In a development that should be a surprise to almost no one, a state district court judge invalidated Maryland’s digital advertising tax, which was slated to apply as of January 1, 2022, with the first filing and remittance due on December 31, 2022.
By way of recap, in 2021, Maryland passed legislation applying a special gross receipts tax on revenue earned from the provision of digital advertising services. “Digital advertising” being defined as “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services.” The bill contained a formula that would determine how much of a particular company’s advertising revenue should be apportioned to Maryland and the applicable tax rate was determined based on the taxpayer’s global annual gross revenue.
Challenges were immediately filed in both federal court and the Maryland state court system. Fundamentally, all the lawsuits contend that the law violates the Commerce Clause of the U.S. Constitution, the First Amendment and the Permanent Internet Tax Freedom Act (PITFA).
Even for a sales tax novice, the PITFA challenge is easy to understand. Under PITFA, states are precluded from taxing commerce that takes place over the internet in a way that’s more expansive than the same type of transactions taking place through traditional commerce channels. In other words, states can’t discriminate against internet commerce. Therefore, since Maryland does not tax traditional advertising services (e.g., billboards, magazine ads, etc.), PITFA precludes them from taxing internet advertising.
When the bill was passed, the Maryland Attorney General authored what can only fairly be described as a contorted analysis through which he concluded that the law could pass Constitutional muster. He said that the tax could be viewed as non-discriminatory against internet commerce since it applies equally no matter how the internet advertising might be purchased (over the phone, in person, over the internet, etc.). Even though a written order has yet been issued by the district court judge, it’s clear that this argument did not hold sway as the court ruled the law indeed violated PITFA.
What does this mean for other states’ digital advertising taxes?
While this lower court ruling will undoubtedly be appealed and the federal court action has yet to reach its conclusion, the interesting question right now is what this decision will mean to other states considering similar measures. In the last year or so, the question about how to apply taxes to digital transactions has received heightened attention across the country. Just last year, there were proposals in 17 states that would have expanded taxes on “big tech” including digital advertising (like Maryland’s), social media advertising and data mining.
Proposals to tax digital advertising have support on both sides of the political aisle. On the left, the perception exists that technology companies earn enormous profits and some of those profits should be used to fund education. On the right (at least in some quarters) there is a desire to punish tech firms for “de-platforming” our former president. From a non-partisan perspective, an argument could be made that digital advertising should be taxed. Companies like Google, Facebook and Twitter don’t make money from licensing software and services. We don’t pay to use Google and we’d probably have a collective freak-out if Google decided to charge people on a per-search basis. Rather, these companies offer their services for free and make their money by selling advertising. So, where other technology companies would pay sales tax on their software license fees or other charges, companies relying on advertising for the bulk of their revenue escape taxation. However, the plain and simple fact remains that PITFA precludes taxing digital advertising unless equivalent taxes against traditional advertising are likewise levied.
While none of these other bills were enacted into law apart from Maryland, things got close in states such as Connecticut and in the District of Columbia. It seems likely that states will try again in current and future legislative sessions. However, it likewise seems clear that states must consider the constitutional infirmities of the Maryland law as they work to draft new bills to generate additional tax revenue from tech giants.
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