IRS Concludes Priority Review Voucher Costs are Capitalizable, Cost Recovery Depends on Pharma Intent

Chief Counsel Advice (CCA) 202304009 concludes that pharmaceutical companies must capitalize costs of acquiring Priority Review Vouchers (PRVs) under Section 263(a) of the Internal Revenue Code. Further, the IRS holds that the recovery of these costs is dependent on the company’s intent to either redeem the PRV for purposes of expediting its New Drug Application (NDA) process or hold the PRV for resale. 

Background - Priority Review Vouchers

Congress created the PRV program to incentivize pharmaceutical companies to develop new treatments for neglected and rare diseases, and to accelerate the U.S. Food and Drug Administration’s (FDA’s) approval and market availability of these potentially important therapies.  Under this program, pharmaceutical companies that have developed therapies may be awarded PRVs for expedited review by the FDA, which can be valuable. In an expedited review, the review time is generally reduced from 10 months or more to within six months. A company can use a PRV in three ways: (i) to expedite review of a specific NDA, (ii) hold it for a future NDA, or (iii) sell it to another pharmaceutical company.  PRVs do not expire and may be sold an unlimited number of times.

CCA 202304009

PRV used to expedite NDA

In CCA 202304009, the IRS concluded that if the company’s intent is to use the PRV to expedite an NDA review — the process by which a pharmaceutical company obtains from the FDA the franchise right to market and sell a new drug in the United States — the tax treatment of the company’s costs is governed by Treas. Reg. §1.263(a)-4(b)(1)(v).  This provision generally requires capitalization of amounts incurred to facilitate the creation of an intangible described in Treas. Reg. §1.263(a)-4(d).  Specifically, a taxpayer must capitalize amounts paid to a government agency to obtain rights under a franchise or other similar right.

The IRS noted that amounts paid directly to a government agency to obtain the right to market and sell a product are treated as costs of obtaining a franchise from the government.  Further, the IRS observed that where a taxpayer pays a party other than the government amounts to facilitate the creation of a right from a government agency, courts have required those amounts to be capitalized as costs that facilitate the acquisition of the right.  Because amounts paid for a PRV are incurred to expedite the NDA process in the pursuit of a franchise, these costs are appropriately viewed as transaction costs, i.e., costs incurred to facilitate, or pursue, the creation of that franchise.

Moreover, the regulations provide that the term “transaction” is meant to include 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 situation, the purchase of the PRV is one step in the pharmaceutical company’s plan to obtain a franchise right from the FDA in an expedited manner.  Therefore, the IRS determined that amounts paid for a PRV are costs incurred to facilitate the creation of the franchise (i.e., the NDA) and, therefore, must be capitalized and added to the basis of the NDA in the taxable year that the costs are paid or incurred. 

Amortization, Depreciation, and Recovery of PRV Costs under Section 167 and Section 197

Under the rationale outlined in the CCA, PRV costs are not amortizable at the time the PRV is acquired.  The PRV by itself is not a Section 197 intangible because the acquisition of rights from a governmental unit are expressly excluded from amortization under Section 197 unless they were acquired as part of a purchase of a trade or business.  Further, PRV costs are not depreciable under Section 167 because PRVs do not expire and have unlimited useful lives.

However, if the pharmaceutical company uses the PRV to expedite the processing of an NDA, the PRV costs may be recovered as a cost of facilitating the creation of a franchise right.  Since a franchise right is held in connection with the conduct of pharmaceutical company’s trade or business, the PRV costs and any other costs incurred in the process of obtaining the franchise are properly treated as an amortizable Section 197 intangible.  Accordingly, under Section 197(a), a pharmaceutical company may recover the costs of the PRV ratably over a 15-year period beginning on the first day of the month that the NDA is approved.

If the pharmaceutical company utilizes the PRV for the NDA process but no NDA is granted by the FDA, the company may deduct a loss under Section 165 in the taxable year it abandons the process.

PRV held for resale or investment

The IRS further concluded in the CCA that if the pharmaceutical company acquires a PRV for the purpose of resale or investment, the PRV costs are capitalized under Treas. Reg. §1.263(a)-4(c)(1) as amounts paid to acquire a separate and distinct intangible asset in a purchase or similar transaction.

If the pharmaceutical company intends to resell or hold the PRV for investment, it may not amortize or depreciate the PRV costs under either Section 167 or Section 197.  Instead, the company recovers its PRV costs on the disposition of the intangible.