Patents, tax shelters, and the firm.

I. INTRODUCTION

The United States patent statute offers exclusive rights in any new and useful "process, machine, manufacture, composition of matter" or new and useful improvements on existing processes, machines, manufactures, and compositions of matter. (1) Courts have read this Congressional subject matter mandate broadly, to include "anything under the sun" developed by humans. (2) Among the processes covered by the patent statute lie a variety of innovative methods for accounting, investment, and other business strategies. (3) And among such patentable business strategies lie a variety of methods for sheltering income from taxation. (4)

Business method patents are relative newcomers to the patent system, having been formally recognized as patentable subject matter for a little less than a decade. Explicit realization that patentable business methods necessarily include patentable tax shelters seems to be even more recent. We are aware that this realization has been the subject of controversy, and even alarm, among practitioners of tax law--hearings have been held, opinions have been voiced, and legislative action has been demanded. (5) The general tenor of the reaction from the tax bar appears to be one of anxiety bordering upon panic.

But from the standpoint of patent law, none of this is particularly startling or even especially exciting. To be sure, there has been an enormous amount of discussion and controversy about the patenting of business methods. Patents are typically justified as an incentive for innovation. Numerous commentators have questioned whether such an incentive is really needed in the area of business methods and, if an incentive to innovation is needed, whether patents are the right mechanism to do the job. (6) But once business methods are allowed as patentable subject matter, the presence of tax shelters among such methods is neither much of a doctrinal novelty nor much of a surprise.

Consequently, in this article we examine certain effects of tax shelter patents but take the existence of tax planning patents as given, assuming that the die for such patents was cast well over a decade ago and is unlikely to undergo a reversal at this late date. As a matter of U.S. patent law, the emergence of tax planning patents was probably inevitable and is almost certainly irreversible. Accepting the patent status quo allows us to move to the more interesting question of how such patents are likely to affect the firms that specialize in tax planning and the employees who move between such firms.

In approaching these questions, we draw upon our previous work regarding the role of intellectual property in the theory of the firm. (7) We compare the emerging regime of tax investment patents with the confidentiality regime that has prevailed for investment methods in the tax planning industry. Moving beyond the standard costs and benefits analysis of patents as incentives for innovation, we discuss the likely impact of tax investment patents on the profession and industry of tax planning. We look in particular at the mobility of tax planning and investment professionals before and after the implementation of tax investment patents. We argue that the advent of tax investment patents may benefit members of the profession, as opposed to their opportunities under the alternative regime of confidentiality. In particular, it may lead to increased labor mobility and to greater entrepreneurial opportunities, with the growth of a new sector of start-ups specializing in innovative tax planning strategies. We finish by considering the social consequences of business method patents for tax planning strategies. We conclude that although the effects are mixed, and potentially negative on net, there is little that one can feasibly and desirably do within patent law to address the resulting problems without upsetting large parts of patent law.

II. BUSINESS METHOD PATENTS

The patentability of business methods has been manifest since the United States Court of Appeals for the Federal Circuit in State Street Bank (8) explicitly disclaimed any prohibition on the patenting of such methods, although the patenting of such methods clearly occurred on an intermittent basis even prior to State Street. (9) Patent doctrine had traditionally resisted the patenting of processes that might be carried out in the human mind, as well as the patenting of inventions consisting of written or printed indicia. (10) This for many years effectively precluded the patenting of the majority of business methods, most of which involved mental processes, written methods, or both. (11)

But these prohibitions were largely eroded by the gradual incorporation of software into the ambit of patentable subject matter. (12) While software is at its core a set of voltages in a machine, these are represented as a type of written code that can sometimes be read by humans and sometimes read by machines--a functional form of writing that "behaves." (13) Software also frequently implements calculations or numerical manipulations that could otherwise be carried out in the human mind. Consequently, the acceptance of software within patentable subject matter undermined the prohibition on which the preclusion of business methods from patent law was also grounded. (14) The implementation of business methods as software cemented this outcome, such that the State Street holding was primarily an admission of de facto practice.

This is not to say that business method patents have been placidly accepted or even that they have become uncontroversial. In one sense, the grant of any patent is a troubling practice; patents and other forms of intellectual property artificially raise prices, restrain trade, and restrict access to what would otherwise be a publicly available good. These costs of exclusivity are typically justified as being outweighed by the benefit of intellectual property as an incentive to investment. (15) Without some period of legal exclusivity to recoup the cost of investment in what would otherwise be a public good, little investment in new innovation would occur, resulting in the underproduction of technical and creative works. The precise contours of the optimal package of exclusive rights to encourage innovation is hotly contested, as both the actual benefits and actual costs of such a system are enormously difficult to quantify, and the correspondence between economic theory and real-world implementation is highly uncertain.

Given the uncertain ratio of cost to benefit for any patent, numerous commentators have challenged the expansion of patent law. Some have argued that on doctrinal grounds, the patent statute contemplates technological rather than business-oriented subject matter. (16) Other commentators have questioned the procedural feasibility of business method patents--the Patent Office has little expertise in evaluating business-related innovation. (17) Yet other commentators have challenged the policy basis for such patents; there is little evidence that development of business methods requires the extra incentive provided by intellectual property or that the costs of bestowing exclusive rights on such innovations will be exceeded by the social gain in business innovation. (18)

For all of these reasons, foreign patent examination corps, especially the European Patent Office (EPO) have been fighting a losing rearguard action to resist such patents, demanding that patent applications have a "technical" aspect to them--a criterion intended to exclude business methods and related subject matter. (19) But in the United States, given the structure of the patent system, patenting of tax planning methods was probably inevitable once software patents became the norm. (20) If software is patentable, some number of software implementations will be business related, opening the door to patenting of business methods. If business methods are patentable, some number of those business methods will concern investment strategies. If investment strategies are patentable, some number of those strategies will concern tax planning. QED.

We return to this question in more detail in Part VII, where we examine the desirability of business method patents for tax planning strategies. Here our point is that the specific questions regarding tax planning patents do not exist in a vacuum; they are inextricably tied to the general questions regarding business method patenting. Consequently, any discussion of the effects of tax planning patents must begin by considering the effects of business method patents; having considered the characteristics of the business method genus, we can turn to the peculiarities of the tax planning species. We approach both classes of patent from the standpoint of confidentiality and disclosure, since these are not only key considerations in implementing investment strategy, but are also key considerations in justifying the patent system generally. The issue common to all these contexts is the cost of controlling of valuable information, which frames the discussion of tax planning patents.

III. BUSINESS PATENTS IN AN EFFICIENT MARKET