Maryland Breaks Ground with Digital Advertising Tax

Sheppard Mullin Richter & Hampton LLP

Overriding the governor’s veto of H.B. 732 (2020), the Maryland Senate on February 12, 2021 passed the nation’s first state tax on the digital advertising revenues pulled in by large companies. This development follows attempts by various other states like New York to directly regulate digital advertising and ecommerce services in new ways. We took a look at the Maryland bill to find out what advertisers need to know about its details and potential pitfalls.

Maryland State Senate President Bill Ferguson said he was inspired to push the legislation by an op-ed essay authored by Nobel Prize-winning economist Paul Romer, who observed that the business models of online digital platform companies, particularly mega-companies like Google and Facebook, have undermined the public’s trust in democratic institutions by permitting their platforms to become “havens for dangerous misinformation and hate speech,” causing erosion of “the commons of shared values and norms on which democracy depends.” To encourage these companies to change to a “healthier, more traditional model,” he proposed that federal and state governments should tax the revenue from these targeted advertisements. At the state level, Romer suggested it could be done via “a type of sales tax on the revenue a company collects for displaying ads to residents of the state.”

The Maryland tax also reflects the collision of two economic forces magnified by the pandemic: While cities and states have seen their tax revenues plummet as the need for government-provided social services has skyrocketed, the tech giants have reaped landmark profits as social distancing has pushed work, leisure activities and commerce to online platforms in levels never before seen.

Large firms will be taxed for Maryland digital advertising services

The tax applies to annual gross revenues derived by large firms from digital advertising services in the state. Excluded from the tax are entities with less than $100 million in global annual gross revenue. From there, the tax rate increases based on the global annual gross revenues of the entity:

  • 5% for entities with over $100 million in global annual gross revenues
  • 5% for entities with over $1 billion in global annual gross revenues
  • 5% for entities with over $5 billion in global annual gross revenues
  • 10% for entities with over $15 billion in global annual gross revenues

Precisely what advertising services are subject to the new tax is laid out without much technical specificity in H.B. 732. While the global annual gross revenues laid out above to set the applicable tax rate apply to all revenue, those tax rates are then applied only to the annual gross revenues derived from digital advertising services in the state of Maryland. The law itself does not provide any rules for determining the state from which revenues from digital advertising services are derived, but instead authorizes the Maryland Comptroller to adopt regulations sourcing such receipts.

Digital advertising services are defined as any advertising services delivered on any type of software, website, or application that a person can access on a device. The bill does provide insight into a few types of advertising services that are specifically covered, including banner advertising, search engine advertising, and interstitial advertising. However, it also includes a vague catch-all: “and other comparable advertising services.”

Effective date and enforcement

H.B. 732 provides that the provisions relating to the Digital Advertising Services Tax are “applicable to all taxable years beginning after December 31, 2020.” However, because the bill was vetoed by the Governor and then overridden by the legislature on February 12, 2021, under the Maryland Constitution the bill cannot take effect until at least 30 days after the veto, or March 14, 2021. Still, there is some risk that the Comptroller could attempt to enforce the new tax retroactively back to January 1, 2021 despite the delayed enactment of the law, taking the position that the effective date of the bill does not impact the retroactive applicability date of the tax. Proceeds from the new tax are allocated to be distributed to education purposes in Maryland through the Blueprint for Maryland’s Future Fund.

Entities with annual gross revenues from digital advertising services in Maryland of at least $1 million must file a return by April 15 of the following year. The law establishes that willful failure to file the required return is a misdemeanor that can be punished by a fine of up to $5,000 and/or imprisonment of up to five years. Falsifying the required tax return is subject to penalty of perjury.

Big tech companies mount challenges

Legal challenges to the innovative tax have begun to surface as large technology firms whose digital platforms may be subject to the law try to prevent its enforcement. A lawsuit filed against the Maryland Comptroller by the U.S. Chamber of Commerce and various trade groups representing large tech companies challenges the digital advertising tax on three fronts. First, the complaint alleges that the tax violates the Internet Tax Freedom Act, a federal law enacted in the 1990s to combat discriminatory taxes aimed at electronic commerce. Second, the tech firms allege a violation of the Commerce Clause of the U.S. Constitution on multiple grounds, including that much of the regulated activity occurs out-of-state, that the law favors in-state companies, and that the tax imposes a substantial risk of conflict with the laws of foreign countries that should be handled on a federal level. Third, the case alleges a violation of the Due Process Clause of the Fourteenth Amendment to the U.S. Constitution on the grounds that the law punishes or regulates activities outside Maryland borders. The case was filed in the District Court for the District of Maryland on February 18, 2021, entitled Chamber of Commerce of the United States of America et al. v. Franchot, Case No. 21-cv-00410-DKC.

Additional constitutional challenges to H.B. 732 may be brought by other entities on First Amendment grounds, arguing that the law creates an impediment to speech on only certain platforms or made in a certain manner. Opponents may also argue the law is void for vagueness under the Due Process Clause and cannot be enforced constitutionally without risk of arbitrary enforcement.

What does this mean for advertisers?

Even if legal challenges to the new tax fail, further guidance will be necessary for firms to calculate which revenues will be subject to the tax. There are many unanswered questions, given the lack of specificity in the bill and this first-of-its kind tax. As of this writing, that guidance and the anticipated forms for the requisite tax filings have not yet been provided by the Maryland Office of the Comptroller. Those regulations may themselves bring additional challenges.

Amending legislation has already been introduced. S.B. 787 would exempt advertisement services on digital interfaces owned or operated by or on behalf of a broadcast entity or news media entity, and prohibit taxpayers from directly passing the cost along to advertising purchasers via a separate fee, surcharge, or line-item. Opponents have warned that the tax still will lead to higher prices for ads. As currently drafted, S.B. 787 would also delay the applicability date of the tax to January 1, 2022. As of this writing, S.B. 787 has passed the Senate and been referred to the House Ways and Means Committee, where it is scheduled for hearing on March 25. Legislation to tax digital advertising revenue has also been introduced in other states, including Texas (H.B. 4467), West Virginia (S.B. 605), Massachusetts (H.D. 3210 and H.D. 3601) and New York (S. 1124). This is definitely a trend for advertisers to keep an eye on going forward.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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