– DRAFT –
Patents, Taxes and the Nuclear Option:
Do We Need a “Tax Strategy Patent” Ban Treaty?
Max Stul Oppenheimer†
(WORK IN PROGRESS – LAST UPDATED 04/16/08)
Introduction.........................................................................................................................................
The Emergence of Tax Strategy Patents...............................................................................................
The Legal Basis for Tax Strategy Patents..................................................................................
The Patent Office Response.....................................................................................................
The Concerns of the Tax Bar...................................................................................................
The Path (and Hurdles) Facing a Tax Strategy Patent Application.........................................................
The Basic Rules of the Patent System.......................................................................................
Hurdle 0..................................................................................................................................
Hurdle 1 - Utility......................................................................................................................
Hurdle 2 – Statutory Subject Matter........................................................................................
Patentability of Business Methods................................................................................
Are Tax Strategies Business Methods?.....................................................................................
Hurdle 3 – Novelty..................................................................................................................
Hurdle 4 – Non-Obviousness..................................................................................................
Hurdle 5 – Written Description and Best Mode........................................................................
Hurdle 6 – Fatal Delay.............................................................................................................
Hurdle 7 – Post Issue Challenges.............................................................................................
Reexamination.............................................................................................................
Declaratory Judgment of Invalidity................................................................................
Infringement Defense...................................................................................................
The Rights of a Tax Strategy Patent Owner..........................................................................................
The Value of a Tax Strategy Patent......................................................................................................
Case I – Consistent Strategy....................................................................................................
Case II - Inconsistent Strategy.................................................................................................
Conclusion and Recommendations.......................................................................................................
†Princeton University, BS cum laude; Harvard Law School, JD; Associate Professor, University of Baltimore School of Law, Faculty, The Johns Hopkins University. I would like to thank my research assistant, Ara Hacopian, UB ’08 and my colleague, Professor Wendy Gerzog for her comments on the tax aspects of this article.
I. INTRODUCTION
Periodically, as industries discover that the patent statute applies to them, there are calls for industry-specific exemptions or special treatment.[1] The tax planning industry is the latest to encounter the patent system, and has reacted according to the general pattern. The reaction is all the more understandable in this particular case, where tax practitioners may be more comfortable with requesting an industry-specific exception than would patent practitioners: patent law is a system of broad principles and few specific exceptions.[2]
Following the initial reaction, though, industries typically adapt to the patent system and incorporate patents as part of their business model. For example, the biotech industry languished until the Supreme Court held that patent law extended to living inventions.[3] Today, the 360 largest biotech companies have a market cap over $500 billion,[4] and the first biotech company, Genentech, alone generates more than $9 billion in revenue annually and employs more than 10,000 people.[5] Software companies, which once thought software unpatentable, now generate annual patent licensing revenue in the billions.[6] Even if the tax planning industry does not experience growth on this scale, it is unlikely that tax strategy patents will pose a threat to the industry. As a system which can grant government sanctioned monopolies, the patent statute includes significant hurdles to patentability to ensure that such monopolies are granted only in exchange for meaningful contributions.[7] Those hurdles are particularly well-suited to deal with tax strategy patents.
To explain why tax strategy patents pose no serious threat, this article begins with a brief history of the emergence of and reactions to tax strategy patents, followed by an overview of the U.S. patent system’s objectives and methods. Then this article traces how a tax strategy patent application would be handled by the U.S. Patent and Trademark Office (PTO) and, if issued, the rights it would confer on its owner, and concludes that tax strategy patents are likely to be valueless.
Finally, suggestions are offered for helping to assure that the patent system responds appropriately in evaluating tax strategy patent applications.
II. THE EMERGENCE OF TAX STRATEGY PATENTS
A. The Legal Basis for Tax Strategy Patents
Patents are only available for certain categories of advances,[8] enumerated in 35 U.S.C. § 101, which provides: “[w]hoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent. . . .”[9] There are no special subcategories – machines, manufactures, compositions of matter and processes may be patented if the claimed invention meets the remaining statutory criteria, while things which are not machines, manufactures, compositions of matter or processes may not be patented even if the claimed invention meets the remaining criteria.[10] Early cases drew a distinction between invention and mere observation of a natural phenomenon, holding only the former patentable.[11] Over time, in an effort to provide practical guidance on locating the dividing line, the circuit courts, including the Court of Claims and Patent Appeals, a predecessor of the Federal Circuit, proposed certain bright line tests, each of which at one time was held unpatentable per se.[12]
In Diamond v. Chakrabarty, the Supreme Court rejected one such bright line category, living matter.[13], In State Street, the Federal Circuit noted the breadth of the Chakrabarty decision and concluded that business methods, like living organisms could satisfy the patentable subject matter requirement and that therefore a patent that met the other requirements of the statute was not invalid solely because it related to accomplishing a business objective.[14] The Supreme Court denied certiorari,[15] and has not spoken on the subject of patentable subject matter since.[16]
To date, one case has been filed alleging infringement of a tax strategy patent. On May 20, 2003, the USPTO issued U.S. Patent 6,567,790 for “Estate Planning Method for Minimizing Tax Liability,” claiming the use of stock options to fund a grantor retained-annuity trust.[17] The patentee sued for the unlicensed use of the technique, and the case was settled by a consent decree which left open the question of patent validity.[18]
B. The Patent Office Response
Following the State Street decision, the PTO has granted patents on business methods[19] in a variety of fields and Congress has enacted special rules allowing competitors to continue to use patented business methods under certain circumstances.[20]
One of the challenges for examination of tax strategy applications is the difficulty of finding relevant prior art.[21] This is a challenge the PTO has faced before, and is not unique to tax strategies but is inherent in fields of rapidly developing technology.
In response to the 1998 decision in State Street, the PTO began planning changes in operation, tripling the number of examiners assigned to the field and identifying new databases to be searched in determining patentability.[22] By 2001, the PTO could report that:
82 examiners work in workgroup 2160. This is an increase of 47 examiners since
the beginning of Fiscal Year 2000. To achieve this increase, an examiner work assignment program was initiated that brought 36 experienced examiners from
other areas of the USPTO that had an interest and the necessary backgrounds in
the business method area. . . . . The majority of the examiners in Class 705 [the
class in which business method patents would be classified] have data processing
and computer education or experience. Other educational and business industry
work experience includes the fields of Banking, Securities, Business Development, Marketing Analysis, Real Estate Analysis, Business Consulting, Management,
Sales, Insurance, Business Information Systems, and Financial Analysis.
Additionally, 30 examiners have advanced or multiple degrees, 12 have law
degrees, 7 have Ph.D. and 21 have their Masters Degree (including 6 examiners
with an MBA).[23]
There was a learning curve, manifested in a longer than average delay in initially acting on business method patents while the PTO adjusted, but by the end of 2001 the average pendency of a business method application was within three months of the overall PTO average.[24]
The Patent Office recently reported that applications for business method patents rose from 1,500 in 1998 (the year that State Street was decided) to 9,000 in 2006 and outlined its plans for the area,[25] including steps specifically directed to tax strategy patent applications. Among those steps, the PTO established an examination subclass dedicated to tax strategy patents[26] and partnered with the Internal Revenue Service “to pursue training and information exchange . . . .”[27]
In 1999, the PTO held hearings seeking help in designing a strategy for dealing with prior art in the then-emerging field of software patents.[28] Assistant Secretary Dickinson commented:
The challenge that we have before us is a challenge for certain emerging technologies. For some, we suspect that the databases and resources the PTO relies on may be not enough to enable the patent examiner to find the best, relevant and current prior art.[29]
Thus, while tax strategy applications will present specific unique problems,[30] the general problem of developing new search strategies and establishing new organizations to handle new technologies has been solved.
C. The Concerns of the Tax Bar
On February 16, 2007 Senators Levin, Coleman and Obama introduced the Stop Tax Haven Abuse Act,[31] section 303 of which would limit patents on “invention[s] designed to minimize, avoid, deter, or otherwise affect liability for Federal, State, local or foreign tax . . . .”[32]
Senator Levin’s comments introducing the bill reflect many of the concerns of the tax bar:
1. The fear that tax shelter patents might increase abusive activities[33]
2. The fear that the patent office is not equipped to evaluate tax strategy patents[34]
3. The fear that owners of tax strategy patents might misrepresent the patent as a government endorsement of the underlying strategy[35]
4. The fear that owners of tax strategy patents could charge a fee for use of the patent[36]
5. The fear that patents would provide incentives for innovation in a field where such incentives are unnecessary.[37]
A similar set of concerns was catalogued by Associate Dean Ellen Aprill at the ABA annual meeting.[38] To summarize, the tax bar fears:
1. “The benefit of our patent system…is the encouragement of innovation . . . . [M]any practitioners suggest that no such incentive is required to encourage development of new tax strategies”;[39]
2. “the patent holder, rather than Congress, would decide eligibility for obtaining a tax advantage”;[40]
3. “patents are not a government seal of approval, although they are often seen – and may be marketed – as such”;[41]
4. “[a]s a result of the difficulties in identifying prior art, 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”;[42] and
5. “The proliferation of tax strategy patents would also affect professional culture. Historically, the dissemination of tax planning ideas has been open and widespread.”[43]
On April 20, 2007 the incoming chair of the ABA Section of Taxation stated that the section’s highest priority would be fighting patenting of tax strategies, characterized as “a threat to the American tax system.”[44]
Much of the concern arises from a misunderstanding of the patent system, which is nearly as complex (although considerably more rational) than the tax system.[45] Some of the concern is attributable to the inherent lag between the emergence of a new technology and the practical ability of the legal system to respond, a problem not unique to the patent system.[46] To the extent the concerns are substantive, they are the intended result of a system whose origins trace to the Constitution and to the first Congress.[47]
While the concern of the tax bar has focused on the question of whether tax strategy patents are statutory subject matter, a patent will be denied if the application fails any of the statutory requirements.[48] In analyzing the concerns, it will be helpful to have a brief overview of the constitutional and statutory authority, goals, and methods of the patent system.
III. THE PATH (AND HURDLES) FACING A TAX STRATEGY PATENT APPLICATION
A. The Basic Rules of the Patent System
The power to create a patent system arises under article I, section 8 of the Constitution, which grants Congress the power to reward invention by granting monopolies on the invention for a limited time.[49] The power is exercised in Title 35 of the U.S. Code.[50] Regulations are contained in Title 37 of the Code of Federal Regulations[51], and specific internal rules governing the examination of patent applications are contained in the Manual of Patent Examining Procedure (MPEP).[52]
In order to receive a patent, an inventor must file an application with the U.S. Patent and Trademark Office.[53] The application is reviewed by a patent examiner for compliance with the patent statute, which requires, among other things, a determination that the claimed invention[54]:
1. is statutory subject matter, i.e., falls within at least one of the following categories: machine, manufacture, composition of matter or process;[55]
2. is useful,[56] meaning that the patent office currently believes that the claimed invention has a “specific, substantial, and credible use”;[57]
3. is novel,[58] meaning that it was not in the public domain[59] before the later of the applicant’s date of invention[60] or one year prior to the effective date of the applicant’s patent application filing.[61]
4. would not be considered obvious by someone of ordinary skill in the field[62] who, under the rules of the patent statute, is presumed to have complete knowledge of the prior art;[63]
5. is described[64] and illustrated[65] in the application in sufficient detail to teach someone of ordinary skill in the art how to make and use the invention;
6. discloses the best way of carrying out the invention;[66]
7. is claimed in a sufficiently specific manner to apprise the public of the scope of the claimed patent monopoly.[67]
The invention is defined by one or more claims which form a part of the patent application.[68] If any of the claims are determined to comply with the statutory requirements, a patent may be issued covering those claims.[69] The issued patent gives its owner the right to stop others from making, using, or selling or offering to sell products incorporating the claims during the term of the patent.[70]
Before it may be issued as a patent, an application for a tax strategy patent must be submitted to the patent office, examined for compliance with the formal requirements of the statute and regulations, proper form, signatures, payment of fees; classified;[71] then forwarded to an examiner in the appropriate Examining Group[72] who will review the application for compliance with the substantive provisions of the patent statute. The examiner’s review is governed by the PTO’s internal policy manual, the MPEP.[73] The application must clear one practical and six statutory hurdles in order to be issued as a patent, and an additional hurdle in order to be held valid if challenged.[74]
B. Hurdle 0 – Delay between Filing and Grant of a Patent
The first hurdle facing any patent applicant is the delay involved in obtaining a patent. While the patent office has announced a long-term strategic goal of disposing of applications within 18 months of filing,[75] its “target” for fiscal 2006 was 31.3 months and the actual average pendency for fiscal 2005 was 31.1 months.[76] This hurdle is particularly significant in areas of rapid obsolescence. While the risk of obsolescence arises more typically where new technology displaces more expensive older technology or offers new features, tax strategy patents are vulnerable to the risk of obsolescence as well, because Congress or the IRS can destroy the value of a tax strategy by changing the statute or regulations at any time.[77] Moreover, tax strategy patents are likely to disclose precisely what the IRS or Congress may view as loopholes in need of closing and therefore expedite their own obsolescence.[78]
Thus, the threshold question for a prospective tax strategy applicant is whether there will be any value to having a patent three or four years in the future.[79]
C. Hurdle 1 - Utility
In order to be patentable, an invention must be useful.[80] The threshold for utility is not high,[81] but if the invention cannot work, it will fail the utility requirement.[82] The Federal Circuit has held, in an en banc decision, that the Constitution limits patentability to the "purpose of advancing the useful arts--the process today called technological innovation."[83] There is case law suggesting that inventions which depend on man-made law (as opposed to natural laws) are not statutory subject matter and therefore not patentable.[84] Even if the prohibition of “law-based” patents is not absolute, the utility of a tax strategy may disappear if the law changes[85] or if the IRS classifies it as abusive.
To some degree, the problem may be solved by creative claim-drafting. For example, a claim to a “process for reducing taxes” would face different challenges than a claim to a “process for structuring a transaction” or a “process for reporting a transaction.” The IRS standard for tax preparers requires that they either disclose the basis for the position and it not be frivolous[86] or that they have a reasonable belief that the position will be sustained.[87] Thus, other possible claims might be to “a process for taking a chance that the IRS will accept the position” or “a process for gambling that the IRS won’t catch on . . . .” In the first case, a claimed process for reducing taxes, the patent would become invalid for lack of utility if Congress changed the statute or the IRS successfully challenged the strategy;[88] the other cases might remain useful in light of such events.
D. Hurdle 2 – Statutory Subject Matter
In order to be patentable, an invention must fit one of the four categories enumerated in 35 U.S.C. § 101, so-called “statutory subject matter.”[89] In addition, certain types of inventions that fall within the literal terms of one of the statutory categories are not patentable under judicially announced exceptions. Under current Supreme Court case law "[p]henomena of nature, though just discovered, mental processes, and abstract intellectual concepts are not patentable as they are the basic tools of scientific and technological work."[90] The dividing line is that "[w]hile a scientific truth, or the mathematical expression of it, is not a patentable invention, a novel and useful structure created with the aid of knowledge of scientific truth may be."[91]
The Patent Office initially interpreted Supreme Court guidance as compelling it to reject claims to inventions using mathematical algorithms as unpatentable per se.[92] In In re Alappat,[93] the inventor had solved the problem of the jagged appearance of waveforms on oscilloscopes by varying the intensity of pixels making up the waveform display according to a formula based on the distance of the pixel from the actual waveform.[94] The examiner rejected claims as unpatentable under 35 U.S.C. § 101 "because the claim was directed to nonstatutory [sic] subject matter."[95] The Board of Patent Appeals reversed, holding that, although the claims included a mathematical algorithm, “the claim as a whole [was] directed to a machine and thus to statutory subject matter.”[96] In an unusual move, an expanded Board reconsidered the case and affirmed the Examiner's rejection, ruling "when the claim is viewed without the steps of this mathematical algorithm, no other elements or steps are found"[97] and therefore was not directed to statutory subject matter for two reasons: it did not describe a machine[98] and it fell within a judicially-created exception that precluded patenting “mathematical algorithms”. The Federal Circuit reversed, holding that although the claim included a formula, the overall claimed invention was a machine.[99]
A close analysis of Diehr, Flook, and Benson reveals that the Supreme Court never intended to create an overly broad, fourth category of subject matter excluded from § 101. Rather, at the core of the Court's analysis in each of these cases lies an attempt by the Court to explain a rather straightforward concept, namely, that certain types of mathematical subject matter, standing alone, represent nothing more than abstract ideas until reduced to some type of practical application, and thus that subject matter is not, in and of itself, entitled to patent protection…. [T]he proper inquiry in dealing with the so called [sic] mathematical subject matter exception to § 101 alleged herein is to see whether the claimed subject matter as a whole is a disembodied mathematical concept, whether categorized as a mathematical formula, mathematical equation, mathematical algorithm, or the like, which in essence represents nothing more than a "law of nature," "natural phenomenon," or "abstract idea."[100]
If so, Diehr precludes the patenting of that subject matter. That is not the case here.
[T]he claimed invention as a whole is directed to a combination of interrelated elements which [sic] combine to form a machine for converting discrete waveform data samples into anti-aliased pixel illumination intensity data to be displayed on a display means. This is not a disembodied mathematical concept . . . but rather a specific machine to produce a useful, concrete, and tangible result.[101]
Whether claims constitute statutory subject matter is a question of law and is reviewed without deference.[102] However, as noted by Judge Newman, concurring in In re Alappat, “[t]he boundary between patentable and unpatentable subject matter is not always a bright line.”[103]
In In re Alappat, the Federal Circuit recognized a certain confusion in the Supreme Court’s guidance:
The Supreme Court has not been clear . . . as to whether such subject matter is excluded from the scope of § 101 because it represents laws of nature, natural phenomena, or abstract ideas. See Diehr, 450 U.S. at 186 (viewed mathematical algorithm as a law of nature); Benson, 409 U.S. 63, 71-72 (1972) (treated mathematical algorithm as an "idea"). The Supreme Court also has not been clear as to exactly what kind of mathematical subject matter may not be patented. The Supreme Court has used, among others, the terms "mathematical algorithm," "mathematical formula," and "mathematical equation" to describe types of mathematical subject matter not entitled to patent protection standing alone. The Supreme Court has not set forth, however, any consistent or clear explanation of what it intended by such terms or how these terms are related, if at all.[104]
The Supreme Court itself noted that the “line between a ‘patentable’ process and an unpatentable ‘principle’ is not always clear.”[105] The PTO and Federal Circuit have announced, then abandoned, a series of shortcut tests for dividing unpatentable subject matter from patentable subject matter, including the “technological arts" test[106]; the “Freeman-Walter-Abele test”[107]; the “mental step” test[108]; the mathematical algorithm test[109]; the “machine implemented” test[110]; and the “data transformation” test[111].
In State Street the Federal Circuit found 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 result” - a final share price momentarily fixed for recording and reporting purposes and even accepted and relied upon by regulatory authorities and in subsequent trades
which satisfied the statutory subject matter requirement.[112]
AT&T v. Excel Communications[113] involved a patent issued for an addition of a field in a telephone billing record. As explained by the circuit court, when a caller makes a direct-dialed long-distance phone call, the system generates a record including the originating and terminating phone numbers, and the length of time of the call for billing.[114] The patent at issue added a “primary interexchange carrier indicator” which allowed long-distance carriers to provide differential billing treatment, depending upon whether the call is to a phone with the same or a different long-distance carrier.[115] The district court held that “the claims implicitly recite a mathematical algorithm, . . . and thus fall within the judicially created ‘mathematical algorithm’ exception to statutory subject matter.”[116]
The Federal Circuit reversed, noting that it had held, in State Street, that a system which “takes data representing discrete dollar amounts through a series of mathematical calculations to determine a final share price - a useful, concrete, and tangible result” was patentable[117] and that, in the pending case a value was derived using a simple mathematical principle but that was
not determinative because AT&T does not claim the Boolean principle . . . AT&T is only claiming a process that uses the Boolean principle in order to determine the value of the PIC indicator. The PIC indicator represents information about the call recipient's PIC, a useful, non-abstract result that facilitates differential billing of long-distance calls. . . . Because the claimed process applies the Boolean principle to produce a useful, concrete, tangible result without pre-empting other uses of the mathematical principle, on its face the claimed process comfortably falls within the scope of § 101.[118]
While the Federal Circuit follows State Street, the validity of State Street, at least in its broadest construction, is not free from doubt.
The Board of Patent Appeals and Interferences, the Patent Office’s internal reviewing authority, continues to affirm examiner rejections of certain business method claims[119] and at least one administrative patent judge considers “[t]he quest for a bright line test for determining whether a claimed invention embodies statutory subject matter under 35 U.S.C. § 101 ... an exercise in futility.”[120] In Ex parte Bilski, an administrative appeal of the rejection claims to a method for hedging risk,[121] the applicant asserted that “energy consumers face two kinds of risk: price risk and consumption risk” and that “consumption risk (e.g., the need to use more or less energy than planned due to the weather) is said to be not currently managed in energy markets, which is the problem addressed by the invention....” but admitted "that the steps of the method need not be performed on a computer.”[122] The examiner rejected the claims as nonstatutory, finding that no specific apparatus was disclosed and "[t]herefore, the claims are non-statutory, because they are directed solely to an abstract idea and solve a purely mathematical problem without practical application in the technological arts."[123] Therefore, the final rejection relies on both the "abstract idea" exclusion and a "technological arts" test for statutory subject matter.”[124] The Board characterized the claims as “‘non-machine-implemented’ method claims, i.e., the claims do not recite how the steps are implemented and are broad enough to read on performing the steps without any machine or apparatus.”[125] In the Board’s view, this took the case beyond the holding of State Street and AT&T v. Excel, viewing those cases as involving the "special case" of transformation of data by a machine.[126]
Noting that “the bounds of patentable subject matter are increasingly being tested” and that “[i]n recent years, the USPTO has been flooded with claims to ‘processes,’ many of which bear scant resemblance to classical processes of manipulating or transforming compositions of matter or forms of energy from one state to another [including] claims to methods of meditation, dating, physical sports moves, etc….”[127] the Board affirmed the rejections.
The Supreme Court declined a recent opportunity to resolve the issue, although a dissenting opinion indicates that the scope of patentability of business methods is not completely settled. In Laboratory Corporation of America v. Metabolite Labs, the applicant claimed a process for diagnosing vitamin deficiency,[128] which consisted of testing a blood sample for elevated levels of homocysteine and then “noticing whether its level is elevated above the norm.”[129] The patent office allowed the claim and a district court upheld a jury verdict that the patent was valid and infringed.[130] The Federal Circuit affirmed.[131] The Supreme Court granted certiorari to determine whether the patent claim is invalid on the ground that it improperly seeks to "claim a monopoly over a basic scientific relationship," namely, the relationship between homocysteine and vitamin deficiency.[132] The Court dismissed the writ as improvidently granted, with three justices dissenting.[133]
In dissent, Justice Breyer argued that the writ should not have been dismissed because of the importance of resolving the patentability of such processes and because “this case is not at the boundary. It does not require us to consider the precise scope of the ‘natural phenomenon’ doctrine or any other difficult issue. In my view, claim 13 is invalid no matter how narrowly one reasonably interprets that doctrine.” There can be little doubt that the correlation between homocysteine and vitamin deficiency set forth in claim 13 is a “natural phenomenon.”[134]
The dissent explains the philosophy behind exclusion of laws of nature from patentable subject matter:
The relevant principle of law “[e]xclude[s] from . . . patent protection . . . laws of nature, natural phenomena, and abstract ideas.” . . . .
The justification for the principle does not lie in any claim that “laws of nature” are obvious, or that their discovery is easy, or that they are not useful. To the contrary, research into such matters may be costly and time-consuming; monetary incentives may matter; and the fruits of those incentives and that research may prove of great benefit to the human race. Rather, the reason for the exclusion is that sometimes too much patent protection can impede rather than "promote the Progress of Science and useful Arts," the constitutional objective of patent and copyright protection.
The problem arises from the fact that patents do not only encourage research by providing monetary incentives for invention. Sometimes their presence can discourage research by impeding the free exchange of information.
. . . .
Thus, the Court has recognized that "[p]henomena of nature, though just discovered, mental processes, and abstract intellectual concepts are . . . the basic tools of scientific and technological work." It has treated fundamental scientific principles as "part of the storehouse of knowledge" and manifestations of laws of nature as "free to all men and reserved exclusively to none." And its doing so reflects a basic judgment that protection in such cases, despite its potentially positive incentive effects, would too often severely interfere with, or discourage, development and the further spread of useful knowledge itself.”[135]
Of particular importance, the dissent questions the validity of State Street.
That case does say that a process is patentable if it produces a ”useful, concrete, and tangible result.” But this Court has never made such a statement and, if taken literally, the statement would cover instances where this Court has held the contrary. The Court, for example, has invalidated a claim to the use of electromagnetic current for transmitting messages over long distances even though it produces a result that seems "useful, concrete, and tangible." Similarly the Court has invalidated a patent setting forth a system for triggering alarm limits in connection with catalytic conversion despite a similar utility, concreteness, and tangibility. And the Court has invalidated a patent setting forth a process that transforms, for computer-programming purposes, decimal figures into binary figures — even though the result would seem useful, concrete, and at least arguably (within the computer’s wiring system) tangible.[136]
1. Patentability of Business Methods
In one sense, there is a special category of inventions known as “business method patents.”[137] However, for purposes of determining patentability, and the PTO’s examination of applications, there is no such category.[138] “Office personnel have had difficulty in properly treating claims directed to methods of doing business. Claims should not be categorized as methods of doing business. Instead such claims should be treated like any other process claims….”[139]
Doubt as to the patentability of business methods was alleviated by the Federal Circuit in State Street. The patent office issued a patent to Signature on "Data Processing System for Hub and Spoke Financial Services Configuration."[140]
In essence, the system…facilitates a structure whereby mutual funds (Spokes) pool their assets in an investment portfolio (Hub) organized as a partnership. This investment configuration provides the administrator of a mutual fund with the advantageous combination of economies of scale in administering investments coupled with the tax advantages of a partnership.[141]
Unable to license the patented invention, State Street sought a declaratory judgment that the patent was invalid.[142] The district court granted summary judgment that the patent was invalid as not meeting the statutory subject matter requirement of 35 U.S.C. § 101.[143] The Federal Circuit reversed, holding that the patent was directed to statutory subject matter, a machine.[144]
Citing the 1980 Supreme Court decision in Diamond v. Chakrabarty, the court held that the “repetitive use of the expansive term ‘any’ in § 101 shows Congress's intent not to place any restrictions on the subject matter for which a patent may be obtained beyond those specifically recited in § 101.”[145] The Federal Circuit went on to note three categories of subject matter that the Supreme Court had held unpatentable: laws of nature, natural phenomena, and abstract ideas.[146]
The Federal Circuit then explained the difference between unpatentable mathematical algorithms and patentable machines or methods:
Unpatentable mathematical algorithms are identifiable by showing they are merely abstract ideas constituting disembodied concepts or truths that are not "useful." From a practical standpoint, this means that to be patentable an algorithm must be applied in a "useful" way. In Alappat, we held that data, transformed by a machine through a series of mathematical calculations to produce a smooth waveform display on a rasterizer monitor, constituted a practical application of an abstract idea (a mathematical algorithm, formula, or calculation), because it produced "a useful, concrete and tangible result"--the smooth waveform.
Similarly, in Arrhythmia Research Technology Inc. v. Corazonix Corp., 958 F.2d 1053. . . (Fed. Cir. 1992), we held that the transformation of electrocardiograph signals from a patient's heartbeat by a machine through a series of mathematical calculations constituted a practical application of an abstract idea (a mathematical algorithm, formula, or calculation), because it corresponded to a useful, concrete or tangible thing—the condition of a patient's heart.[147]
The court applied this rule by holding 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 result"—a final share price momentarily fixed for recording and reporting purposes and even accepted and relied upon by regulatory authorities and in subsequent trades.[148]
The court rejected the argument that there was a judicially-created “business method” exception to patentable subject matter.[149] “We take this opportunity to lay this ill-conceived exception to rest . . . The business method exception has never been invoked by this court . . . to deem an invention unpatentable.”[150]
E. Are Tax Strategies Business Methods?
Under current PTO guidelines, a claim to a specific business process would meet the requirements of statutory subject matter, as it would be one of the categories of inventions covered by the patent statute.[151] It is an open question whether such a process would qualify as statutory subject matter under Supreme Court precedent – the Court has not addressed the issue, and the Breyer dissent language suggests that at least some Justices have questions.[152]
There is, however, a possible distinguishing characteristic of tax strategy patents: they depend on legislation. One possible consequence of this distinction is that the strategy may fail the utility requirement.[153] There is also authority at the Federal Circuit level suggesting that legal agreements may also fail the statutory subject matter requirement.[154]
In re Comiskey involved a method for mandatory arbitration involving legal documents, such as wills or contracts.[155] The examiner rejected the application as obvious.[156] The Federal Circuit held “We do not reach the ground relied on by the Board below—that the claims were unpatentable as obvious ... because we conclude that many of the claims are ‘barred at the threshold by § 101.’"[157] Reaffirming the decision in State Street that patentability does "not turn on whether the claimed subject matter does 'business' instead of something else,"[158] the court also noted that State Street “explicitly held that business methods are ‘subject to the same legal requirements for patentability as applied to any other process or method.’”[159]
The court held that, Comiskey having conceded that the claims at issue did not require a machine, the claims were to the mental process of resolving a legal dispute between two parties by the decision of a human arbitrator and not patentable subject matter.[160] Thus, an applicant for a tax strategy patent would face uncertainty as to whether the category itself is, in fact, patentable.
F. Hurdle 3 – Novelty
Since the first patent statute, patents have been available to novel inventions only, a requirement reflected in sections 101 and 102 of the current statute.[161] Patents are intended to provide an incentive to add to the public domain.[162] Therefore, a patent cannot be granted on something which is already in the prior art.[163]
The prior art consists of information[164] which was available to the public prior to the applicant’s date of invention[165] and information which was available to the public more than a year prior to the applicant’s priority date.[166] The information may have become public through a patent application, through a publication in a journal, through presentation at a conference, or through use of the claimed invention, among other routes.
In addition, patent policy discourages use of the claimed invention by the inventor for any significant period before filing an application. In Metallizing Engineering Co., Inc. v. Kenyon Bearing & Auto Parts Co., Inc.[167], the Second Circuit traced the early history of and policy behind the public use bar:
So far as we can find, the first case which dealt with the effect of prior use by the patentee was Pennock v. Dialogue, 2 Pet. 1, 4, 7 L.Ed. 327, in which the invention had been completed in 1811, and the patent granted in 1818 for a process of making hose by which the sections were joined together in such a way that the joints resisted pressure as well as the other parts. It did not appear that the joints in any way disclosed the process; but the patentee, between the discovery of the invention and the grant of the patent, had sold 13,000 feet of hose; and as to this the judge charged: “If the public, with the knowledge and tacit consent of the inventor, be permitted to use the invention, without opposition, it is a fraud on the public afterwards to take out a patent.” The Supreme Court affirmed a judgment for the defendant, on the ground that the invention had been “known or used before the application.” “If an inventor should be permitted to hold back from the knowledge of the public the secrets of his invention; if he should … make and sell his invention publicly, and thus gather the whole profits, …it would materially retard the progress of science and the useful arts” to allow him fourteen years of legal monopoly ”when the danger of competition should force him to secure the exclusive right” 2 Pet. at page 19, 7 L.Ed. 327. In Shaw v. Cooper, 7 Pet. 292, 8 L.Ed. 689, the public use was not by the inventor, but he had neglected to prevent it after he had learned of it, and this defeated the patent. “Whatever may be the intention of the inventor, if he suffers his invention to go into public use, through any means whatsoever, without an immediate assertion of his right, he is not entitled to a patent” 7 Pet. at 323, 8 L. Ed. 689.[168]
"Public use" of a claimed invention under section 102(b) has been defined as any use of that invention by a person other than the inventor who is under no limitation, restriction or obligation of secrecy to the inventor.[169] Tax returns are confidential by law.[170] However, the duty to maintain the confidentiality of the return runs to the taxpayer, not the tax adviser.[171] Thus, filing a tax return which discloses the tax strategy sought to be patented would create prior art available to defeat a subsequent patent application.[172]
There is an exception for experimental use of an invention by or under control of the inventor in order to perfect the invention,[173] but that exception is unlikely to apply to tax strategy patents.[174]
G. Hurdle 4 – Non-Obviousness
In one sense, the novelty of tax strategy patents may be the easiest hurdle to clear. Every time the tax law changes, there are new opportunities to do things which have never been done before in exactly the same way. The more difficult hurdle is obviousness. The standard is set by 35 U.S.C. § 103.[175] Things which would be obvious to others of ordinary skill in the relevant field are not patentable. As explained in Graham v. John Deere:[176]
Under § 103, the scope and content of the prior art are to be determined; differences between the prior art and the claims at issue are to be ascertained; and the level of ordinary skill in the pertinent art resolved. Against this background the obviousness or nonobviousness of the subject matter is determined.[177]
In KSR International v. Teleflex, the Supreme Court reviewed a holding that claims were patentable under a bright-line test developed by the Federal Circuit.[178] The patent office had issued the patent, but at trial the district court applied the Graham test, found little difference between the prior art and the claimed invention and therefore invalidated the patent as obvious.[179] The Federal Circuit reversed, holding that the District Court had not been strict enough in applying the test, having failed to make "'findings as to the specific understanding or principle within the knowledge of a skilled artisan that would have motivated one with no knowledge of [the] invention'” to combine the references.[180] The Supreme Court reversed. [181]
Throughout this Court's engagement with the question of obviousness, our cases
have set forth an expansive and flexible approach inconsistent with the way the
Court of Appeals applied its TSM test here.[182]
The obviousness analysis cannot be confined by a formalistic conception of the
words teaching, suggestion, and motivation, or by overemphasis on the importance
of published articles and the explicit content of issued patents. . . . Granting patent protection to advances that would occur in the ordinary course without real
innovation retards progress and may, in the case of patents combining previously
known elements, deprive prior inventions of their value or utility.[183]
The obviousness of a tax strategy patent would be measured from the perspective of a tax practitioner – either a CPA or a tax lawyer – given the normal training of such a person and the normal knowledge of the relevant law, resources and techniques used in the field of tax planning.[184] Under In re Winslow[185], this hypothetical practitioner would be presumed to know all of the relevant prior art, which would (at a minimum) include legislative history and IRS regulations and positions.[186]
Thus, strategies which did nothing more than implement statutory objectives could not pass the obviousness hurdle.[187] Implementing a strategy using a computer program might help with the issue of statutory subject matter, but could hardly be considered a non-obvious step in the field of tax planning.[188]
H. Hurdle 5 – Written Description and Best Mode
The patent statute requires that an applicant describe how to make and use the invention and also disclose what the applicant believes to be the best mode for carrying out the invention, referred to as the “enablement” and “best mode” requirements, respectively.[189] The enablement requirement is designed to assure that, in return for the limited term monopoly which a patent confers, the public gets access to sufficient information to practice the invention once the term has expired.[190] The best mode requirement is designed to prevent an applicant from disclosing a theoretically feasible way of implementing the invention while concealing preferable ways of doing so.[191] In other words, “best mode” would require a tax strategy applicant to describe how they would advise clients to use the strategy.[192]
When the patent is issued the entire application and any correspondence is made public.[193] This ordinarily poses little problem for patent owners since competitors are unable to use the patented invention during the term of the patent.[194] However, tax strategy patents are a special case. There is one party which might destroy the value of the patent without using the invention: the IRS. By ruling that the strategy is abusive or successfully lobbying for a change in the statute, the IRS would destroy the value of the patent without infringing.[195]
As demonstrated above, a strategy which merely carries out Congressional intent will be unpatentable as lacking novelty or being obvious.[196] Therefore, presumably the patent at issue will be directed toward a result which, at best, is not consistent with that intent. Since the application must disclose not only how to implement the strategy but also what the applicant considers the best way to carry it out, it will paint a clear target for the IRS. The IRS does not need to infringe the patent to destroy its value – it can adopt regulations making use of the strategy unacceptably risky or it can lobby Congress to amend the tax statute to make the strategy unworkable.[197]
Of perhaps greater practical importance, the patent application must identify the inventor and, if the patent has been transferred (for example, to the practitioner’s firm), the transfer must be recorded to be effective.[198] This could place the practitioner’s clients at greater risk of audit or greater scrutiny simply by virtue of association with the assignee of a tax strategy patent.
I. Hurdle 6 – Fatal Delay
One of the objectives of the patent system is to provide incentives to place technology in the public domain promptly.[199] The statute provides such incentives in Sections 102(b) and 103 which provide, in effect a statute of limitations of one year, running from the time that someone (the applicant included) has made the invention public.[200] In addition, the patent statute denies patentability to applicants who have abandoned, suppressed or concealed their inventions.[201]
The courts have consistently held that an invention, though completed, is deemed abandoned, suppressed, or concealed if, within a reasonable time after completion,
no steps are taken to make the invention publicly known. Thus, failure to file a
patent application; to describe the invention in a publicly disseminated document;
or to use the invention publicly, have been held to constitute abandonment,
suppression or concealment.[202]
In other words, the creator of a tax strategy patent runs a risk by using the strategy in practice for a significant period before filing a patent application.[203] Some tax practitioners attempt to control access to their planning techniques by requiring clients to sign confidentiality agreements.[204] While the length of time required to establish the bar is a question of fact, based on the nature and extent of activity from reduction to practice to filing the patent application [205], attempting to profit from an invention in this fashion is a classic invitation to a rejection based on suppression or concealment.[206]
There is an “experimental use” exception, designed to permit limited public use or sale if necessary in order to perfect the invention,[207] but it is difficult to see how the exemption could apply to tax strategy patents.[208] To successfully establish entitlement to this exception, the applicant would need to demonstrate that experimentation was necessary to perfect the invention, and that the experimentation required public use or sale.[209] Such an argument would appear inconsistent with the IRS regulations requiring a good faith belief in the correctness of the position being taken.[210]
J. Hurdle 7 – Post Issue Challenges
All of the above hurdles relate to the difficulty of getting a patent issued quickly enough to be of any value. They are not meant to be an exhaustive review of the process of obtaining a patent, but rather a catalog of special issues that would be faced with respect to tax strategy patents. For completeness, one more category of hurdles should be mentioned.
Once issued, a patent is presumed valid.[211] That presumption is rebuttable, and there are several avenues for challenging an issued patent.[212] If any party succeeds in invalidating an issued patent through any of these avenues, the patent is invalid as to all parties.[213]
1. Reexamination
The patent statute allows any party to request that the patent office reconsider its decision to issue a patent, by filing a request for reexamination.[214] The process is more abbreviated than the initial examination process, and the types of materials which may be considered is limited[215].
2. Declaratory Judgment of Invalidity
Any party meeting constitutional standing requirements may challenge an issued patent through a declaratory judgment action.[216]
3. Infringement Defense
One of the defenses available to a defendant in an infringement action is the invalidity of the patent.[217] Thus, although an issued patent, as a decision of an expert administrative agency within the area of its expertise, is presumed valid,[218] the presumption is rebuttable. Any of the hurdles overcome in obtaining a patent are open for reconsideration in defense of an infringement action.
IV. THE RIGHTS OF A TAX STRATEGY PATENT OWNER
Once an application is allowed and issues as a patent, its owner has the right to stop competitors from making, using, selling or importing the patented invention for a period of twenty years from the date the patent application was filed.[219] With respect to a tax strategy patent, this would translate into two significant rights: rights against other tax advisers who use the invention to advise clients; and rights against taxpayers who use the invention to structure transactions or file tax returns. Thus, potential defendants include the actual taxpayer, lawyers and accountants.
The rights include the right to recover damages which, by statute, are to be no less than a reasonable royalty[220] and which in practice rarely exceed that measure.[221] Injunctions are also available,[222] although not automatic.[223] In addition, in cases of willful infringement, recovery of attorney fees is authorized.[224]
The “invention” is not the underlying strategy; it is the “claimed invention,” i.e., limited by the terms of set forth in the claim section of the patent. Note that this means that others could publish articles describing the patented techniques, lobby for changes to the patent statute or regulations or find other ways to accomplish the same objectives. None of these activities are within the exclusive rights of a patent holder.
V. THE VALUE OF A TAX STRATEGY PATENT
Taking into account all of the above hurdles, the value of a tax strategy patent appears to be close to zero. To have any significant value, in addition to being a workable strategy which has economic value, it would need to have the following characteristics:
1. Because of the significant delays in processing patent applications, it would need to have value over a period of at least three years. Remedies for patent infringement generally run from the time the patent is issued, so any strategy which ceased to be effective, because of a role change, before the patent issued would be impossible to license.[225]
2. Assuming that the application was filed in the U.S. only[226] (a reasonable, but not necessarily universally applicable assumption), the contents could be kept secret until the patent issued. However, once that happened, the strategy would be fully disclosed, giving the IRS a clear picture of how any loopholes might be used. Therefore, it would need to have value notwithstanding the IRS’s knowledge of its use.
3. Finally, to be valuable, an application would need to meet both of two inconsistent requirements: it must be non-obvious to clear the patent hurdle, and it must be sufficiently consisten