Maryland’s zombie digital ad tax is not dead

Eversheds Sutherland (US) LLPMaryland lawmakers are expected to revive a pair of failed controversial tax expansion proposals shortly after the scheduled start of the next legislative session on January 13, 2021. On May 7, Governor Larry Hogan vetoed H.B. 732, which proposed a first of its kind Digital Advertising Tax, and H.B. 932, which would have expanded Maryland’s sales tax to sales of digital products (both downloads and streaming). The Digital Advertising Tax was widely opposed by the business community and predicted to be immediately challenged due to its constitutional deficiencies. 

With veto-proof Democratic majorities in both the Maryland House of Delegates and the Senate, Governor Hogan’s vetoes were predicted to be overridden. However, veto override attempts may have to wait until the legislature reconvenes next year. The legislature adjourned sine die on March 18 and no special session is planned for the remainder of 2020, according to statements made on Sept. 16 by Senate President Bill Ferguson and House of Delegates Speaker Adrienne Jones.

Vetoes are generally handled during the first few days of a legislative session, giving taxpayers little time to convince lawmakers that the tax proposals will needlessly embroil the state in costly litigation and fail to produce the anticipated revenue. An additional wrinkle for these veto overrides was highlighted in an August memorandum by the state Attorney General’s Office which advised lawmakers that they faced legal risks if they override a gubernatorial veto while meeting online or outside the City of Annapolis. The General Assembly has yet to finalize its pandemic safety protocols for the upcoming session and the votes to override Governor Hogan’s vetoes could dwindle as lawmakers hear taxpayer objections to the legislation and weigh the costs of the inevitable legal battle.  

Eversheds Sutherland Observation: The General Assembly had the numbers to override the bills this year, but continued support for an override is not certain.

Maryland Senate has 47 representatives and the House of Delegate has 141 representatives. Supporters of the Digital Advertising Tax need 29 out of 47 members in the Senate and 85 out of 141 members in the House of Delegates to override the veto. Thus, either 19 members in the Senate or 57 members in the House would be required to sustain the veto. As H.B. 732 passed with three-fifths support of each chamber, some lawmakers would need to withdraw their support of the Digital Advertising Tax to defeat a veto override.

State officials have informally acknowledged that these bills will be subject to an immediate legal challenge, meaning that there will be no additional revenue to offset the anticipated legal costs. Eversheds Sutherland is working with a number of companies to develop a litigation plan.

Background on the Digital Advertising Gross Revenues Tax
 
H.B. 732 proposes a new tax on the annual gross revenues derived from digital advertising services in Maryland. The definition of “digital advertising services” broadly includes “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 rate varies from 2.5% to 10% of the annual gross revenues derived from digital advertising services in Maryland, but the rate is dependent on a taxpayer’s global annual gross revenues. To be required to pay the tax, a taxpayer must have at least $100,000,000 of global annual gross revenues, and at least $1,000,000 of Maryland annual gross revenues derived from digital advertising services. Penalties up to 25% may be imposed on underestimated quarterly installments of the tax.

Determining whether digital advertising taxes are “in Maryland” is problematic. The introduced version of the digital advertising tax proposed to source (and tax) digital advertising services to Maryland based on either: (1) a user’s IP address; or (2) the knowledge or reasonable suspicion that a user is using its device (which receives the advertising) in the state. However, the final version of the tax strikes these provisions. The legislation directs the Comptroller to adopt regulations that will entirely determine how to source digital advertising service revenues to the state.

The vetoed tax measures were intended to fund H.B. 1300, the Blueprint for Maryland’s Future (i.e., the Kirwan education reform package). The Governor also vetoed the education reform package.

Given the current economic climate, lawmakers may return to Annapolis with a change of heart in January, as the burdens of these taxes are likely to fall ultimately on Maryland’s small businesses and consumers who are already being hit hard by the struggling economy.  However, the desire of lawmakers to target companies that sell digital advertising may overshadow concerns about who will ultimately bear the tax burden.

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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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