Principal Economist, Tax Policy Advisor Vertex
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The Maryland Digital Ad Tax’s Possible Impact

A civil case against Maryland’s Digital Advertising Gross Revenues Tax (HB 732) was brought by a coalition including U.S. Chamber of Commerce, the Internet Association, the Computer & Communications Industry Association and NetChoice -- a trade association of businesses that promotes free speech and free enterprise on the Internet.

Mar 30th 2021
Principal Economist, Tax Policy Advisor Vertex
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Maryland’s newly minted digital advertising tax went into effect recently, but for how long remains an enigma, as a coalition of technology and business organizations have mounted a compelling legal challenge.

The coalition in the civil case says in their lawsuit that the new law violates three specific laws: The Permanent Internet Tax Freedom Act (PITFA), the Commerce Clause and the Due Process Clause.

To better understand the case, it’s instructive to dig into each of these alleged breaches.

Violation of the Permanent Internet Tax Freedom Act

The PITFA prohibits new state and local taxes on Internet access and discriminatory taxes on ecommerce. The coalition argues that since no tax was levied on traditional advertising—as seen in newspapers and magazines—that the digital ad tax is a “punitive assault” that violates PITFA because it’s discriminatory against digital media.

The complaint also emphasizes that the levy is more of a “penalty or fine” and not truly a tax under the provisions of the Tax Injunction Act. One concern with that argument, though, is that PITFA does not prohibit states from imposing sales taxes on transactions on the Internet, something that Maryland and other states have already proposed and implemented.

Violation of the Commerce Clause

Tax experts see the Commerce Clause as the most viable route to overturning the Maryland tax. The clause says that, among other things, state and local laws are unconstitutional if they place undue burden on interstate commerce, favor local economic interests or discriminate by favoring local economic interests.

This means that Congress may regulate channels of interstate commerce as well as activities that have a substantial effect on interstate commerce. This is known as the “Affectation Doctrine.”

Critics of Maryland’s tax say it runs afoul of the Commerce Clause because the state’s digital ad tax rate is based on global gross revenues of platforms. Since Maryland plays no role in economic activity outside of the state, the coalition argues that it can’t base its tax rate on revenues being collected around the world.

In addition, the high- revenue threshold requirements of the DAT appear to also exclude Maryland companies from that range, thus placing the burden mainly upon external companies located elsewhere.

Violation of the Due Process Clause

The Due Process Clause, contained in both the 5th and 14th Amendments of the U.S. Constitution, says that no state shall "deprive any person of life, liberty, or property, without due process of law.” However, it is the 14th Amendment that can disallow states from conduct that regulates “extraterritorial” activity or engaging in punitive measures.

This has been interpreted to mean that states cannot tax businesses unless there is some connection between the business and the state in which it operates. The coalition is banking on Maryland courts deciding that a nexus does not exist simply because someone in that state viewed a digital ad.

While the coalition’s case is strong, it does face some hurdles given the fiscal realities of a post-COVID world as well as judicial attitudes toward taxing the digital economy. Similar to the rationale in the Wayfair ruling, Maryland courts could consider these new taxation methods as a way to fairly implement a tax regime that addresses the way the world does business in the digital age.

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