Patent Reform: Tax Shelter Patents

On Friday, Senator Barack Obama (and former University of Chicago Law Professor) along with Senators Levin (D-Mich) and Coleman (R-Minn) filed a new bill to “stop tax haven abuse.” Included in the bill is a provision that would prohibit the USPTO from issuing patents for:

inventions designed to minimize, avoid, defer, or otherwise affect liability for Federal, State, local, or foreign tax.

The main focus of the Bill would be to “impose tougher requirements on U.S. taxpayers using offshore secrecy jurisdictions, give the U.S. Treasury the authority to take action against foreign jurisdictions that impede tax enforcement, stiffen penalties against abusers and close offshore trust loopholes.”

Please: No comments that are not about patents.

Notes:

25 thoughts on “Patent Reform: Tax Shelter Patents

  1. I used to be opposed to business methods patents. Now I’m lukewarm–I’m somewhere in the middle. But now all this negativity towards tax shelter patents has me thinking: Why all the negativity?

    I’m waxing a little philosophical here, but our country was essentially founded on the idea of not wanting to pay taxes. Americans HATE taxes. We have since even before the boston tea party.

    I’m going to proceed with the rest of this post under an assumption that could be incorrect. Please advise if this assumption is ill-founded, but wouldn’t tax strategy patents be quite difficult to enforce? If I set up a tax scheme like one of the ones described in the patent, I may certainly be infringing, but how would the patent holder know? So, I’m going under the assumption that patents on tax strategies are largely unenforceable.

    Take unforceability out of the equation and you are left with public disclosure. Public disclosure of legal ways of working within the laws (enacted by congress) and the regs (promulgated in the tax code) to minimize your taxes. Is anyone — and I mean anyone on this board, or anyone in the general sense — going to argue that there is something wrong with public disclosure that informs citizens as to the legal ways of reducing tax liability? Any takers?

    There is nothing noble about paying more tax than you are legally entitled to pay. Judge Learned Hand said it himself. There is nothing immoral about trying to find legal ways to reduce your taxes.

    So, to the extent that tax patents are essentially an essay to the public on the current tax loopholes….then god bless them. I couldn’t think of anything more american if I was eating apple pie while watching baseball.

    I’m a 27 year old patent clerk who graduates with a JD in may and takes the bar in august (is it?). I am swamped with upcoming exams and patent applications I need to complete and file before exams…..and yet I still feel the strange urge to like file a comment opposed to the proposed IRS rules. Our government is supposed to be for the people and by the people…so it needn’t get fired up when “the people” are clever and figure out way to legally pay less taxes. Again, see quote from Learned Hand.

  2. A patent cannot be issued if it is obvious or has been reflected in “prior art”, which definition is fairly broad. If an inventor creates a new financial structure that reduces, or defers, a tax liability then the inventor is entitled to a royalty. The royalty isn’t any different from a tax attorney or CPA charging their client a fee to reduce or defer a tax liability. Why not create a structure where tax patents are registered with the IRS and the royalty is capped, thus allowing reasonable access to the general public and compensating the inventor for his or her efforts. An additional consideration is when a financial structure provides benefits in addition to the tax savings/delay – such as additional liquidity for third party property owners.

  3. “To promote the Progress of Science and useful Arts”, Congress shall have the power to protect tax avoidance strategies.

    What a country.

  4. More MS v ATT exchanges:

    JUSTICE STEVENS: The software is the component?
    MR. JOSEFFER: Well, but the, the — but like with anything, you could say a computer is also the component, but it’s the actual computer, not you know, any copy of the same computer.
    JUSTICE SOUTER: But in this case, you’re -but Mr. Olson said the component is either the disk or the portion of the hard drive to which the, the coded instructions are transferred.
    MR. JOSEFFER: Right.
    JUSTICE SOUTER: Do you accept that?

  5. Some of the juicier exchanges (pg 13):

    “MR. OLSON: The ’580 patent is a program, as I understand it, that’s married to a computer, has to be married to a computer in order to be patented.
    JUSTICE SCALIA: You can’t patent, you know, on-off, on-off code in the abstract, can you?
    MR. OLSON: That’s correct, Justice Scalia.
    JUSTICE SCALIA: There needs to be a device.
    MR. OLSON: An idea or a principle, two plus two equals four can’t be patented. It has to be put together with a machine and made into a usable device. The bind that AT&T is in here is that the components that make the machines run that are produced abroad are not supplied from the United States. They are made in Belgium or Frankfurt or something.
    JUSTICE GINSBURG: That depends on what you consider the component. They define component as including the, what you’ve been calling the abstract.”

  6. mpbk wrote, “Who would have ever thunk that by figuring out how to best follow the law, I could be sued in civil court?”

    “Following” the law is an awkward choice of words. If the law suggested a claimed path to follow, the claim wouldn’t issue because it would be obvious.

    Complaining about tax patents on the sole basis that they restrict otherwise legal activity is ridiculous because patents are designed to restrict legal activity, that is, making, using, selling or offering to sell the invention.

  7. Wow, a patent on tax strategies. I didn’t even know these sorts of things existed. Who would have ever thunk that by figuring out how to best follow the law, I could be sued in civil court? Lovely. Just lovely.

  8. If patented, only the patent owner, or those licensed by the patent owner, can practice the invention. Knowing this, the IRS can concentrate it’s scrutiny on that patentee to ensure that nothing illegal is being done (avoidance is legal, evasion is not). Take away patent protection, and everyone can practice it. I think that tax scammers throughout the world will line up behind Mr. Obama’s suggestion so that they can take advantage of any and all schemes.

    Further, I have trouble enough educating Examiners to the point where they can understand (electrical/computer) inventions. Now someone (not me) will have to educate the Examiner as to what the scheme is, AND whether it falls into one of the categories Mr. Obama sets. That’s something I bet the IRS couldn’t decide reliably, much less the patent office. Because those CPA/tax attorney’s cannot practice before the USPTO, I think this law would be a “business method patent attorney full employment act”. Maybe we should all come out in favor of it.

  9. Could there be a fifth amendment takings issue? Seems like for issued patents there would be investor-backed expectations that would be destroyed by the legislation. From a patent owner’s perspective the changed law would completely dedicate the property to the public.

    I am just wondering if there are other cases where changes in the patent statute rendered otherwise valid patents invalid and someone brought a takings claim. Seems like a stronger case than Zoltek where the taking claim was based on infringement by the government.

  10. “An invention of a mechanical device must be built simpler materials and comply with the laws of nature – it is still potentially patentable.”

    Agreed. But a mechanical device is not created by the materials or the laws of nature, it is created using them. In contrast, a tax avoidance strategy is created by the laws, rules, and court decisions. As a result, there is no novelty in defining a tax avoidance strategy, whereas there may be novelty in defining a mechanical device.

  11. “The payment of taxes, and therefore the avoidance of payment of taxes, is necessarily based on the laws and rules enacted by a lawmaker and interpreted by the courts. Putting all the pieces together may be very complex, but any LEGAL tax avoidance scheme MUST follow from the existing laws, rules, and decisions.”

    An invention of a mechanical device must be built simpler materials and comply with the laws of nature – it is still potentially patentable.

  12. It seems that tax avoidance patents are necessarily obvious over the rules, statutes, and court decisions that enable the use of these tax avoidance solutions. A few of these patents that I have seen don’t even cite any of the relevant laws, rules, and decisions as background. How can they not be relevant?

    The payment of taxes, and therefore the avoidance of payment of taxes, is necessarily based on the laws and rules enacted by a lawmaker and interpreted by the courts. Putting all the pieces together may be very complex, but any LEGAL tax avoidance scheme MUST follow from the existing laws, rules, and decisions.

    How would granting a monopoly further a science? What is the science? An inventor could apply for (or have prepared and be ready to file) a patent for a new tax avoidance scheme and then successfully lobby to get rules/statutes in place to make the scheme legal. This is like changing the rules of science to fit your invention.

    Legislation like the one proposed is a bad idea. It would open the door to many other special interests looking for their own exceptions. These applications should be readily disposed of with a proper analysis under 103.

  13. Does anyone know the purpose for banning patents on tax minimization inventions? The obvious explanation is that the Senators don’t want encourage the creation of innovative tax shelters. But there could be other explanations. A lot of tax minimization strategies are completely legal, and maybe the Senators just think that those legal strategies should be equally available to all taxpayers.

  14. Executive Order 10096 of Jan. 23, 1950 (yes…1950) enunciates the policy concerning when the USG takes title to the inventions of its employees. The question I raised does not concern ownership. Executive Order 10096 is a whole different matter; one certainly deserving of more scrutiny. In several respects its scope is more than merely being draconian.

    My question is much more generic, and does reach to the heart of who are “inventors” and “authors” in a constitutional sense. Using a fairly routine factual example, a researcher in the full time employ of the USG and dutifully toiling away in a lab at the NIH performing assigned research suddenly has a “flash of genius” that solves the problem being researched and holds the possibility for being awarded in the future a Nobel Prize.

    Is that researcher (now having invented something) an “inventor” within the meaning of Article I, Section 8, Clause 8, such that a patent can lawfully issue for the invention? BTW, 10096 dictates that all rights in both the invention and any patent(s) reside with the USG.

  15. Some people pay too much or too little taxes simply because their taxes aren’t calculated properly. If someone invented a method which improved the accuracy of tax returns it would run afoul of a prohibition on the patenting of “inventions designed to … otherwise affect liability for … tax.”

  16. Aside – this site needs quote tags. :)

    Mr. Slonecker – “Mr. Crouch,

    I do agree that the USG holds many patents. But I have always wondered why no one has ever researched if the USG can lawfully file for patents where the inventor is a USG employee and conceives the invention while acting in his/her capacity as a USG employee.

    Put another way, can a USG emplyeee acting as above be deemed an “inventor” within the meaning of Article I, Section 8, Clause 8?”

    I think you are confusing inventorship and ownership (please correct me if I am wrong). If anyone invents something (whether a USG employee or not), they can file for a patent as an inventor. What I think you are asking, however, is if the inventor is a USG employee, does the government own the patent? Personally, I don’t know of any legislation stating that USG inventors automatically assign their rights to the government. There may be such a law, or it may be that a particular inventor’s USG employment contract provides for such a provision. But if neither of these conditions are true, then the government won’t own that invention.

    The government can of course issue a secrecy order, but that’s a whole other story.

  17. Mr. Crouch,

    I do agree that the USG holds many patents. But I have always wondered why no one has ever researched if the USG can lawfully file for patents where the inventor is a USG employee and conceives the invention while acting in his/her capacity as a USG employee.

    Put another way, can a USG emplyeee acting as above be deemed an “inventor” within the meaning of Article I, Section 8, Clause 8?

    Despite “conventional wisdom”, there are fundamental principles of law involved here that give me much pause for concern.

  18. Consider a more insidious approach:

    An executive order could be issued to declare knowledge of tax avoidance schemes to be an export of secret “know-how” under the export control laws “endangering the financial health of the US treasury!” Many avoidance schemes involve offshore entities. Thus all relevant patent filings could be slapped with a secrecy order only to be allowed after the tax code is amended, ostensibly when the patents are useless. In addition, because a determination of national security is made by the appropriate agency representatives at the OIPE, the IRS would have to read all patent filings. This would allow the agency to further improve “regulation” by scrying all schemes well before they are hatched.

    I suppose president Obama would welcome such action. This could even be done quietly permitting months of “data” gathering while “innocent” patentees submit filings before the first secrecy notices are issued.

    But wait there’s more!

    Since patents cannot be enforced for illegal activity, when does a tax-avoidance patent become unenforceable? Upon a letter ruling by the IRS? An act of congress? Tax law is a complicated mix of administrative rules and statutes (certain latitude is given to the executive). I’d love to see the Fed Cir handle a bunch of those cases.
    The “certain” tax code determining enforcability of patents under the equally “certain” patent law.

    “D: Your Honor, that IRS regulation become effective at midnight on the 10th, and even though my client filed his debt-swap foreign corporations in the Caymen Islands on the previous day, the interest payment deduction only accrued from the following day, so clearly that tax avoidance method is not infringed as it occurs after the date of regulation limiting such practice. Besides my client’s actions occured entirely outside the US.

    P: But that IRS private letter ruling still let your client deduct the interest on his US tax return filed in Washington.

    D: The private letter ruling was made after the regulation was in force, and my client filed his return electronically from the UK.”

  19. One of the worst things that Washington does is to tinker with legislation to achieve collateral purposes. Patent law is in enough trouble without being saddled with this type of amendment.

  20. Tax avoidance is legal. To disallow the issuance of patents pertaining to “avoidance” confuses the distinction between legal “avoidance”, deferral, etc. and illegal “evasion”. I hope our representatives know the difference.

  21. It’s too bad that the government can’t file for their own patents. Then they could file patents on these schemes to get around taxes, then charge potential licensees higher rates than they would have paid to the IRS.

  22. Seems to me that the best way to limit the use of these tax shelters is to allow patents on them, thus making them more expensive (and less desirable) to implement by anyone other than the patentee.

    I guess the flip side is that because enforcement is so difficult, simple publication of the methods is the true harm because it will spread knowledge of tax avoidance strategies.

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