Taxing the New Intellectual Property Right

Abstract:     
Imagine you are counsel for a company that would like to capitalize on the heightened interest in popular culture surrounding a new breed of man who is well-groomed, interested in fashion, and unafraid to express his emotions. He is the “metrosexual”--as reported by the New York Times. In the literary genre this man is the counterpart to Bridget Jones from the best-selling book, Bridget Jones' Diary. Your CEO excitedly informs you that he has just bought the Internet domain name “men.com” for $1.3 million at an auction; and the company is going to build a Web site that will include tips on fashion and grooming, how-to advice, news, and literature, all for this new breed of man. Your CEO then asks you, “What are the tax consequences of purchasing this domain name?" You realize you have no answer. Of course, you know the tax consequences of purchasing traditional intellectual property assets such as patents, copyrights, and trademarks. But you have no idea what to do with this new type of intellectual property, especially when the name is generic, like “men.com.” The company could save or lose hundreds of thousands of dollars depending on your answer, so you promise your CEO you will get back to him as soon as you find out exactly where domain names fit in the current tax regime.

With the arrival of global electronic commerce transactions on the Internet, new forms of intellectual property rights, such as Internet domain names, have emerged. Today, Internet domain names are some companies' most valuable assets. Yet law professors, attorneys, and judges struggle with the legal nature of domain names, which is far from settled. Questions drawing recent attention include: How should domain names be valued? Can domain names be used as collateral in secured transactions, and how does one perfect a security interest in domain names? What will happen to domain names in bankruptcy? Another puzzling question, which has received little attention, is how should domain names be treated for federal tax purposes? Although there are tax rules governing traditional intellectual property rights, there are no rules dealing specifically with domain names. This article addresses these parallel questions: Are domain names merely variations of traditional forms of intellectual property and other intangible rights to which the existing tax regime can be applied? Or are domain names new intangible rights that need their own set of tax laws?

Current, albeit arbitrary, rules exist governing the tax treatment of traditional forms of intellectual property, such as patents, trade secrets, copyrights, trademarks, and trade names. Under present law, most patent creation costs are deductible when incurred, whereas patent acquisition costs are deductible either over an arbitrary fifteen-year period (if the patent was purchased as part of the acquisition of a trade or business) or the useful life of the patent (if the patent was purchased separately). Certain trade secret creation costs are deductible when paid or incurred, whereas others are deductible over fifteen years. Trade secret acquisition costs, however, are always deductible over fifteen years regardless of whether they were acquired separately or with a trade or business. Copyright creation costs are immediately deductible for some creators, but recoverable over the copyright's useful life for other creators. Copyright acquisition costs are deductible either over fifteen years (if the copyright was purchased as part of the acquisition of a trade or business) or the useful life of the copyright (if the copyright was purchased separately). The costs of building the goodwill in a trademark or trade name are deductible, whereas trademark and trade name acquisition costs must be recovered over an arbitrary fifteen-year period. Current rules also exist governing the tax treatment of other intangible rights, such as government licenses and service contracts, the costs of which are usually deductible over fifteen years.

While tax principles exist for these traditional intellectual property and intangible rights, specific tax rules do not exist for new intellectual property rights, such as domain names, that are emerging with the arrival of global electronic commerce transactions on the Internet. This article explores the proper tax treatment of domain name registration and acquisition costs. Part I of this article explains the rise of valuable domain names as a new intellectual property right having uncertain tax consequences. Part II analyzes the historical and current tax rules governing traditional intellectual property and other intangible rights. Part III then examines the legal nature of domain names to determine whether they can readily fit within the current tax regime for intangible rights. It also explores whether domain names should be treated for tax purposes as governmental licenses, service contracts, or intangible property; and, if treated as property, whether domain names can be classified within a category of intangible property covered by existing tax principles, specifically goodwill and trademarks.

Part IV of this article concludes that domain names that function as source identifiers should be treated under the current tax regime applicable to trademarks, so that costs of acquiring such domain names should be recovered ratably over fifteen years. Generic domain names, in contrast, possess “inherent” goodwill not dealt with by the existing intangible tax regime. The disparate treatment between domain names functioning as source identifiers and generic domain names illustrates the inadequacies of tax law in dealing with the expansion of intellectual property rights for existing intangible assets as well as the emergence of new intellectual property rights. Part IV criticizes the ad hoc response by administrative tax agencies in dealing with cyber-assets, and calls for Congress to revisit the current tax regime for intangibles. With the increase of global, electronic commerce transactions on the Internet, the nature of cyberspace will undoubtedly require new tax rules.

Accepted Paper Series