Order Code RL34221
Patents on Tax Strategies:
Issues in Intellectual Property and Innovation
October 25, 2007
John R. Thomas
Visiting Researcher
Resources, Science and Industry Division
Patents on Tax Strategies:
Issues in Intellectual Property
and Innovation
Summary
Several bills introduced in the 110th Congress address the recently recognized
phenomenon of patented tax strategies. These legislative initiatives respond in
different ways to the grant of exclusive intellectual property rights by the United
States Patent and Trademark Office (USPTO) on methods that individuals and
enterprises might use in order to minimize their tax obligations.
Many commentators trace the rise of tax strategy patents to the 1998 opinion of
the Federal Circuit in State Street Bank v. Signature Financial Group, which rejected
a per se rule that methods could not be patented. In recent years, the USPTO has
issued a number of patents that pertain to tax strategies, and numerous other patent
applications remain before that agency. At least one of these patents, the so-called
SOGRAT patent, has been subject to enforcement litigation in federal court.
The impact of tax strategy patents upon social welfare has been subject to a
spirited debate. Some observers are opposed to tax strategy patents. These
commentators believe that patent protection is unnecessary with respect to tax
avoidance techniques due to a high level of current innovation. Others believe that
patent-based incentives to develop tax avoidance strategies are not socially desirable.
They assert that patents may limit the ability of individuals to utilize provisions of
the tax code intended for all taxpayers, interfering with congressional intent and
leading to distortions in tax obligations. Others have expressed concerns that tax
strategy patents may potentially complicate legal compliance by tax professionals and
individual taxpayers alike.
Other experts believe that these concerns are overstated, and also make the
affirmative case that tax strategy patents may provide positive social benefits. They
explain that patents on “business methods” have been obtained and enforced for
many years. They also observe that the grant of a patent does not imply government
approval of the practice of the patented invention, and that professionals in many
spheres of endeavor have long had to account for the patent system during their
decision-making process. They also believe that the availability of tax strategy
patents may promote innovation in a field of endeavor that is demonstrably valuable.
Further, such patents might promote public disclosure of tax strategies to tax
professionals, taxpayers, and responsible government officials alike.
In the 110th Congress, both a Senate bill, S. 681, and two House bills, H.R. 1908
and H.R. 2136, would prohibit the issuance of patents on tax strategies. H.R. 1908
passed the House of Representatives on September 7, 2007. Another bill, H.R. 2365,
would take an alternative approach, limiting the remedies available for certain
infringements of a tax planning method. Other legislative responses, including
oversight of the USPTO, promotion of cooperation between the USPTO and the IRS,
and the encouragement of private sector contributions to the patent examination
process, are also possible.
Contents
Patents and Innovation Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Mechanics of the Patent System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Innovation Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
The Phenomenon of Tax Strategy Patents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Patents on Methods of Doing Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Patents on Tax Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Innovation Policy Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Stated Concerns Over Tax Strategy Patents . . . . . . . . . . . . . . . . . . . . . . . . . 12
Support for Tax Strategy Patents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Congressional Issues and Alternatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Concluding Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Legislation in the 110th Congress. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
This report was funded in part by a grant from the John D. and Catherine T.
MacArthur Foundation.
Patents on Tax Strategies:
Issues in Intellectual Property
and Innovation
Proposed legislation demonstrates congressional interest in the recently
recognized phenomenon of patented tax strategies.1 H.R. 1908, the Patent Reform
Act of 2007, would ban patents on tax strategies.2 This comprehensive patent reform
legislation passed the House on September 7, 2007. Another bill, H.R. 2365, would
limit the remedies available for certain infringements of a “tax planning method.”3
The Stop Tax Haven Abuse Act, introduced in the House as H.R. 2136 and in the
Senate as S. 681, takes an alternative approach. Under this legislation, no patent may
be directed towards a tax strategy patent whatsoever.4 These legislative initiatives
respond in different ways to the grant of exclusive intellectual property rights by the
United States Patent and Trademark Office (USPTO) on methods that individuals
and enterprises might use in order to minimize their tax obligations.
Tax strategy patents are the subject of a spirited debate. Some observers believe
that such patents negatively impact social welfare. According to some experts, tax
strategy patents may limit the ability of taxpayers to utilize provisions of the tax
code, interfering with congressional intent and leading to distortions in tax
obligations.5 Others assert that tax strategy patents potentially complicate legal
compliance by tax professionals and taxpayers alike.6 Still others believe that the
patent system should not provide incentives for individuals to develop new ways to
reduce their tax liability.7
1 This report uses the term “tax strategy patents” to refer to this category of patents. Various
sources referenced within this report identify these sorts of patents as pertaining to tax
loopholes, planning methods, shelters, and other similar terms.
2 H.R. 1908, § 10 (referring to patents claiming a “tax planning method”).
3 H.R. 2365, § 1.
4 S. 681, § 303(a); H.R. 2136, § 303(a) (both referring to patents claiming a “tax shelter”).
5 See Letter from Jeffrey R. Hoops, Chair, American Institute of Certified Public
Accountants Tax Executive Committee, to Members of Congress (February 28, 2007)
(available at [http://tax.aicpa.org]).
6 See Letter from Kimberly S. Blanchard, Chair, New York State Bar Association Tax
Section, to Members of Congress (August 17, 2006) (available at [http://www.nysba.org]).
7 See William A. Drennan, “The Patented Loophole: How Should Congress Respond to This
Judicial Invention?”, 59 Florida Law Review (2007), 229.
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Other commentators explain that patents on “business methods” were obtained
and enforced for many years.8 Legislation enacted in 1999 that accounted expressly
for patents claiming “a method of doing or conducting business” arguably approved
of such patents.9 In addition, some commentators believe that tax strategy patents
present a positive development, potentially improving the public disclosure of tax
shelters for the attention of Congress and federal tax authorities.10 They also observe
that many kinds of patents, on subject matter ranging from automobile seat belts to
airplane navigation systems, potentially involve legal compliance.11
Although views on tax strategy patents vary, evidence suggests that numerous
applications that arguably cover tax planning methods have been filed at the
USPTO.12 Some of these applications have been approved as issued patents.13
Further, at least one granted patent has been the subject of infringement litigation in
the federal judicial system.14 Discussion of the recently appreciated phenomenon of
tax strategy patents therefore appears to be timely.
This report introduces the concept of tax strategy patents and reviews their
implications for intellectual property and tax policy. The report begins by providing
an overview of both the practical workings and innovation policy aspirations of the
patent system. It then provides a brief history of the phenomenon of tax strategy
patents. The report next reviews competing views about the impact of tax patents
upon innovation policy. This report concludes with a summary of congressional
issues and options.
Patents and Innovation Policy
The Mechanics of the Patent System
The U.S. Constitution provides Congress with the power “To promote the
Progress of Science and useful Arts, by securing for limited Times to ... Inventors the
8 See Andrew F. Palmieri and Corinne Marie Pouliquen, “A Primer on Business Method
Patents: What You Need to Know for Your Real Estate Practice,” 21 Probate and
Property (May/June 2007), 26.
9 First Inventor Defense Act of 1999, P.L. 106-113, § 4302, 113 Stat. 1501 (codified at 35
U.S.C. § 273 (2006)).
10 Drennan, supra, at 328 (noting this argument).
11 Stephen T. Schreiner and George Y. Wang, “Discussions on Tax Patents Have Lost
Focus,” IP Law 360 (available at [http://www.hunton.com]).
12 See Jo-el J. Meyer, “Proliferation of Retirement Plan Patents Poses Problems for
Practitioners,” Patent, Trademark, and Copyright Journal (BNA June 8, 2007), 186.
13 Id.
14 Wealth Transfer Group LLC v. Rowe, D. Conn., No. 3:06cv00024 (AWT), filed January
6, 2006.
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exclusive Right to their ... Discoveries....”15 In accordance with the Patent Act of
1952,16 an inventor may seek the grant of a patent by preparing and submitting an
application to the USPTO. USPTO officials known as examiners then determine
whether the invention disclosed in the application merits the award of a patent.17
In determining whether to approve a patent application, a USPTO examiner will
consider whether the submitted application fully discloses and distinctly claims the
invention.18 In particular, the application must enable persons skilled in the art to
make and use the invention without undue experimentation.19 In addition, the
application must disclose the “best mode,” or preferred way, that the applicant knows
to practice the invention.20
The examiner will also determine whether the invention itself fulfills certain
substantive standards set by the patent statute. To be patentable, an invention must
meet four primary requirements. First, the invention must fall within at least one
category of patentable subject matter. According to the Patent Act, an invention
which is a “process, machine, manufacture, or composition of matter” is eligible for
patenting.21 Second, the invention must be useful, a requirement that is satisfied if
the invention is operable and provides a tangible benefit.22
Third, the invention must be novel, or different, from subject matter disclosed
by an earlier patent, publication, or other state-of-the-art knowledge.23 Finally, an
invention is not patentable if “the subject matter as a whole would have been obvious
at the time the invention was made to a person having ordinary skill in the art to
15 U.S. Constitution, Article I, Section 8, Clause 8. This constitutional clause also addresses
copyright law, which provides for protection for original works of authorship. In contrast
to patents, copyright protection arises automatically once a work of authorship has been
fixed in tangible form. 17 U.S.C. § 102(a) (2006). Copyright provides authors with the
exclusive right to reproduce, adapt, and publicly distribute their works, among others,
subject to certain limitations such as the fair use privilege. 17 U.S.C. § 106, 107-122
(2006). Although this report concerns patent protection for tax strategies, it should be
appreciated that computer software that implements a tax strategy, and possibly other sorts
of works, may potentially enjoy protection under the copyright laws as well. See, e.g.,
Roger E. Schechter and John R. Thomas, Intellectual Property: The Law of Copyrights,
Patents, and Trademarks (Thomson/West 2003).
16 P.L. 82-593, 66 Stat. 792 (codified at Title 35 of the United States Code).
17 35 U.S.C. § 131 (2006).
18 35 U.S.C. § 112 (2006).
19 See Invitrogen Corp. v. Clontech Labs., Inc., 429 F.3d 1052, 1070-71 (Fed. Cir. 2005).
20 See High Concrete Structures, Inc. v. New Enterprise Stone and Lime Co., 377 F.3d 1379,
1382 (Fed. Cir. 2004).
21 35 U.S.C. § 101 (2006).
22 Id. See In re Fischer, 421 F.3d 1365, 1371 (Fed. Cir. 2005).
23 35 U.S.C. § 102 (2006).
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which said subject matter pertains.”24 This requirement of “nonobviousness”
prevents the issuance of patents claiming subject matter that a skilled artisan would
have been able to implement in view of the knowledge of the state of the art.25
If the USPTO allows the patent to issue, its owner obtains the right to exclude
others from making, using, selling, offering to sell or importing into the United States
the patented invention.26 Those who engage in those acts without the permission of
the patentee during the term of the patent can be held liable for infringement.
Adjudicated infringers may be enjoined from further infringing acts.27 The patent
statute also provides for an award of damages “adequate to compensate for the
infringement, but in no event less than a reasonable royalty for the use made of the
invention by the infringer.”28
The maximum term of patent protection is ordinarily set at 20 years from the
date the application is filed.29 At the end of that period, others may employ that
invention without regard to the expired patent.
Patent rights do not enforce themselves. Patent proprietors who wish to compel
others to respect their rights must commence enforcement proceedings, which most
commonly consist of litigation in the federal courts. Although issued patents enjoy
a presumption of validity, accused infringers may assert that a patent is invalid or
unenforceable on a number of grounds. The Court of Appeals for the Federal Circuit
(Federal Circuit) possesses nationwide jurisdiction over most patent appeals from the
district courts.30 The Supreme Court enjoys discretionary authority to review cases
decided by the Federal Circuit.31
Innovation Policy
Patent ownership is perceived to encourage innovation, which in turn leads to
industry advancement and economic growth. One characteristic of the new
knowledge that results from innovation is that it is a “public good.” Public goods are
non-rivalrous and non-excludable, for use of the good by one individual does not
24 35 U.S.C. § 103(a) (2006).
25 See KSR International Co. v. Teleflex Inc., 127 S.Ct. 1727 (2007).
26 35 U.S.C. § 271(a) (2006).
27 35 U.S.C. § 283 (2006). See eBay Inc. v. MercExchange L.L.C., 126 S.Ct. 1837 (2006).
28 35 U.S.C. § 284 (2006).
29 35 U.S.C. § 154(a)(2) (2006). Although the patent term is based upon the filing date, the
patentee obtains no enforceable legal rights until the USPTO allows the application to issue
as a granted patent. A number of Patent Act provisions may modify the basic 20-year term,
including examination delays at the USPTO and delays in obtaining marketing approval for
the patented invention from other federal agencies.
30 28 U.S.C. § 1295(a)(1) (2006).
31 28 U.S.C. § 1254(1) (2006).
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limit the amount of the good available for consumption by others, and no one can be
prevented from using that good.32
The lack of excludability in particular is believed to result in an environment
where too few inventions would be made. Absent a patent system, “free riders”
could easily duplicate and exploit the inventions of others. Further, because they
incurred no cost to develop and perfect the technology involved, copyists could
undersell the original inventor. Aware that they would be unable to capitalize upon
their inventions, individuals might be discouraged from innovating in the first
instance. The patent system corrects this market failure problem by providing
innovators with a time-limited exclusive interest in their inventions, thereby allowing
them to capture their marketplace value.33
The patent system purportedly serves other goals as well. The patent law
encourages the disclosure of new products and processes, for each issued patent must
include a description sufficient to enable skilled artisans to practice the patented
invention.34 At the close of the patent’s twenty-year term,35 others may employ the
claimed invention without regard to the expired patent. In this manner the patent
system ultimately contributes to the growth of the public domain.
Even during their term, issued patents may encourage others to “invent around”
the patentee’s proprietary interest. A patentee may point the way to new products,
markets, economies of production and even entire industries. Others can build upon
the disclosure of a patent instrument to produce their own technologies that fall
outside the exclusive rights associated with the patent.36
The regime of patents has also been identified as a facilitator of markets.
Absent patent rights, an inventor may have scant tangible assets to sell or license. In
addition, an inventor might otherwise be unable to police the conduct of a contracting
party. Any technology or know-how that has been disclosed to a prospective licensee
might be appropriated without compensation to the inventor. The availability of
patent protection decreases the ability of contracting parties to engage in
opportunistic behavior. By lowering such transaction costs, the patent system may
make transactions concerning information goods more feasible.37
32 See Dotan Oliar, “Making Sense of the Intellectual Property Clause: Promotion of
Progress as a Limitation on Congress’s Intellectual Property Power,” 94 Georgetown Law
Journal (2006), 1771.
33 See Dan L. Burk and Mark A. Lemley, “Is Patent Law Technology-Specific?,” 17
Berkeley Technology Law Journal (2002), 1155.
34 35 U.S.C. § 112 (2006).
35 35 U.S.C. § 154 (2006).
36 See Rebecca Eisenberg, “Patents and the Progress of Science: Exclusive Rights and
Experimental Use,” 56 University of Chicago Law Review (1989), 1017.
37 Robert P. Merges, “Intellectual Property and the Costs of Commercial Exchange: A
Review Essay,” 93 Michigan Law Review (1995), 1570.
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Through these mechanisms, the patent system can act in a more socially
desirable way than its chief legal alternative, trade secret protection. Trade secrecy
guards against the improper appropriation of valuable, commercially useful and
secret information. In contrast to patenting, trade secret protection does not result in
the disclosure of publicly available information. That is because an enterprise must
take reasonable measures to keep secret the information for which trade secret
protection is sought. Taking the steps necessary to maintain secrecy, such as
implementing physical security measures, also imposes costs that may ultimately be
unproductive for society.38
The patent system has long been subject to criticism, however. Some observers
have asserted that the patent system is unnecessary due to market forces that already
suffice to create an optimal level of innovation. The desire to obtain a lead time
advantage over competitors, as well as the recognition that passive firms may lose
out to their more innovative rivals, may provide sufficient inducement to invent
without the need for further incentives.39 Other commentators believe that the patent
system encourages industry concentration and presents a barrier to entry in some
markets.40
Because the relationship between the rate of innovation and the availability of
patent rights is not well understood, we lack rigorous analytical methods for studying
the impact of the patent system upon the economy as a whole. As a result, current
economic and policy tools do not allow us to calibrate the patent system precisely in
order to produce an optimal level of investment in innovation. Thus, each of these
arguments for and against the patent system remains open to challenge by those who
are unpersuaded by their internal logic.
The Phenomenon of Tax Strategy Patents
Patents on Methods of Doing Business
The availability of patents on tax strategies has been linked to the grant of
patents on the broader category of business methods.41 Prior to 1998, several judicial
opinions could arguably be read to hold that patents could not be granted on methods
of doing business. For example, in the 1908 opinion in Hotel Security Checking Co.
38 David D. Friedman et al., “Some Economics of Trade Secret Law,” 5 Journal of
Economic Perspectives (1991), 61.
39 See Frederic M. Sherer, Industrial Market Structure and Economic Performance (1970),
384-87.
40 See John R. Thomas, “Collusion and Collective Action in the Patent System: A Proposal
for Patent Bounties,” University of Illinois Law Review (2001), 305.
41 See Matthew A. Melone, “The Patenting of Tax Strategies: A Patently Unnecessary
Development,” 5 DePaul Business and Commercial Law Journal (2007), 437.
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v. Lorraine Co.,42 the court considered “a method of and means for cash-registering
and account-checking” designed to prevent fraud by waiters and cashiers.43 At one
point the court stated that a “system of transacting business disconnected from the
means for carrying out the system is not, within the most liberal interpretation of the
term, an art” that could be patented.44 However, the court also explained that the
invention claimed in the patent “would occur to anyone conversant with the
business” and that it was “unable to discover any patentable improvements....”45 As
a result, it was unclear whether the court meant to establish a categorical rule that
business methods were not patentable subject matter, or merely state that the
particular invention before the court would have been obvious. In any event, the
USPTO issued some patents that were arguably directed towards business methods
during its long history.46
This long period of ambiguity over the patentability of business methods ended
with the 1998 opinion of the U.S. Court of Appeals for the Federal Circuit in State
Street Bank & Trust Co. v. Signature Financial Group.47 The patent at issue in that
case concerned a data-processing system for implementing an investment structure
known as a “Hub and Spoke” system.48 This system allowed individual mutual funds
(“Spokes”) to pool their assets in an investment portfolio (“Hub”) organized as a
partnership. According to the patent, this investment regime provided the
advantageous combination of economies of scale in administering investments
coupled with the tax advantages of a partnership.49 The patented system purported
to allow administrators to monitor financial information and complete the accounting
necessary to maintain this particular investment structure. In addition, it tracked “all
the relevant data determined on a daily basis for the Hub and each Spoke, so that
aggregate year end income, expenses, and capital gain or loss can be determined for
accounting and tax purposes for the Hub and, as a result, for each publicly traded
Spoke.”50
Litigation arose between Signature, the patent owner, and State Street Bank over
the latter firm’s alleged use of the patented invention. Among the defenses offered
by State Street Bank was that the asserted patent claimed subject matter that was not
42 106 F. 467 (2d. Cir. 1908).
43 Id. at 467.
44 Id. at 469.
45 Id. at 471.
46 See USPTO, White Paper on Automated Financial or Management Data Processing
Methods (Business Methods) (available at [http://www.uspto.gov]).
47 149 F.3d 1368 (Fed. Cir. 1998).
48 See U.S. Patent No. 5,193,056.
49 149 F.3d at 1370.
50 Id.
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within one of the four categories of statutory subject matter,51 and hence was invalid.
The district court sided with State Street Bank.52 The trial judge explained:
At bottom, the invention is an accounting system for a certain type of financial
investment vehicle claimed as [a] means for performing a series of mathematical
functions. Quite simply, it involves no further physical transformation or
reduction than inputting numbers, calculating numbers, outputting numbers, and
storing numbers. The same functions could be performed, albeit less efficiently,
by an accountant armed with pencil, paper, calculator, and a filing system.53
The trial court further relied upon “the long-established principle that business
‘plans’ and ‘systems’ are not patentable.”54 The court judged that “patenting an
accounting system necessary to carry on a certain type of business is tantamount to
a patent on the business itself.”55 Because the court found that “abstract ideas are not
patentable, either as methods of doing business or as mathematical algorithms,”56 the
patent was held to be invalid.
Following an appeal, the Federal Circuit reversed. The court of appeals
concluded that the patent claimed not merely an abstract idea, but rather a
programmed machine that produced a “useful, concrete, and tangible result.”57
Because the invention achieved a useful result, it constituted patentable subject
matter even though its result was expressed numerically.58 The court further
explained that:
Today, we hold that the transformation of data, representing discrete dollar
amounts, by a machine through a series of mathematical calculations into a final
share price, constitutes a practical application of a mathematical algorithm,
formula, or calculation, because it produces “a useful, concrete and tangible
result” — a final share price momentarily fixed for recording and reporting
purposes and even accepted and relied upon by regulatory authorities and in
subsequent trades.59
The court of appeals then turned to the district court’s business methods rejection,
opting to “take [the] opportunity to lay this ill-conceived exception to rest.”60 The
court explained restrictions upon patents for methods of doing business had not been
51 35 U.S.C. § 101 (2006) (identifying processes, machines, manufactures, and compositions
of matter as patentable subject matter).
52 927 F. Supp. 502 (D. Mass. 1996).
53 Id. at 515.
54 Id.
55 Id. at 516.
56 Id.
57 149 F.3d at 1373.
58 Id. at 1375.
59 Id. at 1373.
60 Id. at 1375.
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the law since at least the enactment of the 1952 Patent Act. The Federal Circuit then
concluded that methods of doing business should be subject to the same patentability
analysis as any other sort of process.61
The holdings of State Street Bank were reached nearly a decade ago. Absent
reconsideration of the issue by Congress, the Supreme Court, or the Federal Circuit
itself, business methods remain patentable subject matter.62 Should a particular
method of doing business meet the other statutory requirements, including utility,
novelty, and nonobviousness, then a patent may issue. Numerous patents that
arguably claim business methods have issued from the USPTO,63 and several have
been the subject of litigation in the federal courts.64
Congressional reaction to the patenting of business methods has to this point
been limited. In 1999, Congress enacted the First Inventor Defense Act as part of the
American Inventors Protection Act.65 That statute provides an earlier inventor of a
“method of doing or conducting business” that was later patented by another to assert
a defense to patent infringement in certain circumstances.
In enacting the First Inventor Defense Act, Congress recognized that some firms
may have operated under the view that business methods could not be patented prior
to the State Street Bank decision. As a result, they may have maintained their
innovative business methods as trade secrets. Having used these trade secrets in
furtherance of their marketplace activities for a period of time, however, these firms
may be unable to obtain a patent upon their business method. Further, should a
competitor later independently invent and patent the same business method, the trade
secret holder would potentially be liable for patent infringement. Following the
confirmation of the patenting of business methods by the State Street Bank court, the
creation of the first inventor defense was intended to provide a defense to patent
infringement in favor of the first inventor/trade secret holder.66
61 Id.
62 On September 20, 2007, the Federal Circuit issued its decision in In re Comiskey, __ F.3d
__, 2007 WL 2728361 (Fed. Cir. 2007). The Comiskey opinion concluded that “mental
processes — or processes of human thinking — standing alone are not patentable even if
they have practical application.” 2007 WL 2728361, at *9. However, the court of appeals
also confirmed that the proposition that when “an unpatentable mental process is combined
with a machine, the combination may produce patentable subject matter,” id. at *11, and that
“business methods are ‘subject to the same legal requirements for patentability as applied
to any other process or method.’” Id. at *6 (citing State Street Bank, 149 F.3d at 1375).
63 See, e.g., John R. Allison and Emerson H. Tiller, “The Business Method Patent Myth,”
18 Berkeley Technology Law Journal (2003), 987.
64 See, e.g., Nicholas A. Smith, “Business Method Patents and Their Limits: Justifications,
History, and the Emergence of a Claim Construction Jurisprudence,” 9 Michigan
Telecommunications and Technology Law Review (2002), 171.
65 P.L. 106-113, 113 Stat. 1536 (1999) (codified at 35 U.S.C. § 273(b) (2006)).
66 See generally David H. Hollander, Jr., “The First Inventor Defense: A Limited Prior User
Right Finds Its Way Into U.S. Patent Law,” 30 American Intellectual Property Law
(continued...)
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By stipulating that the first inventor defense applied only to a “method of doing
or conducting business,” Congress arguably recognized the validity of these sorts of
patents.67 The First Inventor Defense Act did not define the term “method of doing
or conducting business,” however, and to date no published judicial opinion
addresses the precise scope of this defense.68 Other legislation currently before the
110th Congress proposes the expansion of the first inventor defense to all sorts of
patentable subject matter.69
Patents on Tax Strategies
Although the State Street Bank opinion rejected a per se rule denying patents on
business methods, the invention claimed by the Signature patent was arguably
motivated by a desire to reduce tax liability.70 In some sense, then, State Street
Bank may be seen as the first tax patent case. Some commentators believe that the
“increase in the number of tax strategy patents requested and approved by the
[USPTO] came on the heels” of State Street Bank.71
Notably, at least one observer rejects this view. Attorney Andrew Schwartz has
opined that although business methods may be patented following State Street Bank,
the conclusion that tax and other legal methods are patentable subject matter does not
result. Mr. Schwartz has asserted that while “most if not all novel business methods
either save time or harness a law of nature for human benefit,”72 legal methods
instead manipulate “positive law” in order to achieve their advantages.73 According
to Mr. Schwartz, legal methods, including tax strategies, therefore do not qualify as
inventions within the meaning of the Patent Act. It remains to be seen whether this
view will gain more widespread acceptance.
The USPTO classification scheme reflects the relationship between business
method patents and tax patents. Under USPTO practice, business method patents are
organized within class 705, titled “Data Processing: Financial, Business Practice,
66 (...continued)
Association Quarterly Journal (2002), 37.
67 See Rochelle Cooper Dreyfuss, “Are Business Method Patents Bad for Business?,” 16
Santa Clara Computer and High Technology Law Journal (2000), 263.
68 John R. Allison and Starling D. Hunter, “On the Feasibility of Improving Patent Quality
One Technology At a Time: The Case of Business Methods,” 21 Berkeley Technology Law
Journal (2006), 729.
69 CRS Report RL33996, Patent Reform in the 110th Congress: Innovation Issues, by John
R. Thomas and Wendy H. Schacht.
70 See, e.g., Paul E. Schaafsma, “A Gathering Storm in the Financial Industry,” 9 Stanford
Journal of Law, Business and Finance (2004), 176.
71 Meyer, supra, at 187. See also Dan L. Burk and Brett H. McDonnell, “Patents, Tax
Strategies, and the Firm,” 26 Virginia Tax Review (2007), 981.
72 Andrew A. Schwartz, “The Patent Office Meets the Poison Pill: Why Legal Methods
Cannot Be Patented,” 20 Harvard Journal of Law and Technology (2007), 371.
73 Id. at 367.
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Management, or Cost/Price Determination.” Tax strategy patents fall into a subclass
under this heading, being identified under classification number 705/36T.
As of September 1, 2007, the USPTO identified 60 issued patents and 99
published applications under classification number 705/36T.74 As the USPTO
received 417,508 patent applications in 2005, and granted 157,718 patents during that
year, it should be appreciated that tax strategy patents represent a very small share of
that agency’s workload.75 Among the titles of the issued patents are:
! Method and apparatus for tax efficient investment management
U.S. Patent No. 7,031,937
! Method and apparatus for tax-efficient investment using both long
and short positions
U.S. Patent No. 6,832,209
! Tax advantaged transaction structure (TATS) and method
U.S. Patent No. 6,578,016
! Use tax optimization process and system
U.S. Patent No. 6,298,333
! Computerized system and method for optimizing after-tax proceeds
U.S. Patent No. 6,115,697
To date, the only tax strategy patent that has been identified as subject to
enforcement litigation is the so-called “SOGRAT” patent, U.S. Patent No.
6,567,790.76 The SOGRAT patent is titled “[e]stablishing and managing grantor
retained annuity trusts funded by nonqualified stock options.” The patent’s abstract
explains that it concerns:
An estate planning method for minimizing transfer tax liability with respect to
the transfer of the value of stock options from a holder of stock options to a
family member of the holder. The method comprises establishing a Grantor
Retained Annuity Trust (GRAT) funded with nonqualified stock options. The
method maximizes the transfer of wealth from the grantor of the GRAT to a
family member by minimizing the amount of estate and gift taxes paid. By
placing the options outside the grantor’s estate, the method takes advantage of
the appreciation of the options in said GRAT.
74 It should be appreciated that some observers have criticized the USPTO classification
system as unreliable. See, e.g., John R. Allison and Mark A. Lemley, “The Growing
Complexity of the United States Patent System,” 82 Boston University Law Review (2002),
77. As a result, it is possible that some patents arguably directed towards tax strategies may
presently be classified under different categories.
75 USPTO, U.S. Patent Statistics, Calendar Years 1963-2006 (available at
[http://www.uspto.gov/web/offices/ac/ido/oeip/taf/us_stat.pdf]).
76 See Michael Brier, “Patently Foolish? Allowing Firms to Patent Tax Strategies Means
That You and Your Clients Have to Foot the Bill,” Financial Advisor (June 2007).
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On January 6, 2006, the proprietor of the SOGRAT patent, Wealth Transfer Group
L.L.C., brought charges of infringement against John W. Rowe, the former executive
chairman of Aetna Inc. Wealth Transfer Group reportedly asserted that Rowe had
infringed the SOGRAT patent by establishing one or more GRATs that were funded
by nonqualified stock options from Aetna. Because the parties to the litigation
reached a confidential settlement on March 12, 2007,77 the courts did not have the
opportunity to address the validity and infringement of the SOGRAT patent
specifically, nor the concept of tax strategy patents more generally.
Innovation Policy Issues
Although business method patents have been held to be patentable at least since
the issuance of the State Street Bank opinion in 1998, the more recent phenomenon
of tax strategy patents has resulted in a spirited discussion. Some commentators, and
in particular tax professionals, have found tax strategy patents to be “ridiculous,”78
“bizarre”79 and “deeply unsettling.”80 On the other hand, other observers, including
many patent professionals, believe both that concerns over tax patents are overstated,
and that the patenting of tax strategies may lead to numerous positive consequences.
This report next reviews some of the competing concerns about tax strategy patents.
Stated Concerns Over Tax Strategy Patents
Many commentators have asserted that the issuance of tax strategy patents is
improvident as a matter of both innovation and tax policy. Some observers believe
that innovation in tax avoidance techniques has flourished absent the stimulus of
patent protection. For example, the Tax Section of the New York State Bar
Association has stated that “[o]ur experience suggests ... that tax advisors do not need
the protection of the patent laws to develop tax strategies or to comply with their
obligations to represent the interests of their (usually paying) clients.”81 The views
of the American Institute of Certified Public Accountants (AICPA) are similar.
According to the AICPA, “[p]eople already have substantial incentives to comply
with tax law and lower their taxes.”82
Other observers go further, believing that to the extent that tax patents
encourage further innovation in developing innovative tax avoidance strategies, such
77 Wealth Transfer Group LL v. Rowe, D. Conn., No. 3:06CV00245, Consent Final
Judgment Regarding Settlement Agreement (March 12, 2007).
78 Editorial, “Pay to Obey,” New York Times (October 31, 2006).
79 David Nolte, “USPTO is Getting It Wrong on Tax Strategy Patents,” (July 20, 2006)
(available at [http://www.expertclick.com]).
80 Melone, supra, at 438.
81 New York State Bar Association, “Patentability of Tax Advice and Tax Strategies”
(August 17, 2006) (available at [http://www.nysba.org]).
82 AICPA, “Analysis and Legislative Proposals Regarding Patents for Tax Strategies”
(February 28, 2007) (available at tax.aicpa.org) (hereinafter “AICPA Analysis”).
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an incentive is not socially desirable. William A. Drennan, a member of the law
faculty at Southern Illinois University, contrasts the grant of tax strategy patents with
recent Treasury Department Regulations that, in his view, “reduce the economic
incentive to create tax loopholes.”83 Mr. Drennan thus explains:
[O]ne government agency — the Treasury Department — is taking action to
discourage loopholes. In contrast, the Patent Office (at the direction of the
Federal Circuit) is providing a new incentive to create loopholes. Since the
Treasury Department is in charge of the sound administration of the U.S. tax
system, the Treasury Department’s views on sound tax policy should be given
greater weight than the view of the Patent Office on this subject.84
As summarized by the Joint Committee on Taxation, “some may argue that
innovation is either not socially beneficial, or requires no special protection to
encourage its undertaking, and thus a fundamental premise behind a patent system
is missing.”85
Other experts believe that tax strategy patents are inappropriate because they are
said to inject private control over a system of public laws.86 Under this view, a patent
may potentially grant one individual the ability to prevent others from using a new
tax provision. In turn, private actors may effect the ability of federal, state, and local
governments to raise revenue, influence taxpayer behavior, and otherwise achieve the
intended purposes of the tax laws.87 These concerns were voiced by the AICPA in
the following way:
Tax strategy patents also preempt Congress’s prerogative to have full legislative
control over tax policy. Congress enacts tax law provisions applicable to various
taxpayers and intends that taxpayers will be able to use them. Tax strategy
patents thwart this Congressional intent by giving tax strategy patent holders the
power to decide how select tax law provisions can be used and who can use
them.88
Tax professionals have also expressed concerns over the impact of tax strategy
patents upon their own practices, as well as taxpayers in general. Some observers
believe that the burdens of investigating whether a taxpayer’s planned course of
action is covered by a tax strategy patent, determining whether the patent was
providently granted by the USPTO, and potentially negotiating with the patent
proprietor in order to employ the strategy, will be costly and impractical for many
83 Drennan, supra, at 280.
84 Id.
85 Staff of the Joint Committee on Taxation, “Background and Issues Relating to the
Patenting of Tax Advice” (July 13, 2006), 25 (available at [http://www.house.gov/jct]).
86 See Richard S. Marshall, “Tax Strategy Patents — Legislative, Judicial and Other
Developments,” 48 Tax Management Memo (2007), 243.
87 Steve Seidenberg, “Taxation Innovation: Patent Office Receives Criticism for Issuing
Patents on Tax Strategies,” Inside Counsel (December 2006).
88 AICPA Analysis, supra, at 5.
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taxpayers.89 Further, because compliance with the tax laws and its self-assessment
system is obligatory for all citizens of the United States, the scope of this burden
could be considerable.90
Some commentators have also opined that the grant of a patent may mislead
taxpayers. They believe that issuance of a patent may be seen as the government’s
imprimatur that a particular technique may be useful in limiting an individual’s tax
obligations. Because the USPTO does not necessarily evaluate the legality and
comparative effectiveness of a particular tax strategy as part of its decision to issue
a patent, however, such an impression would be mistaken. As the AICPA has stated:
Taxpayers may be misled into believing that a patented tax strategy bears the
approval of other government agencies, such as the IRS, and therefore is a valid
and viable technique under tax law. This is not the case.91
Finally, some commentators have expressed concerns that the USPTO does not
have sufficient expertise to assess whether a particular tax strategy meets the
patentability criteria of novelty and nonobviousness.92 As Ellen P. Aprill, a member
of the law faculty of the Loyola Law School of Los Angeles, has asserted:
It is the duty of patent examiners in the PTO to make the determination that a
patent is novel and not obvious. In order to review the validity under the patent
law of applications for tax strategy patents, patent examiners need expertise not
only in software and finance, but also, of course, tax. They need to understand
the conceptual basis of a range of areas of tax — financial products, estate and
gift tax, pension and deferred compensation, to name a few where tax strategy
patents already exist. Such expertise is difficult to obtain. Few tax practitioners
have such broad knowledge in such varied aspects of the tax law. Most work
very hard just to keep up in developments and changes in the law in their areas
of specialization. Yet the patent examiners evaluating these tax strategy patents
are trained as engineers, with few having some additional financial education,
such as an MBA. They are not tax lawyers or accountants.93
In addition, identifying state of the art knowledge may present complications within
the tax field. Tax return information is maintained in confidence,94 and
communications between taxpayers and their advisors may also be subject to a legal
privilege of nondisclosure.95 Due to these circumstances, reportedly “tax
practitioners are concerned that many of the patents that have or will be issued for tax
89 Gary C. Bubb, “Patented Tax Strategies — Are You Serious?,” Rhode Island Lawyers
Weekly (August 20, 2007).
90 Ellen P. Aprill, “Responding to Tax Strategy Patents,” American Bar Association Annual
Meeting (August 11, 2007), 7.
91 AICPA Analysis, supra, at 2.
92 35 U.S.C. §§ 102, 103 (2006).
93 Aprill, supra, at 7.
94 26 U.S.C. § 6103(a) (2006).
95 26 U.S.C. § 7525(a)(1) (2006).
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strategies will inevitably involve techniques that have long been accepted as
routine.”96
Support for Tax Strategy Patents
In contrast, other observers have expressed support for the allowance of patents
on tax strategies. Some of these commentators believe that previously articulated
concerns about tax strategy patents are overstated. Others make the affirmative case
that tax strategy patents will produce positive social benefits.
Some experts disagree that patents will necessarily prove ineffective in
encouraging the development of new tax strategies. Patent attorney Michael
Sandonato is reported as explaining: “Of course, tax advisers will give their best
advice, but if they can patent it and have some exclusive rights to it, you may see the
extra level of activity that patents can motivate.”97 Others observe that new ways to
reduce tax liability can be both costly to develop and the source of considerable value
for a particular inventor.98 As with more traditional sorts of patents, tax strategy
patents may reward these efforts and differentiate products and services among
competing tax advisors.99
Tax strategy patenting is also said to lead to the affirmative social benefit of
enhanced public disclosure. Each issued patent is required to incorporate a full
description of the patented invention.100 As a result, patents may provide an effective
mechanism for disseminating information regarding the current state of the art in
particular disciplines. Although existing regulations require that certain “tax
shelters” be disclosed to the Department of the Treasury,101 the patent system could
arguably improve the availability of information regarding tax strategies to tax
professionals and regulators alike.102
Some commentators further discount stated concerns that tax strategy patents
potentially allow someone to appropriate a method of complying with the law. They
observe that a variety of patented inventions could be described in this manner. As
explained by patent professionals Stephen T. Schreiner and George Y. Wang,
“[m]any different types of patentable inventions involve a manner of complying with
the law, but they are not prohibited from patenting for that reason.”103 Schreiner and
Wang explain that such inventions as an improved catalytic converter, child’s safety
96 Aprill, supra, at 9.
97 Quoted in Seidenberg, supra.
98 See Dennis I. Belcher and Dana G. Fitzsimmons, Jr., “Tax Planners — Beware of Patented
Estate Planning Techniques!,” Probate and Property (November/December 2006), 24.
99 Id.
100 35 U.S.C. § 112 (2006).
101 Treas. Reg. 1-6011-4(a).
102 House Report, supra, at 23-24.
103 Schreiner and Wang, supra, at 1.
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seat, and machine for weighing trucks may relate to laws governing automobile
emissions, transportation safety, and highway traffic. Because each of these
inventions is nonetheless eligible for patenting, Schreiner and Wang assert that
“eligibility for patent protection should not turn on whether the inventions pertain to
compliance with the law.”104
Observers also note that professionals in many spheres of endeavor have long
had to account for the patent system during their decision-making process. Chemists,
biologists, engineers, computer scientists, and medical doctors are among those
individuals who may obtain patents, but must also be mindful of the patents of others
during the course of their professional activities. These observers find no persuasive
justification for treating tax professionals differently. As Schreiner and Wang state:
[S]ome seem to have taken the position that tax attorneys and wealthy tax clients
should simply not have to be burdened with tax patents. However, this is not
persuasive. If doctors and patients must observe patent restrictions on new
medical techniques and new medicines that may have life-altering consequences,
we can think of no moral, legal or policy basis for why tax attorneys and their
clients should enjoy a special exemption while those in the medical profession
do not.105
Patent experts also explain that patents do not provide the affirmative right to
use the patented invention, but rather the right to exclude others from doing so.106 As
a result, in their view the notion that the grant of patent implies that the patented
invention is effective and approved for use is simply incorrect. This situation is
commonplace in other fields of endeavor: For example, the USPTO commonly
issues patents on pharmaceuticals and medical devices that have not yet received
marketing approval from the Food and Drug Administration.107 In the view of these
experts, if taxpayers mistakenly believe that the grant of a patent implies government
approval of the patented strategy, then the proper response is to promote taxpayer
awareness, not to limit or prohibit tax strategy patents altogether.108
Observers further note that the USPTO has consistently been called upon to
address new categories of inventions throughout that agency’s long history. For
example, contemporary USPTO examiners must respond to cutting-edge innovations
in fields such as nanotechnology by developing technical expertise and establishing
documentation regarding the state of the art. The USPTO potentially faces a similar
104 Id.
105 Id. at 2.
106 E. Anthony Figg, “Should the Patent Laws Exempt Certain Innovations from Patent
Eligibility?,” IPL Newsletter (Summer 2006), 3.
107 See John R. Thomas, Pharmaceutical Patent Law (Bureau of National Affairs, 2005), 7
(“An award of marketing approval by the FDA and the grant of a patent by the PTO are
distinct events that depend upon different criteria.”).
108 Schreiner and Wang, supra, at 2.
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challenge with respect to tax strategies, but many observers believe that there is
nothing particularly noteworthy or unusual about this task.109
Congressional Issues and Options
Should Congress conclude that the current situation with respect to tax strategy
patents is satisfactory, then no action need be taken. If Congress wishes to intervene,
however, a number of options present themselves. In the 110th Congress, four bills
have been introduced that would limit either the availability or the enforcement of tax
strategy patents.
The first of these bills, H.R. 1908, passed the House of Representatives on
September 7, 2007. This legislation, titled the Patent Reform Act of 2007, is a
comprehensive patent reform measure. One of its provisions would prevent a patent
from issuing on a “tax planning method,” which is defined as:
a plan, strategy, technique, or scheme that is designed to reduce, minimize, or
defer, or has, when implemented, the effect of reducing, minimizing, or
deferring, a taxpayer’s tax liability, but does not include the use of tax
preparation software or other tools used solely to perform or model mathematical
calculations or prepare tax or information returns.110
This provision would “take effect on the date of enactment of the Act” and would
apply to any patent “filed on or after the date of the enactment of this Act” or “filed
before that date if a patent or reissue patent has not been issued pursuant to the
application as of that date.”
H.R. 1908 expressly states that it shall “not be construed as validating any patent
issued before the date of the enactment of this Act.”111 This provision would appear
to be relevant in the event that the compliance of tax strategy patents with the
statutory subject matter, utility, or other patentability requirements is called into
question before the courts, USPTO, or other fora. In such a circumstance, this
statutory language indicates that the legislation should not be construed as
constituting congressional approval of tax strategy patents that issued prior to the
effective date of the legislation.
Two additional bills, S. 681 and H.R. 2136, are titled the “Stop Tax Haven
Abuse Act.” That legislation would prevent the issuance of a patent where “the
invention is designed to minimize, avoid, defer, or otherwise affect the liability for
Federal, State, local, or foreign tax.”112 This prohibition would apply “to any
109 Figg, supra, at 3; Schreiner and Wang, supra, at 2.
110 H.R. 1908 at § 10(b)(2)(A).
111 Id.
112 S. 681, § 303(a); H.R. 2136, § 303(a).
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application for a patent that has not been granted” as of the date of enactment of the
bill.113
Another of these bills, H.R. 2365, was introduced on May 17, 2007. That bill
provides in part:
With respect to the use by a taxpayer or a tax practitioner of a tax planning
method that constitutes an infringement under subsection (a) or (b) of section
271, the provisions of sections 281, 283, 284, and 285 shall not apply against the
taxpayer, the tax practitioner, or any related professional organization with
respect to such tax planning method.114
Under these provisions, although an individual may obtain a patent on a tax planning
method, such a patent would essentially be unenforceable. The patent owner would
not be able to bring a civil action against individuals it believes are practicing the
patented tax planning method without authorization.115 Nor would any of the
remedies available against adjudicated infringers — including damages, injunctions,
and, in exceptional cases, attorney fees — be available.116 This limitation on
enforcement would apply “to any action for patent infringement that is filed on or
after” the date of enactment of the bill.117
Other legislative responses are also possible. In furtherance of its oversight over
the USPTO, Congress could continue to track that agency’s activities with respect to
tax strategy patents. In this vein, commentators have proposed several reforms,
including USPTO hiring of examiners with expertise in taxation and related
disciplines.118 Congress could also encourage continued cooperation between the
USPTO and the IRS with respect to tax strategy patents.
Congress may also wish to promote the engagement of the community of tax
professionals with the patent system. The patent laws allow members of the public
both to comment upon many pending patent applications and to challenge issued
patents through administrative proceedings.119 The voluntary contributions of
knowledgeable specialists, through these and other mechanisms, may help promote
a high level of quality of issued tax strategy patents.
113 S. 681, § 303(b); H.R. 2136, § 303(b).
114 H.R. 2365, § 1(a). The term “tax planning method” receives the same definition as in
H.R. 1908. Id.
115 35 U.S.C. § 281 (2006).
116 35 U.S.C. §§ 283-285 (2006).
117 H.R. 2365 at § 1(b).
118 Aprill, supra, at 21.
119 See 35 U.S.C. §§ 301, 311 (2006) (allowing members of the public to commence
reexamination proceedings before the USPTO); 37 C.F.R. § 1.99 (2006) (allowing members
of the public to submit information that they believe is relevant to a published, pending
application to the USPTO under certain circumstances).
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Concluding Observations
Tax strategies represent the latest area of controversy regarding patentable
subject matter. Other sorts of inventions, such as business methods, biotechnologies,
and computer software, have also raised considerable legal and policy questions
when they were initially brought before the patent system.120 Some observers believe
that patents on these and other innovations have been allowed for many years,
without any evidence of harm to the U.S. innovation environment.121 Others contend
that the affirmative case for granting patents on business methods remains weak, and
that patents on tax strategies present uniquely deleterious social consequences.122
Although proposed legislative responses to the phenomenon of tax strategy patents
have thus far been limited to those instruments, this episode might also promote
broader congressional thinking of the sorts of inventions that may be appropriately
patented.
Legislation in the 110th Congress
H.R. 1908 (Berman)
The Patent Reform Act of 2007. Amends Title 35 of the U.S. Code. Introduced
April 18, 2007; reported by the House Committee on the Judiciary September 4,
2007; passed the House of Representatives September 7, 2007.
H.R. 2136 (Doggett)
Stop Tax Haven Abuse Act. Introduce May 3, 2007; referred to the House
Subcommittee on Courts, the Internet, and Intellectual Property of the House
Committee on the Judiciary June 4, 2007.
H.R. 2365 (Boucher)
To amend title 35, United States Code, to limit damages and other remedies
with respect to patents for tax planning methods. Introduced May 17, 2007; referred
to the House Subcommittee on Courts, the Internet, and Intellectual Property of the
House Committee on the Judiciary June 4, 2007.
S. 681
Stop Tax Haven Abuse Act. Introduce February 17, 2007; referred to the Senate
Committee on Finance February 17, 2007.
120 See Alan L. Durham, “‘Useful Arts’ in the Information Age,” 1999 BYU Law Review,
1419.
121 See Schreiner and Wang, supra.
122 See Moore, supra.