Digital Tax Goes to Maryland Supreme Court

Maryland’s Supreme Court will hear arguments on Friday regarding the state’s digital advertising tax, which targets companies like Amazon, Google, and Facebook. The tax applies to gross revenue from digital ads earned by companies with over $100 million in annual revenue.

The Act imposes a tax on companies with over $100 million in global annual gross revenue from digital ads earned in Maryland, ranging from 2.5% to 10%. Plaintiffs challenged the Act, alleging violations of the Commerce Clause, First Amendment, and preemption by the Internet Tax Freedom Act.

Anne Arundel County Circuit Judge Alison L. Asti’s ruled that the online tax contravenes the federal Internet Tax Freedom Act’s ban on discriminatory taxes on online services, given that Maryland does not impose a similar tax on non-digital advertising. The Circuit Court, in its ruling, stated that digital advertising is akin to traditional advertising and, as a result, Maryland’s DAT is discriminatory under the ITFA.  The Comptroller has appealed, arguing that this ruling ignores substantial and fundamental distinctions between the operations of digital advertising platforms and traditional advertising methods.

Most of this battle on appeal is nonsense about whether taxpayers must exhaust administrative remedies before challenging the tax’s constitutionality in court. Any win on that basis will be temporary.  So we will ignore that and get to the heart of the matter: Can Maryland (and soon to be other states) tax digital companies like this?

Challenge to the ITFA and the Dormant Commerce Clause

The challenge to the tax is based on the federal Internet Tax Freedom Act (ITFA), which prohibits discriminatory taxes on electronic commerce. Verizon and Comcast argue that the tax violates the ITFA, while supporters argue that the ITFA is not fit for use in the current digital economy. The challenge also includes the claim that Maryland violates the dormant commerce clause by using global revenues as the threshold for determining who is subject to the tax and at what rate.

The Commerce Clause prohibits states from imposing taxes that either discriminate against interstate commerce or create an undue burden by subjecting activities to multiple or inequitably apportioned taxation.

For a state tax to withstand scrutiny under the Commerce Clause, it must satisfy four criteria: the tax must be applied to an activity with a significant connection to the taxing state, be equitably apportioned, not discriminate against interstate commerce, and be reasonably related to the services provided by the state. This was established in a U.S. Supreme Court case involving also involved the Maryland Comptroller.

The tech companies are arguing that this tax imposes varying rates on taxpayers who are generating equal amounts of digital advertising revenue from Maryland and violates the Commerce Clause.

Maryland Argument

Maryland’s argument is that digital advertising platforms can target individual residents of Maryland with remarkable precision and accuracy. These platforms collect information on various aspects, such as user demographics, social connections, browsing history, and geolocation in relation to other users. This data is then processed through an algorithm that enables the platforms to demand higher bids from advertisers for more precisely targeted access.  Maryland wants to make money off these transactions.

You know how it works.  You are searching for a new pair of running shoes and might continue to see ads for athletic footwear for several weeks. After attending a concert, you receive ads for similar music events or the artist’s merchandise. You order a vegan cookbook online could suddenly start seeing ads for plant-based restaurants and products. These big tech companies know you better than some of your friends.

The reach does not stop there. Each piece of data collected about a user can be bought, sold, or combined into a personalized profile that encompasses all of a user’s online services and physical devices. This results in an incredibly detailed summary of each Maryland user, used to sell targeted advertising opportunities to advertisers.

Now Maryland is not taxing other ads the same way, which the lower court says is discriminatory. Maryland argues that simply determining that the tax applies to a digital service or product similar to a non-digital counterpart is insufficient. Instead, the tax must be applied to the digital product or service in a discriminatory manner. So the ITFA is applicable only if Maryland’s law confers a “preferential advantage” over a comparable industry within the state. Maryland is saying if Google moves its operations to Maryland, it will get the same tax.

Free Speech Concerns Invalid

Maryland also pushes back on free speech concerns. The state argues that the law does not restrict what a taxpayer may say to the customer or anyone else about the tax or any other subject. It argues that the First Amendment is not implicated merely because a taxpayer uses speech in an invoice to directly pass on the cost of the tax. It has never been considered an abridgment of freedom of speech to make a course of conduct illegal simply because the conduct was initiated, evidenced, or carried out by means of language, spoken, written, or printed. The First Amendment does not prevent restrictions directed at commerce or conduct from imposing incidental burdens on speech.