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Patents on Tax Strategies: Issues in
Intellectual Property and Innovation
John R. Thomas
Visiting Scholar
January 6, 2010
Congressional Research Service
7-5700
www.crs.gov
RL34221
CRS Report for Congress
P
repared for Members and Committees of Congress
c11173008
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Patents on Tax Strategies: Issues in Intellectual Property and Innovation
Summary
Several bills introduced in the 111th Congress addressed the recently recognized phenomenon of
patented tax strategies. These legislative initiatives would prevent 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
business 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.
Three bills introduced in the 111th Congress—H.R. 1265, H.R. 2584, and S. 506—would prohibit
the issuance of patents on tax strategies. 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.
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Patents on Tax Strategies: Issues in Intellectual Property and Innovation
Contents
Patents and Innovation Policy ..................................................................................................... 2
The Mechanics of the Patent System ..................................................................................... 2
Innovation Policy.................................................................................................................. 4
The Phenomenon of Tax Strategy Patents .................................................................................... 5
Patents on Methods of Doing Business.................................................................................. 5
Patents on Tax Strategies....................................................................................................... 8
In re Bilski .......................................................................................................................... 10
Innovation Policy Issues............................................................................................................ 11
Stated Concerns Over Tax Strategy Patents.......................................................................... 12
Support for Tax Strategy Patents ......................................................................................... 14
Congressional Issues and Options ............................................................................................. 15
Concluding Observations .......................................................................................................... 16
Contacts
Author Contact Information ...................................................................................................... 17
Acknowledgments .................................................................................................................... 17
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Patents on Tax Strategies: Issues in Intellectual Property and Innovation
roposed legislation in the 111th Congress demonstrates legislative interest in the recently
recognized phenomenon of patented tax strategies.1 Three bills would stipulate that patents
P may not be obtained on methods of tax planning.2 H.R. 1265 and S. 506 define the
excluded category of “tax planning invention[s]†to mean “a plan, strategy, technique, scheme,
process, or system that is designed to reduce, minimize, determine, avoid, or defer, or has, when
implemented, the effect of reducing, minimizing, determining, avoiding, or deferring, a
taxpayer’s tax liability or is designed to facilitate compliance with tax laws, but does not include
tax preparation software and other tools or systems used solely to prepare tax or information
returns....â€3 H.R. 2584 would prevent any patent claiming a “tax planning method,†which is
defined similarly.4 The legislation would apply to any application filed at the USPTO on or after
the date of enactment.5
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.6 Others assert that tax strategy patents potentially
complicate legal compliance by tax professionals and taxpayers alike.7 Still others believe that the
patent system should not provide incentives for individuals to develop new ways to reduce their
tax liability.8
Other commentators explain that patents on “business methods†have been obtained and enforced
for many years.9 Legislation enacted in 1999 that accounted expressly for patents claiming “a
method of doing or conducting business†arguably approved of such patents.10 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.11 They also observe that many kinds of patents, on subject matter ranging from
automobile seat belts to airplane navigation systems, potentially involve legal compliance.12
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. 1265, § 303; H.R. 2584, §1; S. 506, § 303.
3 H.R. 1265, § 303(a); S. 506, § 303(a).
4 H.R. 2584, §1(a).
5 H.R. 1265, § 303(b); H.R. 2584, §1(b); S. 506, § 303(b).
6 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).
7 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).
8 See William A. Drennan, “The Patented Loophole: How Should Congress Respond to This Judicial Invention,†59
Florida Law Review (2007), 229.
9 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.
10 First Inventor Defense Act of 1999, P.L. 106-113, § 4302, 113 Stat. 1501 (codified at 35 U.S.C. § 273 (2006)).
11 Drennan, supra, at 328 (noting this argument).
12 Stephen T. Schreiner and George Y. Wang, “Discussions on Tax Patents Have Lost Focus,†IP Law 360 (available at
http://www.hunton.com).
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Although views on tax strategy patents vary, evidence suggests that numerous applications that
arguably cover tax planning methods have been filed at the USPTO.13 Some of these applications
have been approved as issued patents.14 Further, at least one granted patent has been the subject of
infringement litigation in the federal judicial system.15 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 exclusive Right to their ...
Discoveries.... â€16 In accordance with the Patent Act of 1952,17 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.18
In determining whether to approve a patent application, a USPTO examiner will consider whether
the submitted application fully discloses and distinctly claims the invention.19 In particular, the
application must enable persons skilled in the art to make and use the invention without undue
experimentation.20 In addition, the application must disclose the “best mode,†or preferred way,
that the applicant knows to practice the invention.21
13 See Jo-el J. Meyer, “Proliferation of Retirement Plan Patents Poses Problems for Practitioners,†Patent, Trademark,
and Copyright Journal (BNA June 8, 2007), 186.
14 Id.
15 Wealth Transfer Group LLC v. Rowe, D. Conn., No. 3:06cv00024 (AWT), filed January 6, 2006.
16 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).
17 P.L. 82-593, 66 Stat. 792 (codified at Title 35 of the United States Code).
18 35 U.S.C. § 131 (2006).
19 35 U.S.C. § 112 (2006).
20 See Invitrogen Corp. v. Clontech Labs., Inc., 429 F.3d 1052, 1070-71 (Fed. Cir. 2005).
21 See High Concrete Structures, Inc. v. New Enterprise Stone and Lime Co., 377 F.3d 1379, 1382 (Fed. Cir. 2004).
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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.22 Second, the invention must be useful, a
requirement that is satisfied if the invention is operable and provides a tangible benefit.23
Third, the invention must be novel, or different, from subject matter disclosed by an earlier
patent, publication, or other state-of-the-art knowledge.24 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 which said subject matter pertains.â€25 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.26
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.27 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.28 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.â€29
The maximum term of patent protection is ordinarily set at 20 years from the date the application
is filed.30 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.31 The Supreme Court enjoys discretionary authority to review
cases decided by the Federal Circuit.32
22 35 U.S.C. § 101 (2006).
23 Id. See In re Fischer, 421 F.3d 1365, 1371 (Fed. Cir. 2005).
24 35 U.S.C. § 102 (2006).
25 35 U.S.C. § 103(a) (2006).
26 See KSR International Co. v. Teleflex Inc., 127 S.Ct. 1727 (2007).
27 35 U.S.C. § 271(a) (2006).
28 35 U.S.C. § 283 (2006). See eBay Inc. v. MercExchange L.L.C., 126 S.Ct. 1837 (2006).
29 35 U.S.C. § 284 (2006).
30 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.
31 28 U.S.C. § 1295(a)(1) (2006).
32 28 U.S.C. § 1254(1) (2006).
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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 limit the amount of the good available for
consumption by others, and no one can be prevented from using that good.33
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 ameliorates this market failure by providing innovators with
a time-limited exclusive interest in their inventions, thereby allowing them to capture their
marketplace value.34
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.35 At the close of the patent’s
twenty-year term,36 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.37
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
exchanges concerning information goods more feasible.38
33 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.
34 See Dan L. Burk and Mark A. Lemley, “Is Patent Law Technology-Specific?,†17 Berkeley Technology Law
Journal (2002), 1155.
35 35 U.S.C. § 112 (2006).
36 35 U.S.C. § 154 (2006).
37 See Rebecca Eisenberg, “Patents and the Progress of Science: Exclusive Rights and Experimental Use,†56
University of Chicago Law Review (1989), 1017.
38 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.39
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.40 Other commentators believe that
the patent system encourages industry concentration and presents a barrier to entry in some
markets.41
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.42 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. v. Lorraine Co.,43 the court considered “a method of and
means for cash-registering and account-checking†designed to prevent fraud by waiters and
cashiers.44 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.45 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
39 David D. Friedman et al., “Some Economics of Trade Secret Law,†5 Journal of Economic Perspectives (1991), 61.
40 See Frederic M. Sherer, Industrial Market Structure and Economic Performance (1970), 384-87.
41 See John R. Thomas, “Collusion and Collective Action in the Patent System: A Proposal for Patent Bounties,â€
University of Illinois Law Review (2001), 305.
42 See Matthew A. Melone, “The Patenting of Tax Strategies: A Patently Unnecessary Development,†5 DePaul
Business and Commercial Law Journal (2007), 437.
43 106 F. 467 (2d. Cir. 1908).
44 Id. at 467.
45 Id. at 469.
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any patentable improvements.... â€46 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.47
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.48 The patent at issue in that case concerned a data-processing system
for implementing an investment structure known as a “Hub and Spoke†system.49 This system
allowed individual mutual funds (“Spokesâ€) to pool their assets in an investment portfolio
(“Hubâ€) 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.50 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.â€51
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 within one of the four categories of
statutory subject matter,52 and hence was invalid. The district court sided with State Street Bank.53
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.54
The trial court further relied upon “the long-established principle that business ‘plans’ and
‘systems’ are not patentable.â€55 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.â€56 Because
46 Id. at 471.
47 See USPTO, White Paper on Automated Financial or Management Data Processing Methods (Business Methods)
(available at http://www.uspto.gov).
48 149 F.3d 1368 (Fed. Cir. 1998).
49 See U.S. Patent No. 5,193,056.
50 149 F.3d at 1370.
51 Id.
52 35 U.S.C. § 101 (2006) (identifying processes, machines, manufactures, and compositions of matter as patentable
subject matter).
53 927 F. Supp. 502 (D. Mass. 1996).
54 Id. at 515.
55 Id.
56 Id. at 516.
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the court found that “abstract ideas are not patentable, either as methods of doing business or as
mathematical algorithms,â€57 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.â€58 Because the invention achieved a useful result, it constituted
patentable subject matter even though its result was expressed numerically.59 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 resultâ€â€”a final share price momentarily fixed for
recording and reporting purposes and even accepted and relied upon by regulatory authorities
and in subsequent trades.60
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.â€61 The court explained restrictions
upon patents for methods of doing business had not been 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.62 In the wake of State Street
Bank, 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
57 Id.
58 149 F.3d at 1373.
59 Id. at 1375.
60 Id. at 1373.
61 Id. at 1375.
62 Id.
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)).
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the first inventor defense was intended to provide a defense to patent infringement in favor of the
first inventor/trade secret holder.66
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.
To date, no published judicial opinion addresses the precise scope of this defense.68
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.69 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.70
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,â€71 legal methods instead manipulate “positive law†in order to achieve their
advantages.72 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, Management, or Cost/Price Determination.â€
Tax strategy patents fall into a subclass under this heading, being identified under classification
number 705/36T.
As of January 6, 2010, the USPTO identified 90 issued patents and 136 published applications
under classification number 705/36T.73 As the USPTO received 485,312 patent applications in
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 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 See, e.g., Paul E. Schaafsma, “A Gathering Storm in the Financial Industry,†9 Stanford Journal of Law, Business
and Finance (2004), 176.
70 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.
71 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.
72 Id. at 367.
73 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
(continued...)
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2008, and granted 185,224 patents during that year, it should be appreciated that tax strategy
patents represent a very small share of that agency’s workload.74 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
Perhaps the most notable tax strategy patent that has been subject to enforcement litigation is the
so-called “SOGRAT†patent, U.S. Patent No. 6,567,790.75 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.
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, 2007,76 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.
(...continued)
may presently be classified under different categories.
74 USPTO, U.S. Patent Statistics, Calendar Years 1963-2008 (available at http://www.uspto.gov/web/offices/ac/ido/
oeip/taf/us_stat.pdf).
75 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).
76 Wealth Transfer Group LL v. Rowe, D. Conn., No. 3:06CV00245, Consent Final Judgment Regarding Settlement
Agreement (March 12, 2007).
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In re Bilski
Increasing public scrutiny of business and tax strategy patents in recent years has corresponded
with heightened attention to patent eligibility issues by the USPTO and the courts. On October
30, 2008, the Federal Circuit issued its opinion in In re Bilski. The Bilski appeal was decided en
banc—that is to say, with the participation of each of the active judges of the court. Bilski’s
application concerned a method of hedging risk in the field of commodities trading. In particular,
his application claimed the following method:
A method for managing the consumption risk costs of a commodity sold by a commodity
provider at a fixed price comprising the steps of:
initiating a series of transactions between said commodity provider and consumers of said
commodity wherein said consumers purchase said commodity at fixed rate based upon
historical averages, said fixed rate corresponding to a risk position of said consumer;
identifying market participants for said commodity having a counter-risk position to said
consumers; and
initiating a series of transactions between said commodity provider and said market
participants at a second fixed rate such that said series of market participant transactions
balances the risk position of said series of consumer transactions.77
The USPTO rejected the application as claiming subject matter that was ineligible for patenting
under section 101.
On appeal, the Federal Circuit characterized the “true issue before us then is whether Applicants
are seeking to claim a fundamental principle (such as an abstract idea) or a mental process.â€
Applying Supreme Court precedent, the Federal Circuit explained:
A claimed process is surely patent-eligible under § 101 if: (1) it is tied to a particular
machine or apparatus, or (2) it transforms a particular article into a different state or thing.78
Applying this standard, the Federal Circuit concluded that Bilski’s application did not claim
patentable subject matter. The Court of Appeals acknowledged Bilski’s admission that his
claimed invention was not limited to any specific machine or apparatus, and therefore did not
satisfy the first prong of the section 101 inquiry.79 The Federal Circuit also reasoned that the
claimed process did not achieve a physical transformation. According to Chief Judge Michel,
“[p]urported transformations or manipulations simply of public or private legal obligations or
relationships, business risks, or other such abstractions cannot meet the test because they are not
physical objects or substances, and they are not representative of physical objects or
substances.â€80 As a result, the decision of the USPTO to deny Bilski’s application was affirmed.
Opinions about the impact of the Bilski opinion upon the future availability of business method
and tax strategy patents vary. Randall Picker, a member of the law faculty of the University of
77 545 F.3d at 949.
78 Id. at 954.
79 Id. at 962.
80 Id. at 965.
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Chicago, explained that the Federal Circuit “sharply cut back on the availability of patents for
processes†and “substantially stepped back from its prior decision in State Street Bank, the
decision that brought us the business-method patents controversy.â€81 According to commentator
Mike Masnick of Techdirt.com, the opinion “will significantly limit software and business
method patents.... â€82 Some experts believe that in view of the Bilski standard, many patents that
the USPTO previously issued would now be judged invalid.83
On the other hand, the Bilski opinion arguably does not explain in detail precisely the extent to
which a process must be “tied to a particular machine or apparatus†in order to qualify as
patentable subject matter. As a result, attorney James Myers explains that future litigation may
“focus on what degree of computerized involvement you have to have in order to meet the
threshold.â€84 In view of this possible ambiguity, other observers suggest that the primary impact
of the Bilski opinion may be to alter the way patent applications are drafted. Patent lawyers have
been advised to ensure that claimed methods make use of a computer system, or are instead
directed to a specific computer system, so that they may be viewed as involving “a particular
machine or apparatus†or being transformative in nature.85 Future developments will provide
better perspectives upon the effect of the Bilski opinion upon business methods and tax strategy
patents.
On June 1, 2009, the United States Supreme Court granted certiorari in In re Bilski. The Supreme
Court will therefore have the opportunity to review the Federal Circuit’s holding in this case. The
Supreme Court decision can be expected to be issued, at the latest, by July 2010.
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,â€86 “bizarreâ€87 and “deeply unsettling.â€88 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.
81 Randall Picker, “In re Bilski: The Fed Circuit Tells Inventors to Stuff It,†The University of Chicago: The Law
School Faculty Blog (Oct. 30, 2008).
82 Mike Masnick, “Court Greatly Limits Software and Business Method Patents,†Techdirt.com (Oct. 30, 2008).
83 See Glenn W. Trost et al., Federal Circuit Revises Test for Patentability of Processes/Business Methods (Nov. 3,
2008) (available at http://www.whitecase.com/alert_fed_complicates_patents_11032008/).
84 See Nate Raymond, “Patent Bar is Atwitter About the Bilski Decision,†The AmLaw Daily (Oct. 31, 2008) (available
at http://amlawdaily.typepad.com/amlawdaily/2008/10/patent-bar-is-a.html).
85 See Robert R. Sachs & Robert A. Hulse, “On Shaky Ground: The (Near) Future of Patents After BilskiÃ,†15 The
Intellectual Property Strategist no. 3 (Dec. 2008).
86 Editorial, “Pay to Obey,†New York Times (October 31, 2006).
87 David Nolte, “USPTO is Getting It Wrong on Tax Strategy Patents,†(July 20, 2006) (available at
http://www.expertclick.com).
88 Melone, supra, at 438.
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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.â€89 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.â€90
Other observers go further, believing that to the extent that tax patents encourage further
innovation in developing innovative tax avoidance strategies, such 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.â€91 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.92
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.â€93
Other experts believe that tax strategy patents are inappropriate because they are said to inject
private control over a system of public laws.94 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.95 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
89 New York State Bar Association, “Patentability of Tax Advice and Tax Strategies†(August 17, 2006) (available at
http://www.nysba.org).
90 AICPA, “Analysis and Legislative Proposals Regarding Patents for Tax Strategies†(February 28, 2007) (available at
tax.aicpa.org) (hereinafter “AICPA Analysisâ€).
91 Drennan, supra, at 280.
92 Id.
93 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).
94 See Richard S. Marshall, “Tax Strategy Patents—Legislative, Judicial and Other Developments,†48 Tax
Management Memo (2007), 243.
95 Steve Seidenberg, “Taxation Innovation: Patent Office Receives Criticism for Issuing Patents on Tax Strategies,â€
Inside Counsel (December 2006).
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by giving tax strategy patent holders the power to decide how select tax law provisions can
be used and who can use them.96
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 taxpayers.97 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.98
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.99
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.100 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.101
In addition, identifying state of the art knowledge may present complications within the tax field.
Tax return information is maintained in confidence,102 and communications between taxpayers
96 AICPA Analysis, supra, at 5.
97 Gary C. Bubb, “Patented Tax Strategies—Are You Serious?,†Rhode Island Lawyers Weekly (August 20, 2007).
98 Ellen P. Aprill, “Responding to Tax Strategy Patents,†American Bar Association Annual Meeting (August 11,
2007), 7.
99 AICPA Analysis, supra, at 2.
100 35 U.S.C. §§ 102, 103 (2006).
101 Aprill, supra, at 7.
102 26 U.S.C. § 6103(a) (2006).
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and their advisors may also be subject to a legal privilege of nondisclosure.103 Due to these
circumstances, reportedly “tax practitioners are concerned that many of the patents that have or
will be issued for tax strategies will inevitably involve techniques that have long been accepted as
routine.â€104
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.â€105 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.106 As with more traditional sorts of patents, tax
strategy patents may reward these efforts and differentiate products and services among
competing tax advisors.107
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.108 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,109
the patent system could arguably improve the availability of information regarding tax strategies
to tax professionals and regulators alike.110
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.â€111 Schreiner and Wang explain that such inventions as an improved catalytic converter,
child’s safety seat, and machine for weighing trucks may relate to laws governing automobile
emissions, transportation safety, and highway traffic. Because each of these inventions is
103 26 U.S.C. § 7525(a)(1) (2006).
104 Aprill, supra, at 9.
105 Quoted in Seidenberg, supra.
106 See Dennis I. Belcher and Dana G. Fitzsimmons, Jr., “Tax Planners—Beware of Patented Estate Planning
Techniques!,†Probate and Property (November/December 2006), 24.
107 Id.
108 35 U.S.C. § 112 (2006).
109 Treas. Reg. 1-6011-4(a).
110 House Report, supra, at 23-24.
111 Schreiner and Wang, supra, at 1.
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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.â€112
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.113
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.114 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.115 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.116
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 challenge with respect to tax strategies, but many observers
believe that there is nothing particularly noteworthy or unusual about this task.117
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.
112 Id.
113 Id. at 2.
114 E. Anthony Figg, “Should the Patent Laws Exempt Certain Innovations from Patent Eligibility?,†IPL
Newsletter (Summer 2006), 3.
115 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.â€).
116 Schreiner and Wang, supra, at 2.
117 Figg, supra, at 3; Schreiner and Wang, supra, at 2.
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In the 111th Congress, three bills have been introduced that would limit the enforcement of tax
strategy patents. 118 None has yet been enacted. H.R. 1265 and S. 506 define the excluded
category of “tax planning invention[s]†to mean “a plan, strategy, technique, scheme, process, or
system that is designed to reduce, minimize, determine, avoid, or defer, or has, when
implemented, the effect of reducing, minimizing, determining, avoiding, or deferring, a
taxpayer’s tax liability or is designed to facilitate compliance with tax laws, but does not include
tax preparation software and other tools or systems used solely to prepare tax or information
returns.... â€119 H.R. 2584 would prevent any patent claiming a “tax planning method,†which is
defined similarly.120 The legislation would apply to any application filed at the USPTO on or after
the date of enactment.121
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.122 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.123
The voluntary contributions of knowledgeable specialists, through these and other mechanisms,
may help promote a high level of quality of issued tax strategy patents.
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.124 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.125 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.126 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.
118 H.R. 1265, § 303; H.R. 2584, §1; S. 506, § 303.
119 H.R. 1265, § 303(a); S. 506, § 303(a).
120 H.R. 2584, §1(a).
121 H.R. 1265, § 303(b); H.R. 2584, §1(b); S. 506, § 303(b).
122 Aprill, supra, at 21.
123 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).
124 See Alan L. Durham, “‘Useful Arts’ in the Information Age,†1999 BYU Law Review, 1419.
125 See Schreiner and Wang, supra.
126 See Moore, supra.
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Author Contact Information
John R. Thomas
Visiting Scholar
jrthomas@crs.loc.gov, 7-0975
Acknowledgments
This report was funded in part by a grant from the John D. and Catherine T. MacArthur Foundation.
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