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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. Late last year, the Internal Revenue Service announced that it plans to disallow certain “improper deductions” for charitable contributions of patents and other intellectual property. The IRS also said that it might impose penalties on appraisers who set too high a value on donated patents. The new IRS rules may muddy the waters for corporations that 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,” says William Schwartz, a San Francisco partner at Morrison & Foerster. The IRS did not cite specific examples of egregious donations. But in a Dec. 22 notice, the agency said that corporations have been overvaluing the intellectual property they donate. The IRS is also concerned about improper deductions for the transfer of nondeductible partial interests in intellectual property — for example, a corporation retaining the right to manufacture or use any product covered by the donated patent. And the IRS said it would look at instances in which companies received a benefit in exchange for a donation — for instance, making a donation contingent on getting the recipient’s research results. The IRS action follows on the heels of legislative activity. Sen. Chuck Grassley (R-Iowa), chair of the Senate Finance Committee, has introduced a measure to impose strict limits on deductions for charitable contributions of IP. A committee report on the bill, S. 1637, estimates 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.” 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,” says Schwartz. “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.” Schwartz adds that the value of IP rights is subjective. For example, he says, if General Motors has a patent pertaining to car assembly that gives it a competitive advantage, “that same patent in the hands of Cedars Sinai doesn’t have the same value.” Stephen Fox, associate general counsel and director of IP at the Hewlett-Packard Co., cites many factors that must 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, says Fox. “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, says that companies have donated patents without checking for validity. He particularly criticizes SBC Communications Inc. for putting a $7.3 million price tag on a patent donated to the University of Texas — even though, he says, there was plenty of prior art to reduce its value. Aharonian points out that, until recently, the IRS 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” of a patent’s market share and quality, he says. [For more on IP donations, see "Please Donate Patents on the Shelf."] Brenda Sandburg is a reporter with The Recorder, an American Lawyer Media newspaper. She can be reached at [email protected].

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