Maryland Digital Ad Tax | Digital Advertising Taxes

In a case that legislators across the country have watched with intense interest, the Maryland TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Court struck down the state’s digital advertising tax and ordered that refunds be paid to taxpayers for five and a half years’ worth of collections under the unconstitutional tax. This will not be the end of the story—appeals will follow, with refunds likely stayed pending those appeals—but after long years, it is the beginning of the end, and the Tax Court’s ruling, which represents a robust and comprehensive victory for the petitioners, should be regarded as a harbinger as lawmakers consider digital advertising taxes in other states.

The Maryland Tax Court decided the case for the plaintiffs on the grounds that it violated the Internet Tax Freedom Act (ITFA), the Commerce Clause, and the Due Process Clause, any one of which would have been sufficient to invalidate the tax.

The Digital Ad Tax Violates the Internet Tax Freedom Act

Federal law prohibits discriminatory taxation of e-commerce, and in particular, it prohibits any tax that singles out e-commerce while not taxing “similar property, goods, services, or information” offline. Opponents of the digital ad tax have long argued that by taxing digital ads but not billboards, newspaper ads, television commercials, and other forms of advertising, the tax clearly violated ITFA.

Maryland offered several counterarguments. First, the state argued that digital advertising isn’t actually similar to other advertising, as that term should be interpreted under ITFA. The court rejected this argument, concluding that similarities with other types of advertising far outweighed dissimilarities in the mode of delivery. Second, the state tried to argue that the federal law does not provide a private remedy or create a cause of action allowing anyone other than the federal government to seek to enforce it. The court concluded that this may be true, but that it is irrelevant, as the petitioners had standing to pursue a refund of taxes paid, and ITFA is merely a justification for the refund claim; they are not directly seeking enforcement of the federal law. And third, the state argued that ITFA itself is unconstitutional under anti-commandeering doctrines, pointing to a Supreme Court ruling that struck down a federal ban on gambling on college sports. But the court quite appropriately noted that, whereas Congress does not have plenary authority to regulate intercollegiate gaming, it does have a clear constitutional right to regulate interstate commerce.

This decision is highly relevant to other states: no matter what the other details of a digital ad tax’s design, if it only (or almost exclusively) reaches digital advertising, it violates ITFA. That’s the Maryland Tax Court’s ruling, and while Maryland courts certainly do not bind other states’ courts, policymakers should recognize that other courts are likely to reach the same conclusion.

The Digital Ad Tax Violates the Commerce Clause

Maryland’s digital ad tax has a graduated-rate structure that is not based on the amount of gross revenue generated in Maryland, but rather on the advertising platform’s gross revenue worldwide. This means that the amount of tax owed in Maryland is based on factors entirely outside Maryland. The tax’s thresholds are also designed in such a way as to disproportionately (arguably exclusively) tax out-of-state commerce. The Maryland Tax Court held that the graduated rates on global revenues violate the Complete Auto test for Commerce Clause compliance because it is not fairly apportioned, and because it lacks external consistency since the tax is on activity outside Maryland.

The court also held that the tax is not fairly related to services received, another requirement of Complete Auto. As the court wrote, “The economic reality is that the Tax in its everyday operation discriminates against more globally robust companies in interstate commerce to the advantage of the Maryland tax coffers. Global revenues have no relationship to in-state services under the Tax to those payors.” The tax thus violates three of the four prongs of Complete Auto. Notably, while some of this owes to the unique design of Maryland’s tax—other states could choose not to increase rates based on global revenue of the ad platform—others are inherent to any tax that discriminates by targeting large, out-of-state companies and imposing a tax on them that has no fair relationship to in-state services.

The Digital Ad Tax Violates Due Process

The Due Process Clause has been held to impose two important requirements for taxes involving interstate commerce: (1) a minimal connection between the interstate activities and the taxing state, and (2) a rational relationship between the income attributed to the state and the interstate values of the enterprise. The court found that, for the same reasons that the tax violates the fair apportionmentApportionment is the determination of the percentage of a business’s profits subject to a given jurisdiction’s corporate income tax or other business tax. US states apportion business profits based on some combination of the percentage of company property, payroll, and sales located within their borders. requirement under the Commerce Clause, it fails under the second Due Process requirement because the tax is discriminatory.

This is a robust win for the petitioners on all counts. The Maryland Tax Court is an administrative tribunal, and the state is likely to file for judicial review by the circuit court, which they must do within 30 days. Under today’s summary judgment, companies that paid the tax must receive refunds, though those refunds will presumably be stayed pending the circuit court’s review.

Review by the circuit court would not involve new hearings but would instead be based on the Maryland Tax Court’s administrative record. The losing party in circuit court would then have the right to appeal to Maryland’s appellate court. The Maryland Supreme Court could also expedite the process by granting early cert and taking the case directly at that time.

It appears all but certain that the state will seek circuit court review. If Maryland loses there as well, it remains to be seen whether the state would continue its appeals. The victory petitioners won today is overwhelming. It is the sort of ruling that should have the state very doubtful about its chances on appeal, and the longer the legal fight drags on, the worse Maryland’s budget situation will be when the state has to refund years of improperly collected taxes.

Policymakers in Illinois and Utah, which adopted their own digital ad taxes this year, are surely paying attention. While those taxes aren’t designed identically to Maryland’s and wouldn’t face the exact same set of challenges, the Maryland court’s decisions on ITFA, fair apportionment, fair relation, and due process are of equal importance in those states and elsewhere. Lawmakers in other states considering a digital advertising tax should likewise take note of today’s result. It’s a look into their own future if they choose to adopt a similar tax.

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