Maryland Lawmakers Provide No Solution to Central Issues with Digital Advertisement Tax

March 11, 2020

Maryland’s much-debated Digital Advertising Gross Revenues Tax (SB 2) has been amended and reported from committee after a month’s deliberation in a working group. (For our analysis of the introduced version, click here.)

The amended version of SB 2 changes the language about the sourcing of the digital advertising services to include factor apportionment. The previous version used users’ Internet Protocol (IP) address or reasonable suspicion of whereabouts to determine sourcing. It is unclear what lawmakers are seeking to achieve by employing apportionment to determine the digital advertising revenues attributable to Maryland; this practice is normally used to establish corporate income apportionment. In fact, the new language does nothing to address the key issue of how gross revenue will actually be determined by the companies or the state. Instead it leaves that crucial question up to the state Comptroller.

Companies liable to pay the digital advertising tax will be required to report their annual gross revenues derived from digital advertisement in Maryland. According to the amended SB 2, these gross revenues will be determined by using the following apportionment fraction:

  • The numerator will be annual gross revenues of digital advertising services in the state
  • The denominator will be annual gross revenues of digital advertising services in the U.S.

While there has been vocal critique of the tax’s potential application to activity outside Maryland, the inclusion of an apportionment formula does not solve the issue. In fact, borrowing from corporate apportionment makes exceedingly little sense here. Typically, some other factor or combination of factors (sales, payroll, or property) located in a state are used as a proxy to determine what percentage of a corporation’s profits to attribute to the state for tax purposes. Here, the tax base is gross revenue from advertising in the state of Maryland (x), which is then “apportioned” by dividing Maryland gross advertising revenue (x) by national gross advertising revenue (y), then multiplying that fraction by national advertising revenue (y). This is, literally, (x/y) * y, which is to say: x. Apportionment does nothing here.

Moreover, the problem apportionment was supposed to solve—the potential for taxing ads not actually served to Maryland residents—could still arise depending on final regulation from the Comptroller. If users’ location is still to be used, double taxation could happen due to imprecise IP locations, resulting if multiple states claim jurisdiction to tax the same activity. Further, difficulties could arise if multiple providers are involved in the sale or delivery of the advertisement.

Rather than trying to solve these issues, the amendment leaves the actual decision-making about how the base will be assessed to the state’s Comptroller. Considering that Maryland would be the first state to tax digital advertising, lawmakers would be well-advised to consider these details up-front in the legislative process. Leaving these crucial decisions to the executive branch is not transparent tax policy—especially given the tax’s unorthodoxy.

Additionally, Maryland could run into a number of legal issues surrounding the design of the tax. First, traditional advertising is not taxed in Maryland, which means the tax could effectively encourage companies to move marketing dollars away from online platforms. This particular discriminatory element of the tax is likely in violation of the federal Internet Tax Freedom Act, which protects online businesses from punitive or discriminatory taxation. Second, the application of threshold related to global revenues could be in violation of the Commerce Clause as it results in a higher tax rate for global companies than for domestic ones. Third, targeting one type of speech with this tax could violate the First Amendment of the Constitution.

None of these issues is addressed in the amended legislation. All of them will continue to be important considerations as the bill proceeds.

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