We have seen how digital advertising sales have been eclipsing traditional advertising, and states' increasing interest to cash in on this potential new revenue stream — especially with many jurisdictions facing the prospect of no more federal funding grants and interest rates that make it a challenge to borrow.
Maryland has become the litmus test for how states approach the taxing of digital advertising sales and, thus, taking a chunk of the massive ad revenues generated by large technology companies.
In early 2020, state lawmakers passed legislation that would tax revenue on digital ads served in Maryland. The bill was initially vetoed by then-Governor Larry Hogan on the basis that it would not only have an adverse impact on business in the state, but likely was also unconstitutional.
In February 2021, Maryland's legislature overrode the governor's veto, but delayed implementation of the tax to address any legal questions. The tax went into effect in January 2022 and has since been tied up in both state and federal litigation. Last October, a judge struck down the law.
A tenuous legal situation
Indirect taxes in the digital world have been evolving since the first online sales began. Now, it's appropriate — and legal — to tax the purchase of digital goods and services, and many states have taxed the sale of goods and services for some time. Purchasing a digital album online is taxed the same way as if you bought that album in person at a store. To date, at least 33 states collect taxes on digital streaming services. This has become the norm. However, in this instance, when we speak of "digital taxation," we are referring to a specific regime taxing digital advertising, and not the taxation of digital goods or market intelligence from digital marketing platforms, as cited above.
There are a lot of transactions in the digital space that aren't simply retail consumer purchases. First comes the "digital exhaust," the ancillary things created when people use the internet. This could include digital intelligence on purchases or marketing information that can inform what products you see when you visit a website. This extra information that is bought and sold is also legally taxable.
Maryland's misstep is in the next level of digital detritus — online advertising. There has not been a legal mechanism put into place in any U.S. jurisdiction so far that taxes digital advertising. States are trying to make a path toward that revenue stream, but a tax solely on digital advertising was not the way to do it.
The
- The Maryland Digital Advertising Gross Receipts Tax violates the Supremacy Clause of the U.S. Constitution and the Internet Tax Freedom Act because it constitutes a discriminatory tax.
- The tax violates the Commerce Clause of the Constitution because the tax discriminates against interstate commerce.
- The tax violates the First and Fourteenth Amendments to the Constitution because it singles out the plaintiffs for selective taxation and is not content-neutral.
Further, on Dec. 2, 2022, on a related challenge brought by the U.S. Chamber of Commerce and other industry groups, the federal district court in Maryland held that the complaints challenging the "pass-through prohibition" of the DAGRT, which hindered some large tech companies from passing the tax on to their customers, had already been settled by a state court earlier in a case involving Comcast, ruling that the tax was unconstitutional, although it could be revisited on a federal appeal.
What's next for the U.S.
Other states were waiting to assess whether the Maryland digital ad tax would pass muster in court. Now that it hasn't, those states considering a similar tax will need to pivot to a legal way to levy this new class of tax.
So far, Massachusetts, New York, Texas, West Virginia, Connecticut, Indiana and Montana have
Some of those states are still watching to see if Maryland appeals the ruling. Given Judge Asti's ruling around the three major constitutional hurdles, it's unlikely that an appeal will be successful if Maryland even decides to continue the case. Others will likely try to find a middle ground and modify their own plans to address Judge Asti's concerns. Even then, they'll have to navigate how to legally tax revenue from digital ads without doing the same for traditional advertising. That's a very tough tightrope to walk.
International situation
While big tech companies and fiscal conservatives are celebrating the Maryland ruling as a victory, they should be prepared for fights overseas as well. And those will not be protected by the legalities that struck down the Maryland law.
First, there is no equal protection clause in European countries like France that have expressed interest in taxing digital advertising. That means there is no constitutional protection for businesses when it comes to taxing digital advertising separately from traditional advertising.
Second, with the OECD minimum tax plan in peril, more countries are looking to unilaterally implement digital taxes, some of which would tax digital advertising. The deal was meant to quiet talks of separate taxes across countries and mollify those who think big tech should be paying more in taxes.
These two factors make it highly likely that businesses will have to deal with digital advertising taxes in Europe and should be prepared for the reality that several countries will likely enact laws that fit their own unique needs. On Dec. 15, the EU Council reached an agreement "in principle" where all member states voted in favor of officially adopting the EU Minimum Tax Directive, although a few countries still have concerns. The EU Minimum Tax Directive, also known as the EU's Pillar 2 Directive, aims to ensure a global minimum level of taxation for multinational enterprise groups and large-scale domestic groups in the EU. The directive would tax the profits of large multinational and domestic groups and companies with a combined annual turnover of at least €750 million at a minimum rate of 15%.
Although Treasury Secretary Janet Yellen welcomed the decision by all 27 member states of the European Union to adopt the directive implementing a global minimum tax on corporations, undoubtedly there will be implications and uncertainty for U.S. companies. Uncertainty and risks will come from trade-related consequences, including the potential for trade discrimination. Further, should the U.S. not join the OECD's Pillar 2 initiative, then more countries are sure to follow the EU in enacting their own "unilateral" set of GMT and DST rules.
The states are carefully watching. This battle isn't over domestically, and businesses will be watching how states modify the Maryland plan or even come up with a novel structure for taxing digital ads. Jurisdictions in the U.S. — and likely across the world — will continue to search for ways to pull revenue from digital ads and platforms. But they'll have to find a way to do it that complies with the three constitutional strikes that brought down Maryland's version.
