By JON NEWBERRY
Business Courier of Cincinnati

Procter & Gamble Co. has won what could turn out to be a significant legal battle in its quest to recoup $435 million it paid in back taxes and interest to the IRS.

The consumer-products giant sued the federal government a year ago, contending that the Internal Revenue Service erred when it disallowed hundreds of millions of dollars in tax deductions P&G had claimed. The deductions were based mainly on its estimated "fair market value" of drug patents that P&G donated to colleges and universities from 2001 through 2004.

The IRS's fair-value estimates were much lower - just 20 percent of the $908 million that P&G claimed over that period for 28 donations to various recipients.

U.S. Magistrate Judge Hon. Tim Black in Cin-cin-nati ruled on Aug. 24 that, with limited exceptions, the IRS can't base its value assessment on developments that occurred after the patents were donated. The IRS had sought to subpoena information from the recipients of P&G's patents, including whether the donated technologies had generated any revenue after they were donated and whether any of the patents had been abandoned or allowed to lapse.

P&G argued that events after the date of the donations were irrelevant. The sole issue to be considered was the value of the technologies as of the dates they were transferred, on which subsequent events had no bearing, it said. Since events that happened afterward could not change the previously established value, post-donation information should not be subject to subpoena by the IRS, it said.

The judge agreed with P&G.

Brian Harris, the IRS's trial lawyer in Washington, D.C., declined to comment on the ruling. Mark Vander Laan at Dinsmore & Shohl LLP, who's representing P&G, did not respond to requests for comment.

P&G has declined to disclose publicly what has happened to the patents it donated. It did file a copy of one of its appraisals with the court, however, which shows how its estimate of fair value was derived. It is a valuation of P&G's "Cox-2 inhibitor" drug technology, which includes a group of 12 patents for a compound P&G began developing in 1984 to reduce pain and inflammation.

The technology had possible applications for the relief of arthritis and menstrual pain as well as the treatment or ulcers, cancer, Alzheimer's disease and animal health.

P&G donated the Cox-2 technology to Vanderbilt University in 2001 in keeping with a strategy to dispose of patents that were not part of its strategic focus. P&G has since decided to get out of the pharmaceuticals business altogether, agreeing just last month to sell it for $3.1 billion.

According to the May 2000 valuation report by PricewaterhouseCoopers LLP, the technology donated to Vanderbilt had a fair market value of $43 million. That value was based on a host of wide-ranging estimates related to the odds of obtaining regulatory approval at various stages, the cost of continued development, the future market for Cox-2 inhibitors and the market share P&G's compound could be expected to attain.

The report detailed eight possible outcomes, the market value each would entail based on future cash flows and the probability of each outcome. It assumed that the technology had only a 15.6 percent chance of successfully reaching the consumer market.

More than $22 million of the $43 million total was based on a slim - 1.6 percent - probability that the compound would be a huge commercial success. Under that scenario, it would be worth $1.4 billion, generating annual sales of more than $5 billion by 2012 after entering the market in 2008.

Things have turned out quite differently.

Vanderbilt has done little to commercialize the compound. A spokesman in Nashville said it incorporated some of P&G's technology into its research but that its technology-transfer office could not tell him more precisely what had become of it. The university's primary Cox-2 researcher left for a position elsewhere in 2006, he said.

At least two other of P&G's 28 donated technologies also have made little progress toward commercialization.

Technology used to measure the release of volatile organic compounds during manufacturing, which was donated to the Mid-west Research Institute in Kansas City, was licensed back to P&G. An MRI spokeswoman said P&G uses it for making powdered detergents. It is not licensing the technology to anyone else, she said.

P&G claimed that the technology donated to MRI was worth $17 million. The IRS allowed it only $171,000.

In another instance, P&G claimed a deduction of $87 million for drug technologies that had shown potential for treatment of cancer, HIV and hepatitis C. The IRS said they were worth only $15 million. Those patents were donated to the University of Arizona Foundation in 2003 and are still years away, at best, from commercialization.

Bo Statham, hired by the University of Arizona Foundation to manage the P&G technologies, said the compounds showed potential for treating seven different cancers.

"I'm sure P&G's valuation was based on the development of one or two breakthrough cancer drugs, and HIV and hepatitis C," he said. "If you did any one of those, you'd have a gangbuster drug."