On February 12, 2021, the Maryland General Assembly voted to override Governor Larry Hogan's veto of House Bill 732, which carried over from the close of last year's legislative session and enacts the nation's first gross receipts tax on digital advertising targeted at Maryland consumers. The tax takes effect on March 14, 2021 and applies to all taxable years beginning after December 31, 2020. Legal challenges to the tax have already begun in the Maryland courts.
Overview of Digital Advertising Tax
House Bill 732 passed both the Maryland House and Senate with more than three-fifths support in March 2020, as the legislature rushed to consider legislation before adjourning for 2020 due to COVID-19 concerns. Governor Hogan vetoed the bill, leaving it in limbo until the legislature reconvened in 2021. The legislature's override of the governor's veto leaves companies with little time to determine their compliance obligations.
Who Is Subject to the Tax? The tax applies only to companies with at least $1 million in gross revenues from digital advertising services in Maryland and $100 million in global annual gross revenues. At this time, it appears that the tax would not directly apply to any companies based in Maryland. Rather, the intended targets of the tax are the large national internet-based advertisers.
What Ads Are Taxable? Taxable ads include banner and search engine ads and "other comparable" ads. This broad definition makes the scope of the tax unclear. The tax does not apply to traditional print advertisements.
What Is the Tax Rate? The tax rate ranges from 2.5% to 10% of gross receipts from digital advertising services, depending on a company's global annual gross revenues. The highest rate of 10% is imposed on companies with global annual gross revenues of more than $15 billion. The tax rate is dependent on global annual gross revenues, not revenues from Maryland digital advertising. Thus, for example, two companies with the same amount of Maryland digital advertising activity could be subject to different tax rates, depending on their global annual gross revenues.
When Are Digital Advertising Services "in" Maryland? The tax applies to annual gross revenues derived from digital advertising in Maryland. But the new statutory language does not provide guidance to determine when digital advertising services are derived in Maryland. Instead, the statute provides the Maryland comptroller with express authority to adopt regulations determining the state from which digital advertising revenues are derived. Digital advertising transactions do not occur in a discrete physical or geographic location, but rather in multiple movable locations. The Maryland comptroller could require companies to source digital advertising revenues to Maryland based on the IP addresses of its transactions. An IP address is a unique address for a device connected to the Internet, like a phone number. Determining the situs of a digital advertising transaction based on IP addresses would be an imprecise method that might not withstand legal scrutiny.
Potential Legislative Changes
The sponsors of the digital advertising tax recently introduced a new bill (SB 787) in the 2021 Maryland legislative session that would amend the tax to exclude broadcast and news media entities from the tax. The amendment would also clarify that companies subject to the tax cannot directly pass the cost on to customers through a separate fee. Of course, companies might indirectly pass the cost on to customers by raising prices across all customers so as to obscure the passing on of the new tax.
Legal Challenges
The digital advertising tax faces legal challenges on several grounds, an issue the Maryland attorney general has already noted in a legal memorandum issued to the Maryland legislature in August 2020. Specifically, since the tax is expected to apply only to out-of-state companies, it is subject to challenge on the grounds that the tax violates constitutional provisions that prohibit discriminatory taxes on out-of-state businesses. In addition, by taxing advertising, the law may violate the First Amendment to the Constitution, which protects freedom of speech. The potential ambiguities in defining digital advertising and determining when digital advertising transactions take place in Maryland may also invite a constitutional challenge. The tax may also violate the Internet Tax Freedom Act, a federal law banning discriminatory taxes on Internet commerce. That act arguably is violated, as the new Maryland tax is imposed only on digital advertising, but not non-Internet advertising, such as billboards or classified ads.
Digital Advertising Taxes in Other States
Several other state legislatures are considering taxes on digital advertising or sales of data, including New York, the District of Columbia, Connecticut, Washington state, West Virginia, Montana, and Nebraska. We expect that many more states will consider new ways of taxing the digital economy to raise revenues to make up for budget shortfalls caused by the COVID-19 pandemic. The litigation in Maryland challenging the digital advertising tax may serve to slow the progress of such new taxes in other states. Conversely, once resolved, such litigation may provide guidance for states on how to best impose taxes on digital advertising in a manner that circumvents the several challenges now being raised to such taxes.