Getting cells to make drugs counts as manufacturing for tax purposes, court rules

The Supreme Judicial Court ruled today that a biotech company that genetically modifies bacteria and animal cells to produce new drugs is engaged in manufacturing, which means it has to pay more state taxes.

The ruling is a victory for the state Department of Revenue, which had sought to avoid refunding some $3 million to Genentech for the years 1998 through 2004, years for which the company originally paid taxes based on the manufacturing formula but then sought refunds claiming it is not a manufacturer.

Although Genentech does not produce its drugs in Massachusetts, it has or had significant ties here, including researchers, clinical trials and a partner that would take its drugs and put them into capsules for sale; the state tax amount is based on an estimate of its revenues from the state.

To come to its conclusion that the revenue department was right, the state's highest court first reached back to earlier rulings that defined manufacturing as "the implication of change wrought through the application of forces directed by the human mind, which results in the transformation of some preexisting substance or element into something different, with a new name, nature or use."

And then it delved into how Genentech gets proteins for use against everything from diabetes to cancer, in which company scientists first modify the DNA of E. coli or Chinese-hamster ovary cells to produce a given protein, then grow the cells in vats, then use a series of purification steps to separate the protein from the growth solutions and, in the case of some cells, destroy them to release the protein.

With that, the court rejected Genentech's assertion it is engaged in something akin to mining, in which nothing major is done to the extracted final product:

Genentech argues its activities are comparable to mining. Unlike the extraction and crushing of rocks in the Tilcon-Warren Quarries case [in which a company that took large rocks and smashed them into smaller rocks was ruled not a manufacturer], however, Genentech is not merely paring something down to a smaller size. See 392 Mass. at 673. Nor do the cells that Genentech develops remain significantly unchanged. Rather, Genentech scientists and other employees, by hand or machine, implant DNA molecules into a cell to genetically transform the medium to behave in ways other than what its natural genetic code would dictate. Although the cells may replicate thereafter on their own, each genetically modified and replicated cell is different from the original cell in a most fundamental way. Moreover, the modified cell itself is far from the final product: it is the "protein of interest" that Genentech extracts from each of the modified cells and then purifies that serves as the source of each drug that Genentech then markets and sells.

As a fallback argument, Genentech also argued that even if it did "manufacture" stuff, it was not a manufacturer in "substantial part" because so little of its revenue was actually derived from manufacturing.

The court disassembled that argument as well, noting that that only applied if one included the billions of dollars of "revenue" Genentech derived from a cycle of investments and investment redemptions to meet short-term money needs, carried out by a company department of 3 to 7 employees - out of a workforce of roughly 4,700.

The court, noting the company did not include these billions in its excise-tax filings in California, said that idea was kind of silly:

We agree with the [Mass. Appellate Tax Board] that such a result is "distortive" of Genentech's operations, transforming, for Massachusetts corporate income tax purposes, this self-described biotechnology company with substantial revenue derived from sales of its specialty drugs into essentially an investment business.