A drug company must capitalize what it pays to buy an FDA Priority Review Voucher, and how it later recovers that cost depends on whether it uses the voucher or resells it

Plain-English summary

The FDA gives drug companies a "Priority Review Voucher" (PRV) when they develop treatments for certain neglected, rare-pediatric, or national-security diseases. A voucher lets its holder jump the FDA queue and get a faster (about 6-month) review of a future new drug application (NDA). Vouchers never expire and can be freely sold, so companies buy and sell them for large sums. This Chief Counsel Advice tells an IRS field office how to tax a company that buys a PRV from another company. The core answer: the purchase cost must be capitalized under section 263(a), not deducted right away. How the company gets that cost back depends on its intent. If it buys the voucher to speed up its own NDA, the cost is a transaction cost that facilitates creating a government "franchise" (the right to market the drug), so it is added to the franchise and amortized over 15 years under section 197 starting the month the NDA is approved; if the NDA is never granted, the company can take a section 165 loss when it abandons the effort. If instead the company buys the voucher to hold for resale, the voucher is a separate intangible asset that cannot be amortized (a right to government services is excluded from section 197 and, because it never expires, it is not depreciable under section 167), so the company recovers its cost only through gain or loss when it sells. Pharmaceutical companies and their tax advisers care because the timing of these deductions is worth many millions.

Ruling snapshot

• Question: Must a pharmaceutical company capitalize the cost of acquiring an FDA Priority Review Voucher, and if so, may it recover that cost under section 167 or 197?
• Outcome: advice (Chief Counsel Advice to a field office; no ruling for a specific taxpayer)
• Key authorities: IRC §§ 263(a), 167, 197 (including 197(d)(1)(F), 197(e)(4)(B)), 165; Treas. Reg. §§ 1.263(a)-4, 1.197-2, 1.167(a)-3; Jefferson-Pilot Corp. v. Commissioner; Mylan, Inc. v. Commissioner

Full text (IRS public release)

Office of Chief Counsel
Internal Revenue Service
Memorandum
Number: 202304009
Release Date: 1/27/2023
CC:ITA:3
POSTU-104878-21

UILC: 263.13-00

date: December 22, 2022

 to:   Patricia P. Davis
       Associate Area Counsel
       Large Business & International, Chicago 3

from: Merrill D. Feldstein
Senior Counsel, CC:ITA:3
Associate Chief Counsel (Income Tax & Accounting)

subject: Capitalization and Recovery of Amounts Paid by Taxpayers to Acquire Priority
Review Vouchers under §§ 263(a), 167, and 197 of the Internal Revenue Code

       This Chief Counsel Advice responds to your request for assistance in determining the
       tax treatment of Priority Review Vouchers (PRVs) used in the pharmaceutical industry.
       Specifically, you have asked whether a pharmaceutical company (PC) must capitalize
       its costs of acquiring a PRV from a third-party PC, pursuant to § 263 of the Internal
       Revenue Code (Code), and—if so—whether those costs may be recovered under § 167
       or § 197 of the Code.

                                               ISSUES

       (1)   Whether amounts paid or incurred by a PC to acquire a PRV from a third-party
             PC must be capitalized as the cost of acquiring, creating, or facilitating the
             acquisition or creation of an intangible asset under § 263(a) of the Code?

       (2)   If the costs of acquiring, creating, or facilitating the acquisition or creation of a
             PRV must be capitalized, may these costs be recovered under § 167 or § 197,
             and if so, when does the useful life or amortization period, as applicable for these
             expenditures, begin?

                                       CONCLUSIONS

(1) If the PC’s intent is to use the PRV to expedite a New Drug Application (NDA),
the PRV costs are properly treated as amounts incurred to facilitate the creation
of a franchise right from the Federal Drug Administration (FDA), and therefore,
must be capitalized under § 263(a) and the Income Tax Regulations
(Regulations) thereunder. If the PC can demonstrate that it acquired the PRV
with the intent to hold the PRV for sale, then the acquisition costs are properly
treated as amounts paid for the acquisition of a separate intangible asset in a
purchase or similar transaction, and therefore, must be capitalized under §
263(a) and the Regulations thereunder.

(2) If the PC uses the PRV to expedite the processing of an NDA filed with the FDA,
the PC may amortize the amounts paid for the PRV under § 197 and the
Regulations thereunder over the 15-year period beginning in the month that the
NDA is approved by the FDA. If the PC utilizes the PRV for the NDA process,
but is not awarded an NDA, the PC may recognize a loss under § 165 of the
Code in the taxable year such loss is sustained. Further, if the PC resells the
PRV to a third-party PC, it may not amortize the PRV costs under either § 167 or
§ 197 but may recover its basis through the recognition of gain or loss, whichever
is appropriate, at the time such PRV is sold.

                                            FACTS

Generally, a PC must obtain FDA approval of an NDA to market and sell any new drug
in the United States. To incentivize PCs to develop new treatments for certain
neglected and rare diseases (targeted conditions) and to accelerate the approval and
market availability of these potentially important therapies, Congress created the Priority
Review Voucher Program.1 Under this program, the FDA may award a PRV to any PC
that applies for and receives approval of an NDA for a new drug that treats certain
targeted conditions.

A PRV entitles its holder to an expedited review by the FDA of any future NDA of the
PC’s choosing. Expedited review, in this context, means that the FDA will complete its
review of an NDA within 6 months, rather than the 10 or more months that it generally
takes for the FDA to review and approve an NDA. Although the use of a PRV does not
ensure that the NDA will be approved, PCs treat PRVs as valuable assets because the
use of a PRV in the NDA process can significantly reduce the time that it would take a
PC to bring a desirable new drug to market.

1 Statutory authority for the PRV program is provided by 21 USC §§ 360n (tropical diseases), 360ff (rare

pediatric diseases) and 360bbb-4a (agents that present national security threats).

In addition, a PRV awarded to a PC does not expire2 and is freely transferable to a
related or unrelated party. For example, a PC might receive a PRV for developing a
drug for a neglected disease and sell that PRV to another PC, who will redeem it with
the FDA to expedite the NDA process for a drug that could treat a more prevalent
disease, and thus, is likely to be more profitable to that second PC.3 As a result, PRVs
are often transferred from one PC to another for significant cash market value. Once
the PRV is transferred, the purchasing PC may use the PRV to accelerate the NDA
process for a new drug immediately, it may hold the PRV to use later, or it may resell
the PRV to another PC. There is no limit on the number of times a PRV may be
transferred before it is remitted to the FDA. Thus, although a PRV is typically
purchased by a PC with the intent to use it to expedite review of a specific NDA, a PC
may also purchase a PRV with the intent to hold it for a future NDA, or with the intent to
hold the PRV for sale.

When a PC decides that there is a benefit to expediting the review and approval of a
particular drug, it redeems the PRV with the FDA as part of its NDA. Because this
expedited review diverts the FDA’s resources from the review of other pending NDAs,
the FDA also requires the PC to pay a user fee at the time of redemption.4

                                              LAW

A. Capitalization of Intangible Property

Section 162 of the Code allows taxpayers a deduction for all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or business.

Section 263(a), however, prohibits current deductions for capital expenditures. Section
263(a) and § 1.263(a)-1(a) provide that no deduction is allowed for any amount paid out

2 The PRV program for neglected tropical diseases (enacted in 2007) does not sunset. However, the

program for rare, pediatric diseases will expire in September 2024, although a drug designated as a rare
pediatric treatment can still receive a voucher if the drug is approved by September 2026. See 21 USC
§ 360ff(b)(5); see also 21 USC § 360bbb-4a(g) (providing October 2023 sunset of national security
threats PRV program). These programs can be renewed, and Congress has renewed the program
several times already, most recently in § 321 of Title III of Subdivision BB of the Consolidated
Appropriations Act, 2021, P.L. 116-260.

3 Several factors influence whether a PC that is awarded a PRV will keep the PRV for future use or will
sell the PRV to another PC, including consideration of potential profits from drugs in its development
pipeline, the market value of a PRV, and the revenue that might be generated from its sale.

4 Although the user fee is not the subject of this Chief Counsel Advice, these amounts must generally be

capitalized under § 1.263(a)-4(d)(5)(i) as amounts paid to the government to obtain a franchise right from
the government.

for permanent improvements or betterments made to increase the value of any property
or estate.

Section 1.263(a)-4 provides rules for applying § 263 to amounts paid to acquire or
create intangible property. Section 1.263(a)-4(b)(1) provides that except as otherwise
provided in § 1.263(a)-4, a taxpayer must capitalize an amount paid to (i) acquire an
intangible (see § 1.263(a)-4(c)); (ii) create an intangible described in § 1.263(a)-4(d); (iii)
create or enhance a “separate and distinct intangible asset” within the meaning of
§ 1.263(a)-4(b)(3); (iv) create or enhance a future benefit identified in the Federal
Register or the Internal Revenue Bulletin as an intangible for which capitalization is
required; and (v) facilitate (as defined in § 1.263(a)-4(e)(1)) the acquisition or creation of
an intangible.

Section 1.263(a)-4(b)(3)(i) provides that the term “separate and distinct intangible asset”
means a property interest of ascertainable and measurable value in money’s worth that
is subject to protection under applicable State, Federal or foreign law, and the
possession and control of which is intrinsically capable of being sold, transferred, or
pledged (ignoring any restrictions imposed on assignability) separate and apart from a
taxpayer’s trade or business.

Section 1.263(a)-4(c)(1) provides that a taxpayer must capitalize amounts paid to
another party to acquire any intangible from that party in a purchase or similar
transaction. Section 1.263(a)-4(c)(1)(i)-(xv) provides a non-exclusive list of examples of
the types of intangibles that are within the scope of this paragraph. Section
1.263(a)-4(c)(1)(viii), specifically, includes a franchise, trademark, or tradename (as
defined in § 1.197-2(b)(10)).

Section 1.263(a)-4(d)(5)(i) provides that a taxpayer must capitalize amounts paid to a
governmental agency to obtain, renew, renegotiate, or upgrade its rights under a
trademark, trade name, copyright, license, permit, franchise, or other similar intangible
right granted by that governmental agency.

Section 1.263(a)-4(e) addresses transaction costs that must be capitalized because
they facilitate the acquisition or creation of intangible property. Generally,
§ 1.263(a)-4(e)(1)(i) provides that an amount is paid to facilitate the acquisition or
creation of an intangible if it is paid in the process of investigating or otherwise pursuing
the transaction. Section 1.263-4(e)(3) provides that the term “transaction” means all of
the factual elements comprising the acquisition or creation of an intangible and includes
a series of steps carried out as part of a single plan to do so. Thus, § 1.263-4(e)(3)
provides that a transaction can involve more than one invoice or more than one
intangible.

B. Amortization, Depreciation, and Recovery of Intangible Property

Section 165 allows a deduction for any loss sustained during the taxable year and not
compensated for by insurance or otherwise. Section 1.165-1(d)(1) provides that a loss
is treated as sustained during the taxable year in which the loss occurs, as shown by a
closed and completed transaction, and as fixed by an identifiable event occurring in
such taxable year.

Section 167(a) provides that a reasonable allowance for the exhaustion, wear and tear,
and obsolescence of property used in the trade or business or of property held by the
taxpayer for the production of income shall be allowed as a depreciation deduction.

Section 1.167(a)-3 provides that if an intangible asset is known from experience or other
factors to be of use in the business or in the production of income for only a limited
period, the length of which can be estimated with reasonable accuracy, such an
intangible asset may be the subject of a depreciation allowance. Examples are patents
and copyrights. An intangible asset, the useful life of which is not limited, is not subject
to the allowance for depreciation. No allowance will be permitted merely because, in the
unsupported opinion of the taxpayer, the intangible asset has a limited useful life.

Section 197(a) provides that a taxpayer shall be entitled to an amortization deduction
with respect to any amortizable § 197 intangible. The amount of the deduction under §
197 is determined by amortizing the adjusted basis of such an intangible ratably over
the 15-year period beginning with the month in which the intangible was acquired.
Section 197(b) provides that no other depreciation or amortization deduction shall be
allowable with respect to any amortizable § 197 intangible.

Section 197(c)(1) provides that, except as otherwise provided in this section, the term
“amortizable § 197 intangible” means any § 197 intangible which is (a) acquired by the
taxpayer after August 10, 1993, and (b) held in connection with the conduct of a trade or
business or an activity described in § 212.

Section 197(d)(1)(D) provides that a § 197 intangible includes any license, permit, or
other right granted by a governmental unit or agency or instrumentality thereof. See
also § 1.197-2(b)(8).

Section 197(d)(1)(F) provides that a § 197 intangible also includes any franchise,
trademark, or trade name. See also § 1.197-2(b)(10).

Section 197(e)(4)(B) provides that § 197 intangibles do not include any right to receive
tangible property or services under a contract or from a governmental unit if the right is
not acquired as part of a purchase of a trade or business. See also § 1.197-2(c)(6).

Section 1.197-2(b)(10)(i) provides that the term “franchise” has the meaning given in
§ 1253(b)(1) and includes any agreement that provides one of the parties to the
agreement with the right to distribute, sell, or provide goods, services, or facilities, within
a specified area.

                                     ANALYSIS

The proper tax treatment of a PC’s costs to acquire a PRV is determined by examining
the facts and circumstances surrounding that acquisition. Specifically, an inquiry must
be made of whether a PC acquired the PRV with the intent to redeem the PRV with the
FDA to expedite the NDA process, presently or in the future, or with the intent to hold
the PRV for resale to others. The foregoing discussion details the legal analysis under
both these circumstances by addressing each step of the PRV transactions – i.e., the
PC’s acquisition of the PRV from a third-party PC, the PC’s use of the PRV in the NDA
process, the PC’s amortization and recovery of PRV costs, and the PC’s disposition of
the PRV in a sale or exchange.

A. PRV used to obtain an expedited NDA

   1. Capitalization under § 263(a)

If the PC incurs costs for a PRV with the intent to utilize it to expedite an NDA--the
process by which a PC obtains from the FDA the franchise right to market and sell a
new drug in the United States--then the treatment of PC’s costs is governed by
§ 1.263(a)-4(b)(1)(v). This section requires a taxpayer to capitalize amounts incurred to
facilitate the creation of an intangible described in § 1.263(a)-4(d). Specifically, under
§ 1.263(a)-4(d)(5)(i), a taxpayer must capitalize amounts paid to a government agency
to obtain rights under a trademark, trade name, copyright, license, permit, franchise or
other similar right granted by a government agency.

Generally, amounts paid directly to a government agency to obtain the right to market
and sell a product have been treated as costs of obtaining a franchise from the
government. See Jefferson-Pilot Corp. v. Commissioner, 98 T.C. 435, 443 (1992), aff’d,
995 F.2d 530 (4th Cir. 1993) (“franchise” is sufficiently broad to include FCC licenses
between government and licensee for right to broadcast within a specified area). Thus,
for example, application fees paid to a government agency to obtain a franchise or other
similar right from that agency must be capitalized under § 1.263(a)-4(d)(5)(i).

In addition, where a taxpayer pays a party other than the government amounts to
facilitate the creation of a right from a government agency, the courts have required
those amounts to be capitalized as costs that facilitate the acquisition of such right
under §§ 1.263(a)-4(b)(1) and 1.263(a)-4(e). See Mylan, Inc. v. Commissioner, 156
T.C. No. 10 (Apr. 27, 2021) (holding, in part, that legal fees paid by a PC to prepare
notices to patent owners, which were required to obtain approval of an abbreviated NDA
from the FDA (“ANDA”), must be capitalized under § 263(a) as costs that facilitate the
creation of the rights obtained from the government).

Because amounts paid for a PRV are incurred to expedite the NDA process in the
pursuit of a franchise, these costs are properly characterized as transaction costs, that
is, costs incurred to facilitate, or pursue, the creation of that franchise under
§§ 1.263(a)-4(b)(1)(v), 1.263(a)-4(d)(5)(i), and 1.263(a)-4(e). Further, § 1.263(a)-4(e)(3)
provides that the term “transaction” is meant to encapsulate all the factual elements
comprising the creation of an intangible and includes a series of steps carried out as
part of a single plan to do so. In this circumstance, then, the purchase of the PRV is
one step in the PC’s plan to obtain a franchise right from the FDA in an expedited
manner. Therefore, amounts paid for a PRV are properly characterized as costs
incurred to facilitate the creation of an intangible—the franchise—and must be
capitalized and added to the basis of the that franchise under § 263(a) and
§ 1.263(a)-4(g)(1) in the taxable year that the costs are paid or incurred.

   2. Amortization, Depreciation, and Recovery under §§ 167 and 197

Although they must be capitalized, amounts paid or incurred to acquire a PRV are not
depreciable or amortizable at the time a PRV is acquired. Sections 197(c)(1) and
(d)(1)(D) and § 1.197-2(b)(8) generally provide that licenses, permits, or other rights
granted by a government unit will constitute an amortizable § 197 intangible. With
respect to an acquired PRV, however, an exception applies. Specifically, § 197(e)(4)(B)
and § 1.197-2(c)(6) provide that the definition of a § 197 intangible excludes any right to
receive tangible property or services under a contract or from a governmental unit if the
right is not acquired as part of a purchase of a trade or business. Accordingly, because
a PRV provides the PC with expedited servicing of an NDA by the FDA, the amounts
paid or incurred by a PC to acquire a PRV are not amortizable under § 197 at the time
the PRV is acquired by the PC. Likewise, amounts paid or incurred to acquire a PRV
are not depreciable under § 167 because PRVs do not expire, and assets with unlimited
useful lives are excluded from the scope of § 167. See § 1.167(a)-3.

However, amounts paid or incurred for a PRV may be recovered later as a cost of
facilitating the creation of a franchise right. Section 197(d)(1)(F) provides that a § 197
intangible also includes any franchise, trademark, or trade name. Because such
franchise right is held in connection with the conduct of PC’s trade or business, the
costs of the PRV and any other costs incurred in the process of obtaining the franchise
are properly treated as an amortizable § 197 intangible under §§ 197(c)(1)

and 197(d)(1)(F). See § 1.197-2(b)(10)(i). Accordingly, under § 197(a), the PC may
recover these costs and any other costs related to the creation of the franchise right
ratably over a 15-year period beginning on the first day of the month that the NDA is
approved.

If no NDA is granted by the FDA, the PC would be permitted, subject to the loss
disallowance rules in § 197(f)(1) and § 1.197-2(g), to deduct the costs of acquiring the
PRV, and any application fees associated with the NDA, as a loss under § 165 in the
taxable year the NDA process is abandoned by the PC. See § 1.165-1(d)(1).

B. PRV Acquired for Resale

  1. Capitalization under § 263(a)

If a PC acquires the PRV with the intention to hold the PRV for resale or investment, the
treatment of the PC’s acquisition costs is governed by §§ 1.263(a)-4(b)(1)(i) and
1.263(a)-4(c)(1). Under these intangible property regulations, a taxpayer is required to
capitalize amounts paid to another party to acquire an intangible from that party in a
purchase or similar transaction. Section 1.263(a)-4(c)(1) provides examples of the
types of intangibles that must be capitalized under this provision. However, these
examples are not exclusive. In fact, § 1.263(a)-4(b)(3) provides a definition of separate
and distinct intangible property for purposes of applying the intangible regulations.
Specifically, § 1.263(a)-4(b)(3) states that a separate and distinct intangible asset
includes a property interest of ascertainable and measurable value in money's worth
that is subject to protection under applicable state, federal or foreign law and the
possession and control of which is intrinsically capable of being sold, transferred, or
pledged separate and apart from a trade or business.

Although amounts paid for a PRV are not listed in the specific examples of acquired
intangibles under § 1.263(a)-4(c)(1), these amounts do fall within the definition of a
separate and distinct intangible asset under § 1.263(a)-4(b)(3). Specifically, a PRV is a
property interest that provides the bearer with the right to receive expedited regulatory
review of an NDA by the FDA, and this interest is protected under statutes authorizing
the FDA to grant PRVs and allowing such PRVs to be transferred. See § 1.263-4(b)(3).
The common practice of buying and selling PRVs within the pharmaceutical industry
demonstrates that the value of a PRV is measurable, and the possession and control of
a PRV is capable of sale or transfer separate and apart from the seller PC’s trade or
business. Accordingly, in this context, a PRV is properly characterized as a separate
and distinct intangible asset under § 1.263(a)-4(b)(3) and, as such, the acquisition cost
of the PRV must be capitalized under § 263(a) and § 1.263(a)-4(c)(1) in the taxable
year such costs are paid or incurred.

  2. Amortization, Depreciation, and Recovery under §§ 167 and 197

As discussed above, amounts paid or incurred to acquire a PRV are not depreciable or
amortizable at the time such PRV is acquired. This is because any right to receive
services from a governmental unit is excepted from the definition of a § 197 intangible
unless such right is acquired as part of a purchase of a trade or business. See §
197(e)(4)(B); § 1.197-2(c)(6). Further, assets with unlimited useful lives, such as PRVs
that never expire, are not depreciable under § 167. See § 1.167(a)-3.

Thus, if a PC acquires a PRV with the intent to resell it or hold it for or investment, and
such PRV is never used by the PC in an NDA application, the PC would not be
permitted to amortize or depreciate the capitalized costs of the PRV. Instead, the PC’s
recovery of PRV costs would typically be limited to gain or loss upon the disposition of
the intangible, which would likely occur when the PRV is transferred, sold, or exchanged
to another PC in accordance with applicable provisions of the Code. See, e.g., §§ 1001,
1012.

                                      * * * *

This advice applies only under the facts and circumstances described herein. Pursuant
to § 6110(k)(3) of the Code, this document may not be used or cited as precedent.

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 317-5100 if you have any questions regarding § 263(a) or at 202-317-
7005 if you have any questions regarding § 167 or § 197.