Battle Over Taxing Digital Ads Goes Before Maryland Justices

Maryland’s first-in-the-nation levy on digital advertising is slated for argument Friday before the state’s Supreme Court, which will consider whether it is a legal way to tax tech giants’ activity within state borders.

Maryland had in mind the Facebooks, Googles, and Amazons of the world when it enacted a tax of between 2.5% and 10% on the gross revenue from digital ads earned by companies with annual revenue above $100 million. The state wants the high court to overturn a trial court’s sparse October ruling that the novel levy violates the dormant commerce clause, the First Amendment, and the supremacy clause, and is preempted by the federal Internet Tax Freedom Act.

If the tax survives the challenge brought by Comcast and Verizon, and parallel litigation led by the US Chamber of Commerce that is pending in the US Court of Appeals for the Fourth Circuit, companies can expect to see similar taxes proliferate around the country.

“Other states are definitely watching Maryland,” Jennifer B. Dickey, deputy chief counsel at the U.S. Chamber Litigation Center, said. The challenges have raised a “shroud of illegitimacy” around the tax, which has kept other states from enacting similar laws, she said. “If that shroud is removed they will certainly be interested in pursuing these taxes in their states.”

Christine Kim, a tax professor at Yeshiva University’s Cardozo Law School who filed an amicus brief in support of the tax along with four other professors, said the state’s goal is to tax activity within its borders that has slipped through its fingers.

“Maryland has said that it is going to use the tax revenue for educational programs, and I think this is a very good policy to to achieve a more distributional goal for the state government,” she said.

Revisiting ‘90s Tax Law

The state chiefly argues that the suit is premature, because the communications companies didn’t wait for the tax to be levied, at which point they could challenge it through the state’s administrative processes. It also defends the law on the merits.

Comcast and Verizon argue the tax violates the ITFA, a federal law that prohibits states from imposing discriminatory taxes on electronic commerce when they don’t impose that tax on transactions involving “similar” goods or services. Under Maryland’s tax law, digital advertising services are subject to worse treatment than physical advertising services, Dickey said.

“That seems like clear discrimination in violation of ITFA,” she said.

But Kim stressed that the federal statute doesn’t prohibit taxes on electronic commerce. Traditional advertising and digital advertising are so fundamentally different that they don’t implicate the law’s “similar” language, she said.

Kim said the case highlights why ITFA, which was passed in the 1990s as a temporary measure to protect fledgling internet commerce, may not be “fit for service in the 21st century digital economy.” She described the law as a tool that big tech giants and platform companies have used to short-circuit any potential state taxes on their services.

“If a new tax has policy problems, then of course we have to litigate it,” Kim said. But when ITFA is the only thing standing in the way of a state tax, then that proves problematic, she said.

Commerce Clause

Comcast and Verizon also argue Maryland violates the dormant commerce clause by reaching outside its borders, using global revenues as the threshold to determine who is subject to the tax and at what rate.

“Any tax that applies at different rates to taxpayers that are otherwise generating the same amount of digital advertising revenue from Maryland can’t satisfy the commerce clause,” said Reed Smith LLP partner Michael A. Jacobs, who isn’t involved in the litigation.

Kim pushed back, saying the tax is analogous to states using taxpayers’ nationwide income to determine their ability to pay taxes in the state when assigning income tax rates.

“That has been held constitutional consistently,” she said.

Companies Scrambling

The uncertain fate of the tax has left companies of all sizes scrambling to decide whether they were required to file a return for 2022, what counts as a digital adverting service, and how the tax is sourced, Jacobs said.

“There are a lot of businesses that may in the end not be subject to the tax but they still have to spend a lot of time and effort coming to that conclusion,” he said.

Dickey pointed out potential downstream consequences of the tax, which she said can be passed on to consumers via higher-priced ads. Small businesses rely on digital advertising to connect with specific customers, and those customers are the ones that will bear the burden, she said.

Assistant Attorney General Julia Doyle Bernhardt will argue for the state. Jeffrey A. Friedman of Eversheds-Sutherland (US) LLP will argue for Comcast and Verizon.

The case is Comptroller v. Comcast of Calif., Md., Pa., Va., W. Va., LLC, Md., No. SCM-REG-0032-2022, argument 5/5/23.