The Supreme Court of Maryland recently vacated a state circuit court order that had struck down Maryland’s one-of-a-kind tax on digital advertising. The high court found that the taxpayers—Comcast and Verizon—had failed to exhaust the appropriate administrative remedies.
Despite the justices kicking the can down the road, businesses should determine immediately whether they were subject to the digital advertising gross revenue tax, or DAT.
DAT’s Inner Workings
In general, DAT is imposed on a business’s annual gross revenue derived from digital advertising services, excluding advertisement services from broadcast television, radio stations, or the news. DAT also prohibits digital advertisement service providers from directly passing on the tax to their customers as a separate charge.
Maryland’s comptroller drafted sourcing regulations to determine the state’s sourced revenue from digital advertising services by applying a device-based sourcing rule. Under the regulations, revenue is calculated based on an apportionment fraction, consisting of the number of devices that access digital advertising services from a location in Maryland in the numerator, and the number of devices accessing digital advertising services from any location in the denominator. This fraction is then applied to the taxpayer’s digital advertising annual gross revenue.
While the DAT’s minimum assessable tax base is at least $100 million in global gross revenues, an annual return must be filed if a business has $1 million or more in annual gross revenues from digital advertising in Maryland. Furthermore, tax rates vary with a maximum rate of 10% of global gross receipts from digital advertising services. All required filers must file a declaration of estimated tax and pay 25% of the 2023 estimated tax on or before April 15.
Additional estimated returns, declaration, and 25% payments must be made on or before June 15, Sept. 15, and Dec. 15, 2023. Taxpayers that willfully fail to file an annual return or quarterly estimated tax returns are subject to criminal penalties, which may include a misdemeanor conviction plus either a monetary fine, imprisonment, or both.
Background of Legal Dispute
The comptroller’s office appealed to the Supreme Court in October 2022, after a judgment from the circuit court granted summary judgment to the taxpayers. The Supreme Court rejected the appellees’ arguments on May 9 and ordered the trial court to dismiss the case.
Separately, three trade associations filed suit in the US District Court for the District of Maryland, seeking a declaration and injunction against enforcement of the DAT on constitutional grounds and claiming the Internet Tax Freedom Act prohibits a tax like DAT. Last year, the challenge was dismissed because the court was jurisdictionally barred from hearing the case by the Tax Injunction Act and based on the circuit court’s ruling. The case was appealed and is pending.
Within a day of the Supreme Court of Maryland’s mandate, the comptroller’s office updated and issued a tax alert on the publication of the 2022 annual DAT return. The alert pointed out that the annual return for the tax year 2022 was due on April 17, 2023, and instructed taxpayers who delayed filing a 2022 DAT return pending the outcome of the case to file their return and remit their tax payment.
Digital advertisers who expected their 2023 annual gross revenue derived from digital advertising services in Maryland to exceed $1 million needed to file a declaration of estimated tax and pay 25% of the estimated tax on or before April 15, 2023. Additionally, declarations of estimated tax, estimated tax returns, and payments of 25% of the estimated tax are due on or before June 15, Sept. 15, and Dec. 15, 2023.
As things stand, taxpayers may proceed one of two ways to challenge the tax. They could decline to pay the tax and await the comptroller’s assessment before appealing administratively. The adequacy of this option is questionable, though, because of the tax’s criminal penalty component.
Alternatively, taxpayers could pay the tax and then file an application for revision or a claim for refund with the comptroller’s office. If the post-deprivation procedure is similar to refund claims for sales tax, it will entail a desk audit of the taxpayer’s return and a hearing before the comptroller’s compliance division’s hearings and appeals section on any denied portions.
If the refund denial is upheld, taxpayers can appeal to the Maryland Tax Court, an adjudicatory administrative agency in the executive branch of state government. If the administrative court upholds the denial, taxpayers can then proceed to Maryland’s judicial tax courts. The post-deprivation remedy route is often laborious and costly.
Notwithstanding the constitutional uncertainty surrounding the tax, the Supreme Court of Maryland’s ruling means that no taxpayer may challenge the DAT outside the normal administrative process.
The Domino Effect
As is typical with many novel state taxes, other states have proposed similar digital advertising taxes while anxiously eyeing how the litigation in Maryland unfolds. This year alone, Connecticut, Indiana, Massachusetts, New York, Rhode Island, and New Mexico have introduced bills like Maryland’s DAT. For Connecticut, Massachusetts, and New York, it’s the third attempt to get such a bill passed.
Other states have proposed bills to tax social media companies, collection of data, and sales of personal data. These are all offshoots of the DAT concept. However, we likely won’t see any of these states aggressively move on these proposals until there is some finality in Maryland.
The case is: Comptroller v. Comcast of Calif., Md., Pa., Va., W. Va., LLC, Md., No. SCM-REG-0032-2022, 5/9/23
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Shail P. Shah is a shareholder in Greenberg Traurig’s San Francisco office. He has been helping clients, who range from Fortune 25 companies to high-net-worth individuals, address California tax problems for more than 15 years.
DeAndré R. Morrow is of counsel in Greenberg Traurig’s Washington, D.C., office, where he focuses his practice on state and local tax issues, including Maryland, Virginia, and District of Columbia taxes.
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