A Maryland judge has thrown out the state's controversial digital advertising tax, on the grounds that it is in violation of the U.S. Constitution as well as the federal Internet Tax Freedom Act.
Taxpayers that have been making estimated payments of the tax should be thinking about filing refund claims, according to Reed Smith tax partner Michael Jacobs.
The Maryland digital tax followed the lead of the Supreme Court decision in Wayfair, allowing states to expand their sales and use tax base to include digital transactions. Maryland was the first state in the nation to enact legislation taxing digital advertising.
Judge Alison Asti of Anne Arundel County Circuit Court held that the tax violates the Constitution's prohibition on state interference with interstate commerce. It also violates the Internet Tax Freedom Act, since it discriminates against electronic commerce.
The Digital Advertising Gross Revenues Tax would apply to annual gross revenues of at least $100 million from digital advertising services in Maryland. Under the act, digital advertising services are "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 law was enacted by the Democratic-controlled General Assembly, over the veto of Republican Governor Larry Hogan.
While digital advertising has been characterized as a tax on big U.S. tech companies, Republicans in the legislature celebrated the ruling as a boon to small businesses that depend on affordable advertising to market their services.
"Maryland has an existing income tax," observed Scott Peterson, vice president of U.S. tax policy and government relations at Avalara and the first executive director of the Streamlined Sales Tax Commission Governing Board.
"There's no reason why the state's current income tax wouldn't have already picked up income from those companies," said Peterson. "They might have been concerned that some companies don't have enough presence in Maryland to tax their income — sometimes sales tax nexus and income tax nexus are different in the same state, while sometimes they're the same. For instance, in Tennessee there still has to be physical presence in the state for an entity to be subject to income taxation."
Advertising is speech, and governments can't regulate speech, Peterson noted: "If they do, they have to show an overwhelming state interest. If they adopt laws that impact speech, they must determine that there's a legitimate state interest in treating one type of speech differently from another. That's why you can't yell 'Fire!' in a crowded theater."
The Permanent Internet Tax Freedom Act prohibits states from taxing e-commerce differently from non-e-commerce. "The first argument opponents make is, 'Show us in your law where you would tax a non-electronic version of the same thing.' If they don't tax the non-digital version, it's a violation of the act to tax the digital version," he said. "In this case, the law doesn't apply to the non-digital equivalent. Once a government starts to slice and dice advertising, and treat some speech differently from other speech, that's when they get into trouble."
It could be some time before the issues regarding Maryland's digital tax are settled. Verizon and Comcast were the plaintiffs in the just-decided state case, while a separate case with similar issues is pending in federal court, brought by the U.S. Chamber of Commerce. Oral arguments are scheduled for the federal case on Nov. 29, 2022. Meanwhile, Maryland attorney general Brian Frosh has said he would appeal the decision of the state court.
