Source: https://www.mcguirewoods.com/Client-Resources/Alerts/2015/6/IRS-Disgorgement-Payments-FDA-Consent-Decree-Deductible.aspx
Timestamp: 2019-04-24 10:42:01+00:00

Document:
In Internal Revenue Service Field Attorney Advice released May 22, 2015 (FAA 20152103F), the IRS Office of Chief Counsel expressed its informal view that the evidence suggests that the amount the taxpayer paid the United States as an equitable disgorgement of profits under a consent decree with the Food and Drug Administration (FDA) was not a non-deductible payment in the nature of a fine or penalty. The FAA falls short of stating that the payment is deductible, however; it states only that the evidence does not suggest it was a fine or penalty that would be precluded from being deducted.
The taxpayer developed and manufactured certain drugs. FDA found alleged violations at the taxpayer’s drug manufacturing operation. FDA and the taxpayer agreed to the terms of a consent decree ordered by the U.S. District Court. The consent decree included: (1) detailed injunctive provisions concerning the taxpayer’s manufacturing practices; (2) the taxpayer’s agreement to pay equitable disgorgement of profits to the United States Treasury for the period during which the alleged violations occurred; and (3) the taxpayer’s agreement to pay certain potential liquidated damages, certain potential amounts of equitable disgorgement, and certain potential future costs of FDA and the United States relating to ongoing enforcement of the terms of the consent decree.
Section 162(f) of the Internal Revenue Code (IRC) provides that no deduction shall be allowed under IRC § 162(a) for any fine or similar penalty paid to a government for the violation of any law. Compensatory damages paid to a government are not a fine or penalty. In evaluating the characterization of a payment for purposes of IRC § 162(f), the courts look to the origin and character of the liability giving rise to the payment, according to the FAA.
The claims against the taxpayer in the FAA arose from claimed violations of §§ 331(a) and (k) of the federal Food, Drug, and Cosmetic Act (FD&C Act). The claimed violations are enforceable by injunction under § 332(a), by criminal fines and penalties under § 333(a), and by seizure of goods under § 334. Disgorgement is not specifically authorized by the FD&C Act, but the FAA notes that § 332 has been interpreted broadly to invoke the court’s full equity jurisdiction, including the power to order disgorgement.
After reviewing the purposes of the statutory provisions, the FAA states that the remedy in equity (the disgorgement) takes on the purposes of the statutory origin, which includes both enforcement and compensation. Because of this, the FAA states that the intent of the parties must be examined to determine the goal the disgorgement payment was meant to further.
The FAA notes that the consent decree states that the parties acknowledge that the payment was not a fine, penalty, forfeiture or payment in lieu thereof. It goes on to state, however, that, while this language may be clear on its face, it is ambiguous because there is no evidence that it was intended to address the tax consequences of payments made under the consent decree.
The FAA’s conclusion is not surprising under the facts. What is notable, however, is that the IRS felt compelled to examine the issue notwithstanding the clear statement in the consent decree that the parties acknowledge that the disgorgement payment is not a fine or penalty. Had the consent decree specifically stated that the equitable disgorgement payment was not a fine or penalty for federal income tax purposes, it appears that the IRS would not have found it necessary to examine the intent of the parties. The take away from the FAA is that any settlement agreement should specifically state that the parties do not intend the payment to be a fine or penalty for all purposes, including federal income tax purposes.

References: § 162
 § 162
 § 332
 § 333
 § 334
 § 332