Maryland became the first state to impose a tax on gross revenue from digital advertising when a law it enacted in 2021 took effect on January 1, 2022 (see this Tax Release). To implement the new law, Maryland adopted final regulations on November 24, 2021. The final regulations define relevant terms, set sourcing rules for digital advertising service revenue and clarify filing procedures. Meanwhile, legal challenges to the law are ongoing in both federal and state courts.

Background

Maryland imposes a digital advertising tax on the annual gross revenues of a person derived from digital advertising services in the state. The tax only applies to companies with over $100 million in global annual revenue and at least $1 million of Maryland sourced digital advertising service revenue. It is imposed at a graduated rate from 2.5% to 10% based on global annual gross revenue.

There were several questions regarding the new law's apportionment provisions, which address how the state imposes tax on companies doing business within and outside of Maryland. The statute provides that the tax base, annual global digital advertising revenue, is apportioned based upon the percentage of Maryland-sourced revenue over total revenue within the United States.

In addition, it was unclear what types of activities met the statute's definition of digital advertising services. Specifically, the term 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." Questions arose as to whether Maryland's digital advertising tax would apply to all parties in the chain who are involved in creating the content that is used for digital advertising or just the final party offering the digital advertising services to customers.

There were also questions about how to compute the tax. The statute did not specify what rate to use or how to compute tax in a year in which a taxpayer's global annual gross revenue overlapped into two tax brackets. Should the higher rate be used for the entire year or should the year be bifurcated based on when thresholds are exceeded?

Perhaps of greatest concern was that the statute did not address how to determine the jurisdiction from which digital advertising service revenue is derived.

Final Regulations

Final regulations adopted on November 24, 2021 addressed many of these issues. The regulations provide guidance on how a taxpayer should source revenue and apportion the tax base. Specifically, the regulations direct taxpayers to look to where the services are accessed through a device for sourcing purposes and, unlike the statute, provide that the denominator of the apportionment fraction should include the number of devices that have accessed the digital advertising service from any location, as opposed to just within the United States. To provide further clarification, the regulations include the following example:

Example 1: Company A receives $100 million in gross revenue attributable to digital advertising services. These services are accessed by 1,000 devices worldwide, all of which have an identifiable location. Of these devices, 500 are located outside the United States and 500 are within the United States, 10 of which are in [Maryland]. Company A would have $1 (10/1000 x $100) of digital advertising gross revenues derived from the State.

If a device's location is indeterminate, such device should be excluded from the denominator. Taxpayers must use best efforts to determine the location of a device based upon where it is used. Potential methods to determine location prescribed by the regulation include the use of internet protocol, geolocation data, device registration, cookies, industry standard metrics or any other comparable information.

The regulations further answer the question of what to do in a year in which global annual gross revenue spans two tax brackets by instructing taxpayers to bifurcate the year and compute the tax using the tax rate that applies to each part of the year.

While these clarifications are welcome, the regulations leave many issues unanswered. The regulations do not further clarify the definition of digital advertising service other than adding an exclusion for advertisement services on digital interfaces owned or operated by or operated on behalf of a broadcast or news media entity. Taxpayers left unclear on whether they fall within the definition may consider paying the tax and filing a refund claim to mitigate potential penalties and interest.

Pending Litigation

Soon after Maryland's digital advertising tax was enacted, several lawsuits were filed challenging its validity. Among the legal theories being asserted by opponents of the new law include infringement upon the Internet Tax Freedom Act, interference of interstate commerce under the U.S. Constitution's Dormant Commerce Clause, as well as concerns related to the First Amendment and the Equal Protection Clause. This law faces a potpourri of challenges both at the federal and state level. Questions include whether the law constitutes a tax or a penalty; whether the state has established a timely remedy for legal challenges under the federal Tax Injunction Act; and whether it discriminates against electronic commerce under the Internet Tax Freedom Act. At this point, closure to many of these legal challenges does not appear likely anytime soon.

The Takeaway

The final regulations address several open questions about Maryland's digital advertising tax, which took effect January 1, 2022. These include narrowing the definition of digital advertising service to exclude such services on digital interfaces owned by broadcast or news media outlets. The regulations also help clarify the new law's apportionment and sourcing provisions. However, basic questions about the new tax remain. To find out how Maryland's digital advertising tax may impact your business, contact a member of Andersen's SALT Team.