WASHINGTON — Attorneys are increasingly seeking to patent the advice they give on muni-related and other tax issues as lawmakers consider legislation that would ban the burgeoning practice.
In the municipal market, most of the patents obtained so far pertain to structured finance products. But bond lawyers worry that it could extend to simple tax-exempt bond transaction structures or financial tools, and federal officials warn the proliferation of tax patents could create serious enforcement problems.
The U.S. Patent and Trademark Office has granted 60 tax-related patents since 1998, when a court case paved the way for their application, according to sources.
Nearly 90 applications for other tax patents are pending.
There are 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; and the inventor must have had possession of the claimed invention upon filing the patent application.
The grant of a patent enables the patent owner to exclude, for a limited time, others from making, using, offering for sale, or selling the invention in the U.S. It is not a license to use the invention nor is it a stamp of approval from the federal government.
Tax strategies and financial products were not explicitly deemed to be patentable items until 1998, when the U.S. Court of Appeals ruled in State Street v. Signature Financial that such products could be protected as “business methods.”
The case created a new awareness that business method claims could be patented, according to patent officials who testified at a July 2006 House Ways and Means Committee subcommittee hearing on the issue.
At that hearing, Rep. Dave Camp, R-Mich., then chairman of the subcommittee on select revenue measures at the time, quizzed witnesses, including then-Internal Revenue Service commissioner Mark Everson, about whether the existence of a patent would appear to legitimize an otherwise inappropriate tax arrangement, thereby contributing to tax compliance problems or creating a misunderstanding of tax laws.
Patent officials testifying at the hearing stressed that a patent is not a government seal of approval for a particular product, but simply protects an invention against infringement by others.
Everson told the lawmakers that while the IRS was concerned that some taxpayers may attempt to patent abusive tax schemes, it had found little evidence of such problems.
Treasury Department and IRS officials have since said they strongly support a ban on patents for tax strategies and advice.
Meanwhile, a slew of financial and legal organizations have taken a keen interest in the issue.
“It’s causing some angst among our members, and we are concerned that they could be exposed to liability,” said Eileen Sherr, technical manager of the American Institute of Certified Public Accountants, a group that has led efforts to persuade Congress to prohibit the patenting of tax advice.
The American Bar Association’s tax section set up a task force on the issue in October and made it a high priority.
“These developments could have tremendous implications for the tax system and for the practice of law in general,” section and task force chairman Dennis Drapkin said in a statement on the ABA’s Web site. Ellen P. Aprill, associate dean at Loyola Law School in Los Angeles and vice-chair of the task force, was one of the witnesses at the July 2006 House subcommittee hearing and testified that historically tax lawyers have shared information and ideas freely.
If patents become an important part of the landscape, the atmosphere will become more secretive and less cooperative, and the tax system will suffer, she warned. “This has been an issue for a while,” Aprill, the author of a paper entitled, “Responding to Tax Strategy Patents,” said in a brief interview last week.
She pointed to a suit filed in January 2006 by the holder of a controversial patent on an estate planning technique involving a stock option grantor retained annuity trust, or SOGRAT — the first known challenge of an alleged tax patent infringement. Practitioners contend the suit may be a bellwether for the tax patenting practice.
The National Association of Bond Lawyers has not taken any official position or action regarding tax advice patents, but is communicating with industry groups such as the AICPA and the ABA to understand the issue and any related proposed legislation, according to deputy director of governmental affairs Sean Gard.
NABL’s board of directors has discussed patents of tax advice several times, and plans to have a presentation on tax patents at its annual Bond Attorneys Workshop next month in Chicago, according to board member John O. Swendseid, a partner at Swendseid & Stern in Reno, Nev. “People are becoming increasingly concerned” in the muni arena, he said. “It’s not that new, and there have been some in the tax-exempt bond area.”
Swendseid said lawyers may have difficulty determining if tax advice has been patented. “It’s all words, and whether we use same [descriptions] as the patent people do — that’s a big question. The time it would take to search the patent database could be considerable because they use different language.”
Additionally, since patents do not show up in the federal database immediately after being granted, attorneys could infringe upon one without knowing it, even after conducting a thorough search, Swendseid pointed out.
“It might be one applied for and not public yet — until after the deal is done and they come after your client,” he said. Fundamental Problem Many tax practitioners appear to disagree with the practice on an even more basic level.
“As a practical matter, you shouldn’t be able to collect royalties from someone just because he took a position on his tax return,” said Glenn S. Miller, a structured finance tax partner with Bingham McCutchen LLP here.
“In essence, that’s a higher tax rate. That is something admirable for the government to go after. “That’s to be distinguished from a mechanism that is a financial product; a legitimate business [solution], because it lowers borrowing costs or allows people to take an asset, split it up in different ways, and sell it in way that produces more money,” he said.
“The people doing that aren’t taking a tax position at all.”
One of Miller’s clients in February applied for patent on a structuring method and associated modelling software for the syndication of federal low-income housing tax credits generated by housing projects financed with private-activity tax-exempt bonds.
The client “spent a lot of money and professional time to come up with a computer modelling program and structure to package these [low-income housing tax] credits, so they could be sold,” Miller said.
“It is a way to efficiently syndicate tax credits to sell in the public marketplace. They got it to work,” but as is often the case with such products, Miller added, people tried to copy it.
A patent applied for in September 2004 by an attorney at Chicago law firm Katten Muchin Rosenman LLP protects a method of restructuring a debt instrument without retiring the underlying debt.
The process is accomplished by amending a debt instrument to call for purchase of the bonds in lieu of a redemption and purchasing the bonds for resale to a financial institution pursuant to a purchase agreement, according to the patent application. And George Butcher, a Goldman, Sachs & Co. managing director in New York, has a patent on a method for structuring certain state revolving fund bond programs, records show.
The technique consists of receiving, into the SRF, loan repayments made by the borrower and paying bond debt service with the loan repayments and from program equity and earnings.
There are a handful of recent proposals addressing the patenting of tax advice in Congress, but the one with the most potential is attached to legislation approved by a House committee earlier this month, sources said. Sponsored by Reps. Rick Boucher, D-Va., and Bob Goodlatte, R-Va., the measure would make tax planning methods unpatentable.
The measure would amend the federal tax code to specify that an individual or firm cannot obtain a patent for “any plan, strategy, technique, or scheme” designed to reduce, minimize, or defer a taxpayer’s tax liability.
Boucher originally proposed the ban on patents for tax advice as a separate bill, but on July 18 the House Judiciary Committee added the measure to its wider-ranging patent legislation. Several proposals to ban tax patents have been floated in the Senate, but none have been added to the chamber’s broader patent bill.
Sources indicate that while the full House could take up its patent legislation before the August recess, which begins Friday, it is more likely to act in the fall. One attorney, who wanted to remain unidentified, suggested that the Boucher-Goodlatte amendment will have to be altered to win passage.
“It’s too broad. It captures all kinds of financial products and structured products that have nothing to do with tax,” the attorney said.
The proposal may also violate the Agreement on Trade Related Aspects of Intellectual Property Rights, or TRIPs, an international intellectual property treaty administered by the World Trade Organization, the attorney pointed out.
Some are also waiting for the Supreme Court to weigh in.
“I wouldn’t be surprised to see the Supreme Court saying, 'You’re interpreting this too broadly,’ and then nail it down a bit,” said an attorney and former Internal Revenue Service official. Regardless of how it is done, most muni bond lawyers seem to think banning tax patents is solid tax policy.
“That would be very good news,” Swendseid said. “I think everyone hopes this will go away.”
“The way I’ve thought about it … there are a number of garden variety structures and techniques that people use every day,” said a bond lawyer who did not want to be identified. “If someone says, 'I have a patent on that,’ it would make life very difficult. It is hard to even think about that kind of world, where you’d have to say, 'Okay, there’s a patent on this, what are the amounts due? Do I have to get permission for things that I do routinely?’ ”
“I know lots of people who think of things as somewhat proprietary, but they wouldn’t have the cojones to patent them,” another attorney joked. “It could really cause havoc. I don’t want to have to worry about filing a patent every time I think of something.”