2008 OFII Tax Conference La Quinta, CA IP and Tax— Managing Competing Considerations Greg Barton – Mayer Brown LLP (312) James Ferguson – Mayer Brown LLP (312) The views expressed in this presentation are not intended as, and should not be relied on, as legal or tax advice. The outcome of any independent situation depends on the specific facts and circumstances in which the issue arises and laws and regulations in effect at the time. © 2008 James Ferguson / Greg Barton / Mayer Brown LLP

2008 OFII Tax Conference La Quinta, CA 2 Introduction Development and management of IP (patents and trademarks) obviously creates significant tax and IP legal issues for foreign-based multinational Tax and IP departments may be able to improve a company’s position in both areas through close coordination, not only in the U.S., but with the foreign parent. Worldwide coordination is essential to achieve a consistent approach

2008 OFII Tax Conference La Quinta, CA 3 Tax and IP Coordination is Critical for Foreign-Owned Companies Companies often have significant high-value IP IP may be developed in many locations Long time horizons and multiple business options for product-specific IP mean that early decisions may become important Business pressures may require companies to implement acquisitions and other strategic decisions quickly Tax and IP management teams are often large, influential, and unrelated

2008 OFII Tax Conference La Quinta, CA 4 Identifying IP Understanding company-wide IP is critical to tax and IP departments –IP Considerations Identification and scope of protectable IP Required registrations and maintenance worldwide Licensing Identification of possible infringement –Tax Considerations Cross-affiliate IP use Relative value of IP across company functions IP affecting restructuring transactions Treatment of maintenance and other costs

2008 OFII Tax Conference La Quinta, CA 5 Managing IP--Separate Ownership and Sales Many companies separate IP ownership and product sales for one or more reasons –Concentration in an IP holding company (often in foreign parent or in foreign holding company) –Licensing –Co-promotions and joint ventures –U.S. Acquisitions –Other business or corporate reasons

2008 OFII Tax Conference La Quinta, CA 6 Tax Considerations in IP Use of IP by multiple affiliates across jurisdictions raises ongoing transfer pricing concerns –Tax exposures for royalties –Cross-affiliate use of IP must be documented –Adjustments by IRS can lead to 40% penalties, in addition to tax due Tax departments frequently responsible for intercompany licenses and may reallocate IP ownership or use IP department activities may affect tax treatment –Inconsistent IP use or licensing terms –Management of IP: Coordination of U.S. and foreign roles –Determinations of “significant” IP-which IP is valuable? Inconsistent or incorrect management of IP can compromise tax positions and undermine company IP

2008 OFII Tax Conference La Quinta, CA 7 IP Holding Companies Foreign Parent Subsidiary B: U.S. Manufacturer/ Seller License Subsidiary A: Patent Owner (U.S. or foreign) Sales Tax considerations –Exclusivity of license –IP licensed (patents, TMs, know-how, other intangibles) –Royalties and other consideration –Maintenance and subsequently developed IP Transfer Price 1 Transfer Price 3 Transfer Price 2

2008 OFII Tax Conference La Quinta, CA 8 In-Licensing U.S. Subsidiary Foreign Parent (Licensee) Sales Third Party Patent Owner Third Party License Intercompany License Tax considerations –Appropriate party for in-license –Comparability of third party license and other licenses (the inadvertent comparable) Royalty rates Terms –Familiarity of tax department with third party licensing practices Third Party License Transfer Price 1 Transfer Price Avoided

2008 OFII Tax Conference La Quinta, CA 9 Out-Licensing U.S. Subsidiary IP Licensee Foreign Parent (IP Owner) Third Party License Third Party Patent Owner Intercompany License Tax considerations –Appropriate party for out-license –Consistency with intercompany license (exclusivity constraints) –Scope of IP licensed –Inadvertent comparables Royalty rates Terms Third Party License Transfer Price 1 Potentially Inconsistent

2008 OFII Tax Conference La Quinta, CA 10 Acquisitions Foreign Parent Acquired Subsidiary (IP Owner) Tax considerations –Business pressure for rapid integration of target –Differences in licensing terms in existing structure and target Rates and terms Use of IP (licenses, transfers, sales and distribution agreements –Scope of IP licensed U.S. Subsidiary IP Licensee Intercompany License Transfer Price 1 Intercompany License Transfer Price 2 Sales

2008 OFII Tax Conference La Quinta, CA 11 Other Business or Corporate Considerations Sales Subsidiary Sales Subsidiary Parent (IP Owner) IP Considerations –IP complexity must be tracked and managed –Subsidiaries may jointly use and develop IP Tax Considerations –Consistency between subsidiary licenses and transfer pricing policies –Cross-subsidiary transfer pricing concerns

2008 OFII Tax Conference La Quinta, CA 12 Cost Sharing US IP Holder Cost sharing is a specific creature of tax Cost sharing participants “buy-in” to others’ IP Both have rights to use IP in respective territories Each uses or licenses IP to other affiliates Subsidiary Distributor—Foreign Manufacturing and Distribution Agreements Transfer Price 1 Cost Sharing Agreement Transfer Price 2 Subsidiary Distributor--US Foreign IP Holder Manufacturing and Distribution Agreements Sales

2008 OFII Tax Conference La Quinta, CA 13 Litigation—Protecting the Value of IP  Intercompany IP structures raise at least three critical issues in defending a pharmaceutical IP portfolio 1.Standing to Sue 2.Recovery of Lost Profits 3.Computation of Damages

2008 OFII Tax Conference La Quinta, CA 14 Basic Suit Requirements Patent owner must be a plaintiff Trademark owner must play an active role in maintaining trademark Exclusive licensee can be a co-plaintiff Exclusive distributor can be a co-plaintiff Non-exclusive licensees or distributors cannot be a co-plaintiff

2008 OFII Tax Conference La Quinta, CA 15 If the patent owner does not sell the product, the patent owner cannot recover “lost profits” from the sale of the product Here, separation of ownership and sales limited damages Poly-America L.P. v. GSE Lining Technology, Inc., 383 F.3d 1303, 1311 (Fed. Cir. 2004) Poly-America Parent Subsidiary B: U.S. Manufacturer/ Seller License Subsidiary A: Patent Owner (U.S. or foreign) Sales

2008 OFII Tax Conference La Quinta, CA 16 Lost Profits Issue: To what extent can a corporate organization recover lost profits when patent ownership is separated from the sale of the patented product or service?

2008 OFII Tax Conference La Quinta, CA Structure the relationship so that the sales made by the “selling company” are booked to the IP-owning company –Service Agreement –IP-owning company is the only plaintiff –These may not be consistent with company’s tax treatment 2. Name both the IP-owning company and the selling company as co-plaintiffs in the patent infringement suit Lost Profits—Potential Solutions

2008 OFII Tax Conference La Quinta, CA 18 No Agreement –No recovery of lost profits unless implied exclusive license can be shown Subsidiary Parent (Patent Owner) Sales Lost Profits Recovery—Scenario One

2008 OFII Tax Conference La Quinta, CA 19 Non-Exclusive License –No recovery of lost profits (Poly-America) –Note that nonexclusivity is also potentially inconsistent with the parent’s transfer pricing positions Lost Profits Recovery—Scenario Two Subsidiary (Manufacturer/ Seller) Sales Non-Exclusive License Royalty Parent (IP Owner)

2008 OFII Tax Conference La Quinta, CA 20 Exclusive License –Patent owner and exclusive licensee are co-plaintiffs –Co-plaintiffs can jointly recover full damages –Note that exclusivity is also often more consistent with the Parent’s transfer pricing positions Lost Profits Recovery—Scenario Three Subsidiary (Manufacturer/ Seller) Sales Exclusive License Royalty Parent (IP Owner)

2008 OFII Tax Conference La Quinta, CA 21 Non-Exclusive Distribution Agreement –Patent owner is only plaintiff –Patent owner can arguably recover “lost profits” from sale to subsidiary (but not from subsidiary to third party) Lost Profits Recovery—Scenario Four Subsidiary (Distributor) Sale Re-sale Parent (IP Owner/ Manufacturer) Non-exclusive Distribution Agreement

2008 OFII Tax Conference La Quinta, CA 22 Exclusive Distribution Agreement –Patent owner and exclusive distributor are co-plaintiffs –Co-plaintiffs can jointly recover full damages Lost Profits Recovery—Scenario Five Subsidiary (Distributor) Sale Re-sale Parent (IP Owner/ Manufacturer) Exclusive Distribution Agreement

2008 OFII Tax Conference La Quinta, CA 23 Service Agreement –All sales are booked to the patent owner –IP owner is the only plaintiff –Sales of infringing product cause losses to patent owner Lost Profits Recovery—Scenario Six Subsidiary (Manufacturer/ Seller) Contract Parent (IP Owner) Sales Service Fee

2008 OFII Tax Conference La Quinta, CA IP owner’s intercompany royalty rates may be used by other side to limit “reasonable royalty” damages 2. Similarly, IP owner’s distribution relationships may be used to limit “lost profits” claims Determining Damages

2008 OFII Tax Conference La Quinta, CA 25 The Internal IP and Tax Audit Understand Strategy Portfolio Review Documentation and Ongoing Processes Three overall goals for the IP and Tax Audit: 1.Identifying the uses of the IP portfolio 2.Managing portfolio’s tax and IP positions 3.Protecting the value of IP in litigation

2008 OFII Tax Conference La Quinta, CA IP and Tax— Managing Competing Considerations C. David Swenson – PricewaterhouseCoopers LLP (202) The views expressed in this presentation are not intended as, and should not be relied on, as legal or tax advice. The outcome of any independent situation depends on the specific facts and circumstances in which the issue arises and laws and regulations in effect at the time. © 2008 C. David Swenson – PwC LLP

2008 OFII Tax Conference La Quinta, CA 27 Intangible Property: The Intersection of Intellectual Property and Tax Concepts The Owner of an Intangible is Entitled to the Income Attributable to the Intangible for Tax Purposes. If the Owner of an Intangible Obtains Its Ownership Interest From a Related Party (e.g., a licensee), It must Pay Arm’s Length Consideration for the Transfer. If a Related Party Provides Services that Enhance the Value of the Owner’s Intangible Property Interest, the Owner must Pay the Service Provider Arm’s Length Consideration for those Services.

2008 OFII Tax Conference La Quinta, CA 28 Intangible Property: The Intersection of Intellectual Property and Tax Concepts The Treasury Regulations Contain Rules for Determining the Owner of Intangible Property for Tax Purposes. The Owner for Tax Purposes is the “Legal Owner” of All “Legally Protected” Intangibles (the Owner of “Legal Title”). A Party can be the Owner of a Limited Right in the Intangible (e.g., a licensee is the Owner of its Licensed Interest).

2008 OFII Tax Conference La Quinta, CA 29 Intangible Property: The Intersection of Intellectual Property and Tax Concepts The Party with “Control” Over “Non-Legally Protected” Intangibles is the “Owner” for Tax Purposes. The Tax Ownership Rules can be Disregarded Where the Legal Ownership is Inconsistent with the “Economic Substance” of the Transactions. Intercompany Contracts will be Respected Provided They are Consistent with the Economic Substance of the Transactions. The IRS may “Impute” Legal Ownership of an Intangible, if the Conduct of the Parties Indicates the Existence of such Ownership.

2008 OFII Tax Conference La Quinta, CA 30 Intangible Property: The Intersection of Intellectual Property and Tax Concepts How is “Practical Control” Determined for IP and Tax Purposes? What are “Non-Legally Protected” Intangibles: Know-how? Trade Secrets? Customer Lists? Human Capital (Workforce-in-Place)? Market Power? “First Mover” Advantage? Network Effects? Barriers to Entry? Business Opportunity? Goodwill? Going Concern Value? Is a “Workforce-in-Place” an Intangible for IP Purposes? Is it a Separate Intangible, or is it part of Goodwill or Going Concern value? Secondment of Employees – Can it Constitute a Transfer of an Intangible for IP or Tax Purposes?

2008 OFII Tax Conference La Quinta, CA 31 Intangible Property: The Intersection of Intellectual Property and Tax Concepts Cost-Sharing Agreements and Buy-Ins: Valuation Approaches and IRS Published Positions in Recent CIPs and IDDs. Impact of Refusal to Recognize Bona Fide Cost-Sharing Agreements by Certain Developed and Emerging Countries. Impact of a Recessionary Economy on Certain Profit-Based Pricing Methods and Intangible Property Valuation.