Patents, Tax Shelters, and the Firm

Abstract

Since the landmark State Street decision of the United States Court of Appeals for the Federal Circuit, patentable subject matter has encompassed business methods, including tax investment strategies. Patents provide approximately twenty years of exclusive rights in the claimed method, in return for public disclosure in a published patent. Typically, the efficacy of specialized investment strategies will be diminished as they become generally known and so widely practiced; for this reason, many tax investment methods have been implemented under confidentiality agreements in order to prevent them from becoming widely practiced. However, patenting of such strategies may allow them to be practiced without confidentiality agreements, as the exclusive rights in the patent prevent the method from being generally adopted.

We examine the effects of the shift from confidentiality to exclusive rights by drawing upon our previous work regarding intellectual property and the theory of the firm. The theory of the firm predicts several effects of such a shift from use of confidentiality to use of patents, due to the potentially lowered transactions costs associated with the patent. For example, partner firms that are necessarily affiliated with investment transactions formerly had to be prevented from unauthorized use of knowledge gained in the transaction. This could be accomplished by means of confidentiality agreements, but such agreements are cumbersome and difficult to enforce. The high costs of negotiating, policing, and enforcing confidentiality agreements may have created pressure to bring as much of the transaction as possible in house. Patenting of the transactions may lower such costs, allowing more of the transaction to be outsourced.

Similarly, patenting may have an effect on the hiring, retention, and mobility of employees involved in such transactions. Employees who were skilled at such transactions formerly may have had difficulty changing firms, as they would be unable to take with them specific transactional skills learned under confidentiality agreements, or even describe such skills to a new employer. Patenting of the transactions removes the veil of confidentiality, allowing employees to discuss their skills with potential employers, even if the specific transactions cannot be used by the new employer. Assuming that tax shelter patents will be with us so long as there are business method patents, and that business method patents are for all practical purposes here to stay, we discuss the likely outcomes that tax shelter patents will have on the structure of investment firms and the mobility of skilled employees between such firms.

Keywords: patents, business methods, investment strategy, tax shelters, taxation, tax patents, intellectual property, theory of the firm

JEL Classification: O31, O34, K34, H21, H23, H26, L11, L21, L22