Acquiring Innovation

Abstract

In recent years, the innovation market has witnessed a new business model involving companies that are mere patent holding shells and not operating entities. They have no customers or products to offer, but they do have an aggressive tactic of using patent portfolios to threaten other operating companies with potential infringement litigation. The strategy is executed with the end goal of extracting handsome settlements. Acquisitions of patents for offensive use have become a major concern to operating companies because such acquisitions pose the threats of patent injunction, interrupting the business and crippling further innovation.

While many operating companies today know that innovation is the cornerstone of the technology and information based economy, not many companies today self-develop every segment of their end products or services. If a company cannot self-develop certain innovations, it can acquire the innovations. Purchases, transfers, and licenses of technology are common occurrences, which allow companies to achieve maximum results. Companies acquire innovations to supplement their research and development and ultimately strengthen their presence in the marketplace. Companies often turn to startups and young entities to acquire these supplemental innovations, generally in the form of promising intellectual property portfolios. These new business models beg the question: How should innovation acquisition costs be treated for federal income tax purposes? As a widely accepted principle of taxation, any expenditure that produces a benefit lasting beyond the current tax period should be capitalized. Under current tax policy, the costs of innovation development are not subject to this general capitalization principle, but can be deducted when incurred. In contrast, the costs of innovation acquisitions are subject to normative capitalization, as well as a host of irrational tax depreciation rules that differ depending on method of innovation protection, manner of procurement, and even method of payment.

This Article explores whether exceptions from asset-capitalization and rational tax depreciation rules are justified to reflect the realities of today's segmentation of the innovation market. The Article argues that the federal tax subsidy for innovation should not be limited to initial research, but should be expanded to cover desirable acquisitions in order to achieve optimal innovation outcomes and enhanced economic growth. This Article further explores accelerated tax incentives for innovations purchased for further development or licensing purposes. The addition of adequate economic incentives for select innovation acquisitions would reflect the realities of today's segmentation of innovation and serve to encourage a robust acquisition market.

One option explored is immediate expensing of limited innovation acquisition costs. Expensing would stimulate technological development, eliminate high administrative costs, and reduce harm caused by current irrational tax depreciation rules. Another option explored is an accelerated tax depreciation system for otherwise capitalized innovation acquisition costs. An accelerated depreciation system that takes into account retirement and revenue risks of innovation would serve to encourage desirable innovation acquisitions and reduce administrative costs for taxpayers and the government. So as not to negatively hinder innovation, both options are recommended for innovations acquired for further development or licensing purposes, but not for innovations acquired for offensive uses.

Keywords: intellectual property, intellectual property tax, taxation of intellectual property, patents, tax, tax policy, innovation, technology, patent reform, license, licensing, patent troll, offensive use, defensive use, acquisitions, expensing, depreciation, taxation, write-off, capitalized costs, develop