Appeal of Novo Nordisk Inc.

Appeal of Novo Nordisk Inc., 2024-OTA-679P, decided by Administrative Law Judge Asaf Kletter, is a precedential Office of Tax Appeals (OTA) opinion addressing how a controlled group's research credit "fixed-base percentage" is computed after a group member with research expenses but no gross receipts merges out of existence. Novo Nordisk Inc. appealed proposed assessments for its 2012 and 2013 tax years arising from the Franchise Tax Board's (FTB) inclusion of $0 in gross receipts, but a full year of 2008 research expenses, incurred by Novo Nordisk Delivery Technologies, Inc. (Affiliate), in the taxpayer's fixed-base percentage calculation.

Background

Novo Nordisk's parent had licensed inhaled-insulin technology from Aradigm Corporation and formed Affiliate in 2004 to develop a commercial inhaled-insulin product using that technology. In 2008, facing faltering commercial prospects industry-wide, the parent abandoned the program: Affiliate ceased operations, laid off its 358 employees, sold its lab equipment and terminated its facility lease, and the parent terminated its license agreement with Aradigm, assigning back to Aradigm the related patents, the intellectual property Affiliate had developed, and its preclinical and clinical research data -- all at no cost. Affiliate later merged into its direct parent in 2010 and ceased to be a separate member of the controlled group.

No Disposition of a Viable Business

Because Affiliate incurred qualified research expenses (QREs) but no gross receipts in 2008 -- a year that fell within the controlled group's fixed-base percentage computation for the 2011 through 2013 credit years -- including that year's QREs on an aggregate basis would depress the group's fixed-base percentage and correspondingly increase the allowable credit. Novo Nordisk argued the group could exclude Affiliate's 2008 QREs under IRC section 41(f)(3)(B), which lets a taxpayer that disposes of the major portion of a trade or business exclude that business's prior expenses from its base-period calculations, but a disposition under section 41(f)(3)(B) exists only where a corresponding "acquisition" of a viable trade or business under section 41(f)(3)(A) occurred. OTA found that no such acquisition took place: Aradigm received only Affiliate's patents, license rights, and research data, not the fixed assets, facility, or trained workforce needed to continue operating an inhaled-insulin research and development business, and in fact Aradigm's own SEC filings stated it did not intend to continue that development itself but would instead try to out-license or sell the assets.

OTA distinguished this transfer from Treasury Regulation examples of a viable-business acquisition, where a predecessor ceases operations and the acquirer steps into essentially the same ongoing business using the transferred assets and goodwill. Because Affiliate transferred only intangibles unaccompanied by the operational capacity to continue the business, OTA held that the group did not "dispose" of a business within the meaning of section 41(f)(3), and Affiliate's 2008 QREs therefore had to remain in the controlled group's fixed-base percentage computation for the years at issue. The opinion also rejected Novo Nordisk's arguments based on the Aggregation Rule, the Consistency Rule, and a prior IRS determination reached under the federal alternative simplified credit method, finding none of them addressed the disposition question or bound OTA's independent determination.

Significance

Novo Nordisk is the leading California authority on how the section 41(f)(3) acquisition-and-disposition rules apply when a controlled-group member winds down research operations and licenses out its remaining intellectual property rather than selling an operating business, holding that the transfer of intangible rights alone, without the operational assets needed to continue the business, does not trigger the disposition exclusion from the fixed-base percentage calculation.