Maryland made national news in 2021, when the General Assembly passed the Digital Advertising Gross Revenues Tax, the first of its kind in the country. In doing so, it imposed a tax on proceeds from digital advertising service for entities with a gross annual revenue of at least $100 million. All companies that derive a gross annual revenue of $1 million or more from digital advertising services in Maryland must file a tax return. The rate of the tax imposed ranges from 2.5% to 10%, depending on the entity’s gross annual income.
The Digital Ad Tax garnered controversy from the start. The General Assembly approved the tax over Governor Larry Hogan’s veto. Critics argued that the tax violated the U.S. Constitution and federal law, and would have a chilling effect on digital advertising by Maryland small businesses, while those supporting the tax noted it would raise close to a quarter billion dollars in taxes each year that would be used to support Maryland schools.
The tax faced legal challenges almost immediately after it was passed, with parties filing lawsuits in both federal and state courts. In both venues, the plaintiffs argue that the tax violates the Due Process and Commerce Clauses, as well as the Internet Tax Freedom Act (ITFA). The federal case also alleges the tax violates the First Amendment and that the anti-pass-through provision violates the Commerce Clause and the First Amendment.
In the federal case, Chamber of Commerce of the United States of America v. Peter Franchot (Civil Action No. 21-cv-00410-LKG), the court held that the tax was a legitimate tax. Further, it stated that as an available and adequate remedy existed at the state level, the Federal Tax Injunction Act precluded the court from exercising jurisdiction over a challenge to the Digital Ad Tax. The court agreed to hear the challenge to an anti-pass-through provision, however. The defendants filed a motion to dismiss the remaining count and the plaintiffs filed a cross motion for summary jugment on the issue. Oral argument is scheduled for November 29, 2022.
In the matter of Comcast of California Maryland Pennsylvania Virginia West Virginia LLC v. Comptroller of the Treasury of Maryland, the parties filed cross motions for summary judgment. Following oral argument, Judge Alison Asti of Anne Arundel County Circuit Court ruled in favor of the plaintiffs, finding that the Digital Ad Tax violated (1) the U.S. Constitution’s prohibition on state interference with interstate commerce, (2) the First Amendment, as it is not viewpoint neutral, and (3) the federal Internet Tax Freedom Act’s prohibition on discriminatory taxes on online services, as Maryland does not tax non-digital advertising in a similar manner.
The MSBA’s Taxation Section made the following comment regarding the recent ruling:
One of the Section of Taxation’s purposes is to study proposed legislation concerning Maryland’s tax laws to determine their effect on the taxpayer community and, when necessary, comment as to their legal sufficiency. We are immensely proud of our Legislative Committee members’ work on the Digital Advertising Tax issue. They immediately identified the proposed digital advertising tax legislation as problematic during the 2020 and 2021 legislative sessions. The Legislative Committee’s work led to the Section of Taxation submitting testimony on multiple occasions that alerted the General Assembly that we believed that a court would declare the law void and unenforceable if enacted as drafted.
Shortly after the ruling, Peter Franchot, the Comptroller of the Treasury of Maryland named as a defendant in both the state and federal matters, stated he was “reviewing the decision and deciding next steps.” On October 20, 2022, however, Franchot indicated he would not challenge the ruling, stating:
As was the case when this legislation was being deliberated in the General Assembly, I remain concerned about the constitutionality of this first-in-the-nation law to impose a tax on digital advertisement.
As Comptroller and the state’s chief fiscal officer, I firmly believe that instead of continuing to expend public resources to defend a law that was constitutionally questionable at the time of enactment, the incoming governor and the incoming legislature should instead be given the opportunity to revisit this law.
While the enactment of this law was well-intentioned, with revenue dedicated to funding the Blueprint for Maryland’s Future, its constitutionality – coupled with the tax’s residual impact on small businesses that utilize digital advertising services – continue to give me pause on the prudence of this law.
Despite Franchot’s statements, Attorney General Brian Frosh indicated that he intends to continue to defend the tax.