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Maryland Digital Ad Tax Next Steps, Sovereignty Issues Ahead (1)

Oct. 20, 2022, 5:45 PMUpdated: Oct. 20, 2022, 9:45 PM

The escalating legal fight over Maryland’s recently felled tax on digital advertising could result in a landmark US Supreme Court decision down the line on the reach of a federal law prohibiting internet-only taxes and other matters of state tax sovereignty, an attorney representing state revenue agencies said Thursday.

On this potentially lengthy road to the Supreme Court, a new twist emerged as Maryland weighs its next steps in the litigation. State Comptroller Peter Franchot issued a statement Thursday expressing concern about the state’s chances to successfully appeal a state judge’s ruling this week striking down the tax, pointing to violations of the Internet Tax Freedom Act, the First Amendment, and the commerce clause of the Constitution.

Franchot said any decision to continue the litigation should be left to the incoming governor and legislature.

“While the enactment of this law was well-intentioned,” Franchot said, “its constitutionality—coupled with the tax’s residual impact on small businesses that utilize digital advertising services—continue to give me pause on the prudence of this law.”

Maryland Senate President Bill Ferguson (D) has said the ruling should be appealed.

Important, Complicated, Disputed

More broadly, the state case, along with a federal suit challenging the digital advertising gross revenues tax, raises significant questions for both taxpayers and revenue departments about states’ authority to levy taxes without interference from the federal government, said Brian Oliner, general counsel for the Federation of Tax Administrators. Oliner recently retired as tax counsel to Franchot.

Ultimately, he said, the US Supreme Court may have to weigh in because the issues are so important, complicated, and disputed,

Noting that an attorney representing big tech companies suing Maryland had called the levy “one of the most sinister taxes ever created,” Oliner said the tax program could nonetheless trigger a legal watershed moment.

“It may be a sinister tax, but in my opinion the sinister nature of the tax goes to a question of tax policy, not the legality of the tax, and that is not for the court to decide,” Oliner said during a panel discussion at the Hartman State and Local Tax Forum in Nashville.

Maryland made waves in February 2021 by enacting a levy of between 2.5% and 10% on the gross revenue from digital ads earned by companies with annual revenue above $100 million. The tax is expected to impact big tech companies, such as Amazon.com Inc., Facebook, Google, and Microsoft Corp., which earn significant revenue from advertising.

Two Legal Challenges

The law was quickly challenged in federal court by the US Chamber of Commerce. Verizon Media Inc. and Comcast of California Maryland Pennsylvania Virginia West Virginia LLC followed with a suit in state court. Both actions assert violations of the federal tax freedom law, which prohibits governments from imposing discriminatory internet-only tax structures.

Comcast and Verizon won a major victory Oct. 17 when Anne Arundel County Circuit Court Judge Alison Asti, ruling from the bench, agreed that Maryland’s levy violates the federal tax freedom law. She also accepted assertions that the tax violates the commerce clause and the First Amendment of the Constitution.

Oliner portrayed the decision as an early chapter in a pattern of litigation. Oliner said the decision must be appealed to provide clarity on the reach of the tax freedom law and congressional authority to limit the taxing authorities of the states. He stressed the importance of the anti-commandeering provisions of the 10th Amendment for state tax purposes. The amendment stipulates that powers not constitutionally delegated to the federal government are reserved to the states.

But Oliner also warned that the road to the Supreme Court would be a long one.

“It could be years before we get to answering the questions that you all want answered and that we all want answered; what does the Internet Tax Freedom Act cover and whether or not some of the provisions in Maryland’s act violated the commerce clause,” he said.

((Updates with Franchot statement.))

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bloomberglaw.com

To contact the editors responsible for this story: Kimberly Wayne at kwayne@bgov.com; Kathy Larsen at klarsen@bloombergtax.com