Recently, the IRS released Chief Counsel Advice (CCA) 201543014, which provides guidance on the tax treatment for the costs of internet domain names. Essentially, the IRS determined that the costs of acquiring domain names are to be capitalized under Sec. 263 as intangible assets and that those costs should be amortized under Sec. 197 over a 15-year period.
In the CCA, a company acquired internet domain names on two separate occasions. In 2013, the company acquired two internet domain names as part of an asset acquisition of a trade or business. A portion of the total purchase price of the acquisition was allocated to each domain name. One domain name was considered to be a generic name, and the other was considered to be nongeneric (both of which are defined below).
In 2014, the same company purchased two more domain names, one generic and one nongeneric, from existing holders. Neither purchase was part of a larger asset acquisition. All four domain names were to be used in the taxpayer’s trade or business. No other facts were provided.
The CCA defines the term “generic” as not being a company or product name, but instead a generic term used to describe a product or service. A nongeneric name is the name of a company, product, or service. Additionally, a nongeneric name is used to identify a specific company, product, or service that can be clearly distinguished from all the other companies, products, or services within the industry. Also, nongeneric names can sometimes, depending on the circumstances, meet the definition of a trademark as defined in Regs. Sec. 1.197-2(b)(10).
Capitalizing vs. expensing
CCA 201543014 addresses three issues regarding the acquisition cost of domain names. The first issue is whether the cost the taxpayer incurred to acquire a generic or nongeneric domain name from a secondary market and then used in the taxpayer’s trade or business is currently deductible under Sec. 162 or must be capitalized as an intangible asset under Sec. 263. The IRS concluded that the costs must be capitalized because the cost of the domain names will provide a future benefit to the user, regardless of whether the domain name is generic or nongeneric. Therefore, the cost of the domain name should be capitalized under Sec. 263. Sec. 263(a) provides that “no deduction shall be allowed for—any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate, … [or] any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made.”
Additionally, Regs. Sec. 1.263(a)-4(b)(1)(i) requires a taxpayer to capitalize any amount paid to acquire an intangible, and Regs. Sec. 1.263(a)-4(c)(1) also provides a taxpayer must capitalize amounts paid to another party to acquire any intangible asset from that party in a purchase or similar transaction. Clearly, the IRS takes the position that a domain name is an intangible asset in which the costs must be capitalized under Sec. 263 and not deducted currently under Sec. 162.
Amortization of nongeneric domain
The second issue is whether the cost incurred by a taxpayer to acquire a nongeneric domain name from a secondary market and used in the taxpayer’s trade or business qualifies for amortization under Sec. 197 or if the domain name has an indefinite life for which the cost cannot be amortized. The IRS has concluded that the cost incurred to acquire a nongeneric domain name used in the taxpayer’s trade or business is an amortizable Sec. 197 intangible asset. A nongeneric domain name will qualify for amortization as either a trademark as defined in Regs. Sec. 1.197-2(b)(10) or as a customer-based intangible as defined in Regs. Sec. 1.197-2(b)(6).
If a nongeneric domain name meets the definition of a trademark in Regs. Sec. 1.197-2(b)(10), it qualifies as an intangible asset to be amortized over 15 years. Regs. Sec. 1.197-2(b)(10)(i) defines a trademark as including “any word, name, symbol, or device, or any combination thereof, adopted and used to identify goods or services and distinguish them from those provided by others.” It further states “a trademark or trade name includes any trademark or trade name arising under statute or applicable common law, and any similar right granted by contract. The renewal of a franchise, trademark, or trade name is treated as an acquisition of the franchise, trademark, or trade name.”
If the nongeneric domain name does not meet the IRS definition of a trademark but will be used in the taxpayer’s trade or business to provide goods and/or services through a website that the taxpayer has already constructed and maintained, the capitalized costs meet the definition of a customer-based intangible asset under Regs. Sec. 1.197-2(b)(6). Regs. Sec. 1.197-2(b)(6) states “a customer-based intangible is 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.” Therefore, regardless of the classification of the nongeneric domain name (trademark versus customer-based), the costs of acquisition qualify for amortization over 15 years under Sec. 197.
Amortization of generic domain
The third and final issue is whether the cost incurred by a taxpayer to acquire a generic domain name from a secondary market for use in the taxpayer’s trade or business qualifies for amortization under Sec. 197. The IRS has also concluded that the cost incurred to acquire a generic domain name used in the taxpayer’s trade or business is an amortizable Sec. 197 intangible asset. Since a generic domain name only describes a product or service and does not identify a specific company, product, or service, it does not meet the regulation’s definition of a trademark. However, if the domain name is associated with a fully constructed and maintained website and used in the taxpayer’s trade or business, the domain name will qualify as a customer-based intangible under Regs. Sec. 1.197-2(b)(6), which can be amortized over 15 years.
CCA 201543014 is predicated on two assumptions: (1) Each purchased domain name is associated with a website already constructed and maintained by the acquiring taxpayer; and (2) the taxpayer purchased the generic domain name for use in the taxpayer’s trade or business either to generate advertising revenue by selling space on the website or to increase the taxpayer’s market share by providing goods or services through the website. The facts surrounding the company specified in this CCA were silent to these two conditions. Additionally, CCA 201543014 does not apply to any self-created intangibles under Sec. 197(c)(2).
Given the assumptions of CCA 201543014, the IRS’s position is straightforward. Domain names, regardless of classification as generic or nongeneric, must be capitalized under Sec. 263 and amortized over 15 years under Sec. 197, assuming the domain name is not self-created. However, the IRS’s position remains unclear if the domain name is not currently associated with a website that is already constructed and maintained by the acquiring taxpayer or if it is not used to generate advertising revenue or increase the taxpayer’s market share. In other words, this CCA does not address the tax treatment of domain names acquired for resale or for investment purposes.
Richard Ray is an assistant professor in the College of Business at California State University in Chico, Calif.