Last March, the Maryland General Assembly passed House Bill 732, which imposed a new “gross revenues tax” on digital advertising services. Governor Larry Hogan vetoed the bill in May. Earlier today, the Maryland State Senate completed the General Assembly’s override of the Governor’s veto, making the Maryland digital advertising tax the first of its kind in the United States.
House Bill 732 adds a new tax (imposed in a new Title 7.5) to the Tax General Article of the Maryland Code. This new law imposes a tax on annual gross revenues derived from digital advertising services in Maryland. The statute defines digital advertising services to include “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 is imposed on the portion of a taxpayer’s annual gross revenue derived from digital advertising services in Maryland, as determined using a fraction, the numerator of which is annual gross revenues of a person derived from digital advertising services in Maryland and the denominator of which is annual gross revenues of a person derived from digital advertising services within the U.S. Although the tax is imposed on Maryland revenue, taxpayers must determine their applicable tax rate based on their global annual revenues using generally accepted accounting principles. Thus, the tax owed depends largely on global—not Maryland—business activity. The tax begins at a rate of 2.5% for taxpayers with at least $100 million of global revenue and is as high as 10% for taxpayers with more than $15 billion of global revenue.
The bill requires the new tax to apply for taxable years beginning on or after January 1, 2021.
We anticipate challenges to House Bill 732 on many fronts. First, the tax’s definition of “digital advertising services” is vague and potentially runs afoul of the Internet Tax Freedom Act’s prohibition on taxes that discriminate against electronic commerce. Moreover, the bill’s reliance on global revenues to determine the tax rates and use of U.S. revenues in the apportionment factor denominator may raise Due Process Clause and Commerce Clause concerns. Furthermore, the United States government has aggressively opposed European and other foreign digital service taxes. Maryland’s new digital advertising tax undermines the federal government’s position on such taxes in violation of the United States Supreme Court’s Foreign Commerce Clause jurisprudence.
We note that the Maryland General Assembly is already considering amendments to this bill. As we mentioned in our prior blog post, New Year, New Digital and Data Tax Proposals, currently-pending Senate Bill 787 would prohibit taxpayers from passing the tax on to customers as a separate fee or line item. Thus, taxpayers would be required to either increase prices or absorb the tax in its entirety.
Despite potential challenges and infirmities with the Maryland law, the Maryland tax may open the floodgates to similar taxes. This copycat effect was seen most recently with the adoption of economic nexus and marketplace facilitator laws in the wake of the Wayfair decision, which were enacted by almost every state with a sales tax. As we mentioned in our prior blog post, New Year, New Digital and Data Tax Proposals, Connecticut, Indiana, Montana, New York, Oregon, and Washington have digital advertising, social media, or data tax proposals already pending early in the legislative process. Other state lawmakers have expressed an interest in similar measures to fill COVID-19 budget gaps. In light of the new Maryland digital advertising services tax, we expect a cascade of new proposals this year.
In addition to overriding the governor’s veto of the digital advertising tax bill, the General Assembly overrode the governor’s veto of House Bill 932, which extends the state’s sales tax to “digital products.” Maryland’s sales tax will now apply to sales of digital products, including permanent sales, sales of subscriptions, streaming, and various other forms of access to digital products. “Digital product” is broadly defined to include electronically transferred music, audiobooks, sound files (such as ring tones), motion pictures, live events, video games, e-books, newspapers, chat room discussions, weblogs, and numerous other enumerated items. Maryland joins a number of other states that have expanded their sales tax base to include digital products. These sales tax statutes require careful review because there are significant differences between the various states’ definitions of a taxable “digital product.” As with the digital advertising tax trend, we anticipate that additional states will move to impose sales taxes on digital products in the near future.