business
method patents, but as an instance of a potential new category--legal
method patents. Tax strategy patents differ from other business method
patents in that they depend on the validity of an interpretation of
law. If patents are permitted for interpretation of the federal tax
laws, creative minds coupled with economic incentive will seek--and
obtain--valid patents relating to interpretations of other areas of
law, including, for example, litigation strategies. I ask the
Subcommittee whether this is a desirable goal for a country based on
the rule of law.
Thank you very much. I would be pleased to answer any questions.
Chairman CAMP. Thank you very much. Mr. Belcher.
STATEMENT OF DENNIS I. BELCHER, PARTNER, MCGUIREWOODS, LLP,
RICHMOND, VIRGINIA
Mr. BELCHER. Mr. Chairman, Members of the Subcommittee, I
want to thank you for bringing this issue to the attention of
the public. I come to you as a practitioner with 30 years of
experience. I also come to you as an officer in the American
College of Trust and Estate Counsel, which is an organization
of approximately 2,600 lawyers who specialize in estate
planning. We believe that patenting of tax reduction
techniques, particularly estate planning techniques or transfer
tax reduction techniques, is creating a problem for
practitioners but more importantly a problem for taxpayers. We
also believe that if this is not addressed early, it will no
longer just affect a small group of people, it will affect a
larger group of the taxpayers. As we know, right now there are
less than 2 percent of the population of the country subject to
the transfer tax rules. So, when we see a transfer tax
technique being patented, it is serious to our organization and
it is serious to our clients but that is less than 2 percent of
the population. What we are worried about is if we do not stop
this patenting of tax reduction techniques, it is going to
spread and affect a larger group of people.
When we first encountered this was in 2003 when a patent
was issued that was called a stock option grantor retained
annuity trust. It is the SOGRAT patent. When we first discussed
it in 2004, everyone that I talked to was shocked that we had
to worry about patenting estate planning techniques,
particularly this one because Congress in 1994 created a
grantor--created the principles by which you could use a
grantor retained annuity trust. Then in 1999, a patent was
filed that was granted and issued in 2003 that took a grantor
retained annuity trust and coupled it with a non-qualified
stock option. Practitioners that I deal with have been using
grantor retained annuities trusts for years, and using them
with a variety of techniques. For example, in my paper I point
out that we used agrantor retained annuity trust (GRAT) with a
thoroughbred race horse. What you want to use a GRAT with is an
asset that will appreciate significantly in value, such as a
non-qualified stock option. So, we were surprised when we heard
about the patenting of the technique. Similar to what Ms. Tubbs
Jones' colleagues told her when she asked them were they
worried about it, no, they weren't worried about it. I submit
that they should be worried about it because in January of this
year, there was a lawsuit filed against an individual who had
placed non-qualified stock options into a GRAT, had made a
filing with the Securities and Exchange Commission (SEC)
because he was a corporate insider, and then that showed up and
then he has been sued. If you read the complaint, they leave
open who else will be sued. You would think that the
representatives who helped put this together will also get
sued.
Now, as Mr. Toupin pointed out, lawyers have ethical
obligations to point out to their clients the techniques that
will be used and the drawbacks to the techniques. At a recent
meeting of the American College of Trust and Estate Counsel, we
took a poll, if you were advising a client to put non-qualified
stock options into a grantor retained annuity trust, would you
be obligated to point out the existence of the V patent? Yes,
you would. What are the choices that the client will have?
Ignore the patent and get sued; don't do a technique that has
been governmentally authorized to minimize legally your
transfer taxes; or pay a license fee.
For the reasons that are set forth in the paper, we believe
that transfer tax reduction techniques, as well as all tax
reduction techniques, should not be allowed to be patented. It
should be against public policy that when Congress imposes
taxes, I have no choice but to pay my taxes. I should be
allowed to use the principles that Congress has enacted to
allow me to lawfully reduce my taxes. If someone has a patent
on it because that person was the first person to get to the
Patent Office, then I have got to pay a toll charge, a tariff,
to use it or I just ignore it at my peril. Taxes are different
than businesses. If there is a patent on a mousetrap, as the
Chairman pointed out, I can decide to not use the mousetrap, I
can decided to try to do a better mousetrap, or I could get a
cat to get the mice, or I can just ignore the mice. With taxes,
I cannot do that. So, for the reasons that are set forth in our
testimony, we believe that patents on tax reduction techniques
should not be allowed. Thank you.
[The prepared statement of Mr. Belcher follows:]
Statement of Dennis I. Belcher, Partner, McGuireWoods LLP, Richmond,
Virginia
Chairman Camp and distinguished members of the Subcommittee, I am
Dennis I. Belcher, a partner in the Richmond, Virginia office of the
law firm McGuireWoods LLP. I have been in the private practice of law
for more than thirty years and have spent my career representing
clients in estate planning. In my law practice, I advise clients on how
to minimize federal and state estate, gift and generation-skipping
taxes (``transfer taxes'') using estate planning techniques so as to
maximize the assets passing to family members and other beneficiaries.
I am currently an officer in the American College of Trust and
Estate Counsel (``ACTEC''). ACTEC is a non-profit professional
association comprised of approximately 2,600 lawyers who are selected
on the basis of professional reputation and ability in the field of
trusts and estates and having made substantial contributions to those
fields through lecturing, writing, teaching, and bar leadership
activities. I am the past Chairman of the American Bar Association's
Real Property, Probate and Trust Law Section, which has approximately
30,000 members who are interested in the areas of probate, trust law,
and real estate law. I am also a member of a Task Force, called the
Patenting Estate Planning Techniques Task Force (the ``Task Force''),
created by ACTEC in 2005.
I am testifying today on my own behalf and on behalf of ACTEC and
the Task Force. My testimony represents my own views, the views of
ACTEC and the Task Force, but not those of my firm, any of its clients,
or the American Bar Association.
Summary
From my experience and discussions with other estate planning
professionals, I believe that:
Patents for tax reduction strategies in the area of
transfer taxation are creating problems for many taxpayers;
If patents for transfer tax reduction strategies are not
prohibited, this type of patent will in all likelihood expand and
create problems for more taxpayers; and
Patents for tax reduction strategies should be prohibited
either by the U.S. Patent and Trademark Office or by legislation.
Background
Until 2003, few estate planning advisors\1\ gave consideration to
patents when advising clients about estate planning. That view changed
in 2003 when an individual was awarded a patent for an estate planning
technique that the patent holder called a ``SOGRAT''.\2\ (Although the
SOGRAT patent was awarded in 2003, anecdotal evidence suggests there
are still a significant number of estate planning advisors who are not
aware that patents can be awarded for transfer tax reduction
techniques.) According to the patent, a SOGRAT involves a grantor
retained annuity trust funded with nonqualified stock options. (A
grantor retained annuity trust, referred to as a GRAT, is an estate
planning technique authorized by Congress, the Treasury Department, and
the Internal Revenue Service.\3\) When word of this patent spread
through the estate planning community, most estate planning
professionals were shocked to learn that an individual could patent a
common estate planning technique used in connection with a specific
asset, the purpose of which is to allow taxpayers to minimize their
federal estate and gift tax liability, particularly a technique
authorized under the Regulations issued by the Treasury Department and
approved in many Internal Revenue Service rulings.
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\1\ As used in this statement, estate planning advisors and
professionals refers to lawyers, accountants, financial planners, and
insurance professionals.
\2\ Patent No. 6,567,790, Establishing and Managing Grantor
Retained Annuity Trusts Funded by Nonqualified Stock Options.
\3\ Internal Revenue Code section 2702 and Treasury Regulation
section 25.2702-2(a).
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In response to concerns about the impact of using patents to
restrict the availability of commonly used estate planning techniques,
such as GRATs, experienced estate planning lawyers discussed the
ramifications of such patents at a meeting of ACTEC's Estate and Gift
Tax Committee in October 2004. I had the privilege of chairing that
meeting. Because of the serious nature of the concerns expressed at
this meeting, ACTEC created the Task Force to study this issue\4\ Once
the existence of the Task Force became generally known to the estate
planning community, other professional organizations joined the Task
Force. Organizations with members on the Task Force now include the
American Bar Association's Real Property, Probate and Trust Law
Section, the American Bankers Association, and the AICPA.\5\ Members of
the Task Force agree about the seriousness to taxpayers of the issues
presented by the patenting of estate planning techniques. Although the
Task Force has not completed its study or issued findings or a formal
report as of this date, the Task Force has authorized me to testify on
its behalf. Because ACTEC agrees with the Task Force's concern, on July
8, 2006, ACTEC also authorized me to speak on behalf of ACTEC.
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\4\ In addition to me, members of the Task Force from ACTEC are
Louis S. Harrison and William C. Weinsheimer (Chair of the Task Force).
\5\ The representatives from the American Bar Association's Real
Property, Probate and Trust Law Section include Steve R. Akers,
Christine L. Albright, Alan F. Rothschild, Jr. and Michael D. Whitty.
The representatives from the American Bankers Association include
Kathleen C. Brown, Julianne M. Hallenbeck, and Joseph W. Mooney. The
representatives from the AICPA are Evelyn M. Capassakis, Justin
Ransome, and Steven A. Thorne. Ellen P. Aprill is a liaison to the Task
Force from the American Bar Association's Section of Taxation.
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The purposes of my testimony are to (1) inform Congress that a
patent of one transfer tax reduction technique, the SOGRAT patent, is
presenting significant problems to many taxpayers, and (2) recommend
that either the U.S. Patent and Trademark Office or Congress prohibit
the patenting of tax reduction strategies before the patenting of this
type of strategy becomes more widespread and affects more taxpayers.\6\
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\6\ The U.S. Patent and Trademark Office classifies patents dealing
with tax reduction techniques as subclass 36T in Class 705. According
to the Patent Office's website, 48 patents have been issued in that
subclass and there are 81 patent applications are pending.
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The SOGRAT Patent
In some instances, Congress, the Internal Revenue Service, and the
Treasury Department have authorized tax reduction techniques which
taxpayers may take advantage of to reduce their federal tax liability.
Examples of government authorized tax reduction techniques in the
estate planning area include the federal estate and gift tax marital
and charitable deduction, the gift tax annual exclusion, charitable
remainder and lead trusts, and GRATs. A GRAT is an irrevocable trust in
which the grantor retains an annuity for a fixed term (usually two or
more years) and at the end of the term the remaining trust assets pass
to beneficiaries selected by the grantor (usually the grantor's
family). The grantor transfers assets to the GRAT that the grantor
believes will appreciate significantly over the term of the trust.
Under Internal Revenue Code section 2702, the Regulations issued by the
Treasury Department under section 2702, and rulings issued by the
Internal Revenue Service, the grantor is able to deduct for gift tax
purposes the value of the grantor's retained annuity, thereby reducing
the amount of the gift to the grantor's family.\7\ Because of the
taxpayer's ability to transfer appreciation on assets in the GRAT to
family members at a reduced gift tax cost, the GRAT is a frequently
used estate planning technique.
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\7\ An the article by Robert L. Moshman, ``Good GRATs and Great
GRATs--And An Interview With Robert C. Slane,'' The Estate Analyst,
April, 2006, the author stated: ``Despite cracking down on estate-
freezing techniques, Chapter 14 provided a beautiful safe harbor. The
grantor retained annuity trust, better known as GRAT, is explicitly
authorized under section 2702.''
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On May 20, 2003, the U.S. Patent and Trademark Office awarded Mr.
Robert C. Slane of Wealth Transfer Group, L.L.C. a patent for a GRAT
funded with nonqualified stock options, which Mr. Slane calls a SOGRAT
(a stock option granter retained annuity trust).\8\ The first claim in
the SOGRAT patent is:
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\8\ Patent No. US 6,567,790.
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A method for minimizing transfer tax liability of a grantor for the
transfer of the value of nonqualified stock options to a family member
grantee, the stock options having a stated exercise price and a stated
period of exercise, the method performed at least in part within a
signal processing device and comprising:
Establishing a Grantor Retained Annuity Trust (GRAT);
Funding said GRAT with assets comprising stock options,
The stock options have a determined value at the time the transfer
is made;
Setting a term for said GRAT and a schedule and amount of annuity
payments to be made from said GRAT; and
Performing a valuation of the stock options as each annuity payment
is made and determining the number of stock options to include in the
annuity payment.
Problems Created by the SOGRAT Patent
The existence of the SOGRAT patent is preventing taxpayers from
using a government authorized estate and gift tax reduction technique,
thereby presenting problems to taxpayers in planning their affairs.
During one of the Task Force discussions, one Task Force member
reported that the holder of an estate planning patent recently
contacted an estate planning advisor employed by a financial
institution and informed the advisor that the patent holder was the
owner of the estate planning technique suggested by the advisor in a
newsletter to clients. The advisor sought legal guidance on the proper
course of action. Notwithstanding that the advisor's lawyer believed
the patent may be invalid, the lawyer recommended that the advisor not
risk using the patented technique without permission of the patent
holder. The lawyer gave this advice presumably because of the high cost
of defending a patent infringement law suit or prosecuting a suit to
invalidate the patent. After discussions, the advisor agreed not to
suggest the use of the legally authorized estate planning technique in
connection with a particular type of asset without informing clients
and their lawyers of the existence of the patent so that the client and
lawyer would be responsible to make their own judgments about the
validity of the patent and the degree to which it needed to be honored.
There is a lawsuit pending against a taxpayer alleging the
infringement of the SOGRAT patent. On January 6, 2006, the SOGRAT
patent holder filed suit in the Connecticut United States Federal
District Court for infringement of the SOGRAT patent. The defendant in
the lawsuit is Dr. John W. Rowe, the Executive Chairman of Aetna, Inc.
The lawsuit is in the discovery stage and is anticipated to go to trial
in 2007. Because I understand that the lawsuit is being prosecuted
vigorously, the lawsuit cannot be considered a nuisance lawsuit. When
this lawsuit was discussed at ACTEC's Estate and Gift Tax Committee on
July 8, 2006, the vast majority of lawyers present (more than 100
experienced estate planning lawyers) indicated that they would not
recommend to any client the use of a GRAT funded with nonqualified
stock options without disclosing the existence of the SOGRAT patent and
the pending lawsuit. In addition, these lawyers indicated that they
would be reluctant to allow a client to use this technique without the
permission of the patent holder.
Because I am not trained in intellectual property law, I cannot
comment on the validity or non-validity of the SOGRAT patent. But, I am
qualified to address the taxpayer problems created by patenting estate
tax reduction techniques because of my thirty years' experience in
representing taxpayers. Like most experienced practitioners, I am
troubled by the SOGRAT patent for several reasons. First, an individual
has been allowed to privatize a tax reduction technique authorized by
the United States government. Second, because GRATs can be and are used
for any type of asset\9\, there is nothing unique about coupling a GRAT
with nonqualified stock options. Because nonqualified stock options
have desirable features affecting the valuation of the options for
transfer tax purposes, the use of nonqualified stock options in a GRAT
may be considered rather obvious. In summary, the SOGRAT patent is
creating problems with taxpayers because of the chilling effect on the
use of this authorized technique.
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\9\ Estate planning lawyers in my law firm have used GRATs for many
different types of assets, including real estate, marketable
securities, stock in private businesses, and thoroughbred race horses.
---------------------------------------------------------------------------
Patenting of Transfer Tax Reduction Techniques Should Be Prohibited
Because patents of transfer tax reduction techniques present
problems to many taxpayers, the U.S. Patent and Trademark Office or
Congress should prohibit these types of patents for the following
reasons:
1. It should be against public policy for a private individual to
patent a technique used to reduce a taxpayer's tax burden;
2. Patenting estate planning techniques unfairly increases a
taxpayer's costs or the federal estate and gift taxes payable by the
taxpayer if patented techniques are not used; and
3. Because a patent on a tax planning technique can add
credibility to the technique, patents on objectionable or aggressive
tax planning techniques can hurt compliance with the federal tax laws.
It is not the function of the Internal Revenue Service or the
Treasury Department to curtail patents of tax planning techniques.
Because of the nature of transfer tax reduction techniques, it may not
be possible for the U.S. Patent and Trademark Office to make an
adequate review of these techniques. Accordingly, a legislative
solution may be the appropriate response to protect taxpayers and to
curtail the patenting of all tax planning techniques before these
patents become more widespread.
1. It should be against public policy for a private individual to
patent a technique used to reduce a taxpayer's tax burden.
A patent of a tax reduction technique is unlike other business
method patents because it relates to taxes. If there is a business
method patent in a particular area of business, a citizen has the
choice to either pay for the right to use the technique, to engage in
that business activity in a different way, or not to engage in that
business activity at all. A taxpayer who complies with the tax laws
does not have that choice--the taxpayer must pay his or her tax burden.
In the familiar of words of Judge Learned Hand, however, ``Any one may
so arrange his affairs that his taxes shall be as low as possible; he
is not bound to choose that pattern which will best pay the Treasury;
there is not even a patriotic duty to increase one's taxes.''\10\ It
should be against public policy to allow a patent of a tax reduction
technique because the patent prevents taxpayers from exercising their
right to minimize their taxes within the limits of the law, and
avoiding the activity in question, the payment of taxes, is not an
option.
---------------------------------------------------------------------------
\10\ Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934).
---------------------------------------------------------------------------
In addition, patenting tax reduction techniques allows private
individuals to leverage the federal tax system thereby imposing an
additional cost on taxpayers. As the tax rates vary, the value of a tax
reduction technique patent will vary accordingly. Because a taxpayer
pays the patent holder for the right to use a tax reduction technique
to reduce the taxpayer's tax burden, the patent holder is in effect
imposing a tax in the form of a toll charge on the use of the
technique.
There are a small but growing number of patents in the tax
reduction area. If patenting tax reduction techniques is not stopped,
the practice will spread to other areas of the tax law and affect more
taxpayers. Although GRATs are used only by those taxpayers subject to
the federal estate tax, there may be a rush to the U.S. Patent and
Trademark Office when Congress passes the next tax bill with a new tax
minimization provision. The first individual to file a patent should
not be rewarded at the expense of those taxpayers trying legitimately
to minimize their tax burdens. Consider the result if an individual had
patented the transfer of appreciated securities to a charitable
remainder trust, a technique similar in many ways to a GRAT, when
Congress first allowed these types of trusts in 1969.\11\ Because a
patent holder cannot be compelled to grant a license for a patent, a
patent holder could have precluded any taxpayer from using a charitable
remainder trust, which was a congressionally authorized tax reduction
technique, to the detriment of taxpayers and charity. Clearly, this is
not in the best interest of the public and should be against public
policy.
---------------------------------------------------------------------------
\11\ Internal Revenue Code section 664.
---------------------------------------------------------------------------
Patents on tax reduction techniques are different from other
business method patents. Because patents of tax reduction techniques
prevent taxpayers from minimizing a burden imposed by law and affecting
all taxpayers, it should be against public policy to allow patenting of
tax reduction techniques. Thus, either the U.S. Patent and Trademark
Office or Congress should prohibit patents on tax reduction techniques.
2. Patenting estate planning techniques unfairly increases a taxpayer's
costs and federal estate and gift taxes.
Because taxpayers will have to pay a fee to use an estate planning
technique authorized by law, many taxpayers will be forced to pay more
in an effort legally to minimize their federal taxes. Before an estate
planning advisor recommends that a client use a patented estate
planning technique, the advisor has an obligation to point out the
options and risks to the client of using a patented technique. When a
client is considering the use of a patented estate planning technique,
the client has these options: (a) file a lawsuit to invalidate the
patent; (b) ignore the existence of the patent in the hopes that the
patent holder will not discover its use; or (c) pay a licensing fee to
the patent holder for the use of the technique. Because filing a
lawsuit to invalidate the patent is expensive, filing a lawsuit is not
a viable option.\12\ If the client ignores the existence of the patent
in the hopes that the patent holder will not discover its use, the
risks to the client can be considerable and can include paying treble
damages to the patent holder.
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\12\ According to one source, a suit to invalidate a patent may
cost in excess of $1,000,000. See, ``Patenting Tax Strategies,'' Trusts
and Estates Magazine, March 2004, page 44.
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Patenting estate planning techniques unfairly increases the federal
estate and gift tax liability of taxpayers. Some taxpayers will refuse
to pay tribute to the holder of an estate planning patent. These
taxpayers will be forced either to pay more than their fair share of
federal estate and gift taxes or risk being sued for the unauthorized
use of a patented technique. If the taxpayer refuses to pay tribute and
does not want to take the risk of unauthorized use of the estate
planning technique, the taxpayer will be forced to forgo the use of an
estate planning technique authorized by law. Because the taxpayer will
not be allowed to use this technique, the taxpayer will pay more than
the taxpayer's fair share of federal estate and gift taxes.
Under the ABA Model Rules of Professional Conduct (the ``Model
Rules''), a lawyer has a duty to explain issues that are likely to
result in adverse legal consequences to the client.\13\ Thus, an estate
planning lawyer may have an ethical duty to learn about the existence
of patents affecting estate planning and inform clients of existing
patents on estate planning techniques sought to be used by the lawyer's
clients.\14\ Under the Model Rules, lawyers must give candid and
competent advice using any ``legal knowledge, skill, thoroughness and
preparation [which is] reasonably necessary.''\15\ A lawyer must
explain a client's options to ``the extent reasonably necessary to
permit the client to make an informed decision'' on a course of
action.\16\ Because of the possibility of adverse legal consequences to
a client from the unauthorized use of a patented estate planning
technique, a lawyer may have a duty to (i) determine the existence of
any patent on an estate planning technique under consideration, (ii)
inform the client of the existence of all patents, and (iii) advise the
client of the possible adverse consequences of using the technique
without the consent of the patent holder.
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\13\ Model Rules R. 1.4(b), 2.1 cmt.
\14\ See Model Rules of Prof'l Conduct R. 1.1, 1.4, 2.1 (1983).
\15\ Model Rules R. 1.1, 2.1
\16\ Model Rules R. 1.4.
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By allowing a patent on a transfer tax reduction technique, a
taxpayer will either have to obtain the permission of the patent holder
to use the technique (presumably for the payment of a fee) or have to
forgo the use of the technique. Thus, patented transfer tax reduction
techniques impose an additional tariff for those taxpayers who want to
use legally authorized estate planning techniques to reduce their
federal estate and gift taxes.
Because patents on aggressive tax planning techniques add credibility
to an objectionable or aggressive technique, patents on tax
planning techniques can hurt compliance with the federal tax
laws.
Placing what many taxpayers may interpret as a seal of approval
from the U. S. Patent and Trademark Office on an aggressive tax
planning technique could mislead taxpayers as to the legality of the
tax planning technique. Some taxpayers will believe that because a
United States government agency has approved the technique, the
technique must be a lawful and appropriate technique. Because a patent
on an aggressive tax planning technique can add undeserved credibility
to that technique, patents on tax planning techniques can hurt the
enforcement of the federal tax laws.
Possible Solutions
ACTEC and the Task Force have struggled with the appropriate
solution to protect taxpayers from patents on transfer tax reduction
techniques, particularly techniques authorized by law. Because ACTEC
and the Task Force are not experts in intellectual property, we are
reluctant to make recommendations. But, we will offer some
observations. We see the following options to address this problem: (a)
the Internal Revenue Service could curtail the use of tax planning
technique patents; (b) the U.S. Patent and Trademark Office could
curtail the use of tax planning technique patents; and (c) Congress
could provide a legislative solution.
Because it is not the function of the Internal Revenue Service to
curtail patents of transfer tax reduction techniques, we do not believe
that enforcement by the Internal Revenue Service is the appropriate
solution. ACTEC and the Task Force are concerned about relying on the
U.S. Patent and Trademark Office to curtail or eliminate the patenting
of tax reduction techniques, particularly transfer tax reduction
techniques. If a patent examiner is not familiar with estate planning
techniques, it will be difficult for the examiner to determine whether
a patent should be awarded for a particular tax technique for several
reasons. Presumably, patent examiners are generally not familiar with
researching tax law and are not experienced in making the judgments
that compliance with tax law requires.\17\ Many lawyers, accountants,
and financial planners give estate planning advice and do not publish
their techniques but discuss these techniques in numerous meetings of
professionals. For example, ACTEC's Estate and Gift Tax Committee meets
three times annually, discusses many estate planning techniques, but
only produces summary minutes of the meetings. Other estate planning
professional organizations operate similarly. It is possible that an
estate planning technique will be discussed and will have widespread
use, but a patent examiner would not have knowledge of the prior use of
the technique and mistakenly award a patent for the technique. Although
an individual could challenge the patent on the basis of prior work,
one individual would not have a sufficient interest in the technique to
invest legal fees to challenge the validity of the patent.
---------------------------------------------------------------------------
\17\ ACTEC has volunteered to work with the U.S. Patent and
Trademark Office to educate patent examiners on how to research estate
planning techniques so as to determine the existence of prior work.
---------------------------------------------------------------------------
If the U.S. Patent and Trademark Office cannot prevent patents of
tax reduction techniques, we hope that Congress will find that
patenting tax reduction techniques is against public policy and pass
legislation preventing these types of patents.
Conclusion
ACTEC and the Task Force on Patenting Estate Planning Techniques
believe that patenting transfer tax reduction techniques is creating
problems for many taxpayers. If patents for tax reduction strategies
are not prohibited, this type of patent will in all likelihood expand
and create problems for more taxpayers. We ask that patents for
transfer tax reduction be prohibited either by the U.S. Patent and
Trademark Office or by legislation.
In closing, I thank the Subcommittee and its staff for allowing me
to give you my views on this topic.
Chairman CAMP. Thank you and thank you all for your
testimony. I think you have all raised many good points. My
question is, and I guess all of you can chime in, Ms. Aprill,
you stopped short of saying that we should not allow tax
strategy patents. What do you think about just not allowing tax
strategy patents?
Ms. APRILL. We would have to draw some hard lines. We still
want the kind of patents that help you file your tax return. We
have drawn other hard lines before, and I think it is something
we need to consider while making to make sure it doesn't have
untoward effects. I certainly wouldn't rule it out. This
reminds me of the issues we have with the business purpose test
in the tax law. We want taxpayers to have purposes other than
tax to do certain transactions, not simply to tax savings but
their financial savings as well. We would have to decide how we
could draw the line here. If we could draw a good line, I would
be very happy. I just wouldn't want to be confident that we
have drawn a good line.
Chairman CAMP. Mr. Belcher, you mentioned the case of the
lawsuit, yes, I have some trouble with the notice aspect. I
realize the patent is a public filing but, as you go to the
website, and you read the one sentence summary, it doesn't
necessarily give you any indication of what the patent might
really be about. Is there a best way to put taxpayers and tax
preparers and advisers on notice that a particular tax method
is restricted through the patent process?
Mr. BELCHER. Well, Mr. Chairman, you raise a very good
point because I submit until this hearing that very few
practitioners worried about patents on tax techniques. So, I
think that the notice is going to be well-received in the
public and they are going to be worried about it. Also, I worry
as my obligation to my client is to advise a client on
techniques. Every morning, I receive a publication from the IRS
where I see the latest rulings and the latest announcement from
the Internal Revenue Service. So, when I have meetings that
day, I am up to date on what is going on. Will I be required to
subscribe to a service or something or go on the Patent Office
website and look at every technique, and not just look at the
one blurb summary, which is very difficult to determine what it
is, but to actually have someone go in and look at the file.
So, I think it is going to be a serious problem. You have got
several approaches to that. You could have a government agency
issue a notice of what a tax technique is, but I am not sure
that that is a workable solution. So, I see notice as a real
problem for taxpayers.
Chairman CAMP. I think I understand your testimony, you
draw a distinction as well between a process of maybe a
computer program versus the actual sort of legal or tax
strategy of compliance?
Mr. BELCHER. This Subcommittee and the House Committee on
Ways and Means draw lines all the time, and they don't make
everybody happy where they draw the lines but they do draw the
lines. I think, I could see a good logic to drawing a line
between a method to compute taxes or to manage taxes versus a
technique to reduce taxes. I find it personally offensive that
Congress gives us principles that allow me to encourage my
clients to reduce their taxes and then I have to pay somebody
or a client has to pay somebody, the patent holder, to take
advantage of the technique that Congress has provided.
Chairman CAMP. Yes, that is the point I made to the other
panel, which was it is obligatory to comply with our tax law
and then you have to pay a royalty to do that in certain ways.
I have a problem with that whole thing which I think you are
sort of underscoring as well. All right, thank you. The Ranking
Member, Ms. Tubbs Jones from Ohio, may inquire.
Ms. TUBBS JONES. Thank you, Mr. Chairman. I missed your
testimony, but I have been reading last evening and a couple of
days before. My question to Mr. Belcher is--Mr. Belcher, how
many clients have you had that you have been required to pay a
royalty, if you are permitted to tell me without disclosing any
confidential information, for use of a patented tax whatever
the heck it is?
Mr. BELCHER. None but, as I pointed out earlier, what I
worry about are two aspects of this. First, there is a lawsuit
pending against an individual who used a grantor retained
annuity trust, which was authorized by principles announced by
Congress and by the Internal Revenue Service through numerous
rulings, and if you read that complaint, it is against the
person, the taxpayer who created the trust. If you read that
complaint, it states there may be others who participated in
that. So, as a lawyer, I worry about my liability for doing
that. Now, my choices are----
Ms. TUBBS JONES. Okay, as a lawyer and judge--I don't have
a lot of time so make your answer short.
Mr. BELCHER. Yes, ma'am.
Ms. TUBBS JONES. Go ahead, finish.
Mr. BELCHER. What I worry about is the spread of the
patenting. It is just affecting a limited number of people now.
In the future, it could affect a lot more.
Ms. TUBBS JONES. Good lawyers are able to argue the other
person's side. Tell me if you are stepping in the shoes of the
lawyers who was helping his client obtain a patent, what would
your argument be to me in favor of these?
Mr. BELCHER. That I have been very fortunate to take a
advantage of an area where the law is unclear and able to
extract fees.
Ms. TUBBS JONES. Sure, Mr. Gruner, yes, sure?
Mr. GRUNER. I might answer that question. I think the case
here for individual clients or for the system as a whole is
that the availability of these patentsincents the very best
people who are capable of non-obvious insights on how to extend
tax planning methods, incents those people to pay attention to
these problems and to invest substantial time in the
development of new methods and then to disclose the results,
none of which may happen in the absence of these patent
incentives, that even if you get the best people to work on
them, they are going to devote that method to the clients of
one firm, which is not then going to be available to the public
generally.
Ms. TUBBS JONES. So, your argument is that by patenting it,
we at least open it to the rest of the world?
Mr. GRUNER. We bring forward new techniques that might not
occur at all and then as to those incremental techniques, we
bring them to the world. So, it is two things.
Ms. TUBBS JONES. Can I limit the royalties?
Mr. GRUNER. Well, the royalty is only as much as that
method advantages you. You are not going to pay for a method
that only advantages you a small amount over other alternative
methods.
Ms. TUBBS JONES. So, I get to use it, I get to take a look
at it, apply it to my cost or my tax situation, and then if I
don't use it, I don't pay a royalty?
Mr. GRUNER. Exactly, you only pay a royalty up to the
amount that it looks good to you.
Ms. TUBBS JONES. How much is a general royalty, to your
knowledge? Anybody know what the royalty is?
Mr. GRUNER. I am not aware of how these particular patents
are being licensed but it would be limited by how much the
taxpayer perceived the method as being advantageous.
Ms. TUBBS JONES. Ms. Aprill?
Ms. APRILL. Which question would you like me to answer?
Ms. TUBBS JONES. Any of them or just tell me whatever you
want to say.
Ms. APRILL. My concern is that we have a lot of these being
granted that I think are not obvious and not actually novel. My
understanding of other areas of business method patents is that
the area where the PTO granted them got narrowed in part
through legislation, very, very expensive legislation carried
on by very, very big corporations. Given the fact that we are
talking about individuals and estate planning at the moment, we
might not have the same incentives in the system to get the law
developed in the way we need to in order to make sure that we
only encourage innovation and not discourage compliance.
Ms. TUBBS JONES. Well, then you are suggesting that the
Congress, that we need to go back and re-think or re-look at
that legislation that allowed these things to develop?
Ms. APRILL. Others have tried but I would urge you to do it
again.
Ms. TUBBS JONES. Okay. Let me say for the record, as I said
earlier, I have been talking to my tax friends, tax lawyer
friends, and patent lawyer friends, and they were saying,
``Huh?'' So, I faxed this information out all over the world to
my colleagues and friends, and I am interested to see what they
have to say when it comes back. Personally, I think we could
spend our time better on tax policy other than this because
there are a lot of other issues that would benefit the greater
good than this particular policy, and I have some real
concerns. Thank you.
Chairman CAMP. Thank you very much. Mr. Foley may inquire.
Mr. FOLEY. I share that same concern, and I have got
friends who have great ideas and they are waiting for patents
to take place to protect their ingenuity. The Patent Office is
working on one I think is an abstract area of law, which
troubles me. I would rather them work on the technology and
innovation side and put their people protecting patent rights
rather than in this ambiguous area. I am really troubled
because, I think as Mr. Belcher said, if I read the Wall Street
Journal today and see some tax policy, think of my client, I am
just reading part of it, I don't have a chance to do the whole
article, so I don't catch the part that says this is a patented
protected tax strategy. I just merely see tax protection, blah,
blah. So, I go to the--wow, that applies to my case, that is
interesting. Let me run the numbers. I go do my work. I think I
can save my clients quite a bit. That is a very creative and it
is in the Code, it is allowable. It has been tested. I am going
to recommend it. So, the question to you, 6 months later, he
gets a notice to appear or a lawsuit that he has used
somebody's technique.
Now that seems troubling to me, that what is out there in
the common universe--think about it, Google is now a verb, to
Google is to search. Ultimately at the end of the day, it is
still a search engine. So, if America Online (AOL) has a search
engine or any other computer has a search engine, that no
longer should be rendered un-useable because Google has created
a brand name. Everybody still should be able to search because
they have created a proprietary software or system gives them
the right to perfect that system and market that system, and
they have done a very good job of it. That shouldn't prohibit
anyone else downstream from saying, ``I want to create a search
engine too.
I am going to call it something else but it will function
all the same. It may not be as successful, but I am going to do
it.'' So, I really do have trouble with establishing patents on
things that would normally be as a result of sheer reading the
tax code and saying if I maintain this schedule of assets based
on this date and hold assets until that date. I am either
eligible for capital gains or treatment, short- or long-term,
that is not too complicated. Some of these other areas you talk
about are when you are talking about trusts and estates and
meshing of assets. Yes, that is an interesting formulation and
one that probably deserves a little bit more thought. What
creates that novel idea, if it is allowed by the Tax Code, then
why is it patentable for an outside vendor to say--different
for software, if I create a program by which you can create
this opportunity, I have a right to pursue my patent, but I
don't think the methodology should necessarily be. Yes?
Mr. GRUNER. I just wanted to draw a comparison to other
areas where the law defines required conduct and then the
patent system works within that required conduct. For example,
in the environmental area, the product safety area, the law
requires certain conduct to be maintained and then a whole
bunch of patented methods are devices are used to adhere to
that conduct. We have no hesitancy in encouraging innovation in
those conduct details through the patent system in those kind
of settings. It seems to me that what is going on here is
essentially the same thing, people may be incented to work out
inner details of how to comply with the Tax Code in innovative
ways through the incentives o the patent system.
Mr. FOLEY. Give me one area where it would innovative, that
would be so different than anyone else who has the technology,
the capabilities to sit down--how could it change the outcome
is the law is specific?
Mr. GRUNER. Well, I think the types of patents that are
coming forward are indicative of the direction, I don't want to
try to defend the particular patents that have been issued
because some of them may be just obvious extensions. If one
came up with estate planning management technique that was
highly intricate, highly computer managed, and which at the end
of the process you define what kind of estate transfers were
occurring and then apply the appropriate tax result and tax
rule and got to the appropriate result, that kind of innovation
as to how estates were managed would be a sort of innovation
that might not occur, and the implementation be a complex
computer technology, might not occur absent these kind of
incentives.
Mr. FOLEY. Then, I would apply for a patent on my software
because it is truly a software platform.
Mr. GRUNER. Well, it is going to be a mixture. The method
would include some software steps and that is what these
patents generally are.
Mr. FOLEY. So, you are saying there is a duality there.
Mr. GRUNER. Yes.
Mr. FOLEY. They are both a system as well as an idea.
Mr. GRUNER. Typically, because it is the computer stuff
that makes them new, if at all, in other words, that is where
they are arguing their new extension lays and therefore their
grounds for patenting.
Mr. FOLEY. Well, I seem to be hearing two different things.
I heard about a technology, which is what I believe should have
a right to patent protection, and a technique that is used
simply by taking tax law and using it to its best opportunity.
Mr. GRUNER. I think the distinction that was trying to be
made there was between administrative efficiency, programs that
might allow a taxpayer to account for their assets and income
more efficiently but didn't change the ultimate result under
the Tax Code versus conduct-oriented software, for example,
managing estate in a certain way, that did in fact reduce the
taxes that were paid. These patents cover both those kinds of
technologies.
Mr. FOLEY. If I could just, Mr. Chairman, I know my time is
up, but it still invokes some double jeopardy for the tax
preparer who has the same concept and idea, hasn't impinged on
this patent, simply using his knowledge and expertise and
coming up with the same result is subject to potential lawsuit.
Mr. GRUNER. It is going to be a problem because many of
these methods have been used in secret for some time. That same
problem arose in the software industry when software
techniques, which had been used in private company
environments, were then patented by other parties, and indeed
that type of problem led to the prior user defense we see as to
certain business methods.
Ms. TUBBS JONES. Just a quick question in that line, Mr.
Chairman, thank you. Prior to 1988 and these different products
being patented, lawyers were as smart and as innovative and as
intelligent and on and on, and on, and nobody contemplated that
this would be a patentable subject. Or maybe they contemplated
and said, the hell with that, that is crazy, that just is not
going to happen or did they?
Mr. GRUNER. Well, in general the whole business method area
was thought to be outside the patent system until the State
Street decision confirmed the opposite. So, although people
might have thought vaguely about patents, they thought that the
law was against them. The State Street decision clearly stated
that financial methods and now tax planning methods and other
business methods, other advantageous business practices are
patentable. Now, we are still looking for new----
Ms. TUBBS JONES. I can characterize those judges, as some
my colleagues do, judges making law, right?
Mr. GRUNER. No.
Ms. TUBBS JONES. Go ahead.
Mr. GRUNER. Indeed, they were following the law as they
understood it, and many commentators thought the same.
Ms. TUBBS JONES. You didn't get that but it is okay.
Mr. GRUNER. I got it.
Ms. TUBBS JONES. Go ahead, I am sorry.
Mr. GRUNER. Many commentators thought that was the law as
well, hence, clients didn't seek patents or innovators didn't
seek patents in this area, which now leads to part of our
problem. We don't have a patent record of past innovations that
would now inform current patent issuance decisions.
Ms. TUBBS JONES. Thanks, Mr. Chairman.
Chairman CAMP. Thank you and the gentlewoman from
Pennsylvania may inquire.
Ms. HART. Thank you, Mr. Chairman. This just gets more
interesting and more interesting as time goes by. I said to my
LD as I walked out of the room to take a call, the things that
Mr. Belcher said were exactly what I was thinking. So, with
that having been said, I have a question regarding I guess
public policy issues. The Patent and Trademark Office is
looking at an application. Is there some kind of public policy
bar that would lock them from issuing a patent for something
that they would just, without checking with the IRS, but they
still would know would be illegal or have some inclination to
believe would be an illegal scheme? Is there something out
there now that you would use?
Mr. GRUNER. The issue would be one of utility. An advance
has to have practical utility to be patentable. So, if it were
purely illegal, presumably its consequences are negative and
has no utility. The problem though for the Patent Office is
they don't know that with any firm clarity.
Ms. HART. Right.
Mr. GRUNER. Therefore, they are loathe to make that call as
a matter of patent issuance.
Ms. HART. So, there is no burden really on them to do that?
Mr. GRUNER. They are unlikely to find out.
Ms. HART. Until later, after they have put a lot work in. I
am sorry, Ms. Aprill?
Ms. APRILL. Many of these are not going to be clearly
illegal. They are not going to be something that specifically
violates the current law or that the IRS has said you do this
particular thing and we say it doesn't work under the tax law.
They are going to be gray areas.
Ms. HART. It is like the whole area, the gray area, I
think. Okay. How about the compliance burden challenge? Mr.
Belcher, in your testimony you mentioned that you have a bunch
of choices you are going to have to make with a client as far
as compliance. Are you going to have to do a patent search
every time you try to do estate planning for your client?
Mr. BELCHER. I think to carry out my ethical obligation to
my client, I am going to have to be aware of whether there is a
patent on a technique that I am using or recommending to the
client so the client can make the choice of trying to get a
license or a royalty to paying a royalty to use that. So, I
think it will be a serious compliance burden.
Ms. HART. Okay, and just a general question for all three
of you. I was a private practice lawyer for 13 years and
sitting in a room with a client, trying to do the best for them
that I could possibly do, every plan is different so you are
going to come up with something different for every client and
you are going to have this challenge then with basically every
client.
Mr. BELCHER. Yes, and the problem with the patents is that
they will have multiple different patent claims. So, you will
have to establish--you are going to have to worry about whether
you are violating any of those patent claims. The problem that
with business methods you will have, as Ms. Aprill said, you
will have litigation that will establish the parameters because
you will have big corporations going after it.
Ms. HART. Yes.
Mr. BELCHER. When you have got just taxpayers, a taxpayer
hears that there is a potential issue, the taxpayer is going to
say, ``Well, I am not going to use it because I am not going to
take the risk.''
Ms. HART. Right. Go ahead.
Mr. BELCHER. So, it will be the uninformed who will end up
being hurt by this.
Ms. HART. In a lot of ways, I represent a lot of small
towns and small business people and small family businesses and
that sort of thing, they are going to probably be the most at
risk if someone decides to go after them.
Mr. BELCHER. If the patent of tax reduction techniques
continue, it is accurate that right now it is not a major
problem because less than 2 percent of the people are faced
with transfer tax issues, but once it moves in in greater
threat in the income tax area--I will give you the one example
that we thought about is a charitable remainder trust that
Congress created in 1969. Let's assume that I go down to the
patent office and I patent a charitable remainder trust funded
with multiple securities. Well, obviously, Congress has allowed
charitable remainder trusts for a lot of different policy
reasons. Well, I now control it. Sure, I can license it or I
can decide not to license it at all. I am just going to keep
it, and I am just going to let my friends use it. Who is going
to challenge that? There is not one taxpayer who will have
enough interest, economic interest to challenge these. What we
have been told is that the cost of challenging a patent may
exceed $1 million.
Ms. HART. I am concerned about us, and I will just stop, my
goal obviously here is to make sure that we are not restricting
what would be sort of a natural response to a taxpayer doing
what he or she is supposed to do to comply with the law. In
some ways it seems like we are doing that. As a matter of
policy, would any of the three of you suggest that we should
put forth some restrictions as to what types of things should
be exempted from patent or is that sort of too esoteric a
question?
Mr. BELCHER. Personally, I think that any tax reduction
technique should not be patentable period. Because that
prohibits, that prevents access to minimizing your taxes
through lawful techniques or lawful principles announced by
Congress. When you get into methods or calculations or
assistance in managing assets, I think that Richard is exactly
right. I don't see any problem with patenting that.
Ms. HART. There is software and there is some specific--did
you want to expand on that a little bit?
Chairman CAMP. The gentlewoman's time has expired.
Ms. HART. Oh, I am sorry.
Chairman CAMP. Mr. Gruner, if you want to answer briefly.
Ms. HART. The red light is not facing me.
Mr. GRUNER. Quickly, on the level of whether we need to
change the law to exclude certain types of patents, I think the
law is correct as it stands, the law says only non-obvious
extensions should be patentable. What we need is a better
definition of what is the obvious technique and capability in
the tax planning field so that matters within that range of
normal expansion, day to day effort of tax specialist lawyers
is not being patented because the record of skills and range of
those non-patentable inventions is correctly documented and
available to the Patent Office.
Ms. HART. Okay, so there is actually a line we could find.
Mr. GRUNER. It currently includes that line, we just need
more information to better implement.
Ms. HART. Okay, thank you. Thank you for your indulgence,
Mr. Chairman.
Chairman CAMP. Thank you. I guess just to sum up, my
question for each of you, I would like you just to respond
briefly, is we have heard this about drawing a line between
methods and strategies, and in your opinion, each of your
opinions, could you answer whether or not you think that it is
possible legislatively, you are the experts in this field, to
draw the line for tax strategy purposes, the line between
methods and strategies?
Mr. GRUNER. Well, I think that the two are going to blur
together. If the question goes to the notion of could we define
a tax method exception to the patent law, it would be, I think,
quite difficult because of the blurring between financial
advantage generally and tax advantage specifically unless we
were to exclude financial methods entirely from the patent
laws, which would be a dramatic change after the State Street
opinion. So, I think it would be quite difficult to separate
tax planning strategies from financial methods more generally.
Chairman CAMP. All right, Ms. Aprill, do you have an
opinion?
Ms. APRILL. I think it would be difficult. I think we
should try but because it was difficult. I suggested another
way of going to protect individual taxpayers in their
individual capacity and small businesses, in order to avoid
some of the difficult line drawing.
Chairman CAMP. All right, Mr. Belcher?
Mr. BELCHER. I think there are a lot of bright people who
can draw those lines and so I think you can.
Chairman CAMP. Well, thank you and thank you all----
Ms. TUBBS JONES. One more quick question?
Chairman CAMP. Yes, yes.
Ms. TUBBS JONES. Thank you, Mr. Chairman. Assuming all we
have discussed, I am curious whether you think down the line
all these bright and intelligent lawyers will then be seeking a
patent on legal advice for picking a jury, setting up the
insanity defense, all kind of other things that go on in the
course of a trial? I see some frowns being made back there
but--real stunned, but I am stunned.
Mr. BELCHER. What is to prevent it?
Ms. APRILL. Indeed, when I talk to a lot of patent people
when I was working on this and several of the patent professors
said to me, ``We have been worrying for years about legal
method patents, and I want you to think about this not as a
form of business method pattern but a form of legal method
patent.''
Chairman CAMP. Mr. Gruner?
Mr. GRUNER. Well, let me just say that it is not as scary
as that suggests because the techniques used in the courtroom
and legal practice generally are the common techniques. That is
the methodology that is already known.
Ms. TUBBS JONES. Lawyers don't think they are common but go
ahead.
Mr. GRUNER. Those are not going to be non-obvious methods
if in fact the skills that lawyers have used for years to pick
a jury are brought forth as a possible patent.
Ms. TUBBS JONES. Are you a trial lawyer?
Mr. GRUNER. I'm sorry?
Ms. TUBBS JONES. Are you a trial lawyer?
Mr. GRUNER. No.
Ms. TUBBS JONES. I thought so.
Chairman CAMP. All right, thank you. Any other questions? I
want to thank the panel. This was an excellent hearing, and
very much appreciate all of your effort and testimony. Thank
you very much. This hearing is now adjourned.
[Whereupon, at 12:05 p.m., the Subcommittee was adjourned.]
[Questions From Ms. Tubbs Jones to Mr. Toupin follow:]
Question: Of all of the tax patents that have been issued to date,
how many have generated fees or profits under a licensing agreement for
the patent holder? Is the motive behind seeking a patent to generate a
profit or simply to protect one's ``invention''?
Answer: We are unable to respond to the first question because the
USPTO does not require, request or compile information regarding the
amount of fees or profits received by any particular patent owner or
category of owners under licensing agreements.While the motive or
motives behind seeking a patent vary among inventors, generating a
profit and protecting one's invention are certainly primary motivating
factors.
Question: To your knowledge, how many of the patents that have been
issued are being ``marketed'' by the patent holder? That is, how many
of the tax strategies that have received patents do you know are being
``shopped around'' to taxpayers?
Answer: We are unable to respond to these questions because the
USPTO does not require, request or compile information as to whether a
particular patented invention is ``marketed'' or the nature or extent
of commercialization, if any, of a patented invention.
Question: If taxpayers are believing that a particular tax strategy
has some sort of ``seal of approval'' because it has been patented,
then should the IRS not be intimately involved in the process of
issuing tax patents? To what extent is the IRS currently involved?
Answer: Current patent law governing the USPTO's authority and
operations does not permit the IRS to be ``intimately involved in the
process of issuing tax patents.'' In general, applications are by
statute confidential for the first eighteen months and, while most are
published upon expiration of that period, the Patent Act forbids the
USPTO to entertain third-party protests to published applications.
Indeed, the IRS has expressed its reluctance to be involved in
consideration of individual patent applications. Similarly, though such
a belief might arise in other areas, no other governmental agency with
regulatory authority over particular goods, services or practices is
``intimately involved'' in the process of examining patent applications
that may relate to those goods, services or practices.
While the IRS does not have any direct involvement in the process
of issuing tax patents, the IRS and the USPTO have partnered to pursue
mutually beneficial training and information exchange opportunities.
IRS personnel have provided training to USPTO patent examiners on
financial products, wealth transfer and pensions. The USPTO has
provided modified patent examiner initial training to selected IRS
employees. We look forward to continuing these training and
information-sharing programs.
[Questions From Ms. Tubbs Jones to Mr. Everson follow:]
Question: To your knowledge, how many of the patents that have been
issued are being ``marketed'' by the patent holder? That is, how many
of the tax strategies that have received patents do you know are being
``shopped around'' to taxpayers?
Answer: Based on our focused review of 14 patents and published
applications we observed little conspicuous marketing of the related
patents. In one case a web-site restriction (we needed to be a client)
hampered our ability to drill into the site without a client password.
Nevertheless, it is important to note that there is no requirement in
US patent law to work (or market) the patented invention.
Question: If taxpayers are believing that a particular tax strategy
has some sort of ``seal of approval'' because it has been patented,
then should the IRS not be intimately involved in the process of
issuing tax patents?
Answer: No. The process of examining and granting patents is
outside the IRS' jurisdiction and expertise. Importantly, the granting
of a patent on a tax strategy provides protection to the patent holder
against infringement by other parties, but has no bearing on its
legitimacy or illegitimacy under the tax laws, which remain under the
jurisdiction of the IRS. The IRS is, however, considering taking steps
to clarify for taxpayers that the tax treatment of a strategy is
unrelated to any patent protection and that a patent is not an IRS
``seal of approval.''
Question: To what extent is the IRS currently involved?
Answer: The IRS has no involvement with the USPTO in the patent
review process and does not review patents to determine whether they
are valid or meet the criteria for patentability. We monitor the USPTO
database to gauge the level and type of potential Tax Strategy Patents.
When warranted, we review public applications and previously granted
patents to learn more about the strategy in order to assess the extent
of potential aggressiveness of the strategy/technique and to gain
insight into areas where activity is occurring. Furthermore, in the
summer of2005 we conducted a cross-Agency workshop that encompassed
topics requested by the USPTO. This was an awareness workshop and was
similar to what industries have historically done with the USPTO to
keep them abreast of the latest sources of information, trends in
practice, and the like. Our goal was to assist the USPTO in developing
the resources to determine ``prior art'' in the area of tax strategies
and structures.
Question: Of those tax patents that you have reviewed, how many do
you think are abusive tax shelters?
Answer: In 2004 and 2005, we performed two searches of the USPTO
data base. The first search, conducted in November 2004, was designed
to identify patents and public applications of known tax shelter
strategies. Specifically, we were looking for transactions the IRS has
identified as ``listed'' transactions in Notices 2004-67 and 2005-13.
These Notices describe over thirty transactions the IRS considers tax
avoidance transactions. That search, which was updated in November
2005, and again in June 2006, found no evidence of patents or public
patent applications embodying any abusive tax shelters or listed
transactions.
Question: How many do you think are aggressive--there is a good
likelihood that if audited the legality of the tax strategy will be
challenged by the IRS?
Answer: It is impossible to definitively determine that a patented
structure will constitute an aggressive tax strategy as used by
taxpayers. This determination is inherently factual and depends on how
the transaction is implemented in the real world. However, we have
reviewed patents and applications to determine whether, as described in
the application itself, the patented structure represents a high risk
of aggressive tax planning. We conducted this type of search in July
2005, and update it periodically. The initial search just asked for
patents that included the word ``tax'' in applications and granted
patents in all classifications. We had fewer than 300 ``hits''. A
further analysis showed that approximately 100 of these dealt with
``business methods'' and the majority of those appeared to be software
models for computing tax impact or effect, and not tax strategies.
We pared the potential population to 14 patents and public
applications primarily in the areas of employee compensation, wealth
transfer, and financial products. Upon initial examination, none of the
14 patents were found to clearly involve abusive tax avoidance
transactions. We have subsequently completed our review of 12 of the
14, one of which was allowed by the applicant to expire for non-payment
of fees. While we do not consider them to be abusive tax avoidance
transactions, we are continuing to review two of the transactions to
fully satisfy ourselves that they do not present an apparent compliance
risk requiring follow-up action on our part.
Question: Of those tax patents that you have reviewed, how many
would you say are common tax strategies and how many are truly unique?
Answer: Considering our lack of expertise in the patent review
process and the difficulty in determining ``uniqueness,'' most (11 of
the 14) of the tax strategy patents and public applications reviewed
involved strategies familiar to us and thus appear to be commonly used
``tried and true'' techniques. Of course, it is USPTO's role to decide
whether these patents meet the criteria of patentability, such as
novelty and non-obviousness.
[Submissions for the record follow:]
Statement of Gavalis, Albert, New York, New York
Patenting tax-advice as a form of further-protecting otherwise
privileged material
Upon ``conceptually'' reviewing excerpts from a pending tax-case
review June 20, 2006 Wall Street Journal article by Jesse Drucker,
pages C-1 and C-3, where a particular ``. . . company plans to protect
privileged communications with its lawyers,'' the article goes on to
quote the company's tax-VP:
``Just as the IRS relies on the law to keep communications with its
attorneys confidential, the law also protects the confidential legal
advice that citizens receive from their attorneys.''
However, the article further goes on to state that:
``The courts long have held that, in certain situations, the
attorney-client privilege can't be invoked if the client shares the
communications with outsiders,'' [such as] ``. . . outside auditors . .
.''
The article concludes with the juxtaposition of competing forces
where while on the one hand:
``Tax lawyers have expressed concerns that the IRS's position will
prompt companies to stop sharing tax lawyers' analysis to outside
accountants, leaving them with less information when auditing public
companies for the protection of investors.''
On the other hand:
``. . . accounting regulators are `not going to stand for'
accountants blessing transactions without seeing all documentation.''
As such, the issue at hand would lend themselves towards the
further protection of tax advice in ``patented'' form.
In order for companies to maintain additional protection that
otherwise evaporates when attorney-client privileged material is
disseminated to outside auditors, This ``REQUIRED dissemination'' of
OTHERWISE-privileged attorney-client material to outside auditors WOULD
BENEFIT FROM additional protection that ``patenting'' would lend itself
towards providing.
Statement of Stephen T. Schreiner, Hunton & Williams
Having followed with great interest the testimony from the July 13
``Hearing on Issues Relating to the Patenting of Tax Advice,'' I offer
the following statement which reflects my personal views as a patent
attorney and not necessarily the views of my partners, my firm, or its
clients:
I am a registered patent attorney with nearly 10 years experience
in preparing, prosecuting, and enforcing patents. Prior to that, I
worked as an electrical engineer for the Department of the Navy for
nearly 9 years.
It goes without saying that the Patent Law is esoteric in general
and can be particularly elusive when it comes to new technologies. We
have seen these debates play out multiple times over the last 10-20
years, such as on whether man-made forms of life can be patented (early
80's), whether software can be patented (mid-90's), and whether
business methods can be patented (late 90's).
In every case, we have seen that the Patent Law is a unitary,
flexible system that is adapted to take on new technologies. Each of
the above debates played out in similar fashions. First, there was an
expression of profound surprise, even outrage by some, that certain
types of new technology might be susceptible to patenting. Then there
was robust debate.
But eventually these issues were resolved in favor of allowing the
disputed technology to be patented so long as it satisfied the long-
standing core requirements for a patent: (1) the invention has utility
(is useful in some way), (2) the invention is novel (is new), and (3)
the invention is not obvious (is not a trivial variation of what is
already known by the public).
I submit that the issue of the patenting of tax strategies--which
is really a subset of the business methods category--is resolved in
exactly the same manner: the tax strategy invention at issue should be
considered for a patent only if it can meet the utility, novelty, and
nonobviousness requirements like any other invention.
I respectfully submit that some of the discussion, especially that
leading up to the hearing, lost focus of the fundamental utility/
novelty/nonobviousness standards that act as a filter in our patent
system:
1. The tax strategy issue was incorrectly framed as ``should
somebody be able to patent a method of complying with the law?``
That is not the issue, nor the proper path of inquiry. Many
different types of patentable inventions involve a manner of complying
with the law, but they are not impermissible for that reason. Just a
few examples of very legitimate inventions that involve compliance with
the law:
a. Improved cruise control device--allows you to comply with the
State speed limit.
b. Improved machine to weigh trucks before departure to ensure they
are not overloaded per State law.
c. Improved airplane navigation system to ensure Federal FCC
altitude limits, etc. are observed.
d. Improved baby seat that meets baby seat requirements of State
law.
e. Improved seat belt system that meets seat belt requirements of
State/Federal law.
g. Improved catalytic converter to more effectively meet State
emissions requirements.
h. Improved car engine to meet State or Federal requirements on gas
mileage minimums.
From the legal standpoint, that is, under the Patent Law, all of
the above types of inventions are eligible for patents notwithstanding
that they involve legal compliance.
From a policy standpoint, so long as a patent does not effectively
prevent compliance with the law--i.e., it does not effectively
``preempt'' the law because the patent is so broad--there should be no
issue.
2. The issue, like nearly all of these kinds of these discussions,
turns on the long-standing standards for what can be patented:
something that is useful, new, and not obvious. And, of course, the PTO
must have or develop a good library of ``prior art'' (documenting
technology already in the public domain) to make that assessment. But
that is nothing new here.
Thus, a patent that is so broad that it prevents compliance with
the tax law should never be granted because it cannot be new or non-
obvious. In short, the existing filters in our Patent System will
operate to prevent such a patent from being granted.
3. The IRS's main issue is that the emblem of a patent may give
consumers the impression that the patented tax algorithm is legal and
IRS-approved. Of course, as a matter of law, a patent does not provide
right to use, only a right to exclude.
By way of example, one can invent a very patentable nuclear reactor
technology based on cold fusion or a new drug that halts the aging
process. If those inventions actually work, the inventor will receive a
patent that provides him/her exclusive rights. But that does not mean
that the law will permit the inventor to build the reactor in his/her
back yard or start marketing those new pills.
In sum, no patent provides Governmental approval to use the
invention. Thus, the issue that concerns the IRS, while it is a real
issue of potential significance, is not an issue of the substantive
Patent Law. Rather, it is one of building consumer awareness in a
particular area where patents might be susceptible to being
misrepresented by the unethical. Building consumer awareness through
advertising and/or appropriate regulations by the PTO/IRS is the
solution, not outlawing tax strategy patents altogether.
4. Finally, the position taken by several witnesses that tax
attorneys and wealthy tax clients deserve special treatment so as not
to be burdened with tax patents is unpersuasive. If doctors and
patients have to observe patent restrictions on new medical techniques
and new medicines that may have life-altering consequences, I cannot
fathom any moral, legal, or policy basis for why tax attorneys and
their clients should be enjoy a special exemption from the Patent Laws
that the medical profession does not.
In closing, I thank the Subcommittee and its staff for allowing me
to give my views on this topic.