On Oct. 17, 2022, the Circuit Court for Anne Arundel County, Md., struck down the Maryland Digital Advertising Services Tax on the grounds that the tax violates the Commerce Clause of the U.S. Constitution, the First Amendment to the U.S. Constitution and the federal Internet Tax Freedom Act (ITFA).1 After hearing oral arguments on the relevant issues, the Court issued a bench ruling followed by a brief order declaring that the tax: (i) discriminates against companies providing digital advertising services in violation of the ITFA; (ii) targets out-of-state companies and interstate commerce by using worldwide gross revenues to calculate the tax; and (iii) singles out certain companies for selective taxation in a way that is not content-neutral.
In Feb. 2021, the Maryland legislature enacted the Maryland Digital Advertising Services Tax following an override of a veto by Governor Larry Hogan.2 The tax is imposed on entities with global gross revenues of at least $1 billion.3 Companies having at least $1 million of annual gross revenues derived from digital advertising services in Maryland in a calendar year are required to file a tax return.4 “Digital advertising services” are defined to include advertising services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising and “other comparable advertising services.”5 The applicable tax rate ranges from 2.5% to 10% based on the amount of a company’s global gross revenues.6 The annual gross revenues derived from digital advertising services in Maryland are determined using an apportionment ratio of Maryland to U.S. gross revenue derived from digital advertising services.7
Although the tax was initially intended to be effective beginning in the 2021 tax year, emergency legislation enacted in April 2021 delayed the tax’s effective date to the 2022 tax year due to various difficulties in implementing the tax.8 The corrective legislation amended Maryland law to specify that “digital advertising services” do not include advertising services or digital interfaces owned or operated on behalf of a broadcast or news media entity.9 The legislation also prevents digital advertisers from passing on the cost of the tax to customers purchasing digital advertising services via a separate fee, surcharge or line-item.10
Federal and state litigation
Following enactment of the tax, two separate lawsuits were filed in both federal and state court, challenging the legality of the tax under the ITFA,11 the Commerce and Due Processes Clauses of the U.S. Constitution, and the First Amendment to the U.S. Constitution. In the federal lawsuit, four business groups sought a declaration and injunction from a Maryland federal district court against enforcement of the tax.12 In March 2022, the federal court dismissed much of the lawsuit, ruling that the federal Tax Injunction Act (TIA) bars a challenge to the tax because Maryland state courts provide a plain, speedy and efficient remedy to challenge the tax. However, the federal court also ruled that the plaintiffs may still challenge the provision that prohibits companies from directly passing the cost of the tax onto customers. The remaining issue in that case is whether the pass-through prohibition violates companies’ free speech rights under the First Amendment as opposed to merely regulating their conduct.
In the state lawsuit, Comcast and Verizon filed a complaint in the Circuit Court for Anne Arundel County, a state court, seeking a declaration that the tax is illegal under the ITFA, also alleging Commerce Clause, due process and First Amendment violations.13 In March 2022, the state court ruled that the litigation may proceed after finding that the companies were not first required to exhaust their administrative remedies before bringing the lawsuit in state court. The plaintiffs then filed a motion for summary judgment, asking the state court to rule on several counts of their complaint for declaratory judgment, namely whether the tax violates: (i) the Supremacy Clause of the U.S. Constitution and the ITFA; (ii) the Commerce Clause of the U.S. Constitution; and (iii) the First and Fourteenth Amendments to the U.S. Constitution. On behalf of the Maryland Comptroller, the Maryland Attorney General filed a cross-motion for summary judgment in defense of the tax.
Bench ruling and order
The state court heard oral arguments from both parties in support of their summary judgment motions. After an approximately two-hour hearing, the judge ruled from the bench instead of issuing a written decision. The state court first concluded that the tax violated the ITFA namely because Maryland does not otherwise tax traditional advertising services, which are indistinguishable from digital advertising for ITFA purposes. In the judge’s view, the tax treated digital advertising differently than traditional advertising, implicating the ITFA’s prohibition against discriminatory taxes on electronic commerce. According to the judge, “advertising is advertising . . . and no one taxes advertising in any other manner in the state.”
Moving to the plaintiffs’ Commerce Clause arguments, the state court next concluded that the tax clearly targets out-of-state companies to the exclusion of local in-state businesses, thus discriminating against interstate commerce. The judge noted a Commerce Clause violation particularly due to “the manner in which the tax is calculated, which has nothing to do with even advertising, just gross revenue.” In particular, the judge was persuaded by the plaintiffs’ argument that the tax looks to companies’ global revenues, not Maryland revenue, to determine the applicable tax rate.
Finally, the judge concluded that the tax violated the First Amendment because of its provision exempting broadcast and news media entities from the tax. The plaintiffs had argued that the exemption requires a definition of “news,” an analysis of the content being provided and whether the entity in fact provides news. The Court agreed with the plaintiffs’ argument that such an analysis of taxpayer speech violates free speech rights under the First Amendment.
Three days later, on Oct. 20, 2022, the state court issued a two-page order granting the plaintiffs’ motion for summary judgment. In doing so, the state court concluded that the tax: (i) violates the Supremacy Clause of the U.S. Constitution and the ITFA because it constitutes a “discriminatory tax”; (ii) violates the Commerce Clause because the tax discriminates against interstate commerce; and (iii) violates the First and Fourteenth Amendments because the tax “singles out the Plaintiffs for selective taxation and is not content-neutral.”
The state court’s ruling on the constitutionality of the Maryland Digital Advertising Services Tax represents an important inflection point in both the state and federal litigation that has hampered the enforcement of the tax since its initial enactment in 2021. Both lawsuits have encountered several procedural hurdles before a consideration of the merits could proceed. In the state litigation, Maryland argued that the lawsuit was improperly filed in the state trial court because the plaintiffs did not exhaust their administrative remedies that should have included an administrative appeal filed with the Maryland Tax Court. In the federal litigation, the court ruled that the federal TIA barred the plaintiffs from challenging the tax itself but that the plaintiffs could proceed with their challenge to the tax’s pass-through prohibition on the grounds that it violated the First Amendment. Most recently, the plaintiffs urged the federal court to expedite its review of the lawsuit on the basis that the state court’s ruling did not render the lawsuit moot, and that further guidance from the court is needed regarding whether companies subject to the tax are still required to pay the tax going forward.
In an unusual turn of events, the state court judge hearing oral arguments supporting the parties’ summary judgment motions ruled from the bench “in the interest of time and brevity,” meaning that a written decision supporting her conclusions will not be issued. The bench ruling leaves open the possibility for Maryland to argue on appeal that the state court inappropriately ruled at the summary judgment phase due to the lack of development of a factual record at this stage of the case. In particular, the state may take issue with the state court’s ITFA analysis on the basis that digital advertising is not sufficiently similar to traditional advertising in a way that discriminates against electronic commerce under the ITFA. In Maryland’s view, the issue is a question of fact that should be resolved after a trial.
Maryland intends to appeal the state court’s decision to strike down the tax, according to the Maryland Senate President, who co-sponsored the initial legislation proposing the tax.14 The history of the tax’s existence is a complicated one in that the Maryland legislature voted to enact the tax over the veto of current Governor Larry Hogan, who has voiced his opposition to the tax since its inception. The current Comptroller, an elected official serving in the Governor’s administration, likewise does not support the tax and recently announced that the state should not continue to defend the tax in court, and that the decision should be left to the incoming administration and state legislature.15 Interestingly, although the Comptroller is a named party in both the state and federal litigation, the Comptroller is represented by the Maryland Attorney General, who stated plans to continue defending the tax in both the state and federal court. While the tax was not the subject of significant public debate in this year’s elections in Maryland, the decision to continue defending the tax in court is likely to be consistent with the views of the incoming Maryland Governor, Comptroller and Attorney General, in an effort to provide needed revenue to the state. The differing views on the tax held by state government officials (at least in the outgoing Maryland administration) are indicative of the political issues surrounding the implementation of a novel tax and the resulting controversy associated with its enforcement.
Given the Court’s ruling invalidating the tax, other states are unlikely to pursue similar digital advertising tax proposals until there is further clarity from the courts regarding whether Maryland’s tax can be imposed. For those states that decide to move forward with such proposed taxes, they may be more inclined to wait and see which aspects of the tax are sustained on appeal and structure their proposals accordingly. In the meantime, companies that are currently subject to the tax are faced with the decision of whether to continue making estimated payments given conflicting court decisions at the state and federal levels. The outcome of the federal lawsuit regarding the tax’s pass-through provision may shed light on whether and how companies are required to present the tax on customer invoices. Indeed, additional guidance from the Comptroller may be needed until taxpayers have more certainty regarding the tax’s legality as the state and federal litigation proceeds.
1 Comcast of California/Maryland/Pennsylvania/Virginia/West Virginia, LLC, et al. v. Comptroller of the Treasury of Maryland, Circuit Court for Anne Arundel County, Md., No. C-02-cv-21-000509, order issued Oct. 20, 2022.
2 Md. Ch. 37 (H.B. 732), Laws 2021, enacting Md. Code Ann., Tax-Gen. §§ 7.5-102-7.5-301. For further discussion of the tax, see GT SALT Alert: Maryland enacts digital ad gross revenues tax.
3 Md. Code Ann., Tax-Gen. § 7.5-303.
4 Md. Code Ann., Tax-Gen. §§ 7.5-201(a); 7.5-301(a).
5 Md. Code Ann., Tax-Gen. § 7.5-101(e)(1).
6 Md. Code Ann., Tax-Gen. § 7.5-103.
7 Md. Code Ann., Tax-Gen. § 7.5-102(b)(1).
8 Ch. 669 (S.B. 787), Laws 2021.
9 Md. Code Ann., Tax-Gen. § 7.5-101(e)(2).
10 Md. Code Ann., Tax-Gen. § 7.5-102(c).
11 Pub. L. No. 105-277, 47 U.S.C. § 151. Among other things, the ITFA preempts state and local governments from imposing taxes on internet access services and discriminatory taxes on electronic commerce.
12 U.S. Chamber of Commerce v. Franchot, U.S. District Court for the District of Maryland, North Division, No. 1:21-cv-00410, filed Feb. 18, 2021.
13 Comcast of California/Maryland/Pennsylvania/Virginia/West Virginia, LLC, et al. v. Comptroller of the Treasury of Maryland, Circuit Court for Anne Arundel County, Md., No. C-02-cv-21-000509, complaint filed Apr. 15, 2021.
14 Maria Koklanaris, Md. Will Appeal Adverse Digital Ad Tax Ruling, Senate Prez Says, Law360 Tax Authority, Oct. 18, 2022.
15 News Release, Comptroller Franchot Issues Statement on Digital Ad Tax Ruling, Comptroller of Maryland, Oct. 20, 2022.
Jamie C. Yesnowitz
Principal, SALT Services
National Tax Office Leader
Jamie Yesnowitz, principal serving as the State and Local Tax (SALT) leader within Grant Thornton's Washington National Tax Office, is a national technical resource for Grant Thornton's SALT practice. He has 22 years of broad-based SALT consulting experience at the national and practice office levels in large public accounting firms.
Washington DC, Washington DC
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