DEPARTMENT OF THE TREASURY

![](media/image1.wmf)**INTERNAL REVENUE SERVICE**

# Washington, D. C. 20224

**Originally Published on January 1, 2001**

**MEMORANDUM FOR INDUSTRY DIRECTORS**

**DIRECTORS, FIELD OPERATIONS**

**DIRECTOR, FIELD SPECIALISTS**

**DIRECTOR, PRE-FILING AND TECHNICAL**

**GUIDANCE**

**FROM: /s/ Robert E. Brazzil**

**Industry Director**

> **Retailers, Food, Pharmaceuticals & Healthcare Industry**

**SUBJECT: LMSB Directive on the Planning & Examination of**

**Research Credit -- Generic Drugs**

**[General Guidance]{.underline}**

These procedures provide the guidelines for examiners when they
encounter taxpayers that have claimed entitlement for the research
credit under I.R.C. § 41 for expenses related to the development of a
generic drug.

**[Generic Drugs]{.underline}**

Generic drugs, like all other new drugs, must be approved by the Food
and Drug Administration (FDA) before they are marketed in interstate
commerce. Generally, new drug products are approved by the FDA on the
basis of a \"new drug application\" (NDA). Generic drugs are approved by
the FDA on the basis of an \"abbreviated new drug application\" (ANDA).
ANDAs are permitted for new drugs containing the same active
ingredient(s) as a \"listed drug.\" A listed drug is a new drug product
that has an effective approval under section 505(c) of the Food, Drug,
and Cosmetic Act (the Act), 21 U.S.C. 355(c), for safety and
effectiveness or under section 505(j) of the Act, 21 U.S.C. 355(j).

The significant difference between an ANDA and an NDA is that the NDA
must contain data demonstrating the safety of the new drug and
substantial evidence establishing the effectiveness of the new drug for
its intended use. The safety and effectiveness of a listed drug is
demonstrated through clinical testing of the product.

The information contained in an ANDA must show that the active
ingredient, the route of administration, the dosage form, the strength
and the conditions of use recommended in the labeling of the generic
drug are the same as the listed drug. In addition, the information
contained in the ANDA must show that the generic drug is the
bioequivalent[^1] of the listed drug.[^2] An ANDA applicant must certify
that the generic drug will not infringe any patents held by the maker of
the listed drug, that any patents on the listed drug have expired or the
date on which the relevant patents will expire, or that the patent on
the listed drug is invalid. Drug Price Competition and Patent Term
Restoration Act of 1984, Pub. L. No. 98-417, § 101, 98 Stat. 1586, 21
USC § 355(j). An ANDA does not need to include safety and effectiveness
information and the ANDA applicant does not need to perform clinical
studies. The ANDA applicant relies on information available to the FDA
from tests conducted on the listed drug to demonstrate that the active
ingredient is safe and effective. The generic drug is presumed safe and
effective on the basis of the bioequivalence studies.

For purposes of this guidance, we are concerned only with taxpayers that
are claiming the research credit for activities related to drugs
developed under an ANDA. If you have any questions concerning whether
the drug in question is a generic drug, please contact the Technical
Advisor for the Pharmaceutical Industry.

**[Law]{.underline}**

Section 41 provides a credit for increasing research activities. The
term \"qualified research expenses\" is defined in section 41(b).
Qualified research expenses include in-house expenses for wages paid in
the conduct of qualified research and for supplies used in the conduct
of qualified research, and 65 percent of any contract expenses for
qualified research.

Section 41(d)(1) defines the term \"qualified research\" as research\--

> \(A\) with respect to which expenditures may be treated as expenses
> under section 174,
>
> \(B\) that is undertaken for the purpose of discovering information
> that is technological in nature and the application of which is
> intended to be useful in the development of a new or improved business
> component of the taxpayer, and
>
> \(C\) substantially all of the activities of which constitute elements
> of a process of experimentation for a functional purpose.

However, section 41(d)(4) excludes several activities from the
definition of the term \"qualified research.\" Under section
41(d)(4)(C), any research related to the reproduction of an existing
business component (in whole or in part) from a physical examination of
the business component itself or from plans, blueprints, detailed
specifications, or publicly available information with respect to such
business component is not considered qualified research for purposes of
section 41(d)(1).

**[Discussion]{.underline}**

The recent final regulations issued under section 41 do not contain a
specific rule on the development of generic drugs. The regulations apply
to generic drugs in the same manner they apply to other business
components. Treas. Reg. § 1.41-4(a)(3) provides, \"\[f\]or purposes of
section 41(d) and this section, research is undertaken for the purpose
of discovering information only if it is undertaken to obtain knowledge
that exceeds, expands, or refines the common knowledge of skilled
professionals in a particular field of science or engineering.\" Treas.
Reg. § 1.41-4(a)(3)(ii) provides that the common knowledge of skilled
professionals in a particular field of science or engineering means
information that should be known to skilled professionals had they
performed, before the research in question is undertaken, a reasonable
investigation of the existing level of information in the particular
field of science or engineering. In addition, Treas. Reg. §
1.41-4(a)(3)(iii) states that in seeking to obtain knowledge that
exceeds, expands, or refines the common knowledge of skilled
professionals in a particular field of science or engineering, a
taxpayer may employ existing technologies and rely on existing
principles. Treas. Reg. § 1.41-4(a)(3)(ii) provides that the common
knowledge of skilled professionals in a particular field of science or
engineering means information that should be known to skilled
professionals had they performed, before the research in question is
undertaken, a reasonable investigation of the existing level of
information in the particular field of science or engineering and
explicitly states that knowledge may exceed, expand, or refine the
common knowledge of skilled professionals even where such knowledge has
previously been obtained by others. For example, trade secrets generally
are not within the common knowledge of skilled professionals in a
particular field of science or engineering because they are not
reasonably available to skilled professionals not employed, hired, or
licensed by the owners of such trade secrets.

In addition to satisfying the general rules for credit eligibility,
taxpayers claiming the research credit for any activity, including
activities for the development of generic drugs, must establish that the
activity is not an excluded activity under section 41(d)(4).

Taxpayers who develop generic drugs may be able to satisfy the discovery
test and avoid the duplication exclusion when undertaking research
directed toward the development of a generic drug. [See]{.underline}
Treas. Reg. § 1.41-4(c)(10), Example 6. Accordingly, we will not assert
a per se rule to exclude all generic drug research activities from
credit eligibility.

**[Examination Guidance]{.underline}**

Eligibility for the research credit is to be determined on a case by
case basis. We will not assert a per se rule to exclude all research
credit with respect to generic drug research activities. To avoid
inconsistent and inequitable treatment of taxpayers, we are establishing
the following procedures.

Each Team Manager must notify the Industry Director, the Area Counsel,
and the Technical Advisor for Pharmaceuticals (who will act as a generic
drug review team) whenever an examination team intends to raise a
section 41 credit issue in a generic drug context. This notification is
required whenever an examination team intends to either disallow or
allow the section 41 credit for research done to develop a generic drug.
The generic drug review team, in consultation with the team manager,
will determine the IRS\'s field position regarding whether to allow the
section 41 credit for the research done for the generic drug.

We believe that the best mechanism to resolve this issue may be
prospective pre-filing agreements entered into at the beginning of
research. The data we gather as a result of each team reporting any
generic drug case will assist us in shaping any future pre-filing
agreements. Further, it may assist us in developing Industry Issue
Resolution Program guidance.

If you have any questions regarding this new procedure, please call Greg
Pierce at (630) 493-5900.

[^1]: The term \"bioequivalence\" means the absence of a significant
    difference in the rate and extent to which the active ingredient in
    pharmaceutical equivalents becomes available at the site of drug
    action when administered at the same molar dose under similar
    conditions in an appropriately designed study. 21 CFR 320.1.

[^2]: Section 355(j)(2)(C) of the Food, Drug, and Cosmetic Act, 21
    U.S.C. § 355(j)(2)(C) (1992), does allow variances from these
    requirements in limited circumstances. Applicants under this
    provision must submit a separate petition requesting permission to
    file an abbreviated new drug application.