EBay: Transfer Pricing Treatment of Domain Names in France

In an unprecedented decision that was recently made public, the Administrative Court of Montreuil (Tribunal Administratif de Montreuil) concluded EBay France had made an indirect transfer of profits abroad under Article 57 of the French Tax Code (Code Géneral des Impots) because it held the exclusive right to use the domain name ebay.fr and made it available to its Swiss parent company without receiving compensation beyond the reimbursement of registration and renewal fees associated with the name. ¹Ruling of the Tribunal Administratif de Montreuil of Feb. 9, 2012, no. 1000879.

This ground-breaking case addresses several important issues such as definitional aspects of intangibles, the valuation of domain names, and the arm’s-length compensation linked to the exploitation of a domain name.

Facts

Between 2003 and 2005, EBay France was a French legal entity 99 percent owned by EBay International AG, a Swiss legal entity. Both were subsidiaries of the EBay group. EBay France provided marketing and customer support services for the benefit of the Swiss entity, the latter running the business performed through the domain name ebay.fr. That name was registered with the Association Française pour le Nommage Internet en Coopération (Afnic), the association managing the registry of .fr domain names, under the name of EBay France. The registration dated from Ebay France’s acquisition and merger, in 2001, with the previous owner of that domain name, the French third party IBazar.

EBay France granted the right to exploit the ebay.fr domain name to EBay International for the purpose of conducting its business in France, and EBay International reimbursed EBay France for the registration and maintenance costs of the domain name, as well as for its marketing and customer support services.

In a tax audit covering fiscal years 2003-05, the French tax authorities:

• concluded that the right to use the domain name ebay.fr was an intangible asset that EBay France had failed to register on its balance sheet upon the domain’s registration under its name;
• argued that by granting access to the domain name to EBay International without consideration beyond the reimbursement of registration and maintenance costs, EBay France indirectly transferred profits to a nonresident related party;
• made a transfer pricing adjustment under Article 57 of the French Tax Code equal to 2 percent of the turnover realized by EBay International through the ebay.fr domain name to reflect what the French tax administration considered to be arm’s-length compensation to EBay France as the registered owner of the domain name; and
• treated the indirect transfer of profits abroad as a deemed distribution, subjecting the reassessed amount to withholding tax.

The FTA’s assessment of the withholding tax was challenged in court by EBay France and, in a decision dated Feb. 9, 2012, the Administrative Court of Montreuil confirmed the position of the tax authorities. It should be noted that the court ruled on the application of withholding tax on the deemed dividend distribution and not on the valuation of the ebay.fr domain name or the assessment of the arm’s-length compensation determined by the FTA. However, the ruling itself and the detailed conclusions of the rapporteur public
²Conclusions of the rapporteur public Eric Toutain, BDCF 2012, 82. (similar to the Advocates-General of the European Court of Justice), fully confirm the understanding and view of the FTA in all four considerations described above. No information is publicly available concerning the reasons why EBay France limited its recourse to the court to the withholding tax issue.

Definitional Aspects of Intangibles

One of the main aspects of the ruling is the confirmation of the approach taken by the FTA in the qualification of a domain name as an intangible asset. The Conseil d’Etat, the French Supreme Court, already established in its 1996 SA Sife ruling, ³Ruling of the Conseil d’Etat of Aug. 21, 1996, req. no. 154-488, SA Sife. that an intangible asset must be recognized on the balance sheet when:

• it is a source of future profits, either through direct use or by making the asset available to a third party;
• its use is sustainable, notably for a period exceeding the fiscal year of acquisition; and
• it can be separated from the activity and transferred.

Building on the SA Sife ruling and in order to address questions concerning the definition of intangibles in an electronic commerce context, the General Directorate of Taxes (Direction Générale des Impôts) in 2003 issued administrative guidelines ⁴Administrative Guidelines of May 9, 2003: BOI 4 C-4-03. covering the tax treatment of expenses linked to the creation or acquisition of websites. These guidelines explicitly state that costs linked to the registration or acquisition of domain names should be considered non-depreciable intangible assets to the extent that their duration is not limited in time and that the advantages from their exploitation would not cease at a predetermined date.

It should be noted that this administrative doctrine was modified through administrative guidelines issued in 2005, ⁵Administrative Guidelines of Dec. 30, 2005: BOI 4 A-13-05. which established that costs related to the registration and maintenance of a domain name were to be considered intangible assets in the balance sheet only if development and exploitation expenses related to the web site in that domain name were considered intangible assets and registered in the balance sheet, for which certain conditions had to be met. These administrative guidelines may have changed the analysis and conclusion of the court in the EBay France case; however, they did not apply in the tax audit period reviewed by the FTA.

Valuation of Internet Domain Names

From a transfer pricing perspective, this case provides important insight on the FTA’s approach in valuing domain names and offers an interesting contrast to the approaches currently being considered by the Organization for Economic Cooperation and Development in its work on Chapter VI of its transfer pricing guidelines.

In the case at hand, after determining that the ebay.fr domain name should be considered an asset in the balance sheet of EBay France, the FTA intended to estimate the value for which it should have been recorded. Under Articles 38 and 38 quinquies of Annex III of the French Tax Code, intangible assets acquired by a company must be registered on the balance sheet either at their purchase price or at their market value. Thus, the FTA concluded that the value to be attributed to the domain name in the books of EBay France should be 4.7 million euros ($6.1 million). This value was determined as the average of half of the acquisition price of the shares of IBazar (which had been 10.4 million euros—$13.5 million) and the value of the brand vis@sis as determined by the Vivendi group in 2000, the latter being considered a comparable transaction by the FTA.

The authors assert that this approach challenges both professional financial valuation practices and basic transfer pricing principles simultaneously as it effectively utilizes a valuation method determined as the average of two observations.

On the one hand, the approach relies on half of the value of the shares of IBazar acquired by the taxpayer. It is unknown what other assets were owned by IBazar at the time of acquisition by EBay France, but considering that exactly half of the value of the company consisted of a domain name, a generic rule of thumb appears to have been applied without taking into account the value of other potential assets—or the possibility that the target company was acquired only because it held the ebay.fr domain name.

On the other hand, the FTA refers to the value of a brand name, which does not fulfill the comparability factors required by transfer pricing principles to consider two transactions as comparable. A domain name is, according to the administrative guidelines mentioned above of May 9, 2003, “a term that is used to designate the address of the web site allowing for its identification in the network.” A domain name therefore represents the numeric internet protocol address through which a website is accessed on the internet.

A domain name is unique in that it allows users to locate a website; however, it does not encompass any unique color, shape, font, or other attribute, and it often simply leverages on an existing brand whose value was developed through marketing investment not necessarily made by the owner of the domain name. This is the case of the situation under review, where EBay France is a mere marketing and customer support service provider having no ownership of the EBay brand, the technology platform, or any other intangible asset used on the website located at ebay.fr.

According to the disclosed facts of the case, it seems that EBay International should be seen as the owner of the brand, at least in connection with the French business. Further, the acquisition of a domain name does not require investment or development effort beyond maintenance and safeguarding the name’s registration. In the authors’ view, from a transfer pricing perspective, a domain name should not be seen as different from a telephone number, no matter how memorable or recognizable it is. Consequently, a more appropriate approach to valuing the ebay.fr domain name would have been to compare transactions involving the sale of existing comparable domain names, and not brands, which have a totally different nature.

In the authors’ view, the lack of comparability of the third-party transaction and the general arbitrariness of the financial valuation approach employed by the FTA and supported, even if indirectly, by the administrative court and the rapporteur public seem to indicate an insufficient level of robustness required for such an exercise.

Compensation for Exploiting Domain Name

Beyond valuation aspects, the EBay case also sheds light on how the FTA expects the use of a domain name to be compensated in a related-party relationship. Taking an approach completely disconnected from the valuation of the domain name, the FTA made a transfer pricing adjustment equal to 2 percent ⁶The initial rate was 5 percent, according to rapporteur public Eric Toutain, BDCF 2012, 82. of the turnover realized by EBay International through the ebay.fr domain name to reflect what it considered arm’s-length compensation to EBay France as the registered owner of the domain name.

To determine an arm’s-length compensation for the use of an intangible, the OECD guidelines and French rules refer to the functions, assets, and risks of each of the related parties to the transaction in the context of the overall value chain of their businesses. In the case at hand, and based on the information available, it seems that EBay France recharged its domain registration costs linked to the ebay.fr domain name to EBay International. It also recharged all costs related to the performance of marketing and customer support services in France to the Swiss entity, which managed the business and brand development activities of EBay in Europe during the years in scope of the field tax audit.

When considering the functions, assets, and risks in relation to the ebay.fr domain name, and keeping in mind that a domain name is an intangible asset that does not require development or enhancement, the sole items that seem to be important to establish legal and economic ownership are the undertaking of administrative tasks to maintain and safeguard registration rights and the bearing of costs associated with these tasks. To the extent that EBay France prepared the necessary paperwork to become the registered owner of the domain name and periodically updated such paperwork and registration, the French entity could be considered the legal owner of the asset. On the other hand, because EBay International bore all of the costs linked to the exploitation of the domain name and, as implicitly suggested in the ruling, made all business decisions regarding the use given to that domain name, the Swiss entity could be considered the economic owner of the asset.

As a consequence, from a transfer pricing perspective, it seems that EBay International should not pay compensation for the continued performance of its business through the ebay.fr domain name because it actually was the economic owner of such name. It either owned or had a license to use most of the relevant intangible assets—the brands and the technology platform—linked to the website located under the domain name. It also directed and reimbursed EBay France for all its registration and management activities linked to the domain name as well as for marketing and customer support services.

No detailed information has been disclosed in the ruling about the accounting treatment given by EBay France of the acquisition and subsequent merger with IBazar and whether EBay International reimbursed the acquisition or investment costs; the authors assume that the Swiss entity led and funded the initial acquisition of IBazar by EBay France in order to obtain the ebay.fr domain name.

If this had not been the case, the FTA might have attempted to require the payment of an amount by EBay International to EBay France for the use of the ebay.fr domain name. However, given EBay France’s limited contribution to the value chain and its routine role, as well as the entrepreneurial function of EBay International, the payment likely would not have been significantly higher than the amount paid by EBay France for the domain name—4.7 million euros ($6.1 million) as determined by the FTA, or 10.4 million euros ($13.5 million) if the full price paid for IBazar was allocated to the domain name. In any case, based on these facts and assumptions, a 2 percent royalty over the life of the domain name appears to be excessive.

Unfortunately, EBay France does not seem to have challenged the 2 percent royalty amount determined by the court as compensation for the use of the domain name, although it is unclear whether it was a strategic decision not to do so.

Withholding Tax Effects

The transfer pricing adjustments made under Article 57 of the French Tax Code resulted in a secondary adjustment, as the lack of consideration paid by EBay International was considered as a deemed dividend from EBay France. As such, withholding tax was applied on the adjusted amounts in accordance with Sections 111-c and 119 bis 2 of the French Tax Code. Generally, dividends paid by a French taxpayer to a nonresident shareholder are subject to 30 percent withholding tax on net distributions, subject to reduction under tax treaties or European legislation. Under the Franco-Swiss tax treaty, a deemed dividend qualifies as dividend income and, as such, was subject to withholding tax at a 15 percent rate.

Conclusion

This case provides an unprecedented view of the approach by the FTA and French courts to deal with the transfer pricing treatment of domain names and has major implications for both the valuation of those names and compensation for their exploitation. The reasoning of the FTA and the court follows the assumption that if a domain name is registered under the name of a legal entity, the legal entity must receive brand-like compensation to allow any other entity of the group to exploit it, no matter what its actual value is or who the economic owner is. Similar reasoning often is employed in the context of administrative licenses such as marketing authorizations of pharmaceutical companies.

In a manner resembling the May 11, 2011, ruling in a case involving Nestlé, ⁷Tribunal Administratif Paris, May 11, 2011 (Nestlé). See 20 Transfer Pricing Report 1237, 4/5/12. the French courts have once again taken a hard-line approach on the reassessment of profits deemed indirectly transferred abroad, and also once again have accepted unconventional valuation methods proposed by the tax authorities to reassess the transactions.

Finally, the case demonstrates a continued focus by the FTA on transfer pricing transactions involving intangibles, mainly stemming from the fact that these present relatively straightforward opportunities for the administration to make significant adjustments. Based on this recent case law and current tax audits, it is clear that any intercompany operation may, and likely will, be challenged by the FTA—and held by at least the administrative courts—unless the taxpayer can provide solid analysis and counter-arguments. Therefore, in order to mitigate the risk of large adjustments leading to costly and lengthy processes, it is paramount that taxpayers take an “ex ante” approach to setting and analyzing their transfer prices.