Princeton’s Royalty Windfall Leads to Challenge of Its Tax-Exempt Status

Hundreds of millions of dollars in patent royalties being paid to Princeton University and an emeritus professor for a chemistry-invention-turned-anticancer-drug could be the keystone of a new challenge to the university’s exemption from property taxes, thanks to a ruling last month by a Tax Court of New Jersey judge.

While Princeton officials say that losing tax-exempt status is an unlikely outcome, it wouldn’t be the first time a university’s research and commercialization activities had cost an academic institution its legal exemption.

Back in 2002, a federal appeals court ruled that major research universities, which conduct research to “increase the status of the institution and lure lucrative research grants, students, and faculty,” could not claim a “research exemption” as a defense against charges of patent infringement.

And lawyers who specialize in higher-education tax-exemption issues say that universities should get used to challenges like those. Governments at the local, state, and federal levels are “looking more closely and critically at how universities operate,” says Sean Scally, senior associate counsel and tax attorney for Vanderbilt University. That’s particularly true, he says, “when they get into the commercial and business space.”

In the Princeton case, where the tax-court judge, Vito Bianco, recently agreed to consider the issue, a group of property owners sued the university in 2011, challenging the tax exemption of more than a dozen university buildings. Those included structures housing  campus restaurants; Maclean House, which they contend in a brief is nothing more than the headquarters for “an elite high-level travel agency for Princeton alumni”; and Prospect House, which the plaintiffs’ lawyer, Bruce Afran, calls a catering hall where Princeton “has a wedding and bar mitzvah business.”

The property owners also contend that the university’s overall tax exemption should come into question because of its distribution of royalty payments to faculty members. Since 2004, when a new anticancer drug called Alimta came onto the market—based in part on the patented research of a former Princeton professor, Edward C. Taylor—the university has made hundreds of millions from it and has shared portions of that revenue with Mr. Taylor. (It shares revenues from other patents with other professors, too, but Alimta is the major source of its royalty income, and the major source of what the plaintiffs’ brief says was $118-million in royalties paid to faculty members from 2005 through 2011.)

The plaintiffs argue in their brief:

No one suggests that Princeton’s scientists and engineers should not share in the gains the university makes from their intellectual property, but the university cannot have it both ways under New Jersey’s exemption laws—it cannot claim exemption as a nonprofit organization that does not distribute profit, while intentionally commercializing for profit its intellectual property under a pre-existing policy of profit sharing with its faculty/partners.

Mr. Afran, noting that in 2009 the university also joined with Eli Lilly and Company in suing companies that were making generic versions of the drug, says Princeton has been “acting like a typical, aggressive pharmaceutical company” and, as such, merits additional scrutiny on its tax-exempt status. “These institutions are morphing into commercial entities,” he said in an interview last week. “That also means how government treats them will change.”

Princeton, of course, sees it differently. “The simple and irrefutable truth is that research and discovery are not part of a for-profit business operation conducted by the university, but are instead core components of Princeton’s not-for-profit educational mission, integral to fostering and maintaining a modern-day community of scholars,” it says in its brief. The brief also notes that the Bayh-Dole Act requires universities to share royalties with the faculty members who conduct federally financed research if it leads to commercialization.

Princeton’s vice president and secretary, Robert K. Durkee, says the judge’s ruling—denying a partial summary judgment and allowing the case to proceed partly on the plaintiffs’ arguments over the university’s paying of royalties—will require Princeton to explain to the court how research universities are financed. “We will take it seriously,” Mr. Durkee says, but ultimately, the institution is “very confident” that the case won’t be decided on that issue.

“The judge decided that he wanted the parties to more fully develop the facts in this case,” says Mr. Durkee. “The case will now proceed to trial, where the facts can be presented and assessed.”

Mr. Durkee also says it would be a stretch to think that the principles of the 2002 Duke v. Madey case apply in this one. “To deny the research exception because a university is taking on businesslike activities is not to assert that the university is no longer an educational institution engaged in teaching and research,” he says.

He also notes that even with the tax-exempt properties, the university is the largest taxpayer in Princeton. It paid $7.7-million in taxes to the Township and Borough of Princeton last year (including about $2.5-million on properties that it says might qualify for exemption if it sought it). Princeton also made a $2.48-million payment in lieu of taxes to the town. The two municipal entities have since merged.

This is not the first time Mr. Afran has sued Princeton. He also represented parties in several suits filed by local citizens who oppose the university’s plan to relocate the “Dinky” train, which links Princeton to the Princeton Junction train stop.

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