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Maryland’s Proposed Digital Advertising Gross Revenues Tax Should Not Be Enacted

Feb. 4, 2021, 9:00 AM

The pandemic riddled 2020 with uncertainty, and only time will tell how much havoc it may wreak on 2021. When, if ever, will we return to the office? Will our kids go to school virtually or in person … and does it depend on the week or day of the week? Will our favorite restaurant survive? Will more than 12 friends be permitted to attend our daughter’s wedding? When will we hang out with extended family and friends?

The pandemic has, however, made two things more certain: Consumers are viewing more digital advertising than ever (Digital ad revenue for 2019 was $125 billion, which represented a 16% increase from 2018, Internet Advertising Revenue Report, Full year 2019 results & Q1 2020 revenue, May 2020, prepared by PwC and IAB, at 5 and “For the first time, more than half of U.S. advertising spending is set to go to digital platforms.” Suzanne Vranica, Google, Facebook and Amazon Gain as Coronavirus Reshapes Ad Spending, Dec. 1, 2020, Wall Street Journal, and states are collecting less tax revenue than expected (see Michael Semes, Budget Deficits Create Opportunity to Improve State Tax Policy, Sept. 7, 2020, Tax Notes).

These two certainties coalesce as states are looking to plug their budgetary shortfalls with a new tax on digital advertising—in the form of either a sales or a gross receipts tax. Enacting a new tax as a budget-closing tool should be done only with caution and after thorough debate to increase the likelihood that the new tax will achieve the desired short- and long-term policy and fiscal goals. Advocates of new digital taxes even acknowledge that the cost of new taxes on the digital economy will “likely be passed on to consumers in the form of higher prices” when the current economy sees that “employees and residents are already at their most vulnerable.” These admissions show that new taxes on the digital economy are a treacherous route that needs to be thoroughly charted because it would be imprudent to embark on a journey without a clear vision of the path to the desired destination.

Maryland, which is facing a “massive budget hole for fiscal year 2021 and well into the future,” is the state furthest along the legislative track to tax digital advertising. On March 18, 2020, the Maryland General Assembly passed the Digital Advertising Gross Revenues Tax (MDAGRT). Despite Gov. Hogan’s subsequent veto of the MDAGRT on May 7, 2020, over concerns that “these misguided bills would raise taxes and fees on Marylanders at a time when many are already out of work and financially struggling,” the General Assembly is expected to at least consider overriding the veto this month. As detailed below, the MDAGRT as drafted fails to define key terms and contains other terms that are subject to numerous and inconsistent interpretations that would only cause putative taxpayers to challenge its validity—before paying the tax.

The Maryland attorney general has even acknowledged that some provisions of the MDAGRT “could raise concerns for a reviewing court if the bill is challenged [and are] are not clearly unconstitutional.” This acknowledged litigation would take years to resolve, and therefore, the MDAGRT—if it were to be enacted—would not achieve its goal of raising revenue. Even the fiscal note accompanying the proposed bill acknowledges that the MDAGRT “could face legal challenges on several fronts [and that w]hile it is not possible to determine when potential legal challenges may arise, and how long they would take to resolve, this could limit the amount of any revenues collected from the tax while litigation is pending.”

This article first examines some of the general issues associated with enacting a tax on digital advertising services. Next, it identifies some of the practical issues associated with the MDAGRT. It should be noted that this article focuses on the more practical aspects of taxing digital advertising services while touching on some of the associated legal issues. The proposed bill is also vulnerable to constitutional challenge under the due process clause, commerce clause, First Amendment and Internet Tax Freedom Act, and those issues will be discussed in a future article.

The article concludes by recommending that the MDAGRT not be enacted as drafted because putative taxpayers will undoubtedly litigate the legitimacy of the bill for failing to define critical terms as well as other issues. The MDAGRT as drafted could be read to apply to: every participant in the chain of a digital advertising transaction; and both in-state and out-of-state advertisers. It also places an unwarranted reliance on the accuracy of geolocation through Internet Protocol address.

Therefore, putting aside the economic prudence of—and other constitutional issues associated with—taxing digital advertising, the Maryland Legislature should identify the goals of MDAGRT as it is currently written, work to understand how a more carefully and thoughtfully drafted MDAGRT would further those goals, and engage in an honest and transparent dialogue with all stakeholders for the purpose of remedying, if possible, the failings of the current MDAGRT draft. Doing so would improve Maryland’s overall tax policy strategy while also buttressing relations between taxpayers, legislators, constituents, and all impacted parties. Any piece of tax legislation enacted following such an exercise would most certainly be closer to achieving the legislature’s desired goals while also remaining cognizant of the new policy’s impact on current and future stakeholders once the budgetary woes of the pandemic have subsided.

The Critical Distinction Between a Sales Tax and a Gross Receipts Tax

Let’s first set the table by acknowledging that if a legislature were to choose to tax digital advertising, it could do so by enacting either a sales tax or a gross receipts tax. Therefore, any new sales or gross receipts tax on digital advertising services would generate tax revenue in addition to the income tax revenue that is being collected from the seller of such products. The distinction between these two options has significant economic and political effect. A sales tax is imposed on the seller in addition to the purchase price of the product and is reflected as a separate line item on each invoice/receipt. In theory, it is easy for consumers to discern changes in tax that are broken out in such a way as they are more informed as to how their money is being spent, leading to greater political pushback and consumer response from the addition of the tax.

A gross receipts tax, on the other hand, is more politically palatable—and, some might say, pernicious—for two reasons. First, unlike a sales tax, a gross receipts tax is imposed on the seller. This characteristic means that in the vast majority of instances, a gross receipts tax will be imposed on a business entity that does not vote (at least directly) and thus poses less political risk. Second, the business entity that sells the digital advertising services will embed all or a substantial portion of the tax in the purchase price of its product through what is traditionally known as tax incidence, passing the ultimate burden of the tax to the consumer.

Because a gross receipts tax—like the MDAGRT—is hidden within the purchase price rather than stated as a separate line item on each invoice, the consumer (i.e., voter) is not reminded that her legislature enacted this new tax every time she purchases a product on which a gross receipts tax is imposed. Finally, it is important not to lose sight of the fact that regardless of which type of tax is imposed, the seller is also required to pay tax on the income from its sales of these products.

Digital Advertising Taxes in General

Before we examine the specific flaws of the MDAGRT, it should be noted that taxing digital advertising (whether in the form of a gross receipts tax or a sales tax), as a general matter, makes dubious economic sense. First, it is an indirect tax on business inputs, which means it is a cost that directly or indirectly increases the amount a consumer pays for the product. This means that even though the tax may be intended and appear to be imposed on out-of-state businesses, it “could easily end up hitting domestic businesses and consumers.” Second, the economy has recently undergone a rapid digitization and continues to evolve feverishly. The pace at which business is changing makes it extremely difficult for a legislature to draft a coherent law to achieve its desired goals without extensive dialogue among stakeholders.

The MDAGRT Is Legally and Practically Inoperable

First, as drafted, the MDAGRT is woefully and likely unconstitutionally vague. The MDAGRT fails to define critical terms—such as when a digital advertising service is “in the state”—allowing for multiple and inconsistent interpretations of the fundamental issue of whether a transaction is subject to the MDAGRT. Moreover, the MDAGRT does not provide any guidance as to whose activities determine when the revenues are “in the state.” Instead of defining this critical statutory phrase, the Maryland General Assembly delegated its authority and required that “the Comptroller shall adopt regulations that determine the state from which revenues from digital advertising services are derived.” This language grants the comptroller boundless discretion to determine the types of, and parties to, transactions subject to the MDAGRT. Therefore, the MDAGRT’s Fiscal Note even acknowledges that its ambiguities “could limit the amount of any revenues collected from the tax while litigation is pending[.]”

The MDAGRT’s vagueness may be eclipsed by its lack of economic sense. Because the MDAGRT is a tax on business inputs, it necessarily increases the cost of doing business. This negative economic feature is exacerbated by the pyramiding that may result from the MDAGRT’s failure to clearly define the parties and types of transactions on which it is imposed. More fundamentally, the tax will be passed on to consumers because entities subject to it will embed it in a higher cost of goods.

The potentially fatal legal and economically questionable issues noted above make it unlikely that any putative taxpayer would pay the MDAGRT before these challenges are resolved. Court challenges of this sort would take several years to resolve, causing the MDAGRT to fail to achieve its goal of raising revenue. Additionally, the court challenges will cost the state significant amounts in legal fees, administrative burden and reputational detriment.

The MDAGRT is legally flawed, economically questionable and, as demonstrated in detail below, simply inoperable. Therefore, any attempt to override Gov. Hogan’s veto would be an exercise in futility. Instead, the Maryland General Assembly should review its goals and, if it were to determine it advisable to tax digital advertising, redraft the MDAGRT. If after this exercise in legislative due diligence the Maryland General Assembly were to enact a modified version of the MDAGRT, it would have the distinction of being the first state to impose a gross receipts tax on digital advertising. While this may be a somewhat dubious distinction, enacting such a law following dialogue among all stakeholders would result in legislation to which all should be proud to have contributed.

The Maryland General Assembly Should Measure Twice and Cut Once

History demonstrates that implementing what may seem to be the simplest of multistate tax transactions can take decades to resolve (see, e.g., Wayfair overruling Quill and Karl A. Frieden and Mike Porter, E-Commerce Tax Issues Then and Now, Dec. 7, 1996, Tax Notes. (Many of the questions Frieden and Porter raised remain unanswered.)). In general, two or three parties participate in a typical sale of tangible personal property (TPP): a seller, a buyer and, sometimes, an intermediary broker or marketplace facilitator.

In 2018, the Supreme Court decided Wayfair. That case upheld a South Dakota statute that required a remote retailer that sold more than $100,000 of goods or engaged in more than 200 transactions in the state to collect and remit use tax. Wayfair, which overruled the 1993 case of Quill, ruled on a very straightforward and now commonplace type of transaction: the sale of TPP by a remote seller in one state to a purchaser in another. Nonetheless, Quill and Wayfair (along with the hundreds of cases decided before and in between them) demonstrate that it takes decades to sort out and resolve “plain vanilla” types of tax issues. Moreover, while Wayfair resolved some nexus issues, it has extended an invitation to litigate additional issues (e.g., whether the same nexus standard applies to income tax).

The cross-border sale of TPP decided in Quill and Wayfair is to digital advertising what checkers is to three-dimensional chess. Therefore, if it takes decades to play a game of checkers, how long might a game of three-dimensional chess last? Let’s find out by playing a beginner’s game of three-dimensional chess in which we analyze the current version of the MDAGRT.

The MDAGRT Leaves an Inexcusable Number of Unanswered Questions

Even if the MDAGRT were to surmount the legal hurdles mentioned above, to be administratively efficient, the legislation must address several practical enforcement issues. As will be pointed out, these practical waters run deep and the shallowest parts of them have not yet been charted.

The complexity of a digital advertising transaction demands that a statute specify accurately and precisely: who is subject to the tax; what type of transaction/s is/are subject to the tax (i.e., what is the tax base); what is the tax rate? when is a transaction subject to the MDAGRT “in the state”?

The next sections in this article analyze these questions.

  • Who is subject to the tax?

As is the case with any tax statute, the MDAGRT must first identify who is subject to the tax being imposed. In the case of any digital advertising tax, however, this is a complicated issue that needs to be addressed. A typical digital advertisement involves:

1. Product advertiser.

2. Advertising aggregator or broker.

3. Website owner.

4. Consumer/viewer.

The MDAGRT is drafted in a way that leaves significant doubt as to which party—or parties—may be subject to tax. Moreover, the MDAGRT exacerbates its economic and legal flaws by leaving open the possibility of its being imposed on multiple links in the digital advertising transaction chain. This tax pyramiding is economically abhorrent, practically unwieldy and legally questionable.

  • What type of transaction/s is/are subject to the tax?

Once a digital advertising tax has identified the taxpayer, it must next describe the type of transaction – or types of transactions—subject to tax. Putting aside the constitutional and legal hurdles, the complexity and variations in the types of digital advertising transactions in which parties currently engage make it all the more important for the MDAGRT to describe accurately and precisely the object being taxed. Otherwise, we can expect decades of litigation on a boundless number of issues.

  • What is the tax rate?

The MDAGRT is imposed on an escalating scale of 2.5% to 10% of the taxpayer’s assessable base (“annual gross revenues derived from digital advertising services in the state”). At the bottom end of the scale, the MDAGRT is imposed at the rate of 2.5% of the assessable base of a taxpayer with annual gross revenues of $100 million to $1 billion. The highest rate of 10% is imposed on a taxpayer with annual gross revenue in excess of $15 billion.

  • When is a transaction subject to the MDAGRT “in the state”?

This is, perhaps, the most glaring gap in the MDAGRT. The MDAGRT subjects to tax the “annual gross revenues derived from digital advertising services in the state” (emphasis added). However, in the current version of the MDAGRT, the Maryland General Assembly has chosen to delegate to the comptroller the authority to make the critical determination of when a digital advertising service is “in the state.” Specifically, the statute provides that a “person required to file a return shall file with the return an attachment that states any information that the Comptroller requires to determine annual gross revenues derived from digital advertising revenues in the state.”

Putting aside whether it lawful for the General Assembly to delegate such a critical element of a taxing statute, it is extremely difficult to identify the location or locations of a digital advertising transaction. Such a transaction does not occur in any physical or geographic location, but instead occurs in multiple intangible and geographically ambiguous and movable locations. For instance, should the comptroller require a taxpayer to provide information on the Internet Protocol (IP) addresses of its transactions? First, an IP address is merely a proxy for a user’s identity (see, e.g., Mackey, Schoen and Cohn’s 2016 article, Unreliable Informants: IP Addresses, Digital Tips, and Police Raids for an in-depth discussion of the shortcomings of IP addresses in criminal investigations). Further, a “close enough” method of determining the situs of a digital advertising transaction is woefully—perhaps unconstitutionally—imprecise; nor does not take into account any measure a consumer might adopt to avoid the tax. Finally—and while putting the lack of precision to the side—does a taxpayer have access to this sort of information from all of its customers, and if it does, how difficult is it to obtain? For these reasons, the MDAGRT’s failure to define when a transaction is “in the state” creates a reporting process that would be unwieldy to administer and costly (if not impossible) with which to comply.


This article has illustrated some of the MDAGRT’s fatal flaws. Moreover, this article has demonstrated that applying the MDAGRT leaves countless questions unanswered. And these conceptual questions are to the many real-life transactions occurring every nanosecond in today’s business world what checkers is to three-dimensional chess. Therefore, one is left with the inescapable conclusion (and respectful suggestion) that the Maryland General Assembly would serve itself, its constituents and all stakeholders well by devoting more energy to:

  1. Identifying the goals of the MDAGRT.
  2. Understanding how a more carefully and thoughtfully drafted MDAGRT would further those goals.
  3. Having an honest and transparent dialogue with stakeholders (especially those parties that engage in digital advertising services) for the purpose of eliminating the ambiguities of the current MDAGRT.

It is hoped that this article will advance dialogue on important state tax issues for the purpose of improving state tax policy for the good of all.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Michael J. Semes is professor of practice in the Graduate Tax Program at the Charles Widger School of Law at Villanova University and of counsel at BakerHostetler. He thanks Christian Jorgensen and Jonathan Onufrak, Villanova Law students, for contributing their helpful research and comments to this article.