On March 18, the Maryland General Assembly passed the first state gross revenue tax directed at digital advertising, which is broadly defined to encompass any advertising appearing on a website, mobile app or any similar digital platform (House Bill 732). The legislation’s status remains uncertain due to an expected gubernatorial veto and potential legislative override. Similar tax proposals are now being considered in states including New York, Nebraska and West Virginia. As currently drafted, these proposals could substantially increase the cost of digital advertising – costs that would likely be passed on to digital publishers that rely on digital advertising for revenue, and businesses that rely on digital advertising to reach customers. Ultimately, the residents of the states imposing the tax would likely bear the cost.

Maryland’s Digital Ad Tax

Maryland’s digital ad tax is the first in the nation. Here are key takeaways from the new tax:

• Who is subject to the tax? The tax is levied on any business that satisfies two criteria: $1 million or more of annual gross revenue from digital advertising services in Maryland and $100 million or more of worldwide annual gross revenue. The drafters of this legislation appear to believe that a single business generates revenue from a single digital advertisement, and do not appear to be aware of the complex web of relationships that makes the digital advertising infrastructure work. While it may appear that these minimum revenue thresholds limit the tax’s impact to “big tech,” the digital adverting ecosystem is so interrelated, with multiple companies participating in the display of each ad shown to each consumer of digital content, it is foreseeable that multiple participants in the display of a single ad will be subject to the tax, and the larger market participants will spread on the costs among all participants.
• Which ads are taxable? It is unclear which ads are subject to the tax. The legislation defines “digital advertising services” subject to the tax as advertising services on a “digital interface” in the form of “banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services.” Legislative language such as “other comparable advertising services” is vague and dependent on how the Maryland comptroller interprets its scope. It is conceivable, given the breadth and vagueness of the key definitions, that the comptroller will seek to apply this tax to any method of attempting to monetize digital content, including native advertising and sponsored content.
• What are the tax rates? The tax rates range from 2.5% to 10% of a business’s annual gross revenue from digital advertising services in Maryland.
  • Businesses with less than $100 million in annual gross revenue or less than $1 million in annual gross revenue from Maryland digital advertising services are exempt.
  • The tax rates apply as follows:
  • 5% for companies with annual worldwide gross revenues of $100 million through $1 billion
  • 5% for companies with annual worldwide gross revenues above $1 billion through $5 billion
  • 5% for companies with annual worldwide gross revenues above $5 billion through $15 billion
  • 10% for companies with annual gross worldwide revenues above $15 billion

Note that the volume of worldwide revenue includes all receipts and not just advertising receipts. Using worldwide revenue to set a taxpayer’s tax rate for Maryland digital advertising sales likely would be challenged in court.

• How is digital ad revenue sourced to Maryland? The legislation provides little guidance on the crucial question of what portion of digital ad revenue is taxable in Maryland. Rather than provide clear guidelines, the legislation tasks the Maryland comptroller with interpreting and establishing the sourcing rules. In addition to the direct cost of the tax on the digital advertising ecosystem, this framework could impose additional costs by requiring companies to account for the geographic source of advertising revenue, and will create a tension with the efforts of privacy advocates to limit the use of geolocation in digital advertising.
• When would the tax take effect? The legislation provides that the new digital ad tax takes effect for taxable years beginning after Dec. 31, 2020.
• Who will really pay this tax? The tax is focused on large companies based outside Maryland, just as similar proposals in other states and countries focus on remote companies. The legislation does not recognize or distinguish between the many participants in the digital advertising ecosystem, such as publishers, ad networks, ad exchanges, demand-side platforms, supply-side platforms and data management platforms, all of which may participate in the delivery of a single digital ad. It is unclear the extent to which this tax may apply to business supporting the digital advertising ecosystem, such as suppliers and data analytics and measurement services. What is clear, however, is that this tax, by its nature, would ultimately be paid by the publishers and advertisers serving residents of the states imposing the tax, and the individual residents who consume the goods and services provided by these businesses.

What’s Next?

The Maryland digital ad tax still faces hurdles to enactment. Assuming Gov. Larry Hogan vetoes the measure, a three-fifths supermajority in each house of the Maryland General Assembly is necessary to override it. House Bill 732 achieved that level of support when it passed on March 18, but businesses are mounting efforts to persuade the legislature not to override the veto.

If the Maryland digital ad tax does become law, legal challenges are certain to follow. The Permanent Internet Tax Freedom Act is federal legislation that prohibits state taxes that discriminate against electronic commerce relative to sales accomplished through other means. The new Maryland tax may violate this law because it does not tax non-digital advertising. In addition, the tax may offend protections of free speech under the First Amendment and run afoul of other protections under the Commerce Clause of the U.S. Constitution because of the discriminatory effect on out-of-state companies.

We will continue to monitor developments in this area.