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Companies are set to lose millions of dollars in tax write-offs from donating their patents to universities and nonprofit groups. Last month, the Internal Revenue Service announced that it plans to disallow certain “improper deductions” for charitable contributions of patents and other intellectual property. The agency also said it might impose penalties on appraisers who set too high a value on donated patents. “We became aware that some taxpayers were claiming deductions more than they were entitled to,” an IRS spokeswoman said in an interview. The new IRS rules may muddy the waters for attorneys whose corporate clients use patent donations to garner big tax write-offs. “It will have an effect on companies that are trying to find creative ways to reduce their taxes,” said William Schwartz, a Morrison & Foerster partner. The IRS said it could not cite specific examples of egregious donations. But in a Dec. 22 notice the agency said corporations have been overvaluing the intellectual property they’ve donated. Other improper deductions include transferring a nondeductible partial interest in the intellectual property. An example of this kind of transfer, the IRS said, would be a corporation retaining the right to manufacture or use any product covered by the donated patent. The IRS also said it would look at instances in which a corporation receives a benefit in exchange for the donation. For instance, a corporation might make its donation contingent on getting the recipient’s research results. The IRS action follows on the heels of recent legislation. Last year, Sen. Chuck Grassley, R-Iowa, introduced a measure that would impose strict limits on deductions for charitable contributions of IP. A Senate Finance Committee report on the bill, S. 1637, estimated that the restrictions would generate revenue of $3.85 billion over 10 years. “The committee is concerned that taxpayers with patents or similar property are taking advantage of the inherent difficulties in valuing such property and are preparing or obtaining erroneous valuations,” the report states. “In such cases, the charity receives an asset of questionable value, while the taxpayer receives a significant tax benefit.” Grassley’s legislation is still awaiting congressional approval. Corporations and IP lawyers acknowledge that it is problematic to put a price tag on intellectual property. “I think there is something inherently difficult about valuing these assets,” Schwartz said. “I think people forget that patents are nothing more than a right to stop people from doing something. As a result, they don’t have any value unless the owner or exclusive licensee is willing to sue, to bring an action of infringement.” Schwartz said IP rights also have subjective value. For example, he said if General Motors Corp. has a patent pertaining to car assembly and gives it a competitive advantage, “that same patent in the hands of Cedar Sinai doesn’t have the same value.” Stephen Fox, associate general counsel and director of IP at Hewlett-Packard Co., said many factors have to be taken into account in determining a patent’s worth. “You have to know if the patent covers others’ work, if it is valid, if there are encumbrances,” such as existing licensees, Fox said. “You can’t do the valuation on a hand wave; it has to be quite rigorous.” Greg Aharonian, who publishes an online newsletter critical of the patent system, said companies have donated patents without checking for patent validity. He particularly criticized SBC Communications Inc. for putting a $7.3 million price tag on a patent donated to The University of Texas at Austin. The patent covers methods of online virus scanning and removal. But Aharonian said there was plenty of prior art to invalidate the patent or reduce its value so no one would want to license it. Aharonian, who was recently invited to give a presentation on patent quality to a group of IRS officials, said that until recently the agency hadn’t known the importance of looking at a patent’s validity. In some cases the IRS is now “returning to outside experts to assess the appraisals” regarding a patent’s market share and quality, he said.

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