The Maryland Legislature overrode gubernatorial vetoes on two bills that substantially change how Maryland approaches digital tax. The Legislature adopted a novel rule that seeks to tax digital advertising services. Additionally, it expanded Maryland sales tax to include digital equivalents of tangible personal property.
The concept of taxing the revenue earned by companies operating in the digital economy, while relatively new, is not novel. Over the last year or two, taxes on digital advertising have been enacted in Austria, France, Italy, Hungary (temporarily suspended), Turkey, Spain, and the UK.
From a policy perspective, a general sentiment exists that tax systems fail in effectively capturing revenue earned in the digital economy. Companies earn profits by directing advertising at the eyeballs around the world but the countries where those eyeballs reside are unable to tax those profits. Politically, the perception (exacerbated by the COVID-19 pandemic) is that digital companies have earned substantial profit while not always acting in society’s best interest. Therefore, taxing them a little bit more is not a bad idea.
Maryland Breaks New Ground
While this idea was considered in a handful of state legislatures last year, Maryland is the first state to tax digital advertising services, which the law defines 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 tax would apply to revenue earned in Maryland from said advertising (derived based on an apportionment formula), with the applicable rate varying based on the provider’s global annual gross revenue.
Putting political and social concerns to one side, the question is whether this levy violates the US Permanent Internet Tax Freedom Act (PITFA). Fundamentally, the PITFA prevents state and local governments from enacting discriminatory taxes on internet commerce. Essentially, you cannot pose a tax on commerce conducted over the internet unless an identical levy is imposed when the commerce takes place by more traditional means.
Is the Law Constitutional?
The Maryland Attorney General suggests it is possible if you view the prohibition from the perspective of how digital advertising is sold. Basically, a tax on digital advertising is discriminatory if it is only charged when the buyer and the seller complete their transaction over the internet. When the tax is levied equally, regardless how the buyer and seller effectuate the sale (over the phone, in-person, over the internet), then it is constitutional.
However, if you view the prohibition from the type of good or service being sold, you reach a different result. The tax becomes discriminatory (and thereby unconstitutional) because Maryland does not impose a similar tax on the revenue earned from providing advertising transmitted to Maryland residents by traditional means (print, television, radio, etc.).
The Maryland AG added that since the PITFA intrudes on a matter generally left to state governments, the prohibition must be construed narrowly and will only stand if tied to a “clear and manifest purpose of Congress.” Under this heightened standard, the tax should stand unless it is completely clear that Congress intended to prohibit it.
What’s Next?
The bill makes the tax effective for all taxable years beginning after December 31, 2020. Under Maryland law, bills enacted pursuant to a veto override generally take effect 30 days after the override. In this case, the law becomes effective in mid-March. However, much is left to be determined. For example, the Maryland Comptroller must adopt regulations specifying how companies determine what constitutes advertising revenue earned in Maryland. The legislature is also expected to adopt a bill prohibiting companies from directly passing this tax on to consumers. Finally, a legal injunction could prevent any enforcement until the Constitutional question is settled by the courts.
In any event, the fate of the Maryland Digital Advertising tax will influence other states considering similar levies, including Connecticut, Indiana, Nebraska, New York, Oregon, South Dakota, and Washington. If the law survives legal scrutiny it could absolutely trigger a legislative avalanche.
In an upcoming blog, we will discuss Maryland’s concurrent decision to extend its sales tax to digital products – a move that is squarely less controversial and more likely to become effective in the very near term.
