A full 11-justice panel of the 9th Circuit Court of Appeals in San Francisco sided with YouTube and rejected a court decision last year ordering the service to keep the "blasphemous video" off of its online stage.
Actress Cindy Lee Garcia pitched a legal battle based on an argument that her five-second appearance in the film gave her copyright authority enough to prevent it from being shown without her permission.
The snippet featuring the actress was taken from work she had done for a different film, and a dubbed-over line given to her character was offensive to the Islamic religion, according to her court case.
The film outraged members of the Islamic community around the world and prompted a fatwa to be issued calling for the deaths of all involved in the making of the video.
"In this case, a heartfelt plea for personal protection is juxtaposed with the limits of copyright law and fundamental principles of free speech," Justice Margaret McKeown wrote for the appellate court.
While expressing sympathy for the plight of the actress, the justices reasoned that "a weak copyright claim cannot justify censorship in the guise of authorship."
Censoring "Innocence of Muslims" violated the First Amendment right to free speech at a time of intense debate and interest in actions, according to justices.
The film calls Islam a "cancer" and has prompted often violent anti-American protests in more than 20 countries around the Muslim world.
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