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Acquisition Cost of Internet Domain Names Must Generally be Capitalized and Amortized.

(Parker Tax Publishing November 18, 2015)

The cost of purchasing an Internet domain name is not a currently deductible business expense but instead is generally capitalizable under Code Sec. 263 and amortizable under Code Sec. 197. CCA 201543014.

The correct tax treatment for the cost of purchasing an Internet domain name has been the subject of confusion among practitioners because of a lack of guidance in this relatively new and emerging tax area. Practitioners have been unsure whether the costs of acquiring domain names were currently deducible under Code Sec. 162 as trade or business expenses or were capitalized under Code Sec. 263 and either depreciable under Code Sec. 167 or amortizable under Code Sec. 197. The IRS Office of Chief Counsel (IRS) has now addressed the issue and nixed the idea that the expenses are currently deductible. In CCA 201543014, the IRS addressed the following three issues:

(1) Whether costs incurred by a taxpayer to acquire a generic Internet domain name (generic domain name) or a non-generic Internet domain name (non-generic domain name) from the secondary market for use in the taxpayer's trade or business are deductible under Code Sec. 162 or are required to be capitalized under Code Sec. 263(a)?

(2) If costs incurred by a taxpayer to acquire a non-generic domain name from the secondary market for use in the taxpayer's trade or business are required to be capitalized under Code Sec. 263(a), are these capitalized costs amortized under Sec. 197?

(3) If costs incurred by a taxpayer to acquire a generic domain name from the secondary market for use in the taxpayer's trade or business are required to be capitalized under Code Sec. 263(a), are these capitalized costs amortized under Code Sec. 197?

OBSERVATION: A generic domain name is not a company or product name, but rather describes a product or service using generic terms people associate with the topic. By contrast, a non-generic domain name is usually a company or product name. Besides providing the domain name holder's Internet address, a non-generic domain name is used to identify the particular good, service, and/or business that is associated with the website.

For the first two issues, due to a lack of facts, the IRS made the following assumptions: (a) each purchased domain name was associated with a website already constructed and would be maintained by the acquiring taxpayer; and (b) 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.

With respect to the first issue, the IRS noted that Reg. Sec. 1.263(a)-4(b)(1)(i) generally provides that a taxpayer must capitalize an amount paid to acquire an intangible asset. Reg. Sec. 1.263(a)-4(c)(1) provides that a taxpayer must capitalize amounts paid to another party to acquire an intangible from that party in a purchase or similar transaction and provides examples of intangibles requiring capitalization under this rule. One such example is a trademark. Thus, capitalization is required for an amount paid to another party to acquire a domain name that meets the definition of a trademark (as defined in Reg. Sec. 1.197-2(b)(10)), and is also required for an amount that is paid to acquire a domain name simply because the domain name is an intangible asset. Capitalization is required, the IRS concluded, regardless of whether the acquired domain name is a generic or non-generic domain name.

With respect to the second issue, the IRS advised that if the non-generic domain name is registered as a trademark or functions as a trademark, the capitalized costs of acquiring such a non-generic domain name from the secondary market for use in the acquiring taxpayer's trade or business meets the definition of a trademark and constitutes an amortizable Code Sec. 197 intangible. Alternatively, if the non-generic domain name does not meet the definition of a trademark in Reg. Sec. 1.197-2(b)(10) but will be used by the acquiring taxpayer in its trade or business to provide goods or services through a website that is already constructed and will be maintained by the acquiring taxpayer, the IRS advised that the capitalized costs of acquiring such a non-generic domain name meets the definition of a customer-based intangible in Reg. Sec. 1.197-2(b)(6) and constitutes an amortizable Sec. 197 intangible.

With respect to the third issue, the IRS concluded that if the generic domain name is associated with a website that is already constructed and will be maintained by the acquiring taxpayer, and the taxpayer acquired the generic domain name 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, the capitalized costs of acquiring such a generic domain name meets the definition of a customer-based intangible in Reg. Sec. 1.197-2(b)(6) and constitutes an amortizable Code Sec. 197 intangible.

Finally, the IRS said that if a purchased domain name is not an amortizable Code Sec. 197 intangible, then the domain name is an intangible asset subject to Code Sec. 167. The 15-year safe harbor provided in Reg. Sec. 1.167(a)-3(b), the IRS noted, does not apply because the acquired domain name is an intangible described in Reg. Sec. 1.263(a)-4(c). Therefore, such domain name is amortized under Code Sec. 167 only if the taxpayer can show a limited useful life pursuant to Reg. Sec. 1.167(a)-3(a). For purposes of Code Sec. 167, the IRS observed, the estimated useful life of an asset is not necessarily the useful life inherent in the asset but is the period over which the asset may reasonably be expected to be useful to the taxpayer in its trade or business or in the production of its income. Because a business usually intends to use a domain name for an indeterminable period of time, the IRS opined that the registration period of a domain name subject to Code Sec. 167 is not its useful life for purposes of Code Sec. 167.

For a discussion of the amortization of intangible, see Parker Tax ¶95,110. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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