HEARING ON ISSUES RELATING TO THE PATENTING OF TAX
HEARING ON ISSUES RELATING TO THE PATENTING OF TAX ADVICE
SUBCOMMITTEE ON SELECT REVENUE MEASURES
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
JULY 13, 2006
Printed for the use of the Committee on Ways and Means
COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
E. CLAY SHAW, JR., Florida
NANCY L. JOHNSON, Connecticut
WALLY HERGER, California
JIM MCCRERY, Louisiana
DAVE CAMP, Michigan
JIM RAMSTAD, Minnesota
JIM NUSSLE, Iowa
SAM JOHNSON, Texas
PHIL ENGLISH, Pennsylvania
J.D. HAYWORTH, Arizona
JERRY WELLER., Illinois
KENNY C. HULSHOF, Missouri
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
THOMAS M. REYNOLDS, New York
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
BOB BEAUPREZ, Colorado
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
DEVIN NUNES, California
CHARLES B. RANGEL, New York
FORTNEY PETE STARK, California
SANDER M. LEVIN, Michigan
BENJAMIN L. CARDIN, Maryland
JIM MCDERMOTT, Washington
JOHN LEWIS, Georgia
RICHARD E. NEAL, Massachusetts
MICHAEL R. MCNULTY, New York
JOHN S. TANNER, Tennessee
XAVIER BECERRA, California
LLOYD DOGGETT, Texas
EARL POMEROY, North Dakota
STEPHANIE TUBBS JONES, Ohio
MIKE THOMPSON, California
JOHN B. LARSON, Connecticut
RAHM EMANUEL, Illinois
Allison H. Giles, Chief of Staff
SUBCOMMITTEE ON SELECT REVENUE MEASURES
JERRY WELLER, Illinois
MARK FOLEY, Florida
THOMAS M. REYNOLDS, New York
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
MICHAEL R. MCNULTY, New York
LLOYD DOGGETT, Texas
STEPHANIE TUBBS JONES, Ohio
MIKE THOMPSON, California
JOHN B. LARSON, Connecticut
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records of the Committee on Ways and Means are also published in electronic form. The printed hearing record remains the official version. Because electronic submissions are used to prepare both printed and electronic versions of the hearing record, the process of converting between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process is further refined.
Advisory of June 22, 2006 announcing the hearing
James Toupin, General Counsel, U.S. Patent and Trademark Office
The Honorable Mark Everson, Commissioner, Internal Revenue Service
Richard S. Gruner, Professor of Law, Whittier Law School, Costa Mesa, California
Ellen Aprill, Associate Dean of Academic Programs, Professor of Law, and John E. Anderson Chair in Tax Law, Loyola Law School, Los Angeles, California
Dennis I. Belcher, Partner, McGuireWoods LLP, Richmond, Virginia
SUBMISSIONS FOR THE RECORD
Gavalis, Albert, Graf Repetti & Co., Llp, New York, NY, statement and attachment
Schreiner, Stephen, Hunton & Williams Llp, statement
HEARING ON ISSUES RELATING TO THE PATENTING OF TAX ADVICE
Thursday, July 13, 2006
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
[The advisory announcing the hearing follows:]
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.
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:]
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. Secondly, 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:]
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. Secondly, 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 two months after an application is published and the office is now proposing to extend that to six 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 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, 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 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 developed by a firm can only be marketed by 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:]
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:]
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 a grantor 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:]
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 patents incents 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, six 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 businesspeople 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
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
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:]
Gavalis, Albert, Graf Repetti & Co., Llp, New York, NY, statement and attachment
Schreiner, Stephen, Hunton & Williams Llp, statement