Originally published on June 10, 2021 in ABA Tax Times, Vol. 40 No. 3 – Spring 2021
Maryland has become the first state in the nation to impose a tax on digital advertising services. It is certain not to be the last. While some states and the District of Columbia have abandoned, for now, attempts to impose similar taxes, several more—such as Massachusetts, New York, Texas and West Virginia—are currently advancing legislation nearly identical to Maryland’s Digital Advertising Gross Revenues Tax (the Maryland Tax) that are likely to be signed into law. Much has been written about the Maryland Tax’s numerous constitutional and statutory infirmities, which we explore below. At present, two lawsuits (one federal, one state) are challenging the tax on grounds ranging from the constitutional (i.e., the Supremacy, Commerce and Due Process Clauses) to the statutory (i.e., the Permanent Internet Tax Freedom Act (ITFA)). If the Maryland Tax is enjoined or otherwise declared unconstitutional or in violation of federal or state law, other states’ taxes may fall as similarly violative. But if the Maryland Tax survives judicial scrutiny as the sole tax on digital advertising services, the addition of such taxes in other states will only exacerbate the problems with this vague regime. It will likely open the door to interstate fights as the risk of double taxation under multiple, vague regimes increases.
The bill establishing the Maryland Tax (H.B. 732 or the Act) was introduced in the Maryland House of Delegates in the General Assembly’s 2020 regular session. Originally introduced as a bill affecting the taxation and regulation of vaping devices and other tobacco products, the Senate amended the House-passed bill to include provisions creating a digital advertising tax. The House concurred and the full General Assembly passed the amended legislation on March 18, 2020, but it was vetoed by Governor Lawrence J. Hogan, Jr. on May 7, 2020. Because the Assembly had already adjourned sine die, its first opportunity to override the veto came in the 2021 Regular Session. Both houses overrode the veto on February 11 and 12, 2021, thereby imposing the first-in-the-nation tax on digital advertising.
Under Maryland’s Constitution, when a gubernatorial veto is overridden, the earliest the bill can take effect is thirty (30) days following the veto. Thus, while the language of the Act provides that it would become effective July 1, 2020, the Act did not become effective until March 14, 2021. It currently applies to taxable periods beginning January 1, 2021. This year, however, S.B. 787 was introduced in the General Assembly’s current session to delay the affected tax periods by one year, to January 1, 2022 and to exempt certain broadcast and news media entities from the Maryland Tax, among other amendments. The Senate and House passed the bill and forwarded it to the governor on April 12, 2021.
On February 18, 2021, within one week of the Maryland Assembly’s override vote, the U.S. Chamber of Commerce and various trade groups filed a complaint in federal District Court for the District of Maryland initiating the proceedings styled Chamber of Commerce of the United States of America, et al. v. Franchot, Case No. 21-cv-00410. The lawsuit alleges several constitutional and federal statutory infirmities, including under the Commerce and Fourteenth Amendment Due Process Clauses, and ITFA.
The plaintiffs’ complaint seeking injunctive and declaratory relief alleges both constitutional and ITFA violations. The complaint alleges the Maryland Tax violates the dormant Commerce Clause in multiple ways, including that it regulates both in- and out-of-state activity; that it favors in-state companies; and that the tax creates a substantial risk of conflict with foreign governments or, otherwise undermines the federal government’s ability to speak with one voice on foreign affairs. It alleges violation of the Fourteenth Amendment Due Process Clause by punishing out-of-state conduct or activities—i.e., the tax base specifically includes gross receipts from outside the state of Maryland (and the United States). The complaint alleges that “[l]iability [for the tax] will be borne almost entirely by out-of-state companies based on their out-of-state conduct.” Finally, the complaint alleges that it violates the ITFA on two fronts: (i) as discriminatory; and (ii) as a “multiple” tax, because it is imposed on extraterritorial commerce that is already taxed by states in which the commerce takes place.
On April 15, 2021, Comcast and Verizon filed a separate complaint in Maryland state court challenging the Maryland Tax on grounds similar to those in the federal lawsuit, but on the additional grounds that it violates the Supremacy Clause and the Declaration of Rights in the Maryland Constitution. The state lawsuit does not seek the injunctive relief the federal plaintiffs seek.
Tax Base and Computation
The Maryland Tax is a gross receipts tax on “digital advertising services,” defined 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.” A “digital interface,” the Act provides, is “any type of software, including a website, part of a website, or application that a user is able to access.”
The Maryland Tax is imposed on annual gross revenues derived from digital advertising services in the state, defined as the “assessable base,” but companies earning less than $1 million in annual gross revenues from digital advertising services in the state will not owe any tax. The applicable tax rates progressively increase, as follows, depending on a taxpayer’s annual global gross revenues:
- 2.5% of assessable base if > $100 million in global annual gross revenues;
- 5% of assessable base if > $1 billion in global annual gross revenues;
- 7.5% of assessable base if > $5 billion in global annual gross revenues; and
- 10% of assessable base if > $15 billion in global annual gross revenues.
A taxpayer’s in-state annual gross digital advertising revenues is determined using an apportionment ratio, the numerator of which is “annual gross revenues derived from digital advertising services in the state” and the denominator of which is “annual gross revenues derived from digital advertising services in the United States.”
Reporting and Payment
The Act provides that any taxpayer with annual gross revenues derived from digital advertising services in the state of at least $1 million in a calendar year shall file a return on or before April 15 the next year. Any taxpayer that reasonably expects its annual gross revenues derived from digital advertising services in the state to exceed $1 million must file a declaration of estimated tax for a taxable year on or before April 15 and an estimated return in each succeeding quarter of that year. The taxpayer pays twenty-five percent (25%) of the estimated tax shown on the amended declaration. If a taxpayer fails to report and pay estimated tax of at least ninety (90%) percent of the tax required to be shown on the annual return, interest and penalties are assessed.
Although there is amending legislation to the Act, the Act’s requirements are now in place. Affected taxpayers that did not file declarations and pay estimated quarterly tax on April 15 are in technical violation of the law.
Current (Amending) Legislation
S.B. 787 was introduced in the General Assembly’s current (2021) Regular Session and has three, seemingly remedial, purposes—i.e., to delay by one year the initial tax period for the Maryland Tax; to prohibit taxpayers from passing on the Maryland Tax to their customers; and to exempt certain businesses from the Maryland Tax. Specifically, S.B. 787 makes the Maryland Tax applicable to tax years beginning January 1, 2022, as opposed to January 1, 2021. The legislation further prohibits a taxpayer subject to the Maryland Tax from “directly pass[ing] on the cost of the tax … to a customer who purchases the digital advertising services by means of a separate fee, surcharge, or line-item” (emphasis added). The statute does not, however, limit the prices a company can charge its customers for digital advertising services. Indeed, as Sen. Bryan W. Simonaire of the General Assembly noted, “[t]here is such a thing as ‘indirect.’”
S.B. 787 also excludes from the definition of “digital advertising services” any advertising services “on digital interfaces owned or operated by or operated on behalf of a broadcast entity or news media entity.” This part of the pending legislation appears designed to help local newspapers and television/radio stations and appears to give credence to its opponents’ arguments that the Maryland Tax will ensnare far more businesses than the mega-companies the Act’s authors contemplated. S.B. 787 defines “broadcast entity” as an entity that is “primarily engaged in the business of operating a television or radio station” and defines “news media entity” as an entity “engaged primarily in the business of newsgathering, reporting, or publishing articles or commentary news, current events, culture, or other matters of public interest.” “News media entity” does not include an entity “that is primarily an aggregator or republisher of third-party content.”
The amending legislation does not explain how a taxpayer should determine whether (i) a digital interface is operated on behalf of a broadcast or news media entity; (ii) an entity is “primarily engaged in the business of operating a television or radio station”; or (iii) an entity is primarily an aggregator or republisher of third-party content. In some cases, the answers to these questions may be obvious; but in others, especially involving companies with multiple business lines, the lack of statutory guidance is problematic. Also, many local news publications publish wire service (i.e., Associated Press or Reuters) stories and syndicated columns or stories written for other publications, with little original, local reporting. It is unclear how they would be treated under the plain text of the legislation—i.e., protected as a “news media entity” or excluded from protection as a republisher of third-party content. The language could be seen as including such entities as republishers. Presumably, these are all questions that the Maryland Comptroller will answer by rule.
As expected, Governor Hogan took no action on the amending legislation within the time designated by the Maryland Constitution for vetoing the bill. Accordingly, S.B. 787 automatically became law on May 30, 2021.
Maryland’s law is problematic in numerous ways. First is the lack of clear sourcing rules. While the Maryland Tax is imposed on “digital advertising services in the state,” the Act does not include sourcing rules or methodologies and leaves it to the Comptroller to “adopt regulations that determine the state from which revenues from digital advertising services are derived.” To date, no regulations have been adopted; but an earlier version of the Act, S.B. 2 (2020), provided sourcing would be determined based on the Internet Protocol (IP) address of the user’s device. Also, the Act’s legislative Fiscal and Policy Note suggests that sourcing under the Act will be based on Internet Protocol (IP) addresses. But, the Note points out, because many advertisements are viewed (i) on mobile phones that are, by their nature, not stationary, or (ii) via Virtual Private Networks (VPN) that shield a user’s location, there will likely be compliance issues. Further, it cannot be said that the Comptroller will not adopt, in addition to an IP address standard, the “known or reasonably suspected to be us[ed]” standard originally included in S.B. 2.
The apportionment formula creates more issues. The formula was included to placate critics who argued the Maryland Tax would potentially reach activity outside the state of Maryland; but it does little to resolve that issue: there does not appear to be a true apportionment of revenues, because the ultimate amount to be determined is the revenue from in-state digital advertising services—which is precisely what the Maryland General Assembly left to the Comptroller to determine. Also, though the Maryland Tax is computed against global annual gross revenues from whatever source (including non-advertising revenues), the apportionment ratio only includes U.S. revenues in the calculation. This has the obvious effect of increasing an affected taxpayer’s apportionment percentage and liability. By not providing full factor representation for all revenue subject to apportionment, it may violate the Commerce Clause by subjecting to tax in Maryland revenues from a taxpayer’s global advertising or other business services.
Nor does the Act appropriately define many of its key elements. It is unclear from the Act which advertising services are subject to the tax. Further, “digital advertising services” is written broadly to include not only specific, identified types of advertising but also “other comparable advertising services.” Additionally, the law likely runs afoul of the constitution and ITFA in myriad ways. It arguably violates ITFA as a discriminatory tax on electronic commerce, because it does not impose a similar tax on non-digital advertising revenues from print newspapers or radio. The Commerce Clause is implicated because the Maryland Tax arguably discriminates against out-of-state businesses in favor of in-state businesses. The First Amendment is implicated, too, because it arguably creates an impediment to speech on certain platforms or made in a certain manner. Finally, the Due Process Clause is implicated for multiple reasons, including the vagueness of the statute.
Other States’ Efforts
Maryland’s success at enacting the Maryland Tax, notwithstanding pending legal challenges, may put wind in the sails of states seeking to impose a similar tax. As noted at the outset, at least four states appear to have used Maryland’s legislation as a blueprint and are currently considering their own bills to tax digital advertising services. Indeed, S.1124 in New York; H. 3081 in Massachusetts; H.B. 4467 in Texas; and S.B. 605 in West Virginia would each define covered digital advertising services nearly identically, with substantially similar definitions, incidences of tax, tax bases and rates on a tiered-rate basis, depending on the taxpayer’s global revenue, with similar quarterly filing and estimated payment requirements. There are some notable differences: New York’s bill narrowly tailors its definition of “digital advertising service” to advertisements targeted at a specific individual; Massachusetts’ bill does not have an apportionment factor, provides a sourcing methodology based on IP addresses and other nebulous criteria, includes only three tiers of minimum and maximum rates higher than Maryland’s and based on revenues from all sources earned in the commonwealth, not globally; and Texas’ bill does not include an apportionment formula but expressly directs the Comptroller to consider using an apportionment formula to determine the portion of a company’s gross revenues derived from digital advertising in the state. Nonetheless, each state’s legislation is remarkably similar overall, including leaving much of the heavy lifting in determining compliance and enforcement to an administrative agency.
In New York, S. 1124 would enact the Digital Ad Tax Act (DATA) and establish a tax on digital advertisements. Though similar to the Maryland Act in most respects, including much nearly identical language, New York’s legislation is different in an important way. It expressly limits the term “digital advertising services” to those advertising services that “use personal information about the people the ads are being served to.” A. 734, another bill also moving through the New York State Senate’s current session to impose the state sales tax on digital advertising services, defines “digital advertising services” as “advertisement services on a digital interface, including advertisements in the form of banner advertisements, search engine advertising, interstitial advertising, and other comparable advertising services which markets or promotes a particular good, service, or political candidate or message.” Thus, both versions of New York’s digital advertising tax appear more narrowly tailored to those businesses that use an individual’s personal data to target specific advertisements to the individual. While much has been made of the Maryland Act’s sponsors’ and supporters’ focus on technology companies that use individuals’ personal data to target or otherwise market advertisements to them, the Maryland Tax’s reach is not limited like New York’s proposed tax to targeted advertisements.
In Massachusetts, H. 3081 largely tracks the language of Maryland’s and the other states’ bills, though it does not leave solely to the Commissioner of the Massachusetts Department of Revenue the duty to determine how a digital advertising service is sourced. The legislation still lacks sufficient clarity and presents a significant burden on taxpayers to know or be able to presume where a user’s device is located. Indeed, the legislation provides that “digital advertising services are provided in the commonwealth if the digital advertising services appear on the device of a user: (a) with an Internet Protocol address that indicates the users’ devices (sic) is located in the commonwealth; or (b) who is known or reasonably presumed to be using the device in the commonwealth.” This is similar to the language Maryland abandoned in the earlier legislative iteration of the Maryland Tax. Massachusetts does at least provide some legislative clarity on how a digital advertising service is sourced to the state—i.e., using an IP address, compared to Maryland and the other identified states that leave it solely to their tax administrators. Nevertheless, H. 3081 gives discretion to the Commissioner that is both vague and broad and burdens affected taxpayers with knowing or reasonably presuming that a user is using a device in the commonwealth.
As more states enact similar taxes, the potential for double taxation is great even if they have better sourcing rules. As noted above, there will always be problems determining whether a digital advertising service is in a particular state. Further, with multiple states leaving the sourcing rules to administrative agencies, there will be nearly as many sourcing rules as there are states imposing the tax. The potential for Commerce Clause and Due Process fair apportionment violations is thus significant. ■
 See, e.g., Jeffrey M. Stupak, The Internet Tax Freedom Act: In Brief, Congressional Research Service Report 43772 (Apr. 13, 2015) (ending the temporary extension and making it permanent as of June 30, 2020).
 S.B. 2, a bill to impose the Maryland Tax, was introduced in the Maryland Senate in the 2020 Regular Session. It was abandoned, with much of its language included in the Senate Amendment to the Act.
 There are already disputes with other nations that have gone down the road of taxing this type of activity.
 See Comcast of California/Maryland/Pennsylvania/Virginia/West Virginia LLC, et al. v. Comptroller of the Treasury of Maryland, C-02-CV-21-000509 (Circuit Court for Arundel County). Josh Zunbrun, et al., Trump Administration Proposes Tariffs against $2.4 Billion of French Goods, Wall St. J. (Dec. 2, 2019).
 Md. Legislators Override Gov., Pass Nation’s 1st Digital Ad Tax, Maria Koklanaris, April 12, 2021, Law360 Tax Authority.
 See Md. Const. Art. II, § 17(c). Under Maryland’s Constitution, a bill passed by the General Assembly must be presented to the Governor within six (6) days following adjournment of a legislative session. The Governor then has thirty (30) days to veto the bill. If the veto power is not exercised within the designated time, the bill automatically becomes law.
 See Fiscal and Policy Note, House Bill 732, at 10 (2020 Session).
 Ulrik Boesen, Maryland Lawmakers Provide No Solution to Central Issues with Digital Advertisement Tax, (Tax Foundation, March 11, 2020).
 Aruna Chittiappa et al, Maryland Becomes First U.S. State to Enact Controversial Digital Advertising Tax to Immediate Challenge (February 26, 2021), SeeSalt Blog, Pillsbury Winthrop Shaw Pittman LLP.