United States

IRS provides guidance on treatment of costs to acquire domain names

TAX ALERT  | 

The IRS recently released CCA 201543014 (the CCA) concluding that costs incurred by a taxpayer to acquire certain internet domain names from a secondary market for use in the taxpayer’s trade or business must be capitalized under section 263(a) and amortized over a 15-year period under section 197. The CCA addresses the acquisition of generic and non-generic domain names both in transactions that constitute the acquisition of a trade or business and in transactions that do not (i.e., where the acquisition of one or more domain names is from an existing holder but not as part of the acquisition of a trade or business). Under both scenarios, the IRS concluded that the costs to acquire the generic and non-generic domain names are subject to capitalization and amortization.

The treatment of costs to acquire domain names is unclear under current law, and the IRS’s ruling in the CCA is a step toward providing certainty for taxpayers that acquire and use domain names in their trade or business. However, while guidance in this area is welcome, the IRS’s holding may provide for a longer amortization period than some taxpayers are presently applying to their acquired domain names.

Discussion

The CCA reviews the following two situations regarding the purchase of domain names for use in the taxpayer’s trade or business:

(1)  The acquisition of both generic and non-generic domain names as part of the acquisition of a trade or business

(2)  The acquisition of generic and non-generic domain names from existing holders of the domain names but not as part of the acquisition of a trade or business

Non-generic domain names generally refer to a company or product name. Generic domain names, on the other hand, do not include a company or product name but typically describe a product or service using generic terms.  

In both situations the IRS’s analysis was based on the following assumptions: (1) each of the generic domain names is associated with a website already constructed, which will be maintained by the taxpayer; and (2) the taxpayer purchased the generic domain names for use in its trade or business either to generate advertising revenue by selling space on the website or to increase its market share by providing goods or services through the website.   

As a threshold matter, the IRS ruled that the costs to acquire both types of domain names are capitalizable under Reg. section 1.263(a)-4 (providing rules for the treatment of costs to acquire and create intangible assets) as such costs were incurred to acquire an intangible asset. The IRS then discussed each type of domain name (i.e., non-generic or generic) to determine whether the capitalized acquisition costs were subject to amortization.

Non-generic domain names

Under section 197 and the related Treasury regulations, amortizable section 197 intangibles include both acquired and self-created trademarks. Under Reg. section 1.197-2(b)(10), trademarks include any word, name, symbol, or device adopted and used to identify goods or services and distinguish them from those provided by others. The cost of acquiring trademarks are subject to amortization under section 197 regardless of whether the purchase is part of the acquisition of a trade or business.

Amortizable section 197 intangibles also include customer-based intangibles as described in section 197(d)(2) and Reg. section 1.197-2(b)(6). Customer-based intangibles include any composition of market, market share or other value resulting from the future provision of goods or services pursuant to contractual or other relationships in the ordinary course of business with customers. However, unlike trademarks, self-created customer-based intangibles are not considered amortizable section 197 intangibles unless the customer-base is created in connection with the acquisition of a trade or business.

Because a non-generic domain usually includes a company or product name, the domain name may be akin to a trademark that carries value apart from the name itself (i.e., similar to goodwill associated with the product or company name). Thus, as long as the non-generic domain name is used to identify goods or services and distinguishes them from goods or services provided by others, the domain name functions as a trademark and should be treated in the same manner even if the domain name is not registered as a trademark. The IRS ruled that in both situations (1) and (2) described above, a non-generic domain name that functions as a trademark should be treated as amortizable over 15 years under section 197.

Alternatively, the IRS ruled that non-generic domain names that do not function as a trademark (e.g., because the domain name does not distinguish the goods or services provided by the taxpayer from those provided by others) are properly treated as customer-based intangibles under section 197. In this case, since the domain names were acquired to provide goods or services through a website that was already constructed and will be maintained by the taxpayer, they are not self-created intangible assets. Thus, regardless of whether these domain names were acquired as part of the acquisition of a trade or business, the costs are still subject to amortization under section 197.

Generic domain names

The IRS stated that generic domain names should not be treated as trademarks since such a domain name does not reference a company or product but rather describes a product or service using generic terms people associate with the topic. However, generic domain names may still be amortizable under section 197 if the domain names are customer-based intangibles that are amortizable section 197 intangibles. Here, the generic domain names were acquired either to generate advertising revenue by selling space on the website or to increase the taxpayer’s market share by providing goods and services through the website. Thus, the IRS ruled that the domain names met the definition of a customer-based intangible as provided in Reg. section 1.197-2(b)(6). Further, although certain of the domain names were not acquired as part of the acquisition of a trade or business, because the domain names were associated with existing websites to be maintained by the taxpayer, the domain names should not be treated as self-constructed. Thus, the IRS ruled the acquired generic domain names in both scenarios (1) and (2) are subject to amortization under section 197 as a customer-based intangible.

Implications

The IRS’s ruling in the CCA represents a step toward providing clarity in an area that currently provides little guidance. However, despite the CCA, the treatment of domain names for federal income tax purposes is still subject to much ambiguity, and the IRS takes pains to stress that its conclusions are based on the assumptions that the domain names at issue are used in the taxpayer’s trade or business, are acquired from the secondary market, and are associated with existing websites. Thus, the CCA does not address how domain names that are acquired other than from the secondary market or that are not currently associated with an existing website should be recovered or whether they are amortizable at all. Additionally, the CCA may provide unwelcome news to taxpayers that are presently treating their acquired domain names as depreciable over a shorter useful life under section 167.

Taxpayers that are acquiring or have acquired domain names for use in their trades or business should work with their tax advisors to determine the appropriate treatment of such costs for federal income tax purposes. Such taxpayers should take time to determine whether and how the CCA will impact the present or anticipated methods of recovering such costs.

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