In a triumvirate of cases, the Maryland Tax Court held that Maryland’s Digital Advertising Gross Revenues Tax violates the Internet Tax Freedom Act (ITFA), the dormant Commerce Clause, and the Due Process Clause. The cases involved challenges by Apple, Google, and Peacock, with each company seeking refunds.
Maryland’s first-in-the-nation tax on digital advertising has been tied up in litigation since it was enacted in 2021 over the veto of Governor Larry Hogan (R). It applies only to digital advertising (not all advertising), applies only to (out-of-state) companies with revenues of at least $100 million globally, and it is a tax on revenues rather than profits. Sponsors of the up-to 10% tax hoped to nudge consumers to switch from advertising-supported free services to subscription models while collecting $250 million a year for the state, but collections have come in at less than $100 million. Even that smaller amount must now be returned entirely to taxpayers, plus interest, after yet another legal defeat.
The court ruled on three independent grounds for the taxpayers. First, the advertisers argued that the tax was prohibited by the federal ITFA, which prevents states from taxing internet commerce when they do not tax “similar” non-internet activity. Applied to this case, the court asked if “a tax on digital advertising services” is “a tax on ‘similar property, goods, services, or information’ that is not taxed?” Maryland does not tax ads on billboards, signs, and other media—are digital ads “similar” to these forms of advertising?
The tech companies argued that, yes, digital advertising is similar to physical advertising and the state’s special tax on digital ads violated ITFA. After walking through the provisions of the digital advertising definitions and that of further clarifying regulations, the court was ultimately persuaded that digital advertising and analog advertising are “similar,” meaning ITFA’s restrictions on interstate taxation applied. Ultimately, between digital and analog advertising, the “purpose is the paramount consideration. The purpose of digital advertising services is the same as the purpose of non-digital advertising services, i.e., to make an impression on receivers of the advertising that leads to a sale of goods or other action.”
Maryland’s tax also runs afoul of the dormant Commerce Clause—a constitutional principle that prevents states from discriminating against out-of-state commerce or unduly burdening interstate commerce. In the context of taxes, the dormant Commerce Clause doctrine requires that states only tax activity with a “substantial nexus with the taxing state” and fairly apportion the tax to ensure that all income taxed is fairly attributable to activity within the state. The court found that Maryland’s tax is not properly apportioned because the tax rate depends on a company’s total global revenue—not merely its revenue in Maryland.
Two advertisers with identical revenue in Maryland may be taxed at very different rates depending on the volume of revenue outside the state. This is not taxation that could be described as “evenhanded[]” or “with only incidental effects on interstate commerce,” as the U.S. Supreme Court permits, but instead aimed at the very fact that the taxes are determined by and set by interstate commerce. The court also noted that “few, if any” Maryland businesses have global revenues that meet the threshold for taxation, meaning that the tax falls almost exclusively on out-of-state businesses and is, therefore, discriminatory against out-of-state businesses. The third problem with the tax is related—the court held that, by setting the tax rate based on global revenue and discriminating against out-of-state businesses, Maryland violated the advertisers’ due process rights.
Maryland may now appeal to the state circuit court, but the odds of the state prevailing dim with each new legal defeat. Just last year, another part of the Maryland law—the ban on companies itemizing the tax on customer receipts—was struck down in federal court as violating the First Amendment. Other cases remain pending. Big kudos especially to Joe’s former colleague Steve Kranz and his team at McDermott Will & Schulte, which represented the taxpayers in several of these cases.
As other states contemplate Maryland’s siren call to follow its lead in adopting this “unusual” tax, as the Fourth Circuit panel called it, they should be wary of the years of litigation uncertainty ending in complete refunds for taxpayers that Maryland now faces.
The cases are Apple v. Comptroller of Maryland (Md. TC No. 23-DA-OO-0456), Google v. Comptroller of Maryland (Md. TC No. 23-DA-OO-0649), and Peacock v. Comptroller of Maryland (Md. TC No. 23-DA-OO-0654).