By Scott Booth and Timothy Gustafson

The Arizona Department of Revenue concluded in a Taxpayer Information Ruling that court-ordered proceeds from a patent infringement lawsuit were properly characterized as business income. The taxpayer held more than 200 patents that it developed or acquired for use in its own manufacturing process or patent licensing activities, one of which had been infringed by a competing manufacturer. The taxpayer filed a patent infringement lawsuit, which it successfully prosecuted, and was awarded a judgment intended to compensate the taxpayer for lost profits and reasonable royalties, plus punitive damages, attorney’s fees and interest. The taxpayer requested a ruling addressing Arizona’s corporate income tax characterization of the expected judgment proceeds. The Department determined the taxpayer’s ability to generate revenue was contingent upon effectively managing its patents. Accordingly, because the award was “the result of loss of business or royalties resulting from the patent infringement of a particular patent that was acquired by [the taxpayer] for use in its regular trade or business,” the Department concluded that the award was properly characterized as business income. The Department also determined that the income derived from the 931 total patents in the affiliated group’s manufacturing operations was at the “core of the group’s income producing capabilities,” and as such the income from the patent infringement lawsuit was properly treated as business income when viewed on the whole. Ariz. TIR LR13-004 (Released Nov. 2013).