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. As segmentation of the innovation market expands, acquiring innovations is part of many companies' strategic plan. For example, Intel acquired Oplus Technologies in early 2005 for Oplus's advanced video processing technology and then acquired Zarlink in late 2005 for its demodulation and tuner technologies. Intel used these combined technologies to complement Intel's core microprocessor technology, enhancing Intel's ability to control the consumer electronic market. Likewise, Boston Scientific acquired EndoTex Interventional Systems, Inc. for its NexStent Carotid Stent. This acquisition potentially provides Boston Scientific with the opportunity to incorporate the NexStent Carotid Stent into Boston Scientific's portfolio of available carotid artery products so it can expand its market. These examples beg the questions of how tax law currently treats innovation acquisition costs and whether that treatment stimulates further innovations vis-à-vis encouraging acquisitions of innovations to occur. 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 authors argue 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. Part I focuses on innovation development and the marketplace, discussing the increasing segmentation of the innovation market where startups and universities fill a special niche for major corporations and industries by serving as the incubation centers for ideas. Different methods of acquiring innovations and the available legal protection for innovations are explained to illustrate the dynamics of the marketplace. Part II reveals that licensing of innovations post-development and acquisition serves as the new model of business, representing a paradigm shift in business models. Both defensive and offensive uses of innovation are developing as the new mode of practice today. Part III illustrates flaws with the current federal tax regime governing innovations, namely its focus solely on the development market and its resulting failure to adequately incentivize desirable acquisitions of innovation. Part IV explores accelerated tax incentives for innovation acquisitions. 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. The Article concludes that the proposed options would encourage acquisitions of innovation for societal good and achieve tax policy goals such as efficiency and administrability.

Recommended Citation

Nguyen, Xuan-Thao. et al. “Acquiring Innovation.” American University Law Review 57, no.4 (April 2008): 775-819.