In a recent essay titled, "Seeking Comparable Transactions in Patent and Tax," in the University of Texas Law School Review of Litigation, Professor Susan C. Morse discusses the merits of whether tax transfer prices can help inform patent damages. The introduction of her article states:
Most business firms do not go around licensing their crown jewel intellectual property to unrelated third parties. This presents a problem for both patent law and tax law. In patent litigation, setting damages for a reasonable royalty under Georgia Pacific invites the use of a benchmark royalty rate that would have been agreed to had the litigating parties negotiated a market rate in advance. This counterfactual analysis repeats in tax law when firms allocate taxable income among affiliates located in different tax jurisdictions. Transfer pricing rules similarly seek a price, such as a royalty, that would have been agreed to had the related affiliates negotiated a market rate as adverse, or “arm’s length,” parties.
In their article, Tax Solutions to Patent Damages, Jennifer Blouin and Melissa Wasserman argue that tax transfer prices can provide some of the data needed to set patent litigation damages. One could also ask the converse, which is whether patent litigation outcomes can provide some data that tax transfer pricing needs. If patent law looks to tax transfer prices, it sees the advantage that the tax transfer prices are set ex ante when IP developed by one affiliate was first used by another affiliate. This roughly aligns with patent law’s touchstone of a “hypothetical negotiation” that produces an “ex ante” license. If tax law looks to patent law, it sees the advantage that patent damages emerge from an adversarial process. Patent damages may be set ex post, but their validity is bolstered by the fact that they are contested.
Blouin and Wasserman argue that parties and courts should make use of the large body of tax transfer price information to help support reasonable royalty calculations in patent damages cases. Perhaps so. But transfer pricing data is messy. Using tax transfer prices sets for parties and courts the challenging task of understanding the prices in context. The risk exists that the analysis will fail because of the weight of its own complexity.
Tax transfer prices are imperfect. They are motivated by the incentive to reduce tax, not by the incentive to get the prices right. Theory, doctrine, and constrained administrative resources limit the quality or truth of transfer prices. But this does not mean that tax transfer prices are irrelevant to the problem of patent damages. It means that the prices are contextual. If they are used, they should be used with attention to comparability of terms, taxpayer incentives, and government enforcement. Patent litigants may have ample incentive to engage with questions of comparability, but understanding the interaction between the complex tax system and the complex patent system as applied to transfer pricing data would not be easy. It could be so hard that the transaction costs would exceed the benefit of any increase in the quality of patent damages awards.
The essay can be found, here. A draft of the Professor Blouin and Professor Wasserman paper, titled, "Tax Solutions to Patent Damages," is available, here.