Ongoing insights and analysis regarding Maryland’s proposed digital ad tax bill

The Latest

  • Maryland lawmakers are expected to revive a pair of failed controversial tax expansion proposals shortly after the scheduled start of the next legislative session on January 13, 2021.
  • On May 7, Governor Larry Hogan vetoed H.B. 732, which proposed a first of its kind Digital Advertising Tax, and H.B. 932, which would have expanded Maryland’s sales tax to sales of digital products (both downloads and streaming).
  • The Digital Advertising Tax was widely opposed by the business community and predicted to be immediately challenged due to its constitutional deficiencies.

With veto-proof Democratic majorities in both the Maryland House of Delegates and the Senate, Governor Hogan’s vetoes were predicted to be overridden. However, veto override attempts may have to wait until the legislature reconvenes next year. The legislature adjourned sine die on March 18 and no special session is planned for the remainder of 2020, according to statements made on Sept. 16 by Senate President Bill Ferguson and House of Delegates Speaker Adrienne Jones.

Vetoes are generally handled during the first few days of a legislative session, giving taxpayers little time to convince lawmakers that the tax proposals will needlessly embroil the state in costly litigation and fail to produce the anticipated revenue. An additional wrinkle for these veto overrides was highlighted in an August memorandum by the state Attorney General’s Office which advised lawmakers that they faced legal risks if they override a gubernatorial veto while meeting online or outside the City of Annapolis. The General Assembly has yet to finalize its pandemic safety protocols for the upcoming session and the votes to override Governor Hogan’s vetoes could dwindle as lawmakers hear taxpayer objections to the legislation and weigh the costs of the inevitable legal battle.

Veto override remains uncertain

The General Assembly had the numbers to override the bills this year, but continued support for an override is not certain.

  • Maryland Senate has 47 representatives and the House of Delegate has 141 representatives.
  • Supporters of the Digital Advertising Tax need 29 out of 47 members in the Senate and 85 out of 141 members in the House of Delegates to override the veto.
  • Thus, either 19 members in the Senate or 57 members in the House would be required to sustain the veto.
  • As H.B. 732 passed with three-fifths support of each chamber, some lawmakers would need to withdraw their support of the Digital Advertising Tax to defeat a veto override.

State officials have informally acknowledged that these bills will be subject to an immediate legal challenge, meaning that there will be no additional revenue to offset the anticipated legal costs. Eversheds Sutherland is working with a number of companies to develop a litigation plan.

Maryland’s digital ad tax bill – H.B. 732

Key aspects of the bill

H.B. 732 proposes a new tax on the annual gross revenues derived from digital advertising services in Maryland. The definition of “digital advertising services” broadly includes “advertisement services on a digital interface, including advertisements in the form of banner advertising, search engine advertising, interstitial advertising, and other comparable advertising services.”

  • The tax rate varies from 2.5% to 10% of the annual gross revenues derived from digital advertising services in Maryland, but the rate is dependent on a taxpayer’s global annual gross revenues.
  • To be required to pay the tax, a taxpayer must have at least $100,000,000 of global annual gross revenues, and at least $1,000,000 of Maryland annual gross revenues derived from digital advertising services.
  • Penalties up to 25% may be imposed on underestimated quarterly installments of the tax.

Determining whether digital advertising taxes are “in Maryland” is problematic. The introduced version of the digital advertising tax proposed to source (and tax) digital advertising services to Maryland based on either:

  1. user’s IP address; or
  2. the knowledge or reasonable suspicion that a user is using its device (which receives the advertising) in the state.

However, the final version of the tax strikes these provisions. The legislation directs the Comptroller to adopt regulations that will entirely determine how to source digital advertising service revenues to the state.

The vetoed tax measures were intended to fund H.B. 1300, the Blueprint for Maryland’s Future (i.e., the Kirwan education reform package). The Governor also vetoed the education reform package.

Given the current economic climate, lawmakers may return to Annapolis with a change of heart in January, as the burdens of these taxes are likely to fall ultimately on Maryland’s small businesses and consumers who are already being hit hard by the struggling economy.  However, the desire of lawmakers to target companies that sell digital advertising may overshadow concerns about who will ultimately bear the tax burden.

Eversheds Sutherland’s State and Local Tax team will continue to monitor Maryland’s tax developments. If Maryland’s Digital Advertising Tax is ultimately enacted, litigation based on federal law principles will quickly ensue.

Podcast: Maryland’s digital ad tax – everything you need to know in 10 Minutes

In this podcast from March, Eversheds Sutherland’s SALT Team provides a ten minute update on everything you need to know about this first-of-a-kind state tax, including its applicability and the legal challenges that are expected if it becomes law.

More on the digital advertising tax

The proposed digital advertising tax has drawn scrutiny as violating federal law, including the Permanent Internet Tax Freedom Act and the dormant Commerce Clause. For Eversheds Sutherland’s critique of the tax, please see our recent article, If Md.’s Digital Ad Tax Is Passed, Court Challenges Will Follow (PDF).

Calling all trivia fans! Don’t miss out on a chance to show off your SALT knowledge!

We will award prizes for the smartest (and fastest) participants.

This Week’s Question: What is the largest payment amount the IRS will accept in a single check?

E-mail your response to SALTonline@eversheds-sutherland.com.

The prize for the first response to today’s question is a $20 UBER Eats gift card.

Answers will be posted on Saturdays in our SALT Weekly Digest. Be sure to check back then!

The Wisconsin Tax Appeals Commission recently clarified the applicability of the state’s property tax exemption for machinery, tools, and patterns (“MTP”) under Wis. Stat. § 70.111(27), which took effect in 2018. At issue in this appeal was which of a taxpayer’s property items were eligible for the exemption, which applies to all MTP unless the property is “used in manufacturing.”

The taxpayer—a cheese producer—claimed the MTP exemption for various items of property that were not exclusively used in manufacturing. The Department argued that all property owned by a manufacturer or located at a manufacturing site was “used in manufacturing” and ineligible for the MTP exemption. The Commission rejected Department’s interpretation of the MTP exemption as too narrow. Conversely, the taxpayer argued that only property exclusively used in manufacturing is ineligible for MTP exemption, which the Commission rejected as too broad.

The Commission held that property was not eligible for the MTP exemption if it had any use in the cheese manufacturing process, even if the manufacturing use was non-exclusive, indirect, or occasional. Therefore, the parties had to reexamine the taxpayer’s property to determine which property was not used at all in the cheese manufacturing process.

 

Masters Gallery Foods Inc. v. Wis. Dept. Rev., Wisconsin Tax Appeals Commission Docket No. 19-M-067 (Sept. 8, 2020)

In Letter Ruling 8095, the Missouri Department of Revenue determined that the electronic delivery of medical records is not subject to sales tax. The Department reasoned that electronically delivered information, regardless of the record’s original medium, is not taxable tangible personal property. The Department also concluded that the release of medical records to third parties, upon request, is not a specifically enumerated taxable service. In Letter Ruling 8100, the Department determined that charges by a provider of healthcare information management services were not subject to sales tax. In particular, providing data processing, electronic records retrieval, electronic data storage, information services and customer access to its software were not enumerated taxable services.

The Colorado Department of Revenue has determined that an information technology provider’s sale of its backup service, which allowed its customers to back up business applications, files, and systems, and also included the delivery of computer servers to customers’ locations, constituted a nontaxable service.  Although the Department “considered whether the placement of [the] servers constitut[ed] a taxable lease of tangible personal property to [the taxpayer’s] clients,” it concluded that, based on the “totality of the facts and circumstances,” the true object of the backup service was “the sale of nontaxable computer software products and related services,” and not the use of the servers.

Colo. Dep’t of Revenue, Private Letter Ruling No. PLR-20-008 (June 23, 2020).

The Texas Comptroller of Public Accounts issued a private letter ruling concluding that several services provided to optometrists and ophthalmologists were subject to sales tax as data processing.  Specifically, the Comptroller determined that the taxpayer’s web-based software system, which doctors use to manage patient relationships, schedule appointments, refill prescriptions, and communicate about treatment, is a taxable data-processing service.  The taxpayer’s software “captures and sends data” to and from the taxpayer’s servers and, according to the Comptroller, constitutes “data processing,” which is defined to include “data entry, data retrieval, data search . . . and other computerized data and information storage or manipulation.”

The Comptroller reached the same conclusions with respect to the taxpayer’s software that allows patients to order contact lenses, and allows doctors to manage their social media accounts and business-directory entries.  Lastly, the Comptroller determined that the taxpayer’s service of providing marketing consultants to help acquire and retain patients is also taxable because it is provided with taxable data processing services and not separately stated.

Texas Private Letter Ruling No. 202003061L (Mar. 3, 2020) (released Aug. 2020)

On September 29, 2020, Governor Philip Murphy signed A. 4721, the bill extending and retroactively increasing New Jersey’s Corporation Business Tax (“CBT”) surtax.

Instead of eliminating the surtax after December 31, 2021, as was previously scheduled, A. 4721 increases the CBT surtax rate to 2.5% and extends the surtax through December 31, 2023 for corporations with allocated taxable net income over $1 million for tax periods beginning on or after January 1, 2018 through December 31, 2023.  This increase effectively returns the surtax to the rate imposed in 2018 and 2019 and results in a total corporate tax rate of 11.5% for corporations that are subject to the surtax.  If, however, the federal corporate tax rate is increased to a rate of at least 35% of taxable income (the pre-Tax Cuts and Jobs Act rate), then the surtax will be suspended following the conclusion of the tax period corresponding with the increase to the federal corporate income tax rate.

The bill applies retroactively to tax periods beginning on or after January 1, 2020, but also provides that the Director of the Division of Taxation is prohibited from imposing penalties caused by retroactive imposition of the increased surtax.

The New York Division of Tax Appeals (DTA) recently issued order that highlights the unique discovery rules that apply in the litigation of New York tax matters. These rules differ substantially from other states that offer more expansive discovery options when taxpayers appeal state tax assessments or denials of refund claims.

On Sept. 3, 2020, the DTA issued an order addressing an ‘‘attorney-issued’’ subpoena in In Matter of West 20th Street Enterprises Corp. The order concluded that the DTA lacked jurisdiction to modify or quash the subpoena. But the administrative law judge (ALJ) explained that if he had jurisdiction, he would have quashed the subpoena on the basis that the petitioning taxpayer’s attorney did not have the authority to issue the subpoena under the applicable judicial and administrative procedural rules.

In their new column for Bloomberg Tax, Eversheds Sutherland Partner Open Weaver Banks and Counsel Ted Friedman and Michael Hilkin discuss the unique rules for discovery in New York Tax matters in relation to the DTA’s recent order, highlighting the advantages and disadvantages.

Read the full article here.

The New Jersey Superior Court reversed the New Jersey Tax Court and held that an individual taxpayer was permitted to carry forward losses from a partnership incurred in 2009 to reduce the individual’s distributive share of the partnership’s income in 2010.  The Court explained that, pursuant to IRC § 465, a partner in a partnership may not apply a loss to reduce his distributive share of partnership income when the loss exceeds the partner’s “at risk” exposure in the partnership at the close of the taxable year; and that the loss is not recognizable until the year in which the at risk amount exceeds the loss.  The Court determined that IRC § 465 is a federal method of accounting, and that under the New Jersey Gross Income Tax Act, a taxpayer’s method of accounting for New Jersey Gross Income Tax (“GIT”) purposes must be the same as his accounting method for Federal income tax purposes.  Thus, the Court concluded that the taxpayer property calculated his 2009 GIT liability by not including the amount of a loss that exceeded his at risk exposure in a partnership, and correctly applied the loss in 2010 when his at risk amount exceeded the loss.  The Court also noted that, even if it were to affirm the Tax Court’s decision, the taxpayer should have been allowed to recoup the lost deduction under the “square corners” doctrine.  The Court stated that it is “fundamentally unfair” for the Division of Taxation “to announce in its official publication that, under a certain set of facts, federal methods of accounting will be applied,” and then “retroactively apply a different standard years later.”  Shechtel v. Dir. Div. of Tax, Case No. A-0252-17T1 (N.J. Super. Ct. App. Div. Sept. 3, 2020).

The Michigan Supreme Court held that sales of bottle and can recycling machines that help retailers comply with Michigan’s bottle-deposit law may qualify for the state’s sales and use tax exemption applicable to machinery used in an industrial-processing activity.  The Michigan Department of Treasury unsuccessfully argued that the machines may not qualify for the exemption because they facilitated the collection of raw materials for subsequent processing, and the applicable Michigan statute generally defines “industrial processing” as beginning when tangible personal property is moved from raw materials storage and ending when finished goods first come to rest in inventory.

The Court specifically concluded that the general statutory definition highlighted by the Department could not apply to another subsection of the same statute, which identified specific activities that qualify as “industrial processing.”  According to the court, some of the specifically identified activities—such as “research and experimental activities” and the design of exempt machinery—cannot occur during the period identified in the general definition of “industrial processing.”  The Court refused to apply the “temporal” limitation in the general definition of “industrial processing” because doing so would leave portions of the statute specifically identifying qualifying “industrial processing” activities “without meaning or function.”

In reaching its conclusion, the Court clarified that the interpretive canon requiring tax exemptions be strictly construed in favor of the government must be applied only as a “last resort,” or “when an act’s language, after analysis and subjection to the ordinary rules of interpretation, presents ambiguity.”  In the present case, the Court held the canon was inapplicable because the “ordinary meaning” of “industrial processing” for purposes of the exemption at hand was discernible from reading the appropriate statutory text with the aid of other canons of interpretation.

Tomra of North America v. Dept. of Treasury, — N.W.2d —-, 2020 WL 3261606 (Mich. 2020)